424B4
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Filed pursuant to Rule 424(b)(4)
Registration No. 333-231952

 

PROSPECTUS

 

LOGO

This is the initial public offering of Vericity, Inc. We are offering up to 20,125,000 shares of our common stock for sale at a price of $10.00 per share in connection with the conversion of Members Mutual Holding Company, or Members Mutual, from mutual to stock form of organization. Immediately following the conversion, we will acquire all of the newly issued shares of common stock of converted Members Mutual.

We are offering shares of our common stock in a subscription offering and a community offering. The subscription offering will be made to eligible members of Members Mutual, who were the policyholders of Fidelity Life Association, an Illinois life insurance company and indirect subsidiary of Members Mutual, as of July 31, 2018, and to the directors and officers of Members Mutual. The subscription offering will end at 5:00 PM, Central Time, on July 29, 2019. Concurrently with the subscription offering and subject to the prior right of subscribers in the subscription offering, shares will be offered in an offering we refer to as the community offering to eligible employees of Members Mutual and possibly to a limited number of other potential investors.

Our ability to complete this offering is subject to two conditions. First, a minimum of 14,875,000 shares of common stock must be sold to complete this offering. Second, Members Mutual’s plan of conversion and amended and restated articles of incorporation must be approved by the affirmative vote of at least two-thirds of the votes cast at the special meeting of members to be held on August 6, 2019. Until such time as these conditions are satisfied, all funds submitted to purchase shares will be held in escrow with Computershare Trust Company, N.A. If the offering is terminated, purchasers will have their funds promptly returned without interest. A portion of the net offering proceeds may not be invested in our company but may be used to pay a special dividend. All purchasers of stock in this offering who remain stockholders until the ex-dividend date set with respect to the special dividend, if one is declared, would be eligible to receive the special dividend.

In addition, we have entered into an agreement with Apex Holdco L.P., an affiliate of J.C. Flowers IV L.P., a private equity fund advised by J.C. Flowers & Co. LLC, under which Apex Holdco L.P. has agreed to act as the standby purchaser for this offering. If the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, is less than 14,875,000 shares, and if all of the conditions to the standby purchaser’s purchase commitment have been satisfied, the standby purchaser will be obligated to purchase enough shares to guarantee the sale of 14,875,000 shares in the offerings, and may purchase additional shares as may be necessary in order to permit the standby purchaser to acquire a majority of the shares sold, provided that no more than 20,125,000 shares may be sold in the offerings. Under our agreement with the standby purchaser, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors. We refer to the offering of shares to the standby purchaser as the standby offering, and to the subscription offering, the community offering, and the standby offering collectively as the offerings.

In fulfilling its standby purchase commitment, the standby purchaser will acquire a majority of our shares issued in the offerings if the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, total fewer than 7,437,500 shares. The directors and officers of Members Mutual have indicated their intention to subscribe for approximately 2,123,675 shares, or approximately 14% of the shares at the offering minimum. Due to the standby purchaser’s commitment, the level of sales to eligible members and directors and officers of Members Mutual will not impact the condition that at least 14,875,000 shares must be sold to complete this offering. Accordingly, the sale of the minimum number of shares necessary to complete this offering does not indicate that sales have been made to investors who have no financial or other interest in the offerings, and the sale of the minimum number of shares should not be viewed as an indication of the merits of this offering.

The minimum number of shares that a person may subscribe to purchase is 25 shares. The maximum number of shares that a person may subscribe to purchase in the subscription offering is the lesser of 743,750 or the individual maximum purchase limitations described in this prospectus. If orders are received for more shares than shares offered, shares will be allocated in the manner and priority described in this prospectus.

Raymond James & Associates, Inc. will act as our marketing agent and will use its best efforts to assist us in selling our common stock in this offering, but Raymond James is not obligated to purchase any shares of common stock that are being offered for sale. Any commissions paid in connection with the purchase of shares of common stock in this offering will be paid by us from the gross proceeds of the offering.

There is currently no public market for our common stock. Our common stock has been approved for listing on the NASDAQ Capital Market under the symbol “VERY.”

We are an “emerging growth company” and a “smaller reporting company” as defined under applicable federal securities laws and Securities and Exchange Commission rules and will be eligible for reduced public company reporting requirements. See “Summary—Implications of Being an Emerging Growth Company and a Smaller Reporting Company.”

Investing in our common stock involves risks. For a discussion of the material risks that you should consider, see “Risk Factors” beginning on page 13 of this prospectus.

OFFERING SUMMARY

Price: $10.00 per share

 

     Minimum      Maximum  

Number of shares offered

     14,875,000        20,125,000  

Gross offering proceeds

   $ 148,750,000      $ 201,250,000  

Estimated offering expenses

   $ 9,696,188      $ 9,696,188  

Commissions(1)(2)

   $ 3,525,398      $ 2,012,500  

Net proceeds

   $ 135,528,415      $ 189,541,312  

Net proceeds per share

   $ 9.11      $ 9.42  

 

(1)

Represents commissions to be paid to Raymond James, based on 1.0% of the proceeds from shares sold in the subscription offering, up to 6.0% of the proceeds from shares sold to other potential investors in the community offering, and 3.0% of the proceeds from the shares sold to the standby purchaser. No commission will be paid on the sale of shares sold to directors, officers and eligible employees. Any shares sold to the standby purchaser in the standby offering will be sold in a private placement to close concurrently with the subscription offering at a price equal to the public offering price in this offering. The shares sold to the standby purchaser in the standby offering are not being registered as part of this offering and will be restricted securities. See “The Conversion and Offering—Marketing Arrangements” for a description of the marketing agent compensation.

(2) 

Assumes (x) at the offering minimum, 1,500,000 shares are sold in the subscription offering to eligible members, 2,123,675 shares are sold in the subscription offering to directors and officers of Members Mutual and 11,251,325 shares are sold in the standby offering to the standby purchaser; and (y) at the maximum, that all 20,125,000 shares are sold in the subscription offering to eligible members. We are unable to predict the number of shares the eligible members, eligible employees or other potential investors may subscribe for, and the number of shares the standby purchaser may acquire.

None of the Securities and Exchange Commission, the Illinois Department of Insurance or any state securities commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense.

For assistance, please call the Stock Information Center at 1-866-420-6746.

Raymond James

The date of this Prospectus is June 20, 2019


Table of Contents

TABLE OF CONTENTS

 

     Page No.  

CERTAIN IMPORTANT INFORMATION

     ii  

PROSPECTUS SUMMARY

     1  

RISK FACTORS

     13  

FORWARD-LOOKING STATEMENTS

     33  

USE OF PROCEEDS

     34  

MARKET FOR THE COMMON STOCK

     35  

DIVIDEND POLICY

     36  

CAPITALIZATION

     37  

SELECTED FINANCIAL AND OTHER DATA

     38  

UNAUDITED PRO FORMA FINANCIAL INFORMATION

     40  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     46  

BUSINESS

     74  

THE CONVERSION AND OFFERING

     94  

FEDERAL INCOME TAX CONSIDERATIONS

     116  

MANAGEMENT

     120  

EXECUTIVE COMPENSATION

     127  

DESCRIPTION OF CAPITAL STOCK

     133  

LEGAL MATTERS

     137  

EXPERTS

     137  

ADDITIONAL INFORMATION

     137  

INDEX TO FINANCIAL STATEMENTS

     F-1  


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CERTAIN IMPORTANT INFORMATION

This Prospectus

You should rely only on the information contained in this prospectus. We have not, and Raymond James has not, authorized any other person to provide information that is different from that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We and Raymond James are offering to sell and seeking offers to buy our common stock only in jurisdictions where such offers and sales are permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date. Information contained on our website, or any other website operated by us, is not part of this prospectus.

Frequently Used Terms

Unless the context otherwise requires, as used in this prospectus:

 

   

“accidental death coverage” refers to insurance coverage for a cause of death that does not include illness, suicide in most circumstances, or natural causes;

 

   

“affinity partner” refers to a company with whom we have a marketing relationship to provide agency or insurance product services to that company’s customers, members or sales prospects under its brand or Efinancial’s brand;

 

   

“all-cause” coverage refers to coverage under a life insurance policy that pays the beneficiary of the policy in the event of the death of the insured regardless of the cause of death (except those specifically excluded in the policy). All-cause provides more comprehensive coverage than accidental death coverage, which only covers accidental death;

 

   

“community offering” refers to the offering of shares of Vericity common stock to eligible employees and other potential investors if the number of shares of common stock subscribed for by participants in the subscription offering is less than 20,125,000;

 

   

“the Company,” “we,” “us” and “our” refer to Members Mutual and its consolidated subsidiaries prior to the conversion as described in this prospectus, and to Vericity and its consolidated subsidiaries after the conversion;

 

   

“conversion” refers to a series of transactions by which Members Mutual will convert from mutual to stock form and become a subsidiary of Vericity under the terms of the plan of conversion adopted by the board of directors of Members Mutual;

 

   

“Efinancial” refers to Efinancial, LLC, an insurance agency and indirect subsidiary of Members Mutual;

 

   

“eligible employee” refers to any natural person who is a full or part-time employee of Members Mutual or any of its subsidiaries who meets such eligibility requirements to participate in the Employee Bonus Program as Members Mutual may determine;

 

   

“eligible member” refers to a person who was a member of Members Mutual on July 31, 2018, the date the plan of conversion was adopted by the board of directors of Members Mutual;

 

   

“Employee Bonus Program” refers to the bonus program adopted by Members Mutual in which eligible employees will be provided the opportunity to receive $1,000 cash or acquire 100 shares of Vericity common stock, in either case together with an additional $250 cash to help defray taxes payable with respect to the bonus, as part of the community offering, subject to completion of the conversion;

 

   

“Fidelity Life” refers to Fidelity Life Association, an Illinois life insurance company and indirect subsidiary of Members Mutual;

 

   

“member” refers to a person who is the holder of an in-force policy of insurance, or the holder of a master policy under a group insurance policy, issued by Fidelity Life;

 

   

“Members Mutual” refers to Members Mutual Holding Company and its consolidated subsidiaries;

 

   

“mutual form” refers to an insurance company or its holding company organized as a mutual company, which is a form of organization in which the policyholders or members have certain membership rights in the mutual company, such as the right to vote with respect to the election of directors and approval of certain fundamental transactions, including the conversion from mutual to stock form; however, unlike shares held by stockholders, membership rights are not transferable and do not exist separately from the related insurance policy;

 

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“offerings” refers to the subscription offering, the community offering and the standby offering;

 

   

“standby offering” refers to the purchase by the standby purchaser of shares of our common stock pursuant to the terms of the standby purchase agreement, as described in this prospectus;

 

   

“standby purchase agreement” refers to the standby stock purchase agreement dated October 5, 2018, as amended and restated on March 26, 2019, by and among Members Mutual, Vericity, Fidelity Life and Apex Holdco L.P., under which Apex Holdco L.P. has agreed to act as the standby purchaser for this offering;

 

   

“standby purchaser” refers to Apex Holdco L.P., an affiliate of J.C. Flowers IV L.P., a private equity fund advised by J.C. Flowers & Co. LLC;

 

   

“stock form” is a form of organization in which the only rights that policyholders have are contractual rights under their insurance policies and in which voting rights reside with stockholders under state corporate law;

 

   

“subscription offering” refers to this offering of up to 20,125,000 shares of our common stock under the plan of conversion to eligible members and directors and officers of Members Mutual;

 

   

“subscription rights” refers to the rights to purchase stock in this offering granted to eligible members and directors and officers of Members Mutual under the plan of conversion;

 

   

“term life insurance” refers to a type of life insurance that is pure life insurance that ordinarily does not build up cash value over time. Term life insurance coverage generally lasts for a specified time, generally 5, 10, 15, or 20 years or more, with level premiums over the period; and

 

   

“Vericity” refers to Vericity, Inc., a Delaware corporation formed to be the holding company for Members Mutual upon its conversion from mutual to stock form.

Market And Industry Data

Market data and other statistical information used throughout this prospectus are based on independent industry publications, government publications, publicly available information, reports by market research firms or other published independent sources, none of which has been commissioned by us. Independent industry publications, government publications and other published independent sources generally indicate that the information included therein was obtained from sources believed to be reliable. Some data are based upon good faith estimates derived from our management’s review of the independent sources referenced herein and from experience with partners, licensees and other contacts in the markets in which the Company operates.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. Before making a decision to purchase our common stock, you should read the entire prospectus carefully, including the “Risk Factors” and “Forward-Looking Statements” sections and our consolidated financial statements and the notes to those financial statements.

Overview

We provide life insurance protection targeted to the middle American market. We believe there is a substantial unmet need for life insurance, particularly among domestic households with annual incomes of between $50,000 and $125,000, a market we refer to as our target Middle Market. We strive to deliver to this market affordable, easy to understand term and whole life insurance products through a consumer-friendly and efficient sales process. Through innovation in product design and distribution that provides access to the Middle Market, including call center and web-enabled sales and underwriting processes, quick issuance of policies and an emphasis on products not medically underwritten at the time of sale, we believe we are well positioned to make life insurance more affordable and accessible to the Middle Market.

We conduct our business through our two operating subsidiaries, Fidelity Life Association, an Illinois-domiciled life insurance company chartered in 1896, and Efinancial, LLC, a call center-based insurance agency. Fidelity Life distributes life insurance products through Efinancial and other unaffiliated agents and is licensed in the District of Columbia and every state except New York and Wyoming. A.M. Best has assigned an “A-” (Excellent) rating to Fidelity Life, which is the fourth highest out of fifteen ratings. Fidelity Life is located in Chicago, Illinois.

Efinancial markets life products for Fidelity Life and, as of March 31, 2019, had agency relationships with 25 unaffiliated insurance companies. Efinancial’s primary operations are conducted through employee agents from two call center locations in Bellevue, Washington and Chicago, Illinois, which we refer to as our retail channel, and through independent agents and other marketing organizations, which we refer to as our wholesale channel. In addition to offering Fidelity Life products, Efinancial also sells insurance products of unaffiliated carriers. Efinancial’s principal office is located in Bellevue, Washington.

We believe our ability to unconditionally issue policies either during or within 24 to 48 hours of the initial call differentiates us from our competitors. Leveraging our patented RAPIDecision® sales and underwriting processes, we can sell a life insurance policy to a consumer before medical underwriting is complete. We are able to complete an initial underwriting process for most of our life insurance applicants either during or shortly after the initial call, and if not, within 24 to 48 hours after that initial call. For the three months ended March 31, 2019, approximately 90% of our policy applications processed through our RAPIDecision® underwriting process received an underwriting disposition on or shortly after the initial sales call. Approximately one-half of the remaining applications received final underwriting decisions within the next 24 to 48 hours.

Our RAPIDecision®Life product provides coverage at the point of issue that is a blend of all-cause term life insurance for part of the coverage and accidental death insurance for the remainder of the total face amount. If a policyholder completes medical underwriting after the initial sale of the RAPIDecision®Life product, the policy benefits may be improved based on the underwriting results to increase the proportion of all-cause term life insurance coverage, typically with no increase in premium. In some instances, based upon the results of predictive analytic models, the consumer can qualify for the full amount of all-cause coverage without medical testing.

For the three months ended March 31, 2019 and years ended December 31, 2018 and December 31, 2017, we had total consolidated revenue of $33.2 million, $123.9 million and $115.9 million, net life premium revenue of $23.1 million, $88.6 million and $82.9 million, and a net loss of $6.2 million, $13.8 million and $8.2 million, respectively. As of March 31, 2019, we had total assets of $662.9 million and equity of $179.2 million.

Our Approach

Our business model is predicated upon gaining cost effective access to the Middle Market, engaging consumers in our sales process for life insurance with products that have higher placement rates than traditional fully underwritten term life insurance in a call center environment, and issuing those products quickly. We require access to a large quantity of quality



 

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sales leads to keep our retail call center agents productive. Currently, we acquire most of our sales leads from third party lead vendors. We supplement that lead flow with leads we generate ourselves. More significantly, we are rapidly increasing our affinity business with non-life insurance partners that provide their customers or prospects as leads, and we market and sell life insurance products to those leads.

We tend to sell policies with lower face amounts, resulting in more affordable options for our customers. Although not the lowest priced, our products are competitive and they represent an attractive consumer value considering the coverage they provide and the relative simplicity of our sales and underwriting processes. Our business model allows us to capture end-to-end data beginning with the acquisition of sales leads through the final disposition of life insurance policies. With this data, we plan to develop and apply predictive analytics to realize efficiencies at various points in the sales process.

Our Competitive Strengths

We believe that we are strategically positioned to take advantage of the following competitive strengths:

 

   

Middle Market access. The sales contacts made through Efinancial’s call centers are focused on the Middle Market. This stands in contrast to the life insurance industry at large, which tends to market to a more affluent clientele.

 

   

Multi-channel distribution. We reach Middle Market consumers through multiple distribution channels. Through our retail channel, we engage consumers through Efinancial’s call centers using sales leads that we acquire or generate ourselves, and we leverage our product and sales processes with affinity partners to extend our reach to Middle Market consumers seeking affordable, accessible life insurance. Through our wholesale channel, we offer other carriers’ products through unaffiliated distributors. In addition, Fidelity Life also offers its products through select unaffiliated distributors.

 

   

Patented products and processes. Our RAPIDecision® Life product features a system-and-method patented process that affords higher and faster placement rates than traditional fully underwritten term life insurance in a call center environment. Through our process, policy placement usually occurs during the initial interaction, which leads to customer satisfaction and improved economics in our call centers. Our efficient process contrasts with much of the industry, where the underwriting process extends well beyond the initial interaction. In addition, our flagship RAPIDecision® Life product uses predictive analytics at certain ages and face amounts to place all-cause coverage products during the initial interaction without a medical examination for qualified customers. The product is priced to be profitable even at lower policy amounts, which allows us to align our offerings with Middle Market consumers’ ability to afford life insurance.

 

   

End-to-end lead and policy data. As a life insurance company and a direct distributor, we are positioned to gather end-to-end lead and policy data to develop predictive analytical models that can be applied to identify the characteristics of prospects who are more likely to exhibit favorable placement, persistency and mortality experience. We plan to apply this insight to optimize our marketing, sales and underwriting processes and product development.

Our Growth Strategies

We intend to use our competitive strengths to grow our business through the following strategies:

 

   

Capitalize on the unmet need for life insurance in our target market. We believe we are well positioned to meet demand where there is currently a substantial unmet need for life insurance in the Middle Market. Using our quick-issue products together with our distribution platform, we plan to increase sales to Middle Market consumers by providing a convenient experience to purchase life insurance at an affordable price.

 

   

Use predictive analytics to generate more productive sales leads. By converting data we generate through our distribution platform into actionable insight using statistical analysis, we will seek to be more efficient in our acquisition and use of leads, improving our call center placement ratios and overall profitability.

 

   

Enhance and extend affinity partnerships. We plan to continue and selectively deepen our existing affinity partnerships and develop new and complementary affinity relationships and partnerships. We expect this will expand and diversify our sources of quality leads.



 

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Expand call center operations and improve efficiency. To drive sustainable premium and Efinancial commission growth, we plan to expand our Efinancial call center operations by hiring additional agents. In addition, we evaluate our product offerings and product providers in order to examine whether we are addressing the needs and preferences of the Middle Market.

 

   

Explore alternative means of distribution. We are currently exploring distribution alternatives beyond our call center and independent distributors, including digital and on-line sales.

Our Challenges and Risks

Our company and our business are subject to numerous risks as more fully described in the section of this prospectus entitled “Risk Factors.” As part of your evaluation of our business, you should consider the challenges and risks we face in implementing our business strategies:

 

   

We have incurred net losses over the last nine years. A significant percentage of Fidelity Life’s in-force policies have been written since 2007, and as a result we do not have an established legacy book of business and associated revenue streams like many larger life insurance companies. The lack of cash flows typically associated with a legacy business puts Fidelity Life at a disadvantage in comparison with other life insurance carriers that have a more established book of business and associated revenue streams. We have also incurred a net loss in each of the nine prior fiscal years, resulting in an aggregate of approximately $111.7 million in net losses over that period, including losses of $13.8 million and $8.2 million for the years ended December 31, 2018 and December 31, 2017, respectively. In addition, we have incurred a loss of $6.2 million for the three months ended March 31, 2019. Our losses are due principally to operating expenses and corporate overhead exceeding revenues of our agency and insurance segments, and our inability to defer a majority of commission expense on policies produced by our affiliated agency, Efinancial.

 

   

We expect to continue to incur net losses as we develop our distribution platform. We plan to increase sales through our affiliated distributor, Efinancial, in order to increase our scale to cover our operating expenses and corporate overhead. However, generally accepted accounting principles in the United States (GAAP) require that we immediately expense that portion of our policy acquisition costs for policies placed through our affiliated agency, Efinancial, that cannot be directly tied to the placement of a policy. As a result of this immediate expense recognition for sales through Efinancial, we incur a net loss in the first year on each policy sold through Efinancial. If we are successful in increasing our premium writings through our distribution platform over each of the next several years, we expect that the impact of the immediate expense recognition will continue to contribute to our incurring consolidated net losses and reduction of our consolidated equity in each such year.

 

   

Our call center-based distribution model may not be sustainable. The products and processes that we use to reach the Middle Market rely heavily on retail call center-based sales. There are relatively few such call centers being operated by independent distributors. The call centers that we are familiar with tend to have low placement ratios on medically underwritten products because of the time delay involved in issuing policies and the lack of face to face sales support typically provided by traditional agents. We have developed innovative products and processes designed to streamline the sale of life insurance and improve call center placement ratios, and have made significant investments in cultivating leads and improving our sales process. We cannot assure you that our business model, which is focused on selling quick-issue policies to the Middle Market through our retail call center distribution platform, will prove to be viable or sustainable. If we are not successful in utilizing our products and processes to penetrate our target Middle Market, or if we are unable to hire, develop and retain well qualified individuals to staff our retail call centers, we will not generate sufficient revenues to offset our expenses, which will result in a material and adverse effect on our business, financial condition and results of operations.

 

   

Our target market continues to face a difficult economic environment. While economic conditions have stabilized and improved in a number of areas, economic challenges still remain. Many middle American families, including those that comprise our target Middle Market, have experienced financial hardships and stagnating income levels. We believe that these economic pressures have reduced demand for our life insurance products due to challenging consumer economics, including increased demands on disposable income to pay for increasing costs of living, including health insurance, savings goals and general living expenses. Economic challenges may continue to adversely affect our business in the future.



 

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Business Segments

We manage our business through three segments:

 

   

Agency. Our agency segment operates through Efinancial. Efinancial sells insurance products through its call center distribution platform and through its independent agents and other marketing organizations.

 

   

Insurance. Our insurance segment operates through Fidelity Life. Fidelity Life engages in the principal business lines of core life, non-core life, closed block, and annuities and assumed life. In its core life and non-core life business lines, Fidelity Life offers primarily term life insurance products, and to a lesser extent accidental death and final expense products. We currently do not offer annuity contracts, separate account variable products or universal life products.

 

   

Corporate. Our corporate segment consists primarily of a small amount of capital required to be maintained for regulatory purposes, and also includes certain expenses considered to be corporate and not allocated to our agency or insurance segments.

Implications of Being an Emerging Growth Company and a Smaller Reporting Company

As a company with less than $1.07 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, commonly known as the JOBS Act. An emerging growth company may take advantage of specified reduced reporting requirements and reduction of other obligations that are otherwise generally applicable to public companies. These provisions include:

 

   

a requirement to include in this prospectus only two years of audited financial statements, two years of selected financial information, and two years of related Management Discussion & Analysis;

 

   

exemption from the auditor attestation requirement on the effectiveness of our internal control over financial reporting;

 

   

reduced disclosure about our executive compensation arrangements; and

 

   

no stockholder non-binding advisory votes on executive compensation or golden parachute arrangements.

We may take advantage of these provisions until the earlier of five years or such time as we are no longer an emerging growth company. We would cease to be an emerging growth company if we have more than $1.07 billion in annual revenues, have more than $700 million in market value of our capital stock held by non-affiliates, or issue more than $1.0 billion of non-convertible debt over a three-year period.

Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We have elected to take advantage of the benefits of this extended transition period until we are no longer an emerging growth company or until we affirmatively and irrevocably opt out of this exemption. Our financial statements may therefore not be comparable to those of companies that comply with such new or revised accounting standards.

As a company with less than $250 million of public float, we qualify as a “smaller reporting company” as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended, or the Exchange Act. As a smaller reporting company we are able to take advantage of reduced disclosure requirements, such as simplified executive compensation disclosures and reduced financial statement disclosure requirements in our SEC filings. We plan to take advantage of some or all of the reduced compliance obligations applicable to emerging growth companies and smaller reporting companies.

Our History

We formed Vericity so that it could acquire all of the capital stock of converted Members Mutual as part of the conversion. Prior to the conversion, Vericity has not engaged and will not engage in any operations and does not have any assets or liabilities. After the conversion, Vericity’s primary assets will be the outstanding capital stock of converted Members Mutual and the net proceeds of the offerings described in this prospectus. Vericity Holdings, Inc. is a wholly-owned subsidiary of Members Mutual and the intermediate holding company for Efinancial and Fidelity Life.



 

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In 2007, Fidelity Life completed a reorganization in which it converted from a mutual to a stock insurance company within a newly created mutual holding company structure. As part of the reorganization, Members Mutual was formed as an Illinois mutual insurance holding company and Fidelity Life continued its existence as an Illinois stock life insurance company. All of the shares of Fidelity Life were issued to Vericity Holdings, an intermediate holding company that, in turn, was initially a wholly-owned subsidiary of Members Mutual. In the reorganization, policyholders’ membership interests in Fidelity Life automatically became membership interests in Members Mutual, but policyholders’ contractual rights remained with Fidelity Life. Since the effective date of the reorganization, each person who has become a Fidelity Life policyholder has automatically become a member of Members Mutual and retains that membership interest as long as the Fidelity Life policy owned by the member remains in force.

In 2009, Vericity Holdings acquired Efinancial from its owners. As part of the consideration for the acquisition of Efinancial, the owners were issued shares of common stock of Vericity Holdings. These shares have since been redeemed and Vericity Holdings is wholly-owned by Members Mutual.

Our principal executive offices are located at 8700 West Bryn Mawr Avenue, Suite 900S, Chicago, Illinois, 60631, and our phone number is (312) 379-2397. Our website address is www.vericity.com. Information contained on our website is not incorporated by reference into this prospectus, and such information should not be considered to be part of this prospectus.

Our Structure Prior to the Conversion

Since Fidelity Life converted from mutual to stock form in 2007, we have operated under a mutual holding company structure. Our current corporate structure is shown in the following chart:

 

 

LOGO

 

*

As required by Illinois law, prior to the conversion, Vericity, Inc. is owned by Members Mutual. Prior to the conversion, Vericity, Inc. has not engaged in any operations and does not have any assets or liabilities. The one (1) outstanding share of Vericity, Inc. is owned by Members Mutual and will be cancelled upon completion of this offering.

**

As required by Illinois law, prior to the conversion, the stock of Vericity Holdings is held in trust for the benefit of the policyholders of Fidelity Life.

Our Structure Following the Conversion

Immediately upon the conversion of Members Mutual, all of the authorized capital stock of converted Members Mutual will be issued to Vericity, and the common stock of Vericity held by converted Members Mutual will be cancelled, such that, upon completion of this series of actions, the issued and outstanding shares of our common stock will consist solely of the shares of common stock sold in the offerings.



 

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Following the completion of these actions, assuming that (i) fewer than 14,875,000 shares are sold in the subscription offering and community offering, or (ii) that fewer than 20,125,000 shares are sold in the subscription offering and that the standby purchaser elects to purchase shares in the standby offering, the corporate structure of Vericity, Inc. will be as shown in the following chart:

 

 

LOGO

In fulfilling its standby purchase commitment, the standby purchaser will acquire a majority of our shares issued in the offerings if the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, total fewer than 7,437,500 shares. The directors and officers of Members Mutual have indicated their intention to subscribe for approximately 2,123,675 shares, or approximately 14% of the shares at the offering minimum.

The Conversion of Members Mutual from Mutual to Stock Form

Members Mutual is an Illinois-domiciled mutual insurance holding company. As a mutual company, it has no stockholders but it does have members. A member of Members Mutual is either the holder of an in-force individual insurance policy issued by Fidelity Life or the holder of a group master policy issued by Fidelity Life.

Like stockholders, the members have certain rights with respect to Members Mutual such as voting rights with respect to the election of directors and approval of certain fundamental transactions, including the conversion of Members Mutual from mutual to stock form. However, unlike shares held by stockholders, the membership interests in Members Mutual are not transferable and do not exist separately from the related insurance policies issued by Fidelity Life. Therefore, these membership interests are extinguished when a member’s policy with Fidelity Life is terminated by surrender, death, lapse or cancellation. Those membership interests will also be extinguished upon conversion of Members Mutual from mutual to stock form in accordance with Illinois law and the plan of conversion.

The board of directors of Members Mutual adopted a plan of conversion on July 31, 2018, as amended and restated on September 16, 2018 and March 25, 2019, under which Members Mutual will convert from a mutual insurance holding company to a stock company. Following the conversion, Members Mutual will become a wholly-owned subsidiary of Vericity. A special meeting of the eligible members of Members Mutual (those members who were the policyholders of Fidelity Life as of the close of business on July 31, 2018) will be held on August 6, 2019, to approve the plan of conversion. To become effective, the plan must be approved by the affirmative vote of at least two-thirds of the votes cast at the special meeting.

As part of the conversion, we are offering for sale between 14,875,000 shares and 20,125,000 shares of our common stock at a purchase price of $10.00 per share on a first priority basis to eligible members, and second to the directors and officers of Members Mutual. All purchasers of our common stock in this offering will pay the same cash price per share. If the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community



 

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offering, is less than 14,875,000 shares, Apex Holdco L.P., an affiliate of J.C. Flowers IV L.P., a private equity fund advised by J.C. Flowers & Co. LLC, has agreed to act as the standby purchaser for this offering and to purchase the number of shares of our common stock equal to the difference between 14,875,000 and the number of shares of common stock subscribed for in the subscription offering together with the number of shares for which subscriptions are accepted in the community offering, and may purchase additional shares as may be necessary in order to permit the standby purchaser to acquire a majority of the shares sold, provided that no more than 20,125,000 shares may be sold in the offerings. Under the terms of our agreement with the standby purchaser, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors, whether or not it acquires a majority of the stock sold in the offerings. All membership interests in Members Mutual will be extinguished upon completion of the subscription offering and the plan of conversion, regardless of whether an eligible member exercises subscription rights received under the plan of conversion.

The Subscription Offering

We are offering shares of our common stock in a subscription offering. The subscription offering will end at 5:00 PM, Central Time, on July 29, 2019. In the subscription offering, 20,125,000 shares of common stock are being offered on a first priority basis to the members of Members Mutual who were policyholders of Fidelity Life as of the close of business on July 31, 2018, who we refer to as eligible members, and second to the directors and officers of Members Mutual.

The number of shares of common stock issued will not exceed 20,125,000 shares. Shares purchased by the directors and officers of Members Mutual will be purchased for investment and not for resale and will be counted toward satisfaction of the minimum number of shares needed to be sold to complete this offering. We refer to this offering of the common stock to the eligible members and the directors and officers of Members Mutual as the “subscription offering.”

The Community Offering

If less than 20,125,000 shares are subscribed for in the subscription offering, we will offer shares to eligible employees under the Employee Bonus Program and may offer shares to other potential investors in what we refer to as the community offering. In the community offering, the Company may accept, in its sole and absolute discretion, orders received in the following order of priority: (1) orders from eligible employees who subscribe for shares of common stock as part of the Employee Bonus Program, and (2) if the number of subscribers or the number of shares of common stock subscribed for by participants in the subscription offering, together with any shares subscribed for by eligible employees, is not sufficient to qualify Vericity for listing on the Nasdaq Capital Market, the Company may accept, in its sole discretion, orders for shares of common stock from select investors in the community offering as may be necessary in order for Vericity to qualify for listing on the Nasdaq Capital Market.

The Company may commence the community offering concurrently with, at any time during, or as soon as practicable after the end of, the subscription offering, and the community offering must be completed within 30 days after the end of the subscription offering, unless extended by the Company. Other than eligible employees, whose subscriptions are subject to the terms of the Employee Bonus Program, the maximum amount that any person together with any associate may, directly or indirectly, subscribe for or purchase in the community offering, shall not exceed 743,750 shares of common stock.

The Employee Bonus Program

In connection with the conversion, Members Mutual has adopted a bonus program for eligible employees who, in recognition of their efforts on behalf of Members Mutual to position it to become a publicly-traded stock company, will be given the opportunity to receive a bonus payable either in $1,000 cash or 100 shares of common stock of Vericity, in either case together with an additional $250 cash to help defray taxes payable with respect to the bonus. The Employee Bonus Program will be conducted as part of the community offering and is subject to completion of the conversion.

It is the intention of the Company to accept all orders of stock from eligible employees in the Employee Bonus Program so long as the total number of shares of common stock subscribed for by participants in the subscription offering together with shares subscribed for by eligible employees in the Employee Bonus Program is less than 20,125,000. In the event the total exceeds 20,125,000 shares, no shares of common stock will be issued to eligible employees under the Employee Bonus Program and the bonus will be paid in cash, subject to completion of the conversion.



 

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The Standby Purchaser

Apex Holdco L.P., the standby purchaser, was formed on October 1, 2018 to acquire shares of our common stock pursuant to the standby purchase agreement. Prior to the completion of the standby offering, the standby purchaser has not engaged in any business operations and does not have any assets or liabilities (other than its rights and obligations under the standby purchase agreement). The standby purchaser is managed by Apex Holdco GP LLC, its general partner. Apex Holdco GP LLC is an affiliate of J.C. Flowers & Co. LLC.

At this time it is not possible to determine the number of shares of common stock of the Company that the standby purchaser will purchase pursuant to the standby purchase agreement. However, in fulfilling its standby purchase commitment, the standby purchaser will acquire a majority of our shares issued in the offerings if the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, total fewer than 7,437,500 shares. Pursuant to the standby purchase agreement, after the completion of the offerings, the standby purchaser will have the right to designate a majority of the members of our board of directors. If the standby purchaser acquires a majority of our shares in the standby offering, the standby purchaser will be able to approve most corporate actions requiring stockholder approval by written consent without a meeting of stockholders.

J.C. Flowers & Co. LLC was founded in 1998 and is a leading private investment firm dedicated to investing globally in the financial services industry. J.C. Flowers & Co. LLC invests across a range of deal types and industry sectors including banking, insurance and reinsurance, securities, services and asset management, and specialty finance. J.C. Flowers & Co. LLC is registered with the Securities and Exchange Commission as an investment adviser. With approximately $6 billion of assets under management, J.C. Flowers & Co. LLC has offices in New York and London. Mr. J. Christopher Flowers is the sole owner of, and the managing member of, J.C. Flowers & Co. LLC.

Standby Purchase Agreement

Members Mutual, Vericity and Fidelity Life entered into the standby purchase agreement with the standby purchaser on October 5, 2018, as amended and restated on March 26, 2019, pursuant to which the standby purchaser agreed, subject to certain conditions, to acquire from us at the subscription price of $10.00 per share the number of shares equal to the difference between the offering minimum of 14,875,000 shares and the number of shares of common stock subscribed for in the subscription offering together with any subscriptions for shares accepted in the community offering. In addition, the standby purchaser has the right to purchase additional shares up to the offering maximum, which additional shares may permit the standby purchaser to acquire up to a majority of the stock sold in the offerings. Under the terms of our agreement with the standby purchaser, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors, whether or not it acquires a majority of the stock sold in the offerings. Shares purchased by the standby purchaser in the standby offering will be purchased for investment and not for resale and will be counted toward satisfaction of the minimum number of shares needed to be sold to complete this offering. For a description of the terms and conditions of the standby purchase agreement, see “The Conversion and Offering—Description of the Standby Purchase Agreement.”

We refer to the offering of shares to the standby purchaser as the standby offering. We refer to the subscription offering, the community offering and the standby offering collectively as the offerings.

Conditions to Completion of the Conversion and this Offering

Our ability to complete this offering is subject to two conditions. First, a minimum of 14,875,000 shares of common stock must be sold to complete this offering. Second, Members Mutual’s plan of conversion and amended and restated articles of incorporation must be approved by the affirmative vote of at least two-thirds of the votes cast at the special meeting of members to be held on August 6, 2019. No funds will be released from the escrow account until both of these conditions have been satisfied.

If the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, is less than 14,875,000 shares, and if all of the conditions to the standby purchaser’s purchase commitment have been satisfied, the standby purchaser will be obligated to purchase enough shares in the standby offering to guarantee the sale of the minimum number of shares necessary to complete this offering. In that event, the level of sales to eligible members and directors and officers of Members Mutual will not impact the condition that at least 14,875,000 shares must be sold to complete this offering. Accordingly, the sale of the minimum number of shares necessary to complete this



 

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offering does not indicate that sales have been made to investors who have no financial or other interest in the offerings, and the sale of the minimum number of shares should not be viewed as an indication of the merits of this offering.

Termination of this Offering

Subject to the provisions of the plan of conversion and the standby purchase agreement, we have the right to cancel this offering at any time. In addition, the completion of this offering is subject to market conditions and other factors beyond our control. If this offering is not completed, all funds received will be promptly returned to purchasers without interest.

Stock Pricing and Number of Shares to be Issued

The plan of conversion requires that the range of the value of the total number of shares to be issued in this offering must be based on a valuation of our estimated consolidated pro forma market value. Under the plan of conversion, the valuation must be in the form of a range consisting of a midpoint valuation, a valuation fifteen percent (15%) above the midpoint valuation and a valuation fifteen percent (15%) below the midpoint valuation. We retained Boenning & Scattergood, Inc. to determine the valuation range for this offering. Boenning & Scattergood, Inc. has determined that, as of April 11, 2018, the estimated consolidated pro forma market value of Members Mutual is $175,000,000 at the midpoint, and the range of value of the total number of shares of common stock to be issued in the offering is between a minimum value of $148,750,000 and a maximum value of $201,250,000. We plan to issue between 14,875,000 and 20,125,000 shares of our common stock in this offering. This range was determined by dividing the $10.00 price per share into the range of Boenning & Scattergood, Inc.’s valuation.

We determined to offer the common stock in the subscription offering at the price of $10.00 per share to ensure a sufficient number of shares are available for purchase by eligible members. In addition, Raymond James advised us that the $10.00 per share offering price is commonly used in mutual-to-stock conversions of other insurance companies and savings banks and savings associations that use the subscription rights conversion model. These were the only factors considered by our board of directors in determining to offer shares of common stock at $10.00 per share.

How Do I Buy Stock in this Offering?

If you wish to purchase shares of common stock in the subscription offering, you must sign and complete the stock order form that accompanies this prospectus and send it to us with your payment such that your order is received before the offering deadline. You may submit your order to us by overnight delivery to the address indicated for this purpose on the top of the stock order form or by mail using the stock order reply envelope provided. Payment by check or money order must accompany the stock order form. No cash or third party checks will be accepted. All checks or money orders must be made payable to “Computershare Trust Company, N.A., as escrow agent for Vericity, Inc.” We may permit certain persons whose subscriptions are accepted in the community offering to make payment of the purchase price by a wire transfer to the escrow agent.

The completed stock order form and payment in full for the shares ordered must be received (not postmarked) no later than 5:00 PM, Central Time, on July 29, 2019. Once submitted, your order is irrevocable without our consent unless we terminate this offering. Our consent to any modification or withdrawal request may or may not be given in our sole discretion. We may reject a stock order form if it is incomplete, improperly completed, or not timely received.

If you are an eligible employee and wish to purchase 100 shares of stock under the Employee Bonus Program, you must complete the Employee Bonus Program Election Form and follow the instructions provided.

Offering Deadline

All subscription rights will expire at 5:00 PM, Central Time, on July 29, 2019. We expect that the community offering will terminate on or about the same time. Subscription rights not exercised prior to this deadline will be void, whether or not we have been able to locate each person entitled to receive subscription rights.

Limits on Your Purchase of Common Stock

The plan of conversion and Illinois law establish the following minimum and maximum purchase limitations for participants (including such participant’s associates or a group acting in concert) in the subscription offering:

 

   

No person may subscribe for fewer than 25 shares in this offering.



 

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Each eligible member has been allocated subscription rights to purchase the number of shares that is printed on the stock order form mailed to each such eligible member. No eligible member may subscribe to purchase more shares than the number of subscription rights allocated to such member. The number of subscription rights allocated to each eligible member was determined in accordance with actuarial analyses described in the plan of conversion.

 

   

Subject to the prior rights of eligible members to subscribe for up to 20,125,000 shares in this offering, no director or officer of Members Mutual may purchase more than such person’s individual management purchase limit. Members Mutual has determined each individual management purchase limit based on positions held and compensation. In no event may the directors and officers of Members Mutual, in their capacities as such, purchase more than 4,016,250 shares of the stock sold in the offerings.

 

   

In addition to the limitations set forth above, no person (other than the standby purchaser) may acquire, directly or indirectly, in this offering or any public offering, more than 5% of the capital stock of Vericity for a period of five years from the effective date of the conversion without the approval of the Illinois Director of Insurance.

The subscription of any person who subscribes for more shares than the person’s maximum purchase limitation as set forth on the stock order form will be disregarded in its entirety or reduced to the person’s maximum purchase limitation, at the discretion of Vericity.

We have the right in our absolute discretion and without liability to any participant in the subscription offering, the community offering or to any other person to determine which proposed persons and which subscriptions and orders in this offering meet the criteria provided in the plan of conversion for eligibility to purchase shares of common stock and the number of shares eligible for purchase by any person. Our determination of these matters will be final and binding on all parties and all persons.

Oversubscription

If eligible members subscribe for more than 20,125,000 shares, the shares of common stock will be allocated so as to permit each subscribing eligible member, to the extent possible, to purchase up to the lesser of the number of shares subscribed for or 100 shares. Any remaining shares will be allocated among the eligible members whose subscriptions remain unsatisfied in the proportion in which the number of shares as to which each such eligible member’s subscription remains unsatisfied bears to the aggregate number of shares as to which all such eligible members’ subscriptions remain unsatisfied.

Actuarial Opinion

We retained Milliman, Inc., an independent actuarial consulting firm, to advise us in connection with actuarial matters involved in the allocation of subscription rights and the establishment of the individual maximum purchase limitations. The opinion of Steven I. Schreiber, Principal of Milliman, dated March 25, 2019, relating to the proposed allocation of subscription rights among eligible members in consideration for the extinguishment of their membership interests in Members Mutual, states (in reliance upon the matters described in such opinion) that the principles, methodology and the allocation instructions for allocating consideration among the eligible members and for allocating shares in the event of an over subscription, each as set forth in the plan of conversion, are fair and equitable from an actuarial point of view. The opinion of Steven I. Schreiber is an exhibit to the registration statement of which this prospectus is a part, and is available for inspection in the manner set forth in the section titled “Additional Information.” A copy of the actuarial opinion is also on file and available for inspection at our principal executive offices.

Management Purchases of Stock

The directors and officers of Members Mutual, in their capacities as such, may not purchase in the aggregate more than 4,016,250 shares, which represents 27% of the shares at the minimum of the offering range. If the eligible members subscribe for less than the maximum number of shares, the directors and officers of Members Mutual have indicated their intention to purchase approximately 2,123,675 shares of common stock in the subscription offering. The directors and officers of Members Mutual are not obligated to purchase this number of shares, and in the aggregate they may purchase a greater or smaller number of shares. See “The Conversion and Offering—Proposed Management Purchases.”

If there are insufficient shares remaining after the subscriptions of eligible members to satisfy in full all of the subscriptions of directors and officers of Members Mutual, the available shares of common stock will be allocated among the



 

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subscribing management participants in the proportion in which the number of shares as to which each such management participant’s subscription bears to the aggregate number of shares subscribed for by all management participants.

Undersubscription

If the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, is less than 14,875,000 shares, the standby purchaser has agreed to purchase enough shares in the standby offering to guarantee the sale of the minimum number of shares necessary to complete this offering, and may purchase additional shares as may be necessary in order to permit the standby purchaser to acquire a majority of the shares sold, provided that no more than 20,125,000 shares may be sold in the offerings. In that event, the level of sales to eligible members and directors and officers of Members Mutual will not impact the condition that at least 14,875,000 shares must be sold to complete this offering. Accordingly, the sale of the minimum number of shares necessary to complete this offering does not indicate that sales have been made to investors who have no financial or other interest in the offerings, and the sale of the minimum number of shares should not be viewed as an indication of the merits of this offering.

Benefits to Management

Members of our management, our directors and advisory board members will participate in an equity incentive plan to be established under the terms of the amended and restated limited partnership agreement of the standby purchaser. The plan will be established to promote the long-term growth and profitability of the standby purchaser and all of our stockholders by providing employees, directors and service providers who are or will be involved in our growth with an opportunity to acquire an ownership interest in the standby purchaser, thereby encouraging such persons to contribute to and participate in our success. Under the plan, the general partner of the standby purchaser may grant awards of Class B units to employees, directors and other service providers of the standby purchaser and/or Vericity. Class B units are non-voting profits interests in the standby purchaser that entitle the holders thereof to participate in the appreciation in the value of the standby purchaser above an applicable threshold and to thereby share in our future growth. The grant of equity-based awards to our management and directors is intended to encourage the creation of long-term value for our stockholders by helping to align the interests of the participants under the plan with those of our stockholders and to promote employee retention and ownership. See “Executive Compensation—Apex Holdco Equity Incentive Plan.”

Shares Outstanding Immediately After the Offerings

A minimum of 14,875,000 shares and a maximum of 20,125,000 shares of our common stock will be issued and outstanding after the offerings.

Use of Proceeds

As required under Illinois law, the plan of conversion requires that the total price of the stock to be issued in the conversion must be equal to the estimated pro forma market value of converted Members Mutual as determined by an independent appraiser, which is $148.8 million at the minimum of the offering range. Accordingly, we must sell shares at an aggregate price at least equal to $148.8 million in the offerings. We estimate the net proceeds from the offerings will be between $135.5 million at the minimum of the offering range and $189.5 million at the maximum of the offering range. See the “Offering Summary” on the front cover of the prospectus for the assumptions used to arrive at these amounts. The amount of net proceeds from the sale of common stock in the offerings will depend on the total number of shares actually sold in the subscription offering, the community offering, and the standby offering.

Initially, we plan to retain substantially all of the net proceeds from the offerings at Vericity. The standby stock purchase agreement provides that within six months following the closing of this offering, our board will direct management to undertake and complete a capital needs assessment to project the amount of capital reasonably needed to be maintained at Vericity to support adequate operating capital levels at Fidelity Life and Efinancial. Depending on the results of the assessment, we may allocate a portion of the net proceeds from the offerings to support our insurance and agency businesses, and more particularly to (i) reduce our use of reinsurance to finance growth, while continuing to emphasize risk management; (ii) make investments to strengthen our infrastructure, including our IT platforms; (iii) selectively deploy new capital to acquire and bolster talent in key areas of competency linked to competitive advantage; and (iv) pay amounts due on account of the acceleration of Long-Term Incentive Plan awards (as described below). We expect that any unallocated net proceeds from the offerings will be used for general corporate purposes, including paying holding company expenses, and potentially paying a special cash dividend to our stockholders or repurchasing shares of our common stock. In connection with the



 

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approval of the conversion by the Illinois Director of Insurance, we agreed, for a period of twenty-four months following the completion of the offerings, to either maintain $20 million of the proceeds of the offerings at Vericity or use all or a portion of that $20 million to fund our operations.

If as a result of the capital needs assessment, management determines that the amount of capital retained at Vericity exceeds the reasonable current and near term projected operating capital needs, management will determine the amount of excess capital (if any) that may be available for distribution to stockholders and may recommend the declaration of a special dividend to stockholders in an amount not to exceed any such excess capital. The amount of any special dividend would not equal or exceed one hundred percent of the net proceeds. However, there can be no assurance that our board of directors will declare any dividend. Any decision regarding the declaration or amount of any dividend will be in the sole discretion of the board of directors of Vericity and will depend on many factors, including the capital needs assessment, the amount of net proceeds from this offering, general economic and business conditions, Vericity’s financial results and condition, legal and regulatory requirements and any other factors that the Vericity board may deem relevant.

The following table illustrates the effect on the estimated net proceeds available to the Company following the payment of a potential special dividend in the projected amounts as shown below. This table is presented for illustrative purposes only and does not represent a commitment regarding the payment of a special dividend in any amount, including the amounts shown below:

 

     Offering Minimum      Offering Maximum  
     (dollars in millions except share and per share data)  

Projected dividend per share

     $2        $4        $6        $7        $2        $4        $6        $7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Effective pre-tax net investment per share

     $8        $6        $4        $3        $8        $6        $4        $3  

Gross offering proceeds

   $ 148.8      $ 148.8      $ 148.8      $ 148.8      $ 201.3      $ 201.3      $ 201.3      $ 201.3  

Estimated offering expenses

     9.7        9.7        9.7        9.7        9.7        9.7        9.7        9.7  

Estimated commissions

     3.5        3.5        3.5        3.5        2.0        2.0        2.0        2.0  

Estimated dividend payout

     29.8        59.5        89.3        104.1        40.3        80.5        120.8        140.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Estimated net proceeds

   $ 105.8      $ 76.1      $ 46.3      $ 31.5      $ 149.3      $ 109.1      $ 68.8      $ 48.7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Under the terms of the standby purchase agreement and our bylaws, upon completion of the offerings, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors, and the board will determine the amount and timing of any special dividend, if a special dividend is declared. If the standby purchaser acquires a majority of our shares sold in the offerings, the standby purchaser would receive a majority of the amount of any excess capital distributed to stockholders as a special dividend in proportion to its stock ownership.

On a short-term basis, the proceeds retained at Vericity will be initially invested primarily in U.S. government securities, other federal agency securities, and other securities consistent with our investment policy until utilized.

Dividend Policy

Following completion of this offering, our board of directors will have the authority to declare dividends on our shares of common stock. We currently do not have any plans to pay ordinary cash dividends to our stockholders. Any decision to pay a dividend will depend on many factors, including our financial condition and results of operations, liquidity requirements, market opportunities, capital requirements of our subsidiaries, legal requirements, intercompany dividends from our subsidiaries and other factors as the board of directors deems relevant. For additional information regarding restrictions on our ability to pay dividends, see “Dividend Policy.” For information regarding the potential payment of a special cash dividend following a capital needs assessment to be conducted within six months of the closing of this offering, see “Dividend Policy—Capital Needs Assessment; Potential Special Dividend.”

Market for Common Stock

Our common stock has been approved for listing on the NASDAQ Capital Market under the symbol “VERY.”

How You May Obtain Additional Information Regarding this Offering

If you have any questions regarding the stock offering, please call the Stock Information Center at 1-866-420-6746, Monday through Friday between 10:00 a.m. and 4:00 p.m., Central Time to speak with a representative of Raymond James.



 

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RISK FACTORS

An investment in our common stock involves a number of risks. Before making a decision to purchase our common stock, you should carefully consider the following information about these risks, together with the other information contained in this prospectus. Many factors, including the risks described below, could result in a significant or material adverse effect on our business, financial condition and results of operations. If this were to happen, the price of our common stock could decline significantly and you could lose all or part of your investment.

Risks Relating to Our Business

We have incurred a net loss in each of the nine prior fiscal years.

Although founded over one hundred years ago, we recommenced independent operations in 2005 following the termination of a long-term management relationship with a former affiliate, and a significant percentage of Fidelity Life’s in-force policies have been written only in the years since then. The lack of cash flows typically associated with a legacy business puts Fidelity Life at a disadvantage in comparison with other life insurance carriers that have a more established book of business and associated revenue streams. Also, we have incurred a net loss in each of the nine prior fiscal years, resulting in an aggregate of approximately $111.7 million in net losses over that period, including losses of $13.8 and $8.2 million for the years ended December 31, 2018 and 2017, respectively. In addition, we have incurred a loss of $6.2 million for the three months ended March 31, 2019. Our losses are due principally to operating expenses and corporate overhead exceeding revenues of our agency and insurance segments, and our inability to defer commission expense on policies produced by our affiliated agency, Efinancial.

If we are successful in growing our business through our distribution strategy, we expect to continue to generate consolidated net losses until we have developed a sustainable book of business and our growth rate has leveled.

Revenue growth is required to increase our scale to cover our operating expenses and corporate overhead. Consistent with our distribution strategy, we have been increasing the number of Fidelity Life policies sold through our affiliated distributor, Efinancial. However, generally accepted accounting principles (GAAP) require that we immediately expense that portion of our policy acquisition costs for policies placed through our affiliated agency, Efinancial, that cannot be directly tied to the placement of a policy. As a result of this immediate expense recognition for sales through Efinancial, we incur a net loss in the first year on each policy sold through Efinancial. We plan to increase sales through Efinancial as we seek to further develop our distribution platform and grow our book of business. If we are successful in increasing our premium writings through Efinancial over each of the next several years, we expect that the impact of the immediate expense recognition will continue to contribute to our incurring consolidated net losses and reduction of our consolidated equity in each such year. If we are not able to offset that expense load with additional income streams, we will continue to incur consolidated net losses, which will have a material and adverse effect on our business, financial condition, results of operations, and prospects. There can be no assurance that we will be able to generate a sustainable book of business using our distribution platform that will produce sufficient revenues to offset our expenses.

We use products and processes in order to overcome the barriers that have historically hindered access to the Middle Market, and there can be no assurance our products and processes will fully address these barriers.

Historically, our target market has been underserved by life insurance companies that have tended to focus on more affluent customers. The products and processes that we use to reach the Middle Market rely heavily on retail call center-based sales. The call centers that we are familiar with tend to have low placement ratios on medically underwritten products because of the time delay involved in issuing policies and the lack of face to face sales support typically provided by traditional agents. We have developed innovative products and processes designed to streamline the sale of life insurance and improve call center placement ratios. We cannot assure you that our business model, which is focused on selling quick-issue policies to the Middle Market through our retail call center distribution platform, will prove to be viable or sustainable. If we are not successful in utilizing our products and processes to penetrate our target Middle Market, we will not generate sufficient revenues to offset our expenses, which will result in a material and adverse effect on our business, financial condition, results of operations, and prospects.

Although we are currently exploring direct distribution of insurance policies over the internet, there can be no assurance that we will be successful in placing policies through this distribution platform. Several of our competitors are currently developing, and in some cases have developed, the capability for distribution of insurance products through digital and online platforms. If we are unable to successfully implement our online distribution platform or implement other distribution methods that are preferred by consumers, we may be unable to successfully reach a portion of our target Middle Market. In

 

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addition, there can be no assurance that the performance of the products that we sell through direct online distribution will meet our expectations. Either of these circumstances could cause a material and adverse effect on our business, financial condition, results of operations, and prospects.

Our results of operations have been adversely affected by the current low interest rate environment, and will continue to be adversely affected if interest rates remain low or if interest rates should rapidly increase.

Interest rates have remained at near historically low levels for an extended period. Although the Federal Reserve moved to marginally increase short-term interest rates in 2018, 2017, and 2016 and may continue to increase rates in the future, medium and long-term interest rates have remained at low levels. During a prolonged period of low interest rates, our investment earnings may decrease because the interest earnings on our recently purchased fixed income investments will likely have declined in parallel with market interest rates. In addition, callable fixed income securities in our investment portfolios will be more likely to be prepaid or redeemed as borrowers seek to borrow at lower interest rates. Consequently, we may be required to reinvest the proceeds in securities bearing lower interest rates. In addition, during periods of continuing low interest rates, our financial performance may suffer as a result of a decrease in the spread between interest rates credited to our annuity contractholders and returns on our investment portfolios. A period of prolonged low interest rates may also cause us to change our assumptions of the interest rates that we can earn on our investments and the long-term interest rate that we assume in our calculation of insurance assets and liabilities under GAAP. This revision would result in increased reserves, accelerated amortization of deferred acquisition costs and other unfavorable consequences. In addition, certain statutory capital and reserve requirements are based on formulas or models that consider interest rates, and an extended period of low interest rates may increase the statutory capital we are required to hold and the amount of assets we must maintain to support statutory reserves.

Conversely, an increase in market interest rates could also have a material adverse effect on the value of our investment portfolio by, for example, decreasing the estimated fair values of the fixed income securities within our investment portfolio. In addition, in periods of rapidly increasing interest rates, withdrawals or surrenders under our annuity contracts may increase as policyholders choose to seek higher investment returns. Obtaining cash to satisfy these obligations may require us to liquidate fixed income investments at a time when market prices for those assets are depressed because of increases in interest rates. This may result in realized investment losses. Also, certain statutory reserve requirements are based on formulas or models that consider forward interest rates and an increase in forward interest rates may increase the statutory reserves we are required to hold thereby reducing statutory capital.

Difficult economic conditions have adversely affected the demand for our insurance products in our target Middle Market.

In addition to the adverse impacts of the current low interest rate environment, our business prospects, results of operations and financial condition are affected by general economic conditions. While economic conditions have stabilized and improved in a number of areas, economic challenges still remain. Many middle American families, including those that comprise our target Middle Market, have experienced financial hardships as a result of the slow pace of the economic recovery and stagnant income levels. We believe that these economic pressures have reduced demand for our life insurance products due to challenging consumer economics, including increased demands on disposable income to pay for increasing costs of living, including health insurance, savings goals and general living expenses.

Actual results could materially differ from the third party predictive analytical models that we currently use and those that we plan to develop in the future to assist our decision-making processes.

Our business strategy relies on our ability to develop and effectively utilize predictive analytics to optimize our production of a stable book of life insurance business. Flaws in, or faulty assumptions used by, our predictive models could lead to increased policy claims. If, based upon predictive analytics or other factors, we misprice our products or our estimates of the risks we are exposed to prove to be materially inaccurate, there could be a material and adverse effect on our business, financial condition, results of operations, and prospects.

Our operations are dependent on access to key technology tools; if we lose access to these tools, our ability to conduct business could be significantly impaired.

We make extensive use of internally developed software applications in the conduct of our businesses. In our agency segment, our patented ALISS® software system contains a number of custom applications that are necessary to our ability to operate, including marketing, consumer relationship management, and modules for sales, case management and customer

 

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service. In our insurance segment, we have developed our Rapid Application system and our Fidelity Life Association Sales Handler (FLASH) system to allow our producers to efficiently complete a web-enabled sales application for many of our insurance products. For the three months ended March 31, 2019, nearly all of our new insurance policies were processed through our Rapid Application or FLASH systems.

In the event of a disaster such as a natural catastrophe, an epidemic, an industrial accident, a blackout, a computer virus, a terrorist attack, a cyber-attack, or war that causes ALISS® or our Rapid Application or FLASH systems to not function, unanticipated problems with our disaster recovery systems would have an adverse impact on our ability to conduct business and on our results of operations and financial position, particularly if those problems affect our internet access, computer-based data processing, transmission, storage and retrieval systems or destroy valuable data. Despite our implementation of security measures, disaster recovery plans, system back-up plans and offsite arrangements to reduce the risk of a loss of access to these critical systems, there is no assurance that these security measures and back-up plans will work when needed or would protect the company in all circumstances that could arise. An interruption in our business because of our inability to access our key technology tools could result in the loss of revenue and damage to our reputation and could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

Valuation of our investments, and the determination of whether a decline in the fair value of our invested assets is other-than-temporary, is based on methodologies and estimates that may prove to be incorrect, which could adversely affect our results of operations and financial condition.

Our fixed maturity securities are classified as either “available-for-sale” securities or “trading” securities, both of which are carried at fair value on the balance sheet. Fair value represents the price that would be received from the sale of an asset in an orderly transaction between market participants on the measurement date. Determining the fair value of certain invested assets, particularly those that do not trade on a regular basis, requires an assessment of available data and the use of assumptions and estimates in making these determinations. This analysis requires us to characterize certain of our investment assets among different categories referred to as either Level 1, Level 2 or Level 3 assets. See “Management’s Discussion and Analysis—Valuation of Fixed Maturity Securities and Equity Securities.” At March 31, 2019, we had 3% of our investment assets characterized as Level 1 assets, 93% of our investment assets characterized as Level 2 assets, and 4% of our investment assets characterized as Level 3 assets. See “Note 8—Assets and Liabilities Measured at Fair Value” in the accompanying unaudited condensed consolidated financial statements and “Note 12—Assets and Liabilities Measured at Fair Value” in the accompanying audited consolidated financial statements included in this prospectus.

In addition, GAAP requires that when the fair value of certain of our invested assets declines and such decline is deemed to be other-than-temporary, we recognize a loss in either accumulated other comprehensive income or on our consolidated statement of operations based on certain criteria in the period that this determination is made. Once it is determined that the fair value of an investment asset is below its carrying value, we must determine whether the decline in fair value is other-than-temporary, which is based on subjective factors and involves a variety of assumptions and estimates. For information on our valuation methodology, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Investments.” There are certain risks and uncertainties associated with determining whether declines in market value are other-than-temporary. These include significant changes in general economic conditions and business markets, trends in certain industry segments, interest rate fluctuations, rating agency actions, changes in significant accounting estimates and assumptions and legislative actions. In the case of mortgage- and other asset-backed securities, there is added uncertainty as to the performance of the underlying collateral assets. To the extent that we are incorrect in our determination of fair value of our investment securities or our determination that a decline in their value is other-than-temporary, we may recognize losses that never actually materialize or may fail to recognize losses within the appropriate reporting period that will be recognized in future periods.

If we are unable to protect sensitive consumer information, our reputation could be damaged and we could be subject to fines or litigation.

Our products and services involve the use, collection and storage of confidential information of consumers and the transmission of this information. In our agency segment, this information is used in the underwriting process by our carriers. For example, we collect names, addresses, personal identity and financial information, and information regarding the medical history of consumers in connection with their applications for life insurance. In our insurance segment, we maintain detailed information on our policyholders, including sensitive, non-public personal information.

While we take commercially reasonable measures to keep our systems and data secure, it is difficult or impossible to defend against all risks being posed by changing technologies as well as criminals intent on committing cybercrime. Increasing sophistication of cyber criminals and terrorists make keeping up with new threats difficult and could result in a

 

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breach. As a result, we may be unable to anticipate the type or manner of attempts to breach our security or to implement adequate preventative measures against these attempts. We may be required to expend significant capital and other resources to protect our technology infrastructure from attack or to alleviate problems caused by security breaches.

Changes in legislation relating to information security, industry best practices or the specific requirements of our insurance carriers or other business partners may impose new requirements relating to data security and may present significant implementation costs and challenges. Changing our processes could be time consuming and expensive, and failure to timely implement required changes could result in our inability to sell certain insurance products in a particular jurisdiction or to represent certain insurance carriers, any of which could damage our business and adversely affect our results of operations and financial condition.

Any breach or perceived breach of our security could damage our reputation and our relationship with our policyholders, clients, marketing partners and insurance carriers. Reputational damage of this kind could significantly harm our agency segment. For example, consumers and insurance carriers may be less likely to use our agency services following a breach because of a perceived weakness in our information security measures. Additionally, we could be subject to significant liability as well as regulatory action, which would have a material and adverse effect on our business, financial condition, results of operations, and prospects.

We may be unable to adequately protect our intellectual property rights or avoid infringing the intellectual property rights of third parties and the intellectual property rights we have may not be a meaningful barrier to competition.

Currently, we rely on a combination of several issued U.S. patents and a patent application, copyrights, trademarks and trademark applications, confidentiality or non-disclosure agreements, licenses, work-for-hire agreements and invention assignment agreements to protect our intellectual property rights. We can give no assurance, however, that the protective actions we have taken with respect to our intellectual property rights are adequate to prevent others from developing software platforms or using brands that are substantially similar to our own and upon which we rely to differentiate our products and to provide, through the use of our Rapid Application and FLASH technology platforms, a differentiated web-enabled sales and underwriting process. Competitors may adopt brand names similar to our trademarks and trade names, and owners of similar registered trademarks may bring trade name or trademark infringement claims against us. Further, policing our intellectual property rights is difficult and expensive and may not always be effective. Others may assert claims that our trademarks or copyrights in our proprietary software or materials are invalid or that our proprietary software infringes upon their intellectual property rights. If disputes of this type were to occur, we may not be able to resolve them to our satisfaction. Our inability to protect or maintain exclusive use of our intellectual property could adversely affect our business operations.

Unauthorized parties may copy aspects of our software or obtain and use information we hold as trade secrets and regard as proprietary. While unauthorized parties’ use of our proprietary information may under certain circumstances be actionable, independent development of material we hold as trade secrets does not necessarily give rise to a cause of action for trade secret misappropriation. In addition, in the course of seeking patent protection, we were required to publicly disclose information related to our software sufficient to enable others with “ordinary skill” in the relevant technology area to use our various inventions. Third parties may be able to legally circumvent our proprietary rights by using our former disclosures to assist in independently developing software that is substantially similar to our own but which differs from the claims of our issued patents. Use of our patents in this way does, however, present risk to third parties of a finding of willful patent infringement and correspondingly enhanced damages. Moreover, independent development of our patented technology is actionable as direct patent infringement and is generally a strict liability offense.

Currently, we have seven issued U.S. patents and one pending U.S. patent application related to certain aspects of our RAPIDecision® Life sales process, our LifeTime Benefit Term product, our ALISS® system and other elements of our business. In the past, we have preliminarily pursued foreign protection and continue to evaluate whether such protection is valuable. Generally, patents issued in the United States remain in force for twenty years from the earliest effective filing date, but in some instances can be extended due to patent office delays for as many as several additional years. Our patents and patent application are expected to expire within the period between July, 2024 and July, 2029. In addition, valid patents may not issue from our pending application, and our issued patents, along with any claims in our pending application that are allowed, may be challenged, invalidated or circumvented, or may not be sufficiently broad to foreclose potential competitors from developing similar new technologies. Furthermore, costly and time consuming litigation could be necessary to enforce and determine the scope of our patents.

In its 2014 decision in Alice Corp. v. CLS Bank Int’l., the Supreme Court of the United States reemphasized the general idea that abstract ideas are not patentable as business methods, but that business methods may be patentable processes if they

 

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otherwise satisfy the requirements of the U.S. Patent Act. In particular, the Supreme Court’s two-pronged Alice test first asks whether patents are directed to abstract ideas; if not, patents cover eligible subject matter. If a patent is directed to an abstract idea, prong two of the test asks whether the patents cover “something more” such that they are patent eligible. As a result of Alice, if patents are novel, nonobvious and fully and particularly described, there are arguments to be made that even business method patents can cover patent eligible subject matter. We have endeavored to prosecute patent claims to satisfy the requirements of the U.S. Patent Act in view of Alice, and much of our patent portfolio has been prosecuted post-Alice. Nonetheless, the continued emphasis on the unpatentability of abstract ideas could result in at least some of our existing patents—including our RAPIDecision® Life (Hybrid Life) patent family—being rendered invalid and unenforceable or could result in the denial of our pending patent application.

In the ordinary course of our business we can face coverage disputes and lawsuits that are expensive, time consuming and may include claims for extra-contractual damages, which, if resolved adversely, could harm our business, financial condition, or results of operations.

From time to time, we are involved in coverage and other types of lawsuits in the ordinary course of our business. Defending these claims is costly and can impose a significant burden on our management and employees. We utilize reinsurance to limit our exposure on any one life under the insurance policies we issue. However, our reinsurance arrangements generally do not cover extra-contractual damages that we may incur in connection with coverage disputes. Accordingly, were we to be found liable for extra-contractual damages, we would be responsible for the full amount of extra contractual damages. If we are found to be liable for significant extra-contractual damages in future cases, there could be a material and adverse effect on our business, financial condition, results of operations, and prospects.

Legal and regulatory investigations and actions are increasingly common in the life insurance business and may result in financial losses and harm our reputation.

We face a risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including the risk of class action lawsuits. Fidelity Life and Efinancial may become subject to class actions and regulatory actions or may become subject to individual lawsuits relating, among other things, to sales or underwriting practices, payment of contingent or other sales commissions, claims payments and procedures, product design, disclosure, administration, additional premium charges for premiums paid on a periodic basis, interest crediting practices, denial or delay of benefits and breaches of fiduciary or other duties to customers. Plaintiffs in class action and other lawsuits against Fidelity Life or Efinancial may seek very large or indeterminate amounts, including punitive and treble damages, which may remain unknown for substantial periods of time.

From time to time, Fidelity Life is subject to regulatory review and is currently under an examination by various state treasurers relating to our escheat practices for unclaimed life insurance death benefits. While we believe our practices comply with applicable law, these practices have come under increased scrutiny by state regulatory bodies. State insurance regulators, treasurers and comptrollers are requesting life insurance companies to report on their escheat practices and procedures for tracking and identifying claims that became payable by death or other insured events but were not paid because no claim was presented to the company for payment. As a result of these investigations, regulators are routinely looking to adopt regulations that would require insurance companies to perform regular checks against the Social Security Death Master File, which we currently conduct, or review equivalent sources, as well as require insurance companies to collect more information needed to track policyholders, account holders and beneficiaries. It is possible that these requests by the state regulators may result in payment to beneficiaries, escheatment of funds deemed abandoned under state laws and changes to our escheat practices and procedures.

From time to time, the Illinois Department of Insurance has inquired regarding the levels of our statutory capital and surplus. Fidelity Life is required under Illinois law to maintain minimum statutory capital and surplus of $1.5 million. Since 2007 when we resumed writing business as a stand-alone company, Fidelity Life’s statutory capital and surplus has declined from $275.2 to $112.3 million at March 31, 2019. This decline is due principally to surplus strain from writing new business, which requires us to set aside a portion of surplus for each policy written to fund our reserves for claims, from our acquisition of and investment in Efinancial, and from our operating costs exceeding our revenues. While Fidelity Life’s current level of statutory capital and surplus exceeds the level at which the Illinois Department of Insurance would be authorized to take any action against it, if Fidelity Life were to suffer a significant decline in the level of its statutory capital and surplus, the Illinois Department of Insurance could take various remedial actions, any of which could have a material adverse effect on our business, financial condition, results of operations, and prospects. See “ – Risks Relating to our Insurance Segment—A significant decline in Fidelity Life’s risk-based capital could limit its ability to write new business.”

 

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Fidelity Life is also subject to various regulatory inquiries, such as information requests, subpoenas, market conduct exams and books and record examinations, from state and federal regulators and other authorities, which may result in fines, recommendations for corrective action or other regulatory actions. Fidelity Life is currently in the early stages of a routine financial examination by the Illinois Department of Insurance. Current or future investigations, proceedings or regulatory actions could have an adverse effect on our business, results of operations and financial condition. Moreover, even if we ultimately prevail in the investigation, proceeding or regulatory action, we could suffer significant reputational harm, which could have an adverse effect on our business. Increased regulatory scrutiny and any resulting investigations or proceedings could result in new legal actions or precedents and industry-wide regulations or practices that could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

We rely on the experience of the members of our executive management team and certain key employees and contractors. The loss of any of these individuals could have an adverse impact on our business and our ability to implement our business strategy.

The success of our business is dependent, to a large extent, on our ability to attract and retain key employees including the following members of our executive management team: James E. Hohmann, President and Chief Executive Officer; James C. Harkensee, Executive Vice President of Vericity and President and Chief Operating Officer of Fidelity Life; Chris S. Kim, Executive Vice President, Chief Financial Officer and Treasurer; John Buchanan, Executive Vice President, General Counsel and Secretary; Laura R. Zimmerman, Executive Vice President and Chief Marketing Officer; and Chris Campbell, Executive Vice President of Vericity and President and Chief Operating Officer of Efinancial. Our executive management team has extensive experience in the insurance and direct marketing industries. Were we to lose any of these employees, it may be challenging for us to attract a replacement employee with comparable skills and experience in our market niches. We have employment agreements with our executive officers, which are described under “Executive Compensation—Employment Agreements.” We do not currently maintain key man life insurance policies with respect to any member of our executive management team.

In addition, we rely on certain key employees and contractors who have knowledge of our systems and process. The loss of any one or more of these persons could result in a disruption to our business which could have an adverse effect on our financial performance.

We may be required to establish an additional valuation allowance against deferred income tax assets if our business does not generate sufficient taxable income or if our tax planning strategies are modified, which could have a material adverse effect on our results of operations and financial condition.

Deferred income tax represents the tax effect of the differences between the financial accounting and tax basis of assets and liabilities. Deferred tax assets represent the tax benefit of future deductible temporary differences, operating loss carryforwards and tax credit carryforwards. We periodically evaluate and test our ability to realize our deferred tax assets. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. In assessing the more likely than not criteria, we consider future taxable income as well as prudent tax planning strategies. Future facts, circumstances, tax law changes and financial accounting or GAAP developments may result in an increase in the valuation allowance. An increase in the valuation allowance could have a material adverse effect on the Company’s results of operations and financial condition.

As of March 31, 2019, we had recorded deferred tax assets of $20.9 million and a valuation allowance of $11.6 million, resulting in a net deferred tax asset of $9.3 million. To the extent we are required to establish an additional valuation allowance against deferred income tax assets, the amount of such valuation allowance would be charged against our net income for the period in which that valuation allowance is established, which could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

We operate in a heavily state regulated industry, and the prospect exists for further federal involvement in the regulation of insurance companies.

Our business is regulated by government agencies in the states in which we do business, and we must comply with a number of state and federal laws and regulations. Most insurance regulations are intended to protect the interests of current and potential policyholders and customers rather than those of stockholders and other investors in insurance services companies.

State laws and regulations that apply to us include those governing the financial condition of insurers, including standards of solvency, risk-based capital requirements, types, quality and concentration of investments, establishment and maintenance of reserves, required methods of accounting, reinsurance and requirements of capital adequacy, and those

 

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governing the business conduct of insurers, including transactions with affiliates, sales and marketing practices, claim procedures and practices, and policy form content. In addition, state insurance laws require licensing of insurers and their agents. State insurance regulators have the power to grant, suspend and revoke licenses to transact business and to impose substantial fines and other penalties.

We may be unable to comply fully with the wide variety of applicable laws and regulations that are frequently undergoing revision. In addition, we follow practices based on our interpretations of laws and regulations that we believe are generally followed by the insurance industry. These practices may be different from interpretations of insurance regulatory agencies. Moreover, in order to enforce applicable laws and regulations or to protect policyholders, insurance regulatory agencies have relatively broad discretion to impose a variety of sanctions, including examinations, corrective orders, suspension, revocation or denial of licenses and the takeover of insurance companies. As a result, if we fail to comply with these laws and regulations, state insurance departments can exercise a range of remedies from the imposition of fines to placing the Company in rehabilitation or liquidation. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. Changes in the level of regulation of the insurance industry or changes in laws or regulations or interpretations of laws and regulations by regulatory authorities could adversely affect our ability to operate our business.

We are subject to various accounting and financial requirements established by the National Association of Insurance Commissioners (“NAIC”) as adopted by the states in which we operate. In addition, state regulators and the NAIC continually re-examine existing laws and regulations, with an emphasis on insurance company solvency issues and fair treatment of policyholders. Insurance laws and regulations could change or additional restrictions could be imposed that are more burdensome. Because these laws and regulations are for the protection of policyholders, any changes may not be in your best interest as a stockholder.

Currently, the U.S. federal government does not directly regulate the insurance business. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) established a Federal Insurance Office (“FIO”) within the Department of the Treasury. The FIO initially is charged with monitoring all aspects of the insurance industry (other than health insurance, certain long-term care insurance and crop insurance), gathering data, and conducting a study on methods to modernize and improve the insurance regulatory system in the United States. On December 12, 2013, the FIO issued a report entitled “How to Modernize and Improve the System of Insurance Regulation in the United States” (the “Report”), which stated that, given the “uneven” progress the states have made with several near-term state reforms, should the states fail to accomplish the necessary modernization reforms in the near term, “Congress should strongly consider direct federal involvement.” The FIO continues to support the current state-based regulatory regime, but will consider federal regulation should the states fail to take steps to greater uniformity (e.g., federal licensing of insurers). Each year the FIO also releases an annual report on the insurance industry (“Annual Report”), with its latest Annual Report dated September 2018. The Annual Report provided a set of recommendations along with providing an overview of the financial performance and condition of the U.S. insurance industry and outlining a number of insurance industry and regulatory developments from the past year. We cannot predict what impact, if any, this guidance or any new legislation would have on our business, financial condition and results of operations.

In addition, federal legislation and administrative policies in several areas can significantly and adversely affect the insurance industry. These areas include financial services regulation, securities regulation, pension regulation, privacy, tort reform legislation and taxation. Compliance with applicable laws and regulations is time consuming and personnel-intensive, and changes in these laws and regulations may materially impact our business and increase our direct and indirect compliance and other expenses of doing business, thus having a material and adverse effect on our business, financial condition, results of operations, and prospects.

The life insurance industry in which we operate is highly competitive, which may limit our ability to maintain and increase our market share of our target market.

Competition in the life insurance industry is based on many factors. These factors include the perceived financial strength of the insurer, premiums charged, policy terms and conditions, services provided, reputation, financial ratings assigned by independent rating agencies and the experience of the insurer in the line of insurance to be written.

In our insurance segment, certain of the insurance companies we compete against have substantially greater financial, technical and operating resources than we have. Many of the lines of insurance we write are subject to significant price competition. In addition, there are many competitors that participate in the non-medically underwritten segment of the life

 

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insurance industry. As new competitors enter the non-medically underwritten market using predictive analytics, they may price aggressively to capture market share. If our competitors price their products aggressively, our ability to grow or renew our business may be adversely affected. We pay producers on a commission basis to produce business. Some of our competitors may offer higher commissions or offer insurance products at lower premium rates. Increased competition could adversely affect our ability to attract and retain business and thereby adversely affect our business, financial condition or results of operations.

In our agency segment, we compete for access to talented sales representatives and for quality sales prospects, or leads. Much of the competition for talent involves agent recruitment. Efinancial’s competitors include SelectQuote, AIG Direct, and Health I.Q. among others. Certain of our competitors in the direct distribution call center industry have been in business longer than Efinancial and are more established and have greater resources to hire insurance agents and develop new technologies. Also, agents choose to work through agencies based on a number of factors including marketing service and support, technology tools, the insurance company that the agency represents, sales commission structure, and the number and quality of sales leads. If our competitors provide the agents with better technology, pay higher commissions or provide access to insurance companies and products that are perceived to be better than those we can provide, our ability to attract and retain agents may be reduced, which could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

Recently enacted U.S. tax legislation may adversely affect our business, results of operations, financial condition and cash flow.

On December 22, 2017, the President signed into law Public Law No. 115-97, a comprehensive tax reform bill commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) that significantly reforms the Internal Revenue Code of 1986, as amended (the “Code”). The Tax Act, among other things, contains significant changes to corporate taxation, including a permanent reduction of the corporate income tax rate, a partial limitation on the deductibility of business interest expense, limitation of the deduction for certain net operating losses to 80% of current year taxable income, elimination of net operating loss carrybacks, an indefinite net operating loss carryforward, immediate deductions for certain new investments instead of deductions for depreciation expense over time, and the modification or repeal of many business deductions and credits. The Tax Act is complex and far-reaching. There may be material adverse effects resulting from the Tax Act that could have an adverse effect on our business, results of operations, financial condition and cash flow.

We expect that our ability to use beneficial U.S. tax attributes will be subject to limitations.

Section 382 of the Code operates as an anti-abuse rule, the general purpose of which is to prevent trafficking in tax losses, but which can apply without regard to whether a “loss trafficking” transaction occurs or is intended. Similar rules apply to capital loss carryforwards. Broadly, these rules are triggered when an “ownership change”—generally defined as when the ownership of a company, or its parent, changes by more than 50% (measured by value) on a cumulative basis in any three-year period—occurs and the company is a “loss” corporation. A company is a loss corporation if, at the date of the ownership change, the company has a tax loss carryforward which may be used in a tax year after the ownership change (“pre-change loss”). The Company meets the definition of a loss corporation.

When applicable, the amount of the taxable income for any post-change year which may be offset by a pre-change loss is subject to an annual limitation. Any portion of an annual limitation not used in one year, may be carried over to a subsequent year. Generally, the annual limitation is derived by multiplying the fair market value of the stock of the taxpayer immediately before the date of the ownership change by the applicable federal long-term tax-exempt rate. In addition, to the extent that a company has a net unrealized built-in loss or deduction at the time of an ownership change, Section 382 of the Code limits the utilization of any such loss or deduction which is realized and recognized during the 5-year period following the ownership change. Following the completion of this offering, we expect that these limitations would apply, which could substantially limit our ability to utilize our net operating loss carryforwards.

The Tax Act’s limitation of the deduction for net operating losses to 80% of current year taxable income and its elimination of the deduction for net operating loss carrybacks could further limit our ability to use net operating losses to offset future U.S. federal income.

 

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Risks Relating to our Agency Segment

Our agency segment is focused primarily on a single distribution method – direct sales through call centers. Many Middle Market consumers prefer alternative ways of purchasing insurance, which could have a material adverse effect on our ability to effectively penetrate our target Middle Market.

The vast majority of Efinancial’s sales are made through its call center distribution channel. Our agency segment does not currently actively engage in significant sales activity through other means of distribution, such as over the internet or in person. Market research indicates that many Middle Market consumers prefer to purchase insurance in person rather than over the phone. As a result, our reliance on telephonic sales could adversely affect our results of operations. Additionally, our ability to successfully convert telephonic sales leads to actual sales could be negatively impacted to the extent that competitors enter the Middle Market using other sales methods that are preferred by consumers.

Our agency segment is dependent on having a large quantity of quality insurance sales leads to support our sales of insurance policies and, if we are unable to obtain these insurance sales leads in a cost-effective manner, our business will be adversely affected.

Our retail call center operations require access to a large quantity of quality insurance sales leads to keep our retail call center agents productive. We are dependent upon a limited number of lead suppliers from whom we obtain leads to support our sales of insurance policies. For the three months ended March 31, 2019, approximately 58% of our applications came from leads that were sourced from our top four lead suppliers. The loss of one or more of these lead suppliers could significantly limit our ability to access our target market for selling our policies.

Our business is dependent on our ability to successfully convert sales leads to actual sales of insurance policies. If our conversion rate does not meet expectations, our business may be adversely affected.

Obtaining quality insurance sales leads is very important to our business, but our ability to convert our leads to in-force policies is also a key to our success. Many factors impact our conversion rate, including the quality of our leads and agents. If lead quality diminishes, our conversion rates will be adversely affected. Competition in the marketplace also impacts conversion rates. If competition for Middle Market consumers increases, our conversion rates may decline, even absent a degradation in lead quality. Conversion rates are also positively impacted by tenured, well-trained sales agents. If agent turnover increases, leading to a decline in average tenure, conversion rates may be adversely impacted. Finally, if we are unable to recruit, train and retain talented agents, our ability to successfully convert sales leads may be adversely impacted. Any adverse impact on our conversion rate could cause a material and adverse effect on our business, financial condition, results of operations, and prospects.

If we are unable to hire, develop and retain well-qualified individuals to staff our retail call centers, the growth of our agency segment will be adversely affected.

Our business depends on our ability to hire, develop and retain qualified employees. Our ability to grow and expand our agency business depends on our being able to hire, develop and retain sufficient numbers of employees to staff our retail call center operations. Our success in recruiting individuals to become licensed insurance agents to staff our retail call centers can depend on factors outside of our control. These factors include the general economy and the strength of the local employment markets, including the availability of alternative forms of employment. The call center work environment is challenging and demanding. Agent turnover is a significant issue we face in our call centers, particularly among less tenured agents and agents in training. Our turnover rates can fluctuate for several reasons, including the quality of the agents we are able to recruit and train, which is impacted by the factors discussed above. In periods when we are unable to recruit agents who perform well in our call centers, we tend to experience higher turnover rates. The productivity of our retail call center agents is influenced by their average tenure at our retail call centers. Without qualified individuals to serve in our consumer facing roles, our agency segment may produce less commission revenue, which could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

Efinancial relies on third party insurance companies in addition to Fidelity Life to provide insurance products for sale to our customers. The termination of our relationship with a third party carrier could adversely affect our business.

Our agency segment also generates revenue from the sale of insurance products issued by unaffiliated insurance companies, or carriers. For the three months ended March 31, 2019, Efinancial derived approximately 85% of its commission revenue from Fidelity Life and approximately 15% from all other sources. We typically enter into contractual agency relationships with carriers that are non-exclusive and terminable on short notice by either party for any reason. Carriers may be unwilling to allow us to sell their existing or new insurance products for a variety of reasons, including for regulatory

 

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reasons, as a result of a reluctance to distribute their products through call centers or because they do not want to be associated with our brand. In addition, it is possible that Efinancial’s relationships with the carriers it serves could be adversely affected by Efinancial’s affiliation with Fidelity Life, which competes with many of these carriers. The termination of our relationship with a carrier could reduce the variety of insurance products we offer, which could harm our business. We would also lose a source of commissions for future sales or incur additional costs to implement arrangements with other carriers to replace the commission revenue from the terminated carrier. Our business could also be harmed if in the future we fail to develop new carrier relationships and are unable to offer consumers a wide variety of insurance products. Any decline in commission revenue would adversely impact our business and the loss of any of our carriers that account for a significant portion of our commission revenues could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

We are subject to extensive regulation regarding telephone and email solicitation, which could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.

Federal and state laws and regulations in the jurisdictions in which we conduct business govern personal privacy, telephone and email solicitations and data privacy. From time to time we are subject to actions brought under these statutes. Future rules and laws may require us to modify our operations or service offerings, and these regulations may limit our activities or significantly increase the cost of regulatory compliance, which could adversely affect our results of operations.

There are numerous state statutes and regulations governing phone and email solicitation activities that apply or may apply to us. For example, some states place restrictions on the methods and timing of telephone solicitation calls and require that certain mandatory disclosures be made during the course of a call. We specifically train our retail call center sales agents to handle calls in an approved manner, and such compliance training is costly and time consuming.

Any failure on our part to comply with the legal requirements applicable to companies engaged in phone or email solicitation activities could result in our being subject to regulatory action or litigation. The possibility for significant regulatory fines, penalties, damages or restrictions imposed by regulatory agencies or by private plaintiffs in litigation could have a material and adverse effect on our business, financial condition, results of operations, and prospects. See “Business—Regulation.”

If we are not able to continue to generate insurance lead sales revenue from our eCoverage web properties, our marketing costs will increase, which will adversely affect the results of our agency segment.

Efinancial’s marketing expenses are a significant part of our total cost of doing business. To reduce our customer acquisition costs, we contract with third party marketers who contact consumers, some of whom will click through to one of eCoverage’s landing pages. We are able to generate insurance lead sales revenue when those leads click through to our landing pages to access information about life insurance options. For the three months ended March 31, 2019, the three months ended March 31, 2018, and the year ended December 31, 2018, we generated $1.2 million, $1.7 million and $6.2 million from insurance lead sales revenue, respectively. We rely on insurance lead sales revenue to reduce our overall marketing expenses.

Risks Relating to our Insurance Segment

The actual experience of our insurance products can differ from the assumptions used to develop and price our insurance products, which can cause us to experience losses from these products.

To develop our insurance products we make assumptions regarding policy persistency, mortality and other benefit experience, the level of investment income that will be earned from investing the product cash flows, and our expenses to underwrite, sell and service the policies. Additionally, we make assumptions about the characteristics of our insureds, including age, sex, underwriting class and coverage amounts purchased. These assumptions, along with our anticipated profit levels, are used to develop the premiums that we will charge customers for our products. In many cases, these premium rates are level and cannot be raised during the initial term of the policy. Our operating results may be materially adversely impacted by variances between our pricing assumptions and our actual experience.

Our key product pricing assumptions are based on a combination of industry studies and other third party data as well as our own experience. We regularly monitor our experience and can adjust premium rates on new business sales should the actual results indicate trends or results that we believe need to be reflected. Many of the insurance products that we offer, such as our RAPIDecision® Life and other quick-issue products, are based on or contain innovative product features that we believe provide market advantages. For certain of these innovations the available industry experience may not be applicable

 

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or may require higher levels of judgment to develop our premium rates. For example, the RAPIDecision® underwriting process can be completed in a single session and without a medical exam (including approval of all-cause coverage for the full policy amount for our RAPIDecision® policies for qualified customers). These features can make the underwriting process less reliable and subject to greater variance than products underwritten through processes with more established industry experience. If the actual product experience for any of these areas varies adversely from the assumptions used to price our products, it could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

Our non-medically underwritten insurance products focused on the Middle Market are subject to a higher risk of lapse than more traditional life insurance products, which could have an adverse effect on our insurance segment.

A significant portion of the life insurance policies that we issue are non-medically underwritten, including our RAPIDecision® product line. In our experience, policies of this type have a higher lapse rate than more traditional life insurance products. We believe this higher lapse rate can be attributed to, among other factors, the following:

 

   

the lack of an investment component in term life insurance products compared with whole life policies;

 

   

higher premium rates than medically underwritten coverage alternatives;

 

   

the greater sensitivity of Middle Market consumers to the cost of life insurance in a challenging economic environment compared with more affluent consumers; and

 

   

the purchase of a non-medically underwritten product is more likely to be an impulsive purchase than the purchase of a fully medically underwritten product.

While the risk of higher lapse rates is contemplated in our product pricing, if actual policy lapse rates exceed the lapse rates assumed in pricing our products, we will experience an accelerated write-off of our deferred acquisition costs and lower premium revenues, which could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

Because our acquisition costs for writing a policy exceed the premiums we receive in the first policy year, the early lapse or termination of a policy may cause us to suffer a loss on that policy.

The amount of commission, underwriting and issue costs payable upon the sale of a life insurance policy exceed the amount of premiums receivable during the first policy year or longer. As a result, our sale of a new policy generally results in our incurring a loss on that policy until we have received enough premium payments to offset our policy acquisition expenses. Because of high front-loaded commissions and other expenses, it can take several years for new policies to become profitable. If a policy terminates or lapses before we are able to recover our costs for producing that policy, we will incur a loss on that policy. For example, we have in the past experienced higher lapse rates than expected on certain products, which caused us to incur losses on the policies that lapsed. If we experience higher than expected lapse rates, there could be a material and adverse effect on our business, financial condition, results of operations, and prospects.

We perform annual testing for premium deficiencies on our blocks of business, the results of which could require us to write down deferred acquisition cost balances or increase reserves.

For traditional life business, a premium deficiency can exist if the discounted present value of future premiums plus the current reserve, reduced by unamortized acquisition expenses, is not sufficient to cover the present value of anticipated future claims and related settlement and maintenance costs. When a premium deficiency is indicated we will write down any deferred acquisition cost balance to the point where the premium deficiency is eliminated. If the deferred acquisition cost is fully written down but the premium deficiency is not eliminated, we will record additional reserves on that block of policies. If we experience significant premium deficiencies, there could be a material and adverse effect on our business, financial condition, results of operations, and prospects.

Our investment performance may suffer as a result of adverse capital market developments, which may adversely affect our financial results and ability to conduct business.

We allocate a portion of the insurance premiums we receive from policyholders to fund reserves, which are invested until these amounts are needed to pay insured claims. We invest excess corporate cash in various short term and other investments to earn incremental income. As of March 31, 2019, we held investments with an estimated fair value of $371.2 million and had net investment income of $3.8 million for the three months then ended.

 

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Our investments are subject to a variety of risks that are outside of our control, including risks relating to general economic conditions, market volatility, the extended low interest environment that currently exists, interest rate fluctuations, liquidity risk and credit risk. For example, an unexpected increase in the number or level of benefits incurred with claims may force us to liquidate securities in order to pay such claims. If the duration of our investments does not match our need for liquidity, we may be forced to liquidate investments prior to maturity at a significant loss to cover such payments. Investment losses could significantly decrease our asset base and capital position, thereby adversely affecting our ability to conduct business.

In the current economic environment, we are experiencing interest rates that have remained at near historically low levels across all fixed income investment markets. The effective yield rate of our fixed income investments has declined as currently available interest rates on investments purchased are lower than the rates on our maturing investments. Low current interest rates have resulted in unrealized holding gains recorded as “Other Comprehensive Income.” However, if interest rates were to rise, it is possible that the market value of the securities and other investments we hold may decline, negatively affecting our earnings and capital level through realized and unrealized investment losses. In that event we could experience increased surrender of direct and assumed annuities, which we would have to fund through the sales of securities, possibly at a loss. If market interest rates remain at low levels our investment returns will continue to decline and our investment earnings will be reduced. This could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

Some of our investments are relatively illiquid and are in asset classes that have been experiencing significant market valuation fluctuations.

We hold certain assets that lack liquidity, such as privately placed fixed income securities, commercial mortgage loans, policy loans and limited partnership interests. These asset classes represented 16% of the carrying value of our total cash and invested assets as of March 31, 2019. If we require significant amounts of cash on short notice in excess of normal cash requirements, we may have difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both.

The reported fair values of our relatively illiquid types of investments do not necessarily reflect the current market price for the asset. If we were forced to sell certain of our assets in the current market, there can be no assurance that we would be able to sell them for the prices at which we have recorded them and we might be forced to sell them at significantly lower prices.

If we are unable to enter into reinsurance transactions on a cost-effective basis, our insurance segment will be less profitable and subject to greater risk and we may be unable to expand our business because of capital limitations.

We rely on the availability of reinsurance to manage the risks of our insurance products and to manage the level of capital required to write new business. Reinsurance is the practice of transferring part of an insurance company’s liability under an insurance policy and the premium associated with that insurance policy to another insurance company. We enter into reinsurance contracts to limit and manage the amount of risk we retain relating to the insurance policies we issue. This reduction in risk is intended to reduce volatility in year to year operating results. For example, we limit our retention of exposure on any one life under any insurance policy or policies we issue to a maximum of $300,000. Our ability to write policies in excess of this amount is therefore typically dependent on the availability of reinsurance for the excess amount of the issued policy at commercially reasonable rates. We also use reinsurance to manage the level of capital required to write new business.

The availability and cost of reinsurance are subject to current market conditions and our experience and may vary significantly over time. Any decrease in the amount of reinsurance available will increase the amount of loss that we retain and could decrease our regulatory capital position. We currently rely on our reinsurance arrangements with Hannover and Swiss Re to continue to write our new business. Should either or both of those reinsurers cease to reinsure our business, or should we be unable to obtain replacement reinsurance or otherwise be unable to obtain reinsurance coverage in desired amounts, our inability to obtain such reinsurance could increase the amount of risk that we retain, expose our financial results to more year to year variability and limit the amount of new business that we can write. If the cost of reinsurance coverage increases, we may charge higher premiums, and that could reduce future sales. Alternatively, we may decide to absorb all or a part of the increased reinsurance costs, which could have a material and adverse effect on our business, financial condition, results of operations, and prospects. See also “—A significant decline in Fidelity Life’s risk-based capital could limit its ability to write new business.”

 

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Should any of our reinsurers fail to meet their contractual commitments to us, our financial condition and results of operations could be adversely affected.

The reinsurance contracts that we enter into to help manage our risks require us to pay premiums to the reinsurance carriers who will in turn reimburse us for a portion of covered policy claims. In many cases, a reinsurer will be called upon to reimburse us for policy claims many years after we paid insurance premiums to the insurer. We remain liable to each of our policyholders for their claims, and we rely on our reinsurers to reimburse us for that portion of a claim for which it is responsible. Accordingly, we are subject to loss and credit risk if our reinsurers are not capable of fulfilling their financial obligations to us. We purchase reinsurance coverage from a number of reinsurers. We do not have any in-force reinsurance agreements which are open to new business with companies that have an A.M. Best financial rating lower than “A-” (Excellent), which is the fourth highest of fifteen ratings.

The reinsurance contracts covering our life insurance policies are long term contracts mirroring the term of the underlying life insurance contracts. During the contract term, the financial position of our reinsurers can deteriorate and our reinsurers could become insolvent or otherwise not be able to reimburse us for ceded claims. Should the financial condition of a reinsurer to which we have ceded premiums deteriorate, it may be unable to reimburse us for losses under its contractual obligations to us. This could materially adversely affect our results of operations and financial condition. As of March 31, 2019, we had reinsurance recoverables of $139.8 million.

A significant decline in Fidelity Life’s risk-based capital could limit its ability to write new business.

Illinois imposes the risk-based capital requirements developed by the National Association of Insurance Commissioners (“NAIC”) that require insurance companies to calculate and report information under a risk-based capital formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in an insurance company’s mix of products and investment portfolio.

Fidelity Life’s statutory capital and surplus has declined as we continue to sell new insurance policies each year. Because the amount of commission, underwriting and issue costs payable upon the sale of a life insurance policy exceed the amount of premiums receivable during the first policy year, it can take several years for new policies to become profitable. In addition, mandated statutory policy reserve methods, including the model regulation entitled “Valuation of Life Insurance Policies” commonly known as “Regulation XXX”, require that we increase our reserves over the first several years of the policy term. Should statutory capital and surplus continue to decline relative to risk-based capital, we may have to slow the rate of new sales or enter into additional reinsurance arrangements, both steps that could reduce our ability to generate future profits.

To reduce the future impact on regulatory capital from Regulation XXX and help stabilize our regulatory capital position in light of anticipated sales increases, we entered into a reserve financing agreement with Hannover Re effective July 1, 2013, which was amended and restated as of July 1, 2016. As of March 31, 2019, the reserve credit under this arrangement was approximately $90.0 million. If an insurance regulator were to determine that this agreement did not comply with applicable regulatory requirements, we could lose all or a portion of the reserve credit under this agreement. In that event, our regulatory capital would be significantly reduced and we may be unable to continue writing new business at our anticipated rate.

The failure of Fidelity Life to meet its applicable risk-based capital requirements or minimum capital and surplus requirements, including the effects of Regulation XXX, could also subject it to further examination or corrective action imposed by insurance regulators, including limitations on its ability to write additional business, supervision by regulators or seizure or liquidation. Any corrective action imposed could have a material adverse effect on our business, results of operations and financial condition. A decline in risk-based capital ratios could also limit the ability of Fidelity Life to make dividends or distributions to us, and could be a factor in causing A.M. Best to downgrade Fidelity Life’s financial strength rating, which could have a material and adverse effect on our business, financial condition, results of operations, and prospects. See “Business—Regulation—Risk-Based Capital (RBC) Requirements.”

A significant decline in Fidelity Life’s statutory earnings could limit its ability to write new business.

Fidelity Life’s plans call for significant growth in a capital-intensive business. Over time, this will result in statutory operating losses, which on a sustained basis may need to be addressed by limiting growth or changing product mix, and could be a factor in causing A.M. Best to downgrade Fidelity Life’s financial strength rating. If we have to limit our writing of new business, it could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

 

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A downgrade in Fidelity Life’s A.M. Best rating could affect our ability to write new business or could limit the sale of our insurance products in certain distribution channels.

Fidelity Life has been assigned a financial strength rating of “A-” (Excellent) by A.M. Best, an independent rating agency that specializes in ratings for the insurance industry. The financial strength rating assigned by A.M. Best to Fidelity Life is subject to periodic review and may be upgraded or downgraded by A.M. Best as a result of changes in the views of the rating agency or positive or adverse developments in Fidelity Life’s business. A.M. Best ratings are based in part upon statutory accounting reports submitted to the NAIC and all states in which we do business. If A.M. Best were to downgrade the financial strength rating assigned to Fidelity Life, it could limit our ability to write certain types of insurance or participate with certain distribution groups or consumers. As a result, we could experience a decline in premiums written that could have a material and adverse effect on our business, financial condition, results of operations, and prospects.

We are reliant on third party service providers to conduct our insurance business. If the availability and quality of the services provided by these parties becomes compromised, our operations could be adversely affected.

Fidelity Life uses third parties to provide a number of administrative services related to our insurance segment. These third party services include all administration of in-force policies (including premium billing, commission payment, and claims payment), management of our investment portfolios, payroll processing and payroll tax payments, tax return preparation and administration of reinsurance contracts. We also outsource most of the underwriting of individual insurance policies. The use of third party services provides cost advantages and allows us to access specialized resources on a variable cost basis.

The use of third party service providers requires a high level of oversight by management. Use of third parties makes us dependent on the availability and the quality of these services. We do not currently have the internal capability to perform many of the services. There is no assurance that these key service providers will stay in business or will maintain acceptable service levels, due to circumstances beyond our control or changes in the management or priorities of these third party service providers.

Risks Relating to this Offering

The sale of a minimum of 14,875,000 shares is necessary to complete the conversion and the offerings and does not indicate that sales have been made to investors who have no financial or other interest in the offering, and the sale of the minimum number of shares should not be viewed as an indication of the merits of the offering.

The standby purchaser has agreed to purchase such number of shares in the standby offering as will result in at least the minimum number of shares being sold in the offerings. Accordingly, the sale of the minimum number of shares necessary to complete this offering does not indicate that sales have been made to investors who have no financial or other interest in the offerings, and the sale of the minimum number of shares should not be viewed as an indication of the merits of this offering.

The Internal Revenue Service may disagree with our position that the subscription rights have no value, and therefore eligible members may be deemed to have taxable income equal to the fair market value of the subscription rights granted to them in excess of any tax basis in the membership rights exchanged for such subscription rights.

Generally, the U.S. federal income tax consequences of the receipt, exercise, and expiration of subscription rights are uncertain. We intend to take the position that, for U.S. federal income tax purposes, eligible members will be treated as transferring their membership interests in Members Mutual Holding Company in exchange for subscription rights to purchase Vericity common stock. Any gain realized by an eligible member as a result of the receipt of a subscription right that is determined to have ascertainable fair market value on the date of the deemed exchange must be recognized and included in the eligible member’s gross income for federal income tax purposes, whether or not the subscription right is exercised.

Boenning & Scattergood, Inc., which we have engaged to provide us with a valuation of the consolidated pro forma market value of Members Mutual, has advised us that it believes the subscription rights will not have any fair market value. Boenning & Scattergood, Inc. has noted that the subscription rights will be granted at no cost to recipients, will be nontransferable, nonnegotiable and of short duration, and will provide the recipient with the right only to purchase shares of our common stock at a price that is equal to the estimated pro forma market value of the Company, which will be the same price at which any unsubscribed shares will be sold to the standby purchaser. Nevertheless, Boenning & Scattergood, Inc. cannot assure us that the Internal Revenue Service will not challenge its determination that the subscription rights will not have any fair market value or that such challenge, if made, would not be successful. If the subscription rights do have value,

 

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we note that there also exists uncertainty regarding the determination of the number of subscription rights deemed issued to each eligible member because such calculation depends on the number of eligible members who ultimately exercise subscription rights, how many subscription rights each eligible member exercises and how much the eligible members’ subscription rights may be cut back in the event of an oversubscription. You should consult your tax advisors with respect to the potential tax consequences to you of the receipt, exercise and expiration of subscription rights. For more information see “Federal Income Tax Considerations—Tax Consequences of Subscription Rights.”

The broad valuation range of the subscription offering and the rights of the standby purchaser make your percentage ownership of Vericity uncertain.

The number of shares offered in the subscription offering is based on Boenning & Scattergood, Inc.’s valuation of the consolidated pro forma market value of Members Mutual. Boenning & Scattergood, Inc. has determined that, as of April 11, 2018, the estimated consolidated pro forma market value of Members Mutual is $175 million, and the range of value of the total number of shares of Vericity common stock to be issued in the offering is between $148.8 million and $201.3 million.

There is a difference of approximately $52.5 million between the minimum and maximum of the offering range. The aggregate dollar value of the shares sold in the subscription offering must be within this estimated valuation range. As a result, the percentage interest in Vericity that a purchaser of shares in this offering will have is greater if 14,875,000 shares are sold than if 20,125,000 shares are sold.

The amount of the net proceeds from the offerings is uncertain, and we will have broad discretion over the use of the net proceeds from the offerings.

The amount of proceeds from the sale of common stock in the offerings will depend on the total number of shares actually sold in the subscription offering, the community offering and the standby offering, for which a higher commission percentage is applicable. As a result, the net proceeds from the sale of common stock cannot be determined until this offering is completed. However, because of the standby purchaser’s commitment, we expect to receive net proceeds of at least $135.5 million. See “Use of Proceeds.”

Risks Relating to Ownership of Our Common Stock

Upon completion of the offerings, we may be a “controlled company” within the meaning of Nasdaq Stock Market (“Nasdaq”) rules, and as a result, would qualify for, and rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.

If the standby purchaser acquires a majority of the shares of our common stock in the standby offering, the standby purchaser will control a majority of the voting power of our outstanding common stock and will hold a controlling interest in us. As a result, we would qualify as a “controlled company” within the meaning of the corporate governance rules of Nasdaq. “Controlled companies” under those rules are companies of which more than 50% of the voting power is held by an individual, a group or another company. If we become a “controlled company” upon the completion of the offerings, we will avail ourselves of the “controlled company” exception under the Nasdaq rules, in which event we will not be required not to comply with certain corporate governance requirements, including:

 

   

the requirement that a majority of our board of directors consist of independent directors;

 

   

the requirement that we have a nominating and corporate governance committee that is composed entirely of independent Directors, or otherwise have director nominees selected by vote of a majority of the independent directors;

 

   

the requirement that we have a compensation committee that is composed entirely of independent directors; and

 

   

the requirement for an annual performance evaluation of the nominating and corporate governance and compensation committees.

If the standby purchaser acquires a majority of our shares in the standby offering and we become a “controlled company,” you will not have the same protections afforded to stockholders of companies that are subject to all of the Nasdaq corporate governance requirements.

 

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We cannot assure you that we will declare a special dividend, or that a special dividend will be beneficial to stockholders if paid; you may owe tax on a special dividend if one is paid, and you will not receive a special dividend if one is declared if you sell your stock prior to the ex-dividend date set with respect to such dividend.

If as a result of the capital needs assessment described elsewhere in this prospectus, management determines that the amount of capital retained at Vericity exceeds the reasonable current and near term projected operating capital needs, management may recommend to the Board that it consider declaration of a special dividend in an amount not to exceed any such excess capital. If a special dividend is declared by the Board, the payment of any special dividend could lead to a decline in our stock price in a per share amount equal to or exceeding the amount of the per share special dividend paid, negatively impacting stockholders’ investments. In addition, distributions with respect to our common stock, including any special dividend, generally will be taxable to the recipient as a dividend to the extent of our accumulated earnings and profits (as determined under U.S. tax principles). Distributions in excess of our earnings and profits will be treated first as a nontaxable return of capital to the extent of your tax basis in our common stock (on a dollar-for-dollar basis) and thereafter as capital gain. Also, if a special dividend is declared, a stockholder who buys shares in the Company on or after the ex-dividend date set with respect to such dividend, or sells its shares prior to the ex-dividend date, will not be eligible to receive such special dividend.

We are an “emerging growth company” and a “smaller reporting company” and we intend to take advantage of reduced disclosure and governance requirements applicable to emerging growth companies and smaller reporting companies, which could result in our common stock being less attractive to investors.

We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, which we refer to as the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. For example:

 

   

We will not be required to comply with the auditor attestation requirement on the effectiveness of our internal control over financial reporting contained in Section 404(b) of the Sarbanes-Oxley Act;

 

   

We will be subject to reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements;

 

   

We will not be required to hold a non-binding advisory vote on executive compensation and golden parachute arrangements not previously approved;

 

   

We will be exempt from certain audit requirements of the Public Company Accounting Oversight Board, unless the SEC determines otherwise; and

 

   

We will take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards, as a result of which our financial statements may not be comparable to those of companies that comply with such new or revised accounting standards.

In addition, based on the maximum number of shares that will be outstanding after the offerings, we will have a public float of less than $250 million and therefore will qualify as a smaller reporting company under the rules of the SEC. As a smaller reporting company we are able to take advantage of reduced disclosure requirements, such as simplified executive compensation disclosures and reduced financial statement disclosure requirements in our SEC filings. Decreased disclosures in our SEC filings due to our status as an emerging growth company or smaller reporting company may make it harder for investors to analyze our company’s results of operations and financial prospects.

We cannot predict if investors will find our common stock less attractive if we rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We may take advantage of the reporting exemptions applicable to emerging growth companies until we are no longer an emerging growth company, which in certain circumstances could be for up to five years. We may take advantage of the reporting exemptions applicable to a smaller reporting company until we are no longer a smaller reporting company, which status would end once we have a public float greater than $250 million. In that event, we could still be a smaller reporting company if our annual revenues were to decline below $100 million and we have a public float of less than $700 million. Shares of our common stock held by our directors, executive officers and other affiliates (which may include the standby purchaser) would not be counted in determining our public float. See “Prospectus Summary—Implications of Being an Emerging Growth Company and Smaller Reporting Company.”

 

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The valuation of our common stock in this offering is not necessarily indicative of the future price of our common stock, and the price of our common stock may decline after this offering.

There can be no assurance that shares of our common stock will be able to be sold in the market at or above the $10.00 per share initial offering price in the future. The final aggregate purchase price of our common stock sold in this offering will be based upon an independent appraisal. The appraisal is not intended, and should not be construed, as a recommendation of any kind as to the advisability of purchasing shares of common stock. The valuation is based on estimates and projections of a number of matters, all of which are subject to change from time to time. See “The Conversion and Offering—The Appraisal” for the factors considered by Boenning & Scattergood, Inc. in determining the appraised value.

The trading price of our common stock may be volatile and subject to wide price fluctuations in response to various factors, including:

 

   

market conditions in the broader stock market in general;

 

   

The standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors and may acquire a majority of the shares sold in the offerings;

 

   

actual or anticipated fluctuations in our quarterly financial and operating results;

 

   

the level of any potential share repurchases and the effect of such repurchases on our per share financial data;

 

   

changes in interest rates;

 

   

departure of key executives;

 

   

introduction of new services or announcements of significant contracts, acquisitions or capital commitments by us or our competitors;

 

   

regulatory or political developments;

 

   

issuance of new or changed securities analysts’ reports or recommendations, or the announcement of any changes to our A.M. Best rating;

 

   

availability of capital;

 

   

litigation and government investigations;

 

   

legislative and regulatory developments;

 

   

future sales of our common stock;

 

   

investor perceptions of us and the life insurance industry; and

 

   

economic conditions.

These and other factors may cause the market price of our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock.

In addition, the stock market has in the past experienced substantial price and volume fluctuations that sometimes have been unrelated or disproportionate to the operating performance of companies. As a result, the trading price of shares of our common stock may be below the initial public offering price, and you may not be able to sell your shares at or above the price you pay to purchase them.

Anti-takeover provisions contained in our amended and restated certificate of incorporation, which we refer to as our charter, and our amended and restated bylaws, which we refer to as our bylaws, as they will be in effect upon completion of this offering, as well as provisions of Delaware and Illinois law, may render more difficult or discourage takeover attempts on Vericity that you may believe are in your best interests or that might result in a substantial profit to you.

The Illinois Insurance Code requires prior approval by the Illinois Department of Insurance for a change of control of an insurance holding company. Under Illinois law, the acquisition of 10% or more of the outstanding voting stock of an insurer or its holding company is presumed to be a change in control. Approval by the Illinois Department of Insurance may be withheld even if the transaction would be in the stockholders’ best interest if the Illinois Department of Insurance determines

 

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that the transaction would be detrimental to policyholders. In addition, for 5 years following the effective date of the conversion, no person or a group of persons acting in concert (other than the standby purchaser) may acquire more than 5% of the capital stock of Vericity in this offering or any other public offering without the approval of the Illinois Department of Insurance.

As a Delaware corporation, we are also subject to provisions of Delaware law, which may impair a takeover attempt that our stockholders may find beneficial. Specifically, we are subject to Section 203 of the General Corporation Law of the State of Delaware (the “DGCL”). Section 203 may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time after such ownership interest is acquired, unless such acquisition was approved by our board of directors. The standby purchaser’s acquisition of more than 15% of our common stock was approved by the board of directors and therefore is not subject to this restriction.

Furthermore, unless we otherwise consent in writing to the selection of an alternative forum, the sole and exclusive forum for any actions asserting claims brought against or on behalf of the Company, including any derivative action, any action for breach of fiduciary duty owed to the Company or the Company’s stockholders, any action arising under the DGCL, our charter or bylaws, or any action governed by the internal affairs doctrine, shall be a state or federal court located within the State of Delaware, in all cases subject to the court having personal jurisdiction over the indispensable parties named as defendants; provided that, the exclusive forum provision will not apply to suits brought to enforce any liability or duty created by the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. We believe these provisions may benefit us by providing increased consistency in the application of Delaware law by chancellors and judges, as applicable, particularly experienced in resolving corporate disputes, efficient administration of cases on a more expedited schedule relative to other forums and protection against the burdens of multi-forum litigation. However, these provisions may have the effect of limiting a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with directors, officers or other employees, and may discourage lawsuits with respect to such claims. The enforceability of similar choice of forum provisions has been challenged in legal proceedings, and it is possible that, in connection with any applicable action brought against us, a court could find the choice of forum provisions contained in our bylaws to be inapplicable or unenforceable in such action.

Additionally, our charter and bylaws contain provisions that could have the effect of rendering more difficult or discouraging a change in control. These provisions:

 

   

contain advance notice procedures with which stockholders must generally comply to nominate candidates to our board or to propose matters to be acted upon at a meeting of stockholders, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us; and

 

   

authorize our board of directors, without stockholder approval, to amend our bylaws, which may allow our board of directors to take additional actions to prevent an unsolicited takeover and inhibit the ability of an acquiror to amend the bylaws to facilitate an unsolicited takeover attempt.

These provisions of our charter and bylaws, alone or together with certain provisions of Illinois law and Delaware law, could serve to entrench management and may discourage a takeover attempt that you may consider to be in your best interest or in which you would receive a substantial premium over the current market price. These provisions may make it extremely difficult for any one person, entity or group of affiliated persons or entities to acquire voting control of Vericity, with the result that it may be extremely difficult to bring about a change in the board of directors or management. Some of these provisions also may perpetuate present management because of the additional time required to cause a change in the control of the board of directors.

The standby purchaser will obtain control over the election of a majority of our board of directors, may not always exercise its control in a way that benefits, and may have interests that differ from, our public stockholders, and if it acquires a majority of our shares, it will be able to approve most corporate actions requiring stockholder approval by written consent.

Under the terms of the standby purchase agreement and our bylaws, upon completion of the offerings, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors, and may acquire a majority of the shares sold in the offerings. If the standby purchaser acquires more than 50% of our outstanding common stock, the standby purchaser generally will be able to determine the outcome of corporate actions requiring stockholder approval. The standby purchaser’s interests may differ from your interests, and therefore actions the standby purchaser takes, as a controlling or significant shareholder, with respect to us, may not be favorable to you. Under the terms of the standby

 

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purchase agreement, the standby purchaser has agreed to take, or not to take, certain actions for certain periods of time following the completion of this offering. See “The Conversion and Offering – Description of the Standby Purchase Agreement—Post-Closing Covenants.”

Our charter and bylaws will not prohibit action by written consent of our stockholders, and therefore any action required or permitted to be taken by our stockholders may be taken by written consent. If the standby purchaser acquires a majority of our shares in the standby offering, the standby purchaser will be able to approve most corporate actions requiring stockholder approval by written consent without a duly-noticed and duly-held meeting of stockholders.

In addition, as permitted by Section 122(17) of the Delaware General Corporation Law, our charter contains provisions renouncing any interest or expectancy of Vericity in, or in being offered an opportunity to participate in, any business opportunities that are presented to one or more of our directors or stockholders who are, at the time, associated with or nominated by, or serving as such as representatives of, the standby purchaser or its affiliates, other than those directors or stockholders who are employees of Vericity or its subsidiaries, unless such opportunity is presented to, acquired, created or developed by, or otherwise comes into the possession of, any such director in such director’s capacity as a director of Vericity.

Our ability to pay dividends will be limited.

Upon completion of this offering, Vericity will be a holding company with no operations of its own. Vericity initially will have no significant source of funds other than the amount of net proceeds of the offerings retained by Vericity and investment earnings thereon, and intercompany dividends from Efinancial and Fidelity Life, if any. Therefore, the payment of dividends by us to stockholders would depend significantly upon the amount of net proceeds of the offerings retained by Vericity that may be available for the declaration of dividends and our receipt of dividends from Efinancial or Fidelity Life. Fidelity Life’s ability to pay dividends to Vericity is subject to limitations under Illinois insurance laws and regulations and under the standby purchase agreement. See “The Conversion and Offering—Description of the Standby Purchase Agreement—Post-Closing Covenants—Standstill Period.” We presently do not intend to pay ordinary cash dividends to our stockholders. See “Dividend Policy.”

The standby stock purchase agreement provides that within six months following the closing of this offering, our board will direct management to undertake and complete a capital needs assessment to project the amount of capital reasonably needed to be maintained at Vericity to support adequate operating capital levels at Fidelity Life and Efinancial. If our management determines that the amount of capital at Vericity is in excess of these needs, our management may recommend to the Vericity board of directors the declaration of a special cash dividend in an amount not to exceed any such excess capital. However, there can be no assurance that our board of directors will declare any dividend. Any decision regarding the declaration or amount of any dividend will be in the sole discretion of the board of directors of Vericity and will depend on many factors, including without limitation the capital needs assessment, general economic and business conditions, Vericity’s financial results and condition, legal and regulatory requirements and any other factors that the Vericity board may deem relevant.

Under the terms of the standby purchase agreement and our bylaws, upon completion of the offerings, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors, and the board will determine the amount and timing of any special dividend, if a special dividend is declared. If the standby purchaser acquires a majority of our shares sold in the offerings, the standby purchaser would receive a majority of the amount of any excess capital distributed to stockholders as a special dividend in proportion to its stock ownership.

There may not be an active, liquid trading market for our common stock.

Prior to the subscription offering, there has been no public market for our common stock. We cannot predict the extent to which an active trading market with adequate liquidity will develop. The liquidity of our common stock will be impacted by the fact that the shares purchased by the directors and officers of Members Mutual and the standby purchaser will be purchased for investment and not for resale. The shares purchased by directors and officers will be subject to lockup periods for one year and the shares purchased by the standby purchaser will be restricted securities and subject to trading limitations under applicable law and the standby purchase agreement. If an active trading market does not develop, you may have difficulty selling any of our common stock that you purchase and the value of your shares may be impaired.

 

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As a public company, we will become subject to additional financial and other reporting and corporate governance requirements, which will require additional expense and management resources.

Upon completion of the offerings, we will become obligated to file with the Securities and Exchange Commission, or SEC, annual and quarterly information and other reports that are specified in Section 13 of the Securities Exchange Act of 1934, or Exchange Act. We will also be required to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. Unless an exemption is available to us as an emerging growth company, we will also become subject to other reporting and corporate governance requirements, including the requirements of Nasdaq and certain provisions of the Sarbanes-Oxley Act of 2002 and the regulations promulgated thereunder, which will impose significant compliance obligations upon us.

These changes will require a significant commitment of additional expense and other resources, and these expenses may increase after we are no longer an emerging growth company as defined in the JOBS Act. We may not be successful in implementing these requirements and implementing them could adversely affect our business or operating results. In addition, if we fail to implement the requirements with respect to our internal accounting and audit functions, our ability to report our operating results on a timely and accurate basis could be impaired and there could be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. Confidence in our financial statements is also likely to suffer if we or our independent registered public accounting firm report a material weakness in our internal control over financial reporting.

We may require additional capital in the future and such additional capital may not be available to us, or only available to us on unfavorable terms.

We plan to increase the number of policies sold through Efinancial as we pursue our strategic plan to further develop our controlled distribution platform and grow our book of business. To the extent that the funds generated by our ongoing operations and capital remaining at Vericity are insufficient to fund future operating requirements, we may need to raise additional funds through financings or curtail our growth. We cannot be sure that we will be able to raise equity or debt financing on terms favorable to us and our stockholders in the amounts that we require, or at all. If we cannot obtain adequate capital, our business, financial condition, results of operations and prospects could be materially and adversely affected.

In addition, the terms of a capital raising transaction could require us to agree to stringent financial and operating covenants and to grant security interests on our assets to lenders or holders of our debt securities that could limit our flexibility in operating our business or our ability to pay dividends on our common stock and could make it more difficult for us to obtain capital in the future.

If we are unable to realize the anticipated benefits of being a public reporting company, we may voluntarily file for deregistration of our common stock with the SEC, which could result in limited publicly available information about the Company and adversely affect the trading market of our common stock.

We expect that compliance with SEC rules and regulations, including the periodic reporting requirements, will cause us to incur significant accounting, legal, and other costs and make some activities more time-consuming and costly. If we are unable to realize the anticipated benefits of being a public company, including the development of an active trading market for our common stock, we may seek to deregister our common stock with the SEC. If we are able and determine to deregister our common stock under the Exchange Act in the future, it would enable us to save significant expenses relating to our public disclosure and reporting requirements under the Exchange Act. However, a deregistration of our common stock would also result in a reduction in the amount and frequency of publically available information about the Company and may further limit the liquidity of our common stock.

Our failure to meet the continued listing requirements of Nasdaq could result in a delisting of our common stock.

If, after listing, we fail to satisfy the continued listing requirements of Nasdaq, Nasdaq may take steps to delist our common stock. Such a delisting would likely have a negative effect on the price of our common stock and would impair your ability to sell or purchase our common stock when you wish to do so. In the event of a delisting, we can provide no assurance that any action taken by us to restore compliance with listing requirements would allow our common stock to become listed again, stabilize the market price or improve the liquidity of our common stock, prevent our common stock from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq’s listing requirements.

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains “forward-looking” statements that are intended to enhance the reader’s ability to assess our future financial and business performance. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and contain words and phrases such as “may,” “expects,” “should,” “believes,” “anticipates,” “estimates,” “intends” or similar expressions. In addition, statements that refer to our future financial performance, anticipated growth and trends in our business and in our industry and other characterizations of future events or circumstances are forward-looking statements. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different.

Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs with respect to, among other things, future events and financial performance. Except as required under the federal securities laws, we do not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of such statements.

The forward-looking statements include, among other things, the factors discussed under “Risk Factors” and those listed below:

 

   

future economic conditions in the markets in which we compete that could be less favorable than expected and could have impacts on demand for our products and services;

 

   

our ability to grow and develop our agency business through expansion of retail call centers, wholesale operations and other areas of opportunity;

 

   

our ability to grow and develop our insurance business and successfully develop and market new products;

 

   

our ability to enter new markets successfully and capitalize on growth opportunities either through acquisitions or organically;

 

   

financial market conditions, including, but not limited to, changes in interest rates and the level and trends of stock market prices causing a reduction of investment income or realized losses and reduction in the value of our investment portfolios;

 

   

increased competition in our businesses, including the potential impacts of aggressive price competition by other insurance companies, payment of higher commissions to agents that could affect demand for our insurance products and impact the ability to grow and retain agents in our agency segment and the entry of new competitors and the development of new products by new or existing competitors, resulting in a reduction in the demand for our products and services;

 

   

the effect of legislative, judicial, economic, demographic and regulatory events in the jurisdictions where we do business;

 

   

the effect of challenges to our patents and other intellectual property;

 

   

costs, availability and collectability of reinsurance;

 

   

the potential impact on our reported net income that could result from the adoption of future accounting standards issued by the Public Company Accounting Oversight Board or the Financial Accounting Standards Board or other standard-setting bodies;

 

   

the inability to maintain or grow our strategic partnerships or our inability to realize the expected benefits from our relationship with the standby purchaser;

 

   

the inability to manage future growth and integration of our operations; and

 

   

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

You should review carefully the section captioned “Risk Factors” in this prospectus for a complete discussion of the material risks of an investment in our common stock.

 

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USE OF PROCEEDS

As required under Illinois law, the plan of conversion requires that the total price of the stock to be issued in the conversion must be equal to the estimated pro forma market value of converted Members Mutual as determined by an independent appraiser, which is $148.8 million at the minimum of the offering range. Accordingly, we must sell shares at an aggregate price at least equal to $148.8 million in the offerings. We estimate the net proceeds from the offerings will be between $135.5 million at the minimum of the offering range and $189.5 million at the maximum of the offering range. See the “Offering Summary” on the front cover of the prospectus for the assumptions used to arrive at these amounts. The amount of net proceeds from the sale of common stock in the offerings will depend on the total number of shares actually sold in the subscription offering, the community offering and the standby offering.

Initially, we plan to retain substantially all of the net proceeds from the offerings at Vericity. The standby stock purchase agreement provides that within six months following the closing of this offering, our board will direct management to undertake and complete a capital needs assessment to project the amount of capital reasonably needed to be maintained at Vericity to support adequate operating capital levels at Fidelity Life and Efinancial. Depending on the results of the assessment, we may allocate a portion of the net proceeds from the offerings to support our insurance and agency businesses, and more particularly to (i) reduce our use of reinsurance to finance growth, while continuing to emphasize risk management; (ii) make investments to strengthen our infrastructure, including our IT platforms; (iii) selectively deploy new capital to acquire and bolster talent in key areas of competency linked to competitive advantage; and (iv) pay amounts due on account of the acceleration of Long-Term Incentive Plan awards (as described below). We expect that any unallocated net proceeds from the offerings will be used for general corporate purposes, including paying holding company expenses, and potentially paying a special cash dividend to our stockholders or repurchasing shares of our common stock. In connection with the approval of the conversion by the Illinois Director of Insurance, we agreed, for a period of twenty-four months following the completion of the offerings, to either maintain $20 million of the proceeds of the offerings at Vericity or use all or a portion of that $20 million to fund our operations.

If as a result of the capital needs assessment, management determines that the amount of capital retained at Vericity exceeds the reasonable current and near term projected operating capital needs, management will determine the amount of excess capital (if any) that may be available for distribution to stockholders and may recommend the declaration of a special dividend to stockholders in an amount not to exceed any such excess capital. The amount of any special dividend would not equal or exceed one hundred percent of the net proceeds. However, there can be no assurance that our board of directors will declare any dividend. Any decision regarding the declaration or amount of any dividend will be in the sole discretion of the board of directors of Vericity and will depend on many factors, including the capital needs assessment, the amount of net proceeds from this offering, general economic and business conditions, Vericity’s financial results and condition, legal and regulatory requirements and any other factors that the Vericity board may deem relevant.

The following table illustrates the effect on the estimated net proceeds available to the Company following the payment of a potential special dividend in the projected amounts as shown below. This table is presented for illustrative purposes only and does not represent a commitment regarding the payment of a special dividend in any amount, including the amounts shown below:

 

     Offering Minimum      Offering Maximum  
     (dollars in millions except share and per share data)  

Projected dividend per share

     $2        $4        $6        $7        $2        $4        $6        $7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Effective pre-tax net investment per share

     $8        $6        $4        $3        $8        $6        $4        $3  

Gross offering proceeds

   $ 148.8      $ 148.8      $ 148.8      $ 148.8      $ 201.3      $ 201.3      $ 201.3      $ 201.3  

Estimated offering expenses

     9.7        9.7        9.7        9.7        9.7        9.7        9.7        9.7  

Estimated commissions

     3.5        3.5        3.5        3.5        2.0        2.0        2.0        2.0  

Estimated dividend payout

     29.8        59.5        89.3        104.1        40.3        80.5        120.8        140.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Estimated net proceeds

   $ 105.8      $ 76.1      $ 46.3      $ 31.5      $ 149.3      $ 109.1      $ 68.8      $ 48.7  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Under the terms of the standby purchase agreement and our bylaws, upon completion of the offerings, the standby purchaser will have the right to designate a majority of the nominees to serve on our board of directors, and the board will determine the amount and timing of any special dividend, if a special dividend is declared. If the standby purchaser acquires a majority of our shares sold in the offerings, the standby purchaser would receive a majority of the amount of any excess capital distributed to stockholders as a special dividend in proportion to its stock ownership.

On a short-term basis, the proceeds retained at Vericity will be initially invested primarily in U.S. government securities, other federal agency securities, and other securities consistent with our investment policy until utilized.

 

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MARKET FOR THE COMMON STOCK

Our common stock has been approved for listing on the NASDAQ Capital Market under the symbol “VERY.”

We have never issued any capital stock to the public. Consequently, there is no established market for our common stock. The development of a public market having the desirable characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of a sufficient number of willing buyers and sellers at any given time. Neither we nor any market maker has any control over the development of such a public market. Although our common stock has been approved for listing on the NASDAQ Capital Market, an active trading market is unlikely to develop. This is, in part, because of the size of the offering and, depending upon how many eligible members subscribe, a majority of our stock may be held by the standby purchaser and our management.

One of the requirements for initial listing of our common stock on the NASDAQ Capital Market is that there are at least three market makers for the common stock. Raymond James and Griffin Financial have indicated that they intend to act as a market maker in our common stock following this offering, but are under no obligation to do so. We cannot assure you that there will be three or more market makers for our common stock. Furthermore, we cannot assure you that you will be able to sell your shares of common stock for a price at or above $10.00 per share, or that final approval for listing on the NASDAQ Capital Market will be available upon completion of the offerings as contemplated.

 

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DIVIDEND POLICY

Following completion of this offering, our board of directors will have the authority to declare dividends on our shares of common stock. We currently do not have any plans to pay ordinary cash dividends to our stockholders. Any decision to pay a dividend will depend on many factors, including our financial condition and results of operations, liquidity requirements, market opportunities, capital requirements of our subsidiaries, legal requirements, dividends from our subsidiaries and other factors as the board of directors deems relevant.

Vericity initially will have no significant source of funds other than the amount of net proceeds of the offerings retained by Vericity, the investment earnings on any net proceeds of the offerings not contributed to Efinancial or Fidelity Life, and intercompany dividends from Efinancial and Fidelity Life, if any. Therefore, the payment of dividends by us to stockholders would depend significantly upon our receipt of dividends from Efinancial or Fidelity Life and the amount of net proceeds of the offerings retained by Vericity that may be available for the declaration of dividends.

Fidelity Life’s ability to pay dividends is subject to restrictions contained in the insurance laws of Illinois, which require that ordinary dividends be reported to the Illinois Department of Insurance prior to payment of the dividend and that extraordinary dividends be submitted for prior approval. An extraordinary dividend is generally defined as a dividend that, together with all other dividends made within the past 12 months, exceeds the greater of 10% of its statutory policyholders’ surplus as of the preceding year end or the statutory net income of the company for the preceding year. Statutory policyholders’ surplus, as determined under statutory accounting principles, or SAP, is the amount remaining after all liabilities, including loss and loss adjustment expenses, are subtracted from all admitted assets. Admitted assets are assets of an insurer prescribed or permitted by a state insurance regulator to be recognized on the statutory balance sheet. Insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no assurance that extraordinary dividend payments will be permitted. As a result of the payment of dividends in the amount of $8.5 million in the last twelve months, Fidelity Life’s remaining ordinary dividend capacity as of March 31, 2019 is $3.7 million. However, under the standby purchase agreement, Fidelity Life has agreed that following the conversion it will not pay any dividends during the standstill period without the consent of a majority of the company designees. See “The Conversion and Offering—Description of the Standby Purchase Agreement—Post-Closing Covenants—Standstill Period.” In connection with the approval of the conversion by the Illinois Director of Insurance, we agreed, for a period of twenty-four months following the completion of the offerings, to seek the prior approval of the Illinois Department of Insurance for any declaration of an ordinary dividend by Fidelity Life.

Capital Needs Assessment; Potential Special Dividend

The standby stock purchase agreement provides that within six months following the closing of this offering, our board will direct management to undertake and complete a capital needs assessment to project the amount of capital reasonably needed to be maintained at Vericity to support adequate operating capital levels at Fidelity Life and Efinancial. If our management determines that the amount of capital at Vericity is in excess of these needs, our management may recommend to the Vericity board of directors the declaration of a special cash dividend in an amount not to exceed any such excess capital. The amount of any special dividend would not equal or exceed one hundred percent of the net proceeds from the offerings. However, there can be no assurance that our board of directors will declare any dividend. Any decision regarding the declaration or amount of any dividend will be in the sole discretion of the board of directors of Vericity and will depend on many factors, including without limitation the capital needs assessment, general economic and business conditions, Vericity’s financial results and condition, legal and regulatory requirements and any other factors that the Vericity board may deem relevant.

 

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CAPITALIZATION

The following table displays information regarding our historical and pro forma capitalization at March 31, 2019, on a consolidated basis. The pro forma information gives effect to the sale of common stock at the minimum of the estimated valuation range of our consolidated pro forma market value, as determined by the independent evaluation of Boenning & Scattergood, Inc., and the maximum of the estimated valuation range. The various capital positions are displayed based upon the assumptions set forth in the “Offering Summary” on the front cover of the prospectus. The total number of shares to be issued in the conversion will range from 14,875,000 shares to 20,125,000 shares. See “Use of Proceeds” and “The Conversion and Offering—Stock Pricing and Number of Shares to be Issued.”

 

            Pro Forma Capitalization
of Vericity, Inc. at
March 31, 2019
 
            (dollars in thousands)  
     Historical
Consolidated
Capitalization
of Members Mutual at
March 31, 2019
     Minimum      Maximum  

Stockholders’ equity:

  

Common Stock, par value $0.001 per share; authorized 30,000,000 shares; shares to be outstanding—as shown

   $ —        $ 15      $ 20  

Additional paid-in capital

     —          135,514        189,521  

Retained earnings

     176,894        176,894        176,894  

Accumulated other comprehensive income (loss), net of tax

     2,330        2,330        2,330  
  

 

 

    

 

 

    

 

 

 

Total stockholders’ equity

   $ 179,224      $ 314,753      $ 368,765  
  

 

 

    

 

 

    

 

 

 

 

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SELECTED FINANCIAL AND OTHER DATA

The following table sets forth selected consolidated financial and other data for Members Mutual prior to this offering. You should read this data in conjunction with our financial statements and accompanying notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this prospectus. The balance sheet data as of March 31, 2019, and the statement of operations data for the three months ended March 31, 2019 and March 31, 2018, are derived from our unaudited condensed consolidated financial statements that are included elsewhere in this prospectus. The balance sheet data as of December 31, 2018 and 2017, and the statement of operations data for the years then ended, are derived from our audited consolidated financial statements that are included elsewhere in this prospectus.

These historical results are not necessarily indicative of future results.

 

     For the Three Months Ended      For the Years Ended
December 31,
 
     March 31,
2019
     March 31,
2018
     2018      2017  
     (dollars in thousands)  

Statement of Operations Data:

           

Life premiums (Direct & Assumed)

   $ 41,061      $ 39,748      $ 163,411      $ 161,855  

Ceded life premiums

     (17,972      (18,735      (74,838      (78,982
  

 

 

    

 

 

    

 

 

    

 

 

 

Net life premiums

     23,089        21,013        88,573        82,873  

Net investment income

     3,820        3,744        15,101        15,119  

Net realized investment gains

     1,048        (561      (967      571  

Earned commissions

     3,746        3,334        13,404        11,514  

Insurance leads and sales

     1,435        2,182        7,633        5,523  

Other income

     55        113        236        270  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 33,193      $ 29,825      $ 123,980      $ 115,870  

Benefits and expenses

           

Life, annuity and health claim benefits

   $ 16,244      $ 13,052      $ 56,556      $ 56,035  

Interest credited to policyholders account balances

     801        922        3,598        3,776  

General operating expenses

     18,907        16,894        68,353        55,912  

Amortization of deferred policy acquisition costs

     3,140        2,825        11,506        10,926  

Other Expenses

     22        41        164        163  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total benefits and expenses

   $ 39,114      $ 33,734      $ 140,177      $ 126,812  
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) before income taxes

     (5,921      (3,909      (16,197    $ (10,942

Income tax (benefit)

     (314      643        (2,350      (2,701
  

 

 

    

 

 

    

 

 

    

 

 

 

Net (loss)

   $ (6,235    $ (3,266    $ (13,847    $ (8,241
  

 

 

    

 

 

    

 

 

    

 

 

 

Segment Information:

           

Revenues

           

Agency

   $ 11,300      $ 12,575      $ 49,893      $ 40,325  

Insurance

     28,035        24,332        103,039        98,923  

Corporate and Other

     82        51        290        210  

Eliminations

     (6,224      (7,133      (29,243      (23,588
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $ 33,193      $ 29,825      $ 123,979      $ 115,870  

Income (loss) before taxes

           

Agency

   $ (1,116    $ 47      $ (759    $ (624

Insurance

     (1,476      (549      (629      2,343  

Corporate and Other

     (1,745      (1,263      (4,765      (4,713

Eliminations

     (1,584      (2,144      (10,044      (7,948
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ (5,921    $ (3,909    $ (16,197    $ (10,942

 

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Table of Contents
     For the Three Months Ended
March 31,
     For the Years End
December 31,
 
     2019      2018      2017  
    

(dollars in thousands)

 

Balance Sheet Data:

        

Total investments

   $ 371,232      $ 368,079      $ 393,060  

Cash and cash equivalents

     13,332        20,984        11,766  

Accrued investment income

     2,592        2,985        3,323  

Reinsurance recoverable

     139,774        136,601        143,915  

Deferred policy acquisition costs

     84,614        84,567        82,319  

Commissions and agent balances

     11,571        1,864        2,034  

Intangible assets

     1,695        1,716        1,880  

Deferred income tax assets

     9,320        10,663        4,925  

Other assets

     28,808        27,511        23,192  
  

 

 

    

 

 

    

 

 

 

Total Assets

   $ 662,938      $ 654,970      $ 666,414  
  

 

 

    

 

 

    

 

 

 

Future policy benefits and claims

   $ 320,316      $ 320,397      $ 302,782  

Policyholder account balances

     91,632        93,051        98,899  

Other policyholder liabilities

     27,862        25,738        36,011  

Policyholder dividend obligations

     10,196        9,383        11,097  

Reinsurance liabilities and payables

     5,192        6,167        7,468  

Long-term debt

     11,814        10,294        —    

Short-term debt

     3,217        3,072        —    

Other liabilities

     13,485        14,678        13,954  
  

 

 

    

 

 

    

 

 

 

Total Liabilities

   $ 483,714      $ 482,780      $ 470,211  

Equity

   $ 179,224      $ 172,190      $ 196,203  
  

 

 

    

 

 

    

 

 

 

Total Liabilities and Equity

   $ 662,938      $ 654,970      $ 666,414  
  

 

 

    

 

 

    

 

 

 

 

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UNAUDITED PRO FORMA FINANCIAL INFORMATION

The following unaudited pro forma condensed balance sheet as of March 31, 2019 gives effect to the conversion and completion of this offering, as if it had occurred as of March 31, 2019. The data is based on the assumption that 14,875,000 shares of common stock (the minimum number of shares required to be sold) are sold in the offerings, with estimated net proceeds from the offerings of $135.5 million. See the “Offering Summary” on the front cover of the prospectus for the assumptions used to arrive at this amount. For information on the impact of transaction sizes above the minimum level, see “—Additional Pro Forma Data.”

The following unaudited pro forma condensed statement of operations for the three months ended March 31, 2019 and the year ended December 31, 2018 present our operating results as if this offering was completed as of January 1, 2019 and January 1, 2018, respectively.

Completion of this offering is conditioned on the sale of a minimum of 14,875,000 shares of common stock in this offering. If the number of shares subscribed for in the subscription offering, together with any subscriptions accepted in the community offering, is less than 14,875,000 shares, and if all of the conditions to the standby purchaser’s purchase commitment have been satisfied, the standby purchaser will be obligated to purchase enough shares in the standby offering to guarantee the sale of the minimum number of shares necessary to complete this offering. In that event, the level of sales to eligible members and directors and officers of Members Mutual will not impact the condition that at least 14,875,000 shares must be sold to complete this offering.

The unaudited pro forma information does not claim to represent what our financial position or results of operations would have been had this offering occurred on the dates indicated. This information is not intended to project our financial position or results of operations for any future date or period. The pro forma adjustments reflect all material adjustments associated with the conversion and are based on available information and certain assumptions that we believe are factually supportable and reasonable under the circumstances. The unaudited pro forma financial information should be read in conjunction with our financial statements, the accompanying notes, and the other financial information included elsewhere in this prospectus.

The pro forma adjustments and pro forma amounts are provided for informational purposes only. Our financial statements will reflect the effects of this offering only from the date it is completed.

 

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Unaudited Pro Forma Condensed Balance Sheet

As of March 31, 2019

 

     MMHC
Historical
Consolidated
     Pro Forma
Adjustments
    Vericity, Inc.
Pro Forma
Consolidated(1)
 
     (dollars in thousands except share and per share data)  

Assets

       

Cash and investments

   $ 384,564      $ 135,529 (2)    $ 520,093  

Commissions & agents’ balance receivable

     11,571        —       11,571  

Deferred policy acquisition costs

     84,614        —       84,614  

Accrued Investment Income

     2,592        —       2,592  

Reinsurance recoverables

     139,774        —       139,774  

Intangible assets, net

     1,695        —       1,695  

Deferred income tax asset, net

     9,320        —       9,320  

Other assets

     28,808        —       28,808  
  

 

 

    

 

 

   

 

 

 

Total assets

   $ 662,938      $ 135,529     $ 798,467  
  

 

 

    

 

 

   

 

 

 

Liabilities & equity

       

Liabilities

       

Policy reserves and liabilities

   $ 455,198        —     $ 455,198  

Debt

     15,031        —         15,031  

Other liabilities

     13,485        —       13,485  
  

 

 

    

 

 

   

 

 

 

Total liabilities

     483,714        —       483,714  

Common stock

     —        15       15  

Additional paid-in capital

     —        135,514 (3)      135,514  

Retained earnings

     176,894        —       176,894  

Accumulated other comprehensive income

     2,330        —       2,330  
  

 

 

    

 

 

   

 

 

 

Total equity

     179,224        135,529       314,753  
  

 

 

    

 

 

   

 

 

 

Total liabilities & equity

   $ 662,938      $ 135,529     $ 798,467  
  

 

 

    

 

 

   

 

 

 

Notes to Unaudited Pro Forma Condensed Balance Sheet

 

1) 

The unaudited pro forma condensed balance sheet, as prepared, gives effect to the sale of the common stock at the minimum of the estimated range of our consolidated pro forma market value, as determined by the independent valuation of Boenning & Scattergood. The unaudited pro forma condensed balance sheet is based on the assumptions set forth in the “Offering Summary” on the front cover of the prospectus.

2) 

Reflects the sale of 14,875,000 shares at $10.00 per share, less estimated conversion and offering expenses and commissions in the amount of $13.2 million.

3) 

Pro forma additional paid in capital represents the net proceeds from the conversion less common stock:

 

Sale of 14,875,000 shares at $10.00 per share

   $ 148,750  

Less:

  

Conversion and offering expenses

     9,696  

Commissions

     3,525  
  

 

 

 

Total

   $ 135,529  
  

 

 

 

Common stock

     15  

Additional paid in capital

   $ 135,514  
  

 

 

 

Total

   $ 135,529  
  

 

 

 

 

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Unaudited Pro Forma Condensed Statement of Operations

March 31, 2019

 

     MMHC
Historical
Consolidated
     Pro Forma
Adjustments
    Vericity, Inc.
Pro Forma
Consolidated
 
     (dollars in thousands except share and per share data)  

Revenues

       

Net insurance premiums

   $ 23,089      $ —       $ 23,089  

Net investment income

     3,820        —   (1)      3,820  

Net realized investment gains

     1,048        —   (1)      1,048  

Earned commissions

     3,746        —         3,746  

Other income

     1,490        —         1,490  
  

 

 

    

 

 

   

 

 

 

Total revenues

     33,193        —         33,193  

Benefits and Expenses

       

Life, annuity and health claim benefits

     16,244        —         16,244  

Interest credited to policyholder account balances

     801        —         801  

General operating expenses

     18,907        —   (2)      18,907  

Amortization of deferred policy acquisition costs

     3,140        —         3,140  

Amortization of intangible assets

     22        —         22  
  

 

 

    

 

 

   

 

 

 

Total benefits and expenses

     39,114        —         39,114  

Loss before income taxes

     (5,921      —         (5,921

Income tax benefit

     314        —         314  
  

 

 

    

 

 

   

 

 

 

Net loss

   $ (6,235    $ —       $ (6,235
  

 

 

    

 

 

   

 

 

 

Loss per share data

       

Basic and diluted loss per common share

        $ (0.42

Weighted average basic and diluted shares outstanding

          14,875,000  

 

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Unaudited Pro Forma Condensed Statement of Operations

December 31, 2018

 

     MMHC
Historical
Consolidated
     Pro Forma
Adjustments
    Vericity, Inc.
Pro Forma
Consolidated
 
     (dollars in thousands except share and per share data)  

Revenues

       

Net insurance premiums

   $ 88,573      $ —       $ 88,573  

Net investment income

     15,101        —   (1)      15,101  

Net realized investment gains

     (967      —   (1)      (967

Earned commissions

     13,404        —         13,404  

Other income

     7,869        —         7,869  
  

 

 

    

 

 

   

 

 

 

Total revenues

     123,980        —         123,980  

Benefits and Expenses

       

Life, annuity and health claim benefits

     56,556        —         56,556  

Interest credited to policyholder account balances

     3,598        —         3,598  

General operating expenses

     68,353        —   (2)      68,353  

Amortization of deferred policy acquisition costs

     11,506        —         11,506  

Amortization of intangible assets

     164        —         164  

Total benefits and expenses

     140,177        —         140,177  
  

 

 

    

 

 

   

 

 

 

Loss before income taxes

     (16,197      —         (16,197

Income tax benefit

     (2,350      —         (2,350
  

 

 

    

 

 

   

 

 

 

Net loss

   $ (13,847    $ —       $ (13,847
  

 

 

    

 

 

   

 

 

 

Loss per share data

       

Basic and diluted loss per common share

        $ (0.93

Weighted average basic and diluted shares outstanding

          14,875,000  

 

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Table of Contents

Notes to Unaudited Pro Forma Condensed Statements of Operations

 

(1)

We anticipate that we would earn approximately $1.0 million and $4.1 million investment income, assuming the net proceeds were received and available for investment as of January 1, 2019 and January 1, 2018, respectively, and that they were invested with an average annual pre-tax rate of return of 3.0%. This income is not included as it is not “factually supportable” as that term is used in the Securities and Exchange Commission’s rules and regulations and therefore no pro forma adjustment of investment income or realized investment gains are reflected.

(2)

No pro forma adjustment of general operating expenses has been made to reflect additional costs that we expect to incur operating as a public company as such amount would not be “factually supportable.”

Additional Pro Forma Data

The actual net proceeds from the sale of our common stock in the offering cannot be determined until the offering is completed. However, the offering net proceeds are currently estimated to be between $135.5 million and $189.5 million, based on the following assumptions:

 

   

Expenses of the conversion and offering will be $9.7 million; and

 

   

Marketing agent commissions will equal $3.5 million at the minimum of the estimated offering range and $2.0 million at the maximum of the offering price.

We have prepared the following table which sets forth our historical net loss and retained earnings prior to the offering and pro forma net loss and shareholders’ equity following the offering. In preparing this table and in calculating the pro forma data, the following assumptions have been made:

 

   

Pro forma earnings have been calculated assuming the stock had been sold at the beginning of the period;

 

   

Pro forma per share amounts have been calculated by dividing historical and pro forma amounts by the indicated number of shares of stock; and

 

   

Pro forma shareholders’ equity amounts have been calculated as if our common stock had been sold in the offering on March 31, 2019, and, accordingly, no effect has been given to the assumed earning effect of the net proceeds from the offering.

The following pro forma information may not be representative of the financial effects of the offering at the date on which the offering actually occurs and should not be taken as indicative of future results of operations. The pro forma shareholders’ equity is not intended to represent the fair market value of the common stock and may be different from amounts that would be available for distribution to shareholders in the event of liquidation.

The following table summarizes historical data and our pro forma data at March 31, 2019, based on the assumptions set forth above and in the table and should not be used as a basis for projection of the market value of the common stock following the completion of the offering.

 

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Table of Contents

At or for the Three Months Ended March 31, 2019

 

     14,875,000
Shares Sold
at $ 10.00
per Share
(Minimum
of Range)
    20,125,000
Shares Sold
At $ 10.00 per
Share
(Maximum
of Range)
 
     (dollars in thousands except
shares and per share data)
 

Pro forma offering proceeds

    

Gross proceeds of public offering

   $ 148,750     $ 201,250  

Less offering expenses and commissions

   $ 13,222     $ 11,709  

Net Proceeds

   $ 135,529     $ 189,541  

Pro forma shareholders’ equity

    

Historical Equity

   $ 179,224     $ 179,224  

Net proceeds

   $ 135,529     $ 189,541  

Pro forma shareholders’ equity

   $ 314,753     $ 368,765  

Pro forma per share data

    

Total shares outstanding after the offering

     14,875,000       20,125,000  

Pro forma book value per share

   $ 21.16     $ 18.32  

Pro forma price-to-book value per share

     47.3     54.6

Pro forma net income

    

Historical net loss

   $ (6,235   $ (6,235 )  

Pro forma loss

   $ (6,235 )     $ (6,235 )  

Weighted average shares outstanding

     14,875,000       20,125,000  

Pro forma loss per share

   $ (0.42   $ (0.31

Computation of Weighted Average Shares Outstanding

    

Total Shares Issued

     14,875,000       20,125,000  

Weighted Average Shares Outstanding

     14,875,000       20,125,000  

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and accompanying notes included elsewhere in this prospectus. Some of the information contained in this discussion and analysis and set forth elsewhere in this prospectus constitutes forward looking information that involves risks and uncertainties. You should review “Forward Looking Statements” and “Risk Factors” for a discussion of important factors that could cause actual results to differ materially from the results described, or implied by, the forward-looking statements contained herein.

Overview

We provide life insurance protection targeted to the middle American market. We believe there is a substantial unmet need for life insurance, particularly among domestic households with annual incomes of between $50,000 and $125,000, a market we refer to as our target Middle Market. We differentiate our product and service offerings through innovative product design and sales processes, with an emphasis on rapidly issued products that are not medically underwritten at the time of sale.

We conduct our business through our two operating subsidiaries, Fidelity Life, an Illinois-domiciled life insurance company, and Efinancial, a call center-based insurance agency. Efinancial sells Fidelity Life products through its own call center distribution platform, independent agents and other marketing organizations. Efinancial, in addition to offering Fidelity Life products, sells insurance products of unaffiliated carriers. We report our operating results in three segments: agency, insurance and corporate.

Agency Segment

This segment primarily consists of the operations of Efinancial. Efinancial is a call center-based insurance agency that markets life insurance for Fidelity Life and unaffiliated insurance companies. Efinancial’s primary operations are conducted through employee agents from two call center locations, which we refer to as our retail channel. In addition, Efinancial operates as a wholesale agency, assisting independent agents that desire to work for the carriers that Efinancial represents, which we refer to as our wholesale channel. Efinancial also generates insurance lead sales revenue through its eCoverage web presence. For the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, our agency segment revenue was earned 83%, 78%, 81% and 81% through the retail channel, 4%, 4%, 3% and 5% through the wholesale channel, and 13%, 18%, 16% and 14% through insurance lead sales revenue, respectively.

The agency segment’s main source of revenue is commissions earned on the sale of insurance policies sold through our retail channel. Efinancial’s employee agents utilize insurance sales leads to contact or be contacted by potential customers and then work with the customers to complete the sales process, which can occur during the initial contact or within 24 to 48 hours for non-medically underwritten policies. In our wholesale channel, we subcontract with our independent agents who sell through Efinancial’s contracts with its unaffiliated insurance carriers. In consideration for using our carrier contracts and services, we receive a portion of the commission earned by the independent agent from the carrier.

Agency segment expenses consist of marketing costs to acquire potential customers, salary and bonuses paid to our employee agents, salary and other costs of employees involved in managing the underwriting process for our insurance applications, sales management, agent licensing, training and compliance costs. Other agency segment expenses include costs associated with financial and administrative employees, facilities rent, and information technology. After payroll, the most significant agency segment expense is the cost of acquiring leads. We are able to partially offset our sales leads expense through advertising revenues from individuals who click on specific advertisements while viewing one of our web pages, and through the resale of leads that are not well suited for our call center. For the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, these offsetting revenues were $1.4 million, $2.2 million, $7.6 million and $5.5 million, respectively, which reduced our total agency expenses by approximately 10%, 4%, 13% and 9%, respectively. Our agency operations segment recognizes income (loss) to the extent that commissions and other revenue exceed (are less than) our marketing, agency and overhead costs for the period.

Insurance Segment

This segment consists of the operations of Fidelity Life. Fidelity Life underwrites primarily term life insurance through Efinancial and a diverse group of independent insurance distributors. Fidelity Life specializes in life insurance products that can be issued immediately or within a short period following a sales call, using non-medical underwriting at the time of policy issuance.

 

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Table of Contents

Our insurance segment revenues consist of net insurance premiums, net investment income, and net realized gains (losses) on investments. Our distributors consist of Efinancial and the independent insurance agencies that we contract with to sell our insurance products to the customers (policyholders) who buy our insurance policies. We recognize premium revenue from our policyholders. We purchase reinsurance coverage to help manage the risk on our insurance policies by paying, or ceding, a portion of the policyholder premiums to the reinsurance company. Our net insurance premiums reflect amounts collected from policyholders, plus premiums assumed under reinsurance agreements less premiums ceded to reinsurance companies. Net investment income represents primarily interest income earned on fixed maturity security investments that we purchase with cash flows from our premium revenues. We also realize gains and losses on sales of investment securities. These investments support our liability for policy reserves and provide the capital required to operate our insurance business. Capital requirements are primarily established by regulatory authorities. See “—Investments” and “Business—Risk-Based Capital (RBC) Requirements.”

Insurance segment expenses consist of benefits paid to policyholders or their beneficiaries under life insurance policies. Benefit expenses also include additions to the reserve for future policyholder benefits to recognize our estimated future obligations under the policies. Benefit expenses are shown net of amounts ceded under our reinsurance contracts. Our insurance segment also incurs policy acquisition costs that consist of commissions paid to agents, policy underwriting and issue costs and variable sales costs. A portion of these policy acquisition costs are deferred and expensed over the life of the insurance policies acquired during the period. In addition to policy acquisition costs, we incur expenses that vary based on the number of contracts that we have in-force, or variable policy administrative costs. These variable costs consist of expenses paid to third party administrators based on rates for each policy administered. As the number of in-force policies increases, these expenses will increase. Conversely, when the number of in-force policies declines, variable policy expenses decline. Our insurance operations also incur overhead costs for functional and administrative staff to support insurance operations, financial reporting and information technology. We recognize income (loss) on insurance operations to the extent that premium revenues, net investment income and realized gains (losses) exceed (are less than) benefit expenses and general operating expenses for the period.

Our insurance segment also includes the results of certain legacy business lines that were entered into in prior years, which we refer to as the closed block, and annuities and assumed life. The closed block was established in connection with our 2007 reorganization into a mutual holding company structure and represents all in-force participating insurance policies of Fidelity Life. Annuities and assumed life represents (i) our assumed life business, which consists of policies primarily written in the 1980s and early 1990s; (ii) our direct annuity contracts, which consist of approximately 78 structured settlement contracts that remain from a group of contracts entered into in the late 1980s; and (iii) our assumed annuities, which consist of contractholder deposits assumed from a former affiliate under two coinsurance treaties entered into in 1991 and 1992.

We have not accepted new policies in these legacy lines since 2006 or prior, and these lines are considered to be in “run-off” with a declining number of policies in force each period. We recognize income on the closed block and annuities and assumed life to the extent that premium revenues and investment income exceed the benefit expenses and operating expenses (including paid and accrued policyholder dividends) of these lines of business. On the two annuity lines we recognize income (loss) to the extent that our net investment income earned exceeds (are less than) benefit expenses (direct annuities) and amounts credited on policy deposits (assumed annuities) and operating expenses of the two lines.

Corporate Segment

The results of this segment consist of nominal net investment income and nominal realized investment gains (losses) earned on nominal invested assets. We also include certain corporate expenses that are not allocated to our other segments, including expenses of Vericity, board expenses, allocation of executive management time spent on corporate matters, and financial reporting and auditing costs related to our consolidation and internal controls. Our corporate segment recognizes income (loss) to the extent that investment income and realized investment gains exceed (are less than) corporate expenses.

Factors Affecting Our Results

Strategic Goals and Financial Impact of Sales of Policies Produced by Efinancial

Using Efinancial, our controlled distribution platform, we have full vertical integration for the sale and issuance of life insurance policies and are able to gather end-to-end consumer data, extending from tracking data to analyzing the characteristics of leads that generate successful marketing efforts to the associated underwriting and claims experience. Since we acquired Efinancial in 2009, we have made significant investments in the development of our controlled distribution

 

47


Table of Contents

strategy for reaching our target market. By converting data we generate through our distribution platform into actionable insight using statistical analysis, we will seek to be more efficient in our acquisition and use of leads, improve our call center placement ratios and strive to achieve overall profitability. However, the investments made in pursuit of this strategy, among other factors, have adversely affected our historical results of operations. We have incurred a net loss in each of the nine prior fiscal years, resulting in an aggregate of approximately $112 million in net losses over that period, including losses of $13.8 million and $8.2 million for the years ended December 31, 2018 and December 31, 2017, respectively. In addition, we incurred losses of $6.2 million and $3.3 million for the three months ended March 31, 2019 and March 31, 2018, respectively. Our losses are due principally to operating expenses and corporate overhead exceeding revenues of our agency and insurance segments, and our inability to defer a majority of our commission expense on policies produced by our affiliated agency, Efinancial.

Efinancial produced 56.3%, 75.8%, 61.9% and 61.1% of the policies written by Fidelity Life for the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, respectively. We plan to increase the number of policies sold through Efinancial as we pursue our strategic plan to further develop our controlled distribution platform and grow our book of business. However, sales of insurance policies through Efinancial immediately result in significantly higher consolidated expense recognition and lower consolidated net income in comparison to Fidelity Life policies distributed through an unaffiliated entity. GAAP requires that we immediately expense that portion of our policy acquisition costs for policies placed through Efinancial that cannot be directly tied to the placement of a policy. As a result of this immediate expense recognition for sales through Efinancial, we incur a net loss in the first year on each policy sold through Efinancial. To the extent we are successful in increasing our premium writings through Efinancial over each of the next several years or more, we expect that the impact of recognizing a majority of Efinancial commissions as a current expense will, among other factors, continue to adversely affect our results of operations and contribute to our continuing to incur consolidated net losses and a reduction to our consolidated equity in each such year as we seek to implement our distribution strategy. Over the long term and assuming that our products perform consistent with our assumptions, once we have developed a sustainable book of business and our expected growth through Efinancial has leveled, we expect that revenues from policy renewals may begin to offset the immediate expense recognition resulting from writing new policies through Efinancial. See “—Critical Accounting Policies—Deferred Policy Acquisition Costs (DAC)” and “—Results of Operations—Analysis of Segment Results—Corporate Segment—Intercompany Eliminations.”

Accuracy of Our Pricing Assumptions

In order for our insurance operations to be profitable, we must achieve product experience consistent with our pricing assumptions. We price our products using a number of assumptions that are designed to support the desired level of profitability. Our operating results will be affected by variances between our pricing assumptions and our actual experience. The key pricing assumptions made are:

 

   

Investment Returns. We earn income on the investments held to support reserves and capital requirements. The amount of net investment income that we recognize will vary depending on the amount of invested assets that we own, the types of investments we own, the interest rates earned and amount of dividends received on our investments. If the actual amount of net investment income earned is less than projected, our products may not generate the desired level of profitability.

 

   

Persistency Experience. Many of the non-medically underwritten products that we issue have a limited amount of insurance industry information to use in developing policy lapse rates. We are developing our own historical experience as to expected lapse rates for these products and reflect our emerging experience in our pricing. If actual policy lapse rates exceed the lapse rates assumed in pricing our products, we may receive lower premium revenues and may not receive enough premium to cover all of our acquisition costs for the policy.

 

   

Mortality Experience. We use our historical experience combined with experience projections from our reinsurance partners to develop our assumptions for the level, frequency and pattern of future claims experience. In our insurance operations segment, we principally issue non-medically underwritten products through underwriting processes that generally have limited recent company and industry experience; therefore, their performance may be less reliable and subject to greater variance than products underwritten through processes with more established industry experience.

 

   

Operating Expenses. Our level of operating expenses affects our reported net income (loss). Our general operating expenses include expenses that vary based on the growth in our revenues and expenses that are fixed regardless of revenue growth. As discussed above, we have experienced operating losses principally because our operating expenses and corporate overhead exceed our revenues, and our inability to defer a majority of our commission expense on policies produced by our affiliated agency, Efinancial.

 

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Efinancial Commission Financing

Beginning in the fourth quarter of 2017, Fidelity Life changed the commission structure related to Efinancial’s sale of the RAPIDecision® Life to pay annual level commissions over the life of the product instead of heaped, or first-year-only commissions. This change reduced Fidelity Life’s surplus strain associated with issuing RAPIDecision® Life business by spreading its statutory commission expenses over the life of the policy instead of incurring it all in the policy year of issue. In order to help provide liquidity for Efinancial through the receipt of larger first-year-only commissions, Fidelity Life and Efinancial entered into a financing arrangement with Hannover Life Reassurance Company of America (Hannover Life) under which, on a monthly basis, Hannover Life advances to Efinancial amounts approximately equal to the first-year-only commissions on Fidelity Life RAPIDecision® Life business sold through Efinancial. In exchange, Efinancial assigns to Hannover Life its right to all future levelized commission payments on that business due from Fidelity Life, and Fidelity Life pays to Hannover Life the level commissions over the life of the contract. Our arrangement with Hannover Life allows us to finance up to $20 million of commission expense. Efinancial’s ability to receive advances under this arrangement will terminate on the earlier of June 30, 2019 or the date when the aggregate amount advanced under the arrangement equals or exceeds $20 million. As of March 31, 2019, we had net advances of $15.0 million under this arrangement.

Recapture of Assumed Life Business

Under an agreement with Protective Life Insurance Company, the successor to a former affiliate of Fidelity Life, Fidelity Life had assumed a portion of risk on a group of life insurance contracts primarily written in the 1980s and early 1990s. On March 29, 2019, Protective Life and Fidelity Life agreed that Protective Life would recapture the majority of this assumed life block of business, thereby relieving Fidelity Life from further liability under the recaptured business (except for obligations incurred prior to the recapture effective date). Under the recapture agreement, Fidelity Life paid Protective Life an amount equal to the assumed carried reserves, and in turn, Fidelity Life will receive payment from its reinsurers of this business for their portion of the related ceded reserves. We recognized a $2.2 million gain from this transaction for the three months ended March 31, 2019.

Critical Accounting Policies

Our critical accounting policies are described in Note 2—Basis of Presentation and Summary of Significant Accounting Policies to our consolidated financial statements included elsewhere in this prospectus. The accounting policies discussed in this section are those that we consider to be the most critical to an understanding of our financial statements. The preparation of the consolidated financial statements in conformity with GAAP requires management to use judgment in making estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and related disclosures. We regularly evaluate our estimates and judgments based on historical experience, market indicators and other relevant factors and circumstances. Actual results may differ from these estimates under different assumptions or conditions and may affect our financial position and results of operations.

Valuation of Fixed Maturity Securities and Equity Securities

Our fixed maturity securities are classified as either “available-for-sale” securities or “trading” securities which are both carried at fair value on the balance sheet. Fair value represents the price that would be received to sell an asset in an orderly transaction between market participants on the measurement date. For investments that are not actively traded, the determination of fair value requires us to make a significant number of assumptions and judgments. Fair value determinations include consideration of both observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. Security pricing is applied using a hierarchy approach.

Level 1—Unadjusted quoted prices for identical assets in active markets the Company can access.

Level 2—This level includes fixed maturity securities priced principally by independent pricing services using observable inputs other than Level 1 prices, such as quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments on inactive markets; and model-derived valuations for which all significant inputs are observable market data. Level 2 instruments include most corporate debt securities and U.S. government and agency mortgage-backed securities that are valued by models using inputs that are derived principally from or corroborated by observable market data.

Level 3—Fair values are derived from valuation techniques in which one or more significant inputs are unobservable. Level 3 instruments include less liquid securities for which significant inputs are unobservable in the market, such as structured securities and private placement bonds that require significant management assumptions or estimation in the fair value measurement. Level 3 hierarchy requires the use of observable market data when available.

 

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At March 31, 2019, December 31, 2018 and December 31, 2017, the estimated fair value of our investments by fair value hierarchy was as follows:

 

Fair Value of Investments as of March 31, 2019

(dollars in thousands)

 

Level 1

   Level 2      Level 3      Total Fair
Value
 

$7,381

   $ 291,864      $ 13,515      $ 312,760  

     3%

     93%        4%        100%  

 

Fair Value of Investments as of December 31, 2018

(dollars in thousands)

 

Level 1

   Level 2      Level 3      Total Fair
Value
 

$6,460

   $ 291,353      $ 13,695      $ 311,508  

     2%

     94%        4%        100%  

 

Fair Value of Investment as of December 31, 2017
(dollars in thousands)

 

Level 1

   Level 2      Level 3      Total Fair
Value
 

$7,530

   $ 312,553      $ 23,290      $ 343,373  

     2%

     91%        7%        100%  

Level 1 securities include principally exchange traded funds that are valued based on quoted market prices for identical assets.

All of the fair values of our fixed maturity and equity securities within Level 2 are based on prices obtained from independent pricing services. All of our prices for each security are generally sourced from multiple pricing vendors, and a vendor hierarchy is maintained by asset type and region of the world, based on historical pricing experience and vendor expertise. We ultimately use the price from the pricing service highest in the vendor hierarchy based on the respective asset type and region. For fixed maturity securities that do not trade on a daily basis, the pricing services prepare estimates of fair value measurements using their pricing applications which incorporate a variety of inputs including, but not limited to, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, and U.S. Treasury curves. Specifically, for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data. Securities with validated quotes from pricing services are reflected within Level 2 of the fair value hierarchy, as they generally are based on observable pricing for similar assets or other market significant observable inputs.

Level 3 fair value classification consists primarily of investments in private placement securities where the fair value of the security is determined by a pricing service using spread matrix pricing which incorporates a discounted cash flow model where one or more of the significant inputs is unobservable in the marketplace. The remaining securities in Level 3 consist of corporate bonds whose fair values are determined by pricing models where there is a lack of transparency to one or more significant inputs, or broker/dealer quotes. The fair value of a broker-quoted asset is based solely on the receipt of an updated quote from a single market maker or a broker-dealer recognized as a market participant. The Company does not adjust broker quotes when used as the fair value measurement for an asset.

If we believe the pricing information received from third party pricing services is not reflective of market activity or other inputs observable in the market, we may challenge the price through a formal process with the pricing service. Historically, we have not challenged or updated the prices provided by third-party pricing services. However, any such updates by a pricing service to be more consistent with the presented market observations, or any adjustments made by us to prices provided by third-party pricing services, would be reflected in the balance sheet for the current period.

When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3).

 

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Other-Than-Temporary Impairments on Available-For-Sale Securities

Securities that are classified as available-for-sale are subject to market declines below amortized cost (a gross unrealized loss position). When a gross unrealized loss position occurs, the security is considered impaired. Quarterly or when necessary, we review each impaired security to identify whether the impairment may be an other-than-temporary impairment (“OTTI”), and require the recognition of an impairment loss in the current period earnings. Indication of OTTI includes potential credit deterioration whether due to ratings downgrades, unexpected price variances, and/or other company or industry specific concerns. A number of factors are considered in determining whether or not a decline in a specific security is other-than-temporary, including our current intention or need to sell the security or an indication that a credit loss exists. An impairment loss will be recorded if our intention is to sell an impaired security or it is considered to be more likely than not we will be required to sell the security.

Our review of our available-for-sale securities for impairment includes an analysis of impaired securities in terms of severity and/or age of the gross unrealized loss. Additionally, we consider a wide range of factors about the issuer of the security and use our best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the likelihood for near-term recovery. Inherent in our evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential that includes the evaluation of the financial condition and expected near-term and long-term prospects of the issuer, collateral position, the relevant industry conditions and trends, and whether expected cash flows will be sufficient to recover the entire amortized cost basis of the security.

The credit loss component of fixed maturity security impairment is calculated as the difference between amortized cost of the security and the present value of the expected cash flows of the security. The present value is determined using the best estimate of cash flows discounted at the effective rate implicit to the security at the date of purchase or prior impairment. The methodology and assumptions for estimating the cash flows vary depending on the type of security. For mortgage-backed and asset-backed securities, cash flow estimates, including prepayment assumptions, are based on data from widely accepted third-party sources or internal estimates. In addition to prepayment assumptions, cash flow estimates vary based on assumptions regarding the underlying collateral characteristics, expectations of delinquency and default rates, and structural support, including subordination and guarantees. If the present value of the modeled expected cash flows equals or exceeds the amortized cost of a security, no credit loss exists and the security is considered to be temporarily impaired. If the present value of the expected cash flows is less than amortized cost, the security is determined to be other-than-temporarily impaired for credit reasons and is recognized as an OTTI loss in earnings. The portion of the OTTI that is not considered a credit loss, is recognized as OTTI in accumulated comprehensive income.

There was no OTTI on fixed maturity securities for the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017.

Mortgage Loans

Our mortgage loans are held on commercial real estate and are stated at the aggregate unpaid principal balances, net of any write downs and valuation allowances. We identify loans for evaluation of impairment primarily based on the collection experience of each loan. Mortgage loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect principal or interest amounts according to the contractual terms of the loan agreement. Impairment is measured on a loan by loan basis based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral. Impairments are included in realized investment gains and losses in the Consolidated Statements of Operations.

Interest income from mortgage loans is recognized on an accrual basis using the effective yield method. Accrual of income is generally suspended for mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable. Mortgage loans are considered past due when full principal or interest payments have not been received according to contractual terms.

At March 31, 2019, March 31, 2018, December 31, 2018 and December 31 2017, there was a valuation allowance of $0.1 million, $0.2 million, $0.2 million and $0.3 million, respectively.

Deferred Policy Acquisition Costs (DAC)

For our insurance segment, the costs of acquiring new business are deferred to the extent that they are directly related to the successful acquisition of insurance contracts. Deferred acquisition costs include commissions paid in the first policy year

 

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that are in excess of the ultimate renewal commissions payable on the policy. For any of our policies for which we do not pay renewal commissions, the deferred acquisition costs (at the segment level) include all commissions paid in the first year. For policies for which we pay levelized commissions over the life of the policy, we expense the first-year commission and therefore do not defer any other commission expense. We also defer costs associated with policy underwriting and issuance related to the successful acquisition of insurance contracts. Non-deferred first year acquisition costs that are expensed as incurred include expenses that do not meet the definition of a deferrable cost, which includes the acquisition costs incurred on insurance applications that do not result in an in-force policy (unsuccessful efforts).

The amortization of DAC for traditional life insurance products is determined as a level proportion of premium based on actuarial methods and assumptions about mortality, morbidity, lapse rates, expenses, and future yield on related investments, established by us at the time the policy is issued. GAAP requires that assumptions for these types of products not be modified while the policy is outstanding. Amortization is adjusted each period to reflect policy lapse or termination rates compared to anticipated experience. Accordingly, acceleration of DAC amortization could occur if policies terminate earlier than originally assumed. We establish the assumptions used to determine DAC amortization based on estimates using company experience and other relevant information that is used to price the products. We monitor our actual experience and will update the actuarial factors applied to future policy issues if warranted. The selection of actuarial assumptions requires considerable judgment and has inherent uncertainty. Should actual policy lapse experience be higher than that assumed during a reporting period, we will amortize our DAC balance faster and report lower net income.

We evaluate the recoverability of our DAC asset as part of our premium deficiency testing. If a premium deficiency exists, we reduce DAC by the amount of the deficiency through a charge to current period earnings (loss). If the deficiency is more than the recognized DAC balance, we reduce the DAC balance to zero and increase the reserve for future policy benefits by the excess with a corresponding charge to current period earnings (loss). See “—Future Policy Benefit Reserves” below for more information on premium deficiency testing.

Our consolidated DAC will be lower relative to other insurance companies that utilize unaffiliated distributors. GAAP does not permit the deferral of commission revenues paid to Efinancial, our affiliated agency, in excess of those expenses actually incurred by Efinancial in the placement of the policy. Because we are focused on increasing insurance premium volume through Efinancial, our operating results will reflect higher current period expenses and lower current reported net income. Therefore, in consolidation, the first-year commission acquisition costs (“Commission DAC”) recorded in our insurance segment is reduced to reflect the elimination of that portion of Commission DAC that results from expenses of Efinancial that cannot be directly tied to the successful placement of a policy. The amount of eliminated Commission DAC is charged to current expense, and acquisition cost DAC is recorded at a reduced amount, which represents the amount of Commission DAC that is eligible for deferral. As a result of recognizing expenses for the Efinancial sales immediately, we will recognize a charge against our consolidated earnings (loss) and consolidated equity in the amount of such expenses for the period in which they are incurred. See “—Results of Operations—Analysis of Segment Results—Corporate Segment—Intercompany Eliminations.”

Future Policy Benefit Reserves

We calculate and maintain reserves for estimated future claims payments to policyholders using actuarial assumptions in accordance with industry practice and GAAP. Many factors affect these reserves, including mortality trends, policy persistency and investment returns. We establish our reserves based on estimates, assumptions and our analysis of historical experience.

The calculation of future policy reserves requires the use of significant judgment and is inherently uncertain. If our actual experience differs from the experience assumed in establishing our reserves, the impact of these differences is reflected in the results of operations in each period. If actual claims are higher than assumed claims experience, our reported income (loss) will be reduced (increased) for the periods in which this experience occurs. If actual policy lapses are higher than that assumed, our future policy benefit reserves will be reduced for the period in which this experience occurs.

The primary reserve method that is used in calculation of our future policy benefit reserves is the net level premium method. The net level premium method requires that the future policy benefit reserves are accrued as a level proportion of the premium paid by the policyholder. In applying this method, we use a number of actuarial assumptions that represent management’s best estimate at the time the contract was issued with the addition of a margin for adverse deviation. Actuarial assumptions include estimates of morbidity, mortality, policy persistency, discount rates and expenses over the life of the contracts.

 

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A premium deficiency can exist if the discounted present value of future gross premiums is not sufficient to cover anticipated future cash flows. To assess the adequacy of our benefit reserves, we annually perform premium deficiency testing for each of our lines of business using best estimate assumptions as of the date of the test without provision for adverse deviation. If benefit reserves minus the DAC asset are less than the present value of future cash flows on the line of business, then first the DAC asset will be reduced. If reducing the DAC asset down to zero is still not sufficient to eliminate the premium deficiency, then benefit reserves will be increased. Recognizing a premium deficiency will reduce our reported net income, or increase our reported loss, for the period.

In connection with our premium deficiency testing on our most significant business lines, we performed sensitivity analyses on our core life, non-core life, closed block, and annuities and assumed life business lines to capture the effect that certain key assumptions have on expected future cash flows, and the impact of those assumptions on the adequacy of DAC balances and GAAP benefit reserves. The sensitivity tests are performed independently, without consideration for any correlation among the key assumptions.

We performed the following sensitivity tests as of September 30, 2018:

 

   

future lapse assumptions increased by a multiplicative factor of 1.05,

 

   

future mortality increased by a multiplicative factor of 1.05 for all life blocks,

 

   

future investment yield assumptions were lowered by 50 basis points.

Under all tests described above, the DAC was still recoverable on the core life, non-core life, and the closed block lines. For the annuities and assumed life line, there is no remaining DAC due to the age of the contracts. As such, these sensitivity runs tested the adequacy of the benefit reserves for these lines. For the annuities and assumed life line, a drop in investment yield of 50 basis points would result in a required reserve increase of $0.5 million, for the 105% mortality scenario the result would be a required increase of $0.6 million, while for the lapse scenario there would be no impact to benefit reserves.

Intangible Assets

Intangible assets include trade names, internet domain sites, software and contract-based assets composed of future renewal commissions, distribution agreements, and non-compete agreements. These intangible assets, with the exception of trade names, are amortized over their expected useful lives based on the expected pattern of benefit of the asset.

We amortize the domain site intangible assets on a straight-line basis over a useful life of ten years and software intangible assets are amortized over a useful life of four years using an accelerated amortization method. Contract-based intangible assets are amortized on a straight-line basis over a useful life of primarily five years, with the exception of some distribution contracts where the amortization period is seven years. Trade names are not amortized as they have been determined to have indefinite useful lives. Trade names are tested at least annually for impairment using expected future cash flows.

The determination of the estimated fair value and estimated useful lives of intangible assets require the exercise of considerable management judgment. If the actual useful life is less than that assumed or the pattern of benefits is shorter than that used in developing the initial estimates, we could write down the carrying value of intangible assets and reduce our reported income, or increase our reported loss.

Interim impairment testing may be performed when events or changes in circumstances indicate that the carrying amount of the intangible assets may not be recoverable. Amortizable intangible assets are tested for impairment based on undiscounted cash flows, which requires the use of estimates and judgment, and, if impaired, are written down to fair value based on discounted cash flows. For the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, we have not recorded an impairment of intangible assets.

Commission Revenue Recognition

We recognize commission revenue from the sale of insurance products by Efinancial. We recognize revenue at the time that the insurance policy is issued by the insurance company and accepted by the customer, which we call policy placement. In addition, as a result of the implementation of Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 606”), effective January 1, 2019, we record as Efinancial revenue the full amount of first year commission expected to be paid on the sale of insurance products and any renewal commission to be paid on such products. Prior to the implementation of ASU 606, for the years ended December 31, 2018 and December 31, 2017, we recognized the full amount of first year commission when the policy was placed, and the renewal commissions

 

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were recognized when received. See “Note 1—Summary of Significant Accounting Policies—Revenue Recognition” in the accompanying unaudited condensed consolidated financial statements included in this prospectus. The commission payment terms of each carrier vary according to the contract that we have with the carrier. Some carriers will advance a portion of the premium at policy placement. Other carriers pay the commission as they collect and earn the policy premiums. We record a commission receivable at policy placement, net of any advances received. We establish a provision for commission revenue that, based on experience, will ultimately not be earned due to the customer discontinuing the underlying insurance policy. Our agency segment results include revenue from third party agencies and from Fidelity Life. The revenues from Fidelity Life sales are eliminated in consolidation.

Income Taxes

We file a consolidated Federal income tax return that includes both a life insurance company subgroup and a non-life subgroup. Under the Federal income tax regulations, the taxation of life insurance companies is subject to special rules not applicable to non-life companies. Accordingly, we have to consider the implications of these different tax rules in accounting for income tax expense. We record federal income tax expense in our consolidated statements of earnings based on pre-tax income as determined using GAAP accounting. The timing of the recognition of certain income and expense items for GAAP accounting can differ from the timing of recognition of the same income and expense items in our federal tax returns. The timing of recognition in the federal tax return is based on tax laws and regulations. As a result, the annual tax expense reflected in our consolidated statements of earnings is different than that reported in the tax returns. We account for income taxes under the asset and liability method, which requires the recognition of deferred taxes for temporary differences between the financial statement and tax return basis of assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expenditures for which we have already taken a deduction in our tax return but have not yet been recognized in our financial statements. Under GAAP we are required to evaluate the recoverability of our deferred tax assets and establish a valuation allowance if necessary to reduce our deferred tax assets to an amount that is more likely than not to be realized. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. To the extent that we are required to establish an additional valuation allowance against deferred income tax assets, the amount of such valuation allowance would be charged against our net income for the period in which that valuation allowance is established.

We establish or adjust valuation allowances for deferred tax assets when we estimate that it is more likely than not that future taxable income will be insufficient to fully use a deduction or credit. In assessing the need for the recognition of a valuation allowance for deferred tax assets, we consider whether it is more likely than not that some portion, or all, of the deferred tax assets will not be realized and adjust the valuation allowance accordingly. We evaluate all significant available positive and negative evidence as part of our analysis. Negative evidence includes the existence of losses in recent years. Positive evidence includes the forecast of future taxable income and tax-planning strategies that would result in the realization of deferred tax assets. The underlying assumptions we use in forecasting future taxable income require significant judgment and take into account our recent performance. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which temporary differences are deductible or creditable. If actual experience differs from these estimates and assumptions, the recorded deferred tax asset may not be fully realized, resulting in an increase to income tax expense in our results of operations.

As of March 31, 2019, we had a 100% valuation allowance recorded against the deferred tax assets related to the non-life subgroup of our tax return because we determined that it is more likely than not that these assets will not be recoverable. The recording of the valuation allowance increases our federal income tax expense which in turn reduces our reported net income, or increases our net loss as applicable. Our recorded net deferred tax liability is shown in the following table. The balances for each period are shown based on the life/non-life portions of the consolidated federal tax returns and in total.

 

    March 31, 2019     December 31, 2018     December 31, 2017  
    Life     Non-Life     Total     Life     Non-Life     Total     Life     Non-Life     Total  
    (dollars in thousands)  

Deferred Tax Asset

                 

Total deferred tax assets

  $ 49,960     $ 20,186     $ 70,146     $ 49,874     $ 18,271     $ 68,145     $ 45,140     $ 15,653     $ 60,793  

Total deferred tax liabilities

    40,640       7,107       47,747       39,211       6,787       45,998       40,215       5,058       45,273  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net deferred tax asset (liability) before valuation allowance

    9,320       13,079       22,399       10,663       11,484       22,147       4,925       10,595       15,520  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Valuation allowance

    —         (13,079     (13,079     —         (11,484     (11,484     —         (10,595     (10,595
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Deferred income tax asset

  $ 9,320     $ —       $ 9,320     $ 10,663     $ —       $ 10,663     $ 4,925     $ —       $ 4,925  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Due to the valuation allowance on the non-life subgroup, the effective income tax rate reflected on our statement of operations will vary depending on the portion of our pretax income (loss) that results from our life subgroup and the portion from our non-life subgroup. With the current full valuation allowance, the current tax benefit related to our non-life subgroup is limited. We continue to record tax expense (benefit) related to the pretax income (loss) of our life subgroup.

Principal Revenue & Expense Items

Revenues

Our primary revenue sources are life insurance premiums, commissions, net investment income, realized investment gains and losses and other income.

Net Premiums

Net premiums consist of direct life insurance premiums due and collected from our policyholders on in-force insurance policies and premiums collected on assumed life reinsurance contracts, less reinsurance premiums paid to reinsurers. Direct premiums are recorded in our insurance segment and classified as first year premiums when they relate to the first calendar year coverage period. Premiums for policies outside their first calendar year are called renewal premiums.

Earned Commission Revenue

Earned commission revenue consists of amounts received and due from insurance carriers on policies sold by Efinancial and is recorded in our agency segment. However, the commission revenue from sales of Fidelity Life policies is eliminated in our consolidated statement of operations because Efinancial and Fidelity Life are affiliated.

Net Investment Income

Investment income consists of income generated from our investment portfolio and is recorded net of related expenses incurred to manage our investments. Investment income primarily consists of interest income earned on fixed maturity investments and dividends earned on our equity holdings, net of related expenses incurred to manage our investments. Net investment income earned on assets required to support insurance reserves, annuity deposits and related regulatory capital requirements is allocated to our insurance segment. Any other net investment income is recorded in the corporate segment.

Net Realized Investment Gains (Losses)

Net realized investment gains (losses) result from sales of investment securities and OTTI for estimated credit losses of fixed income investments.

Insurance Lead Sales

In our agency segment, insurance lead sales revenue consists of (i) click-through revenues we generate when leads click through to our webpages to access information about life insurance options sponsored by another company, (ii) data revenues we generate through the sale of information regarding leads sourced through the eCoverage landing pages, and (iii) transfer revenues we generate from the sales of insurance leads.

Other Income

For our insurance segment, other income primarily consists of cost of insurance charges on universal life contracts, and also includes prepayment fees received on investment securities that are called prior to contract maturity.

Benefits and Expenses

This category consists of benefits to policyholders, which include policyholder dividends and policyholder dividend obligations (PDO), interest credited to policyholder and contractholder balances, general operating expenses and amortization of DAC.

Life, Annuity and Health Benefits

Benefit expenses are recorded in our insurance segment. Benefit expenses include claims paid or payable on in-force insurance policies, as well as the change in our reserves for future policy benefits during the period. Benefit expenses are reduced by amounts ceded to reinsurance companies with whom we contract to share policy risks.

 

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Interest Credited to Policyholder and Contractholder Account Balances

The interest credited primarily relates to amounts that contractholders earn on any contractholder deposits from our assumed annuity contracts and other amounts left on deposit with us. Our universal life policies and assumed annuity contracts require Fidelity Life to periodically establish the crediting rate to be paid on policyholder and contractholder deposits. All current assumed annuity contracts are credited with interest at the minimum interest rate guaranteed in the contract. Interest credited relates solely to our insurance segment.

General Operating Expenses

Operating expenses are incurred by all of our segments. The operating expenses of our insurance segment include policy acquisition costs in excess of amounts that qualify for deferral, ceding commissions received on ceded reinsurance in excess of amounts deferred, variable policy administration costs, general overhead and administration costs, and insurance premium taxes and assessments paid to various states. Agency segment expenses consist of compensation paid to employee sales agents, costs of insurance sales leads (marketing), costs of sales management and support activities, agent licensing expenses and general overhead and administration expenses. The expenses of the corporate segment include allocation of a portion of the compensation of senior executives related to corporate activities, board of director expenses related to corporate business, and other operating costs considered to be of a corporate nature and not directly related to either of our other business segments. Overhead and administrative expenses of the segments include employee costs (salaries, bonuses and benefits), office rent, information technology and costs of third party administrators and other contractors.

Amortization of DAC

DAC amortization represents the actuarially determined reduction in the DAC asset for the period. The amount of acquisition cost amortization recognized each period is based on actual factors established when the insurance contracts were written.

Results of Operations

The major components of operating revenues, benefits and expenses and net (loss) income are as follows:

MMHC Consolidated Results of Operations

(dollars in thousands)

 

REVENUES    For the
Three Months Ended
March 31,
    For the
Years Ended
December 31,
 
   2019     2018     2018     2017  

Net insurance premiums

   $ 23,089     $ 21,013     $ 88,573     $ 82,873  

Net investment income

     3,820       3,744       15,101       15,119  

Net realized investment (losses) gains

     1,048       (561     (967     571  

Earned commissions

     3,746       3,334       13,404       11,514  

Insurance lead sales

     1,435       2,182       7,633       5,529  

Other income

     55       113       236       264  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     33,193       29,825       123,980       115,870  
  

 

 

   

 

 

   

 

 

   

 

 

 

BENEFITS AND EXPENSES

        

Life, annuity, and health claim benefits

     16,244       13,052       56,556       56,035  

Interest credited to policyholder account balances

     801       922       3,598       3,776  

General operating expenses

     18,907       16,894       68,353       55,912  

Amortization of deferred policy acquisition costs

     3,140       2,825       11,506       10,926  

Amortization of intangible assets

     22       41       164       163  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

     39,114       33,734       140,177       126,812  
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) before income taxes

     (5,921     (3,909     (16,197     (10,942

Income tax benefit

     314       (643     (2,350     (2,701
  

 

 

   

 

 

   

 

 

   

 

 

 

NET (LOSS)

   $ (6,235   $ (3,266   $ (13,847   $ (8,241
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018

Total Revenues

For the three months ended March 31, 2019, total revenues were $33.2 million compared to $29.8 million for the three months ended March 31, 2018. This increase of $3.4 million (11.4%) resulted from higher net insurance premiums, earned commissions and net realized investment gains, partially offset by a decrease in insurance lead sales.

Benefits and Expenses

For the three months ended March 31, 2019, total benefits and expenses were $39.1 million compared to $33.7 million for the three months ended March 31, 2018. This increase of $5.4 million (16.0%) was primarily due to increases in life, annuity, and health claim benefits and general operating expenses as a result of increases in variable sales costs, commission expenses net of reinsurance allowances and variable policy issue and maintenance expenses.

Loss Before Income Taxes

For the three months ended March 31, 2019, we had a loss before taxes of $5.9 million compared to a loss before taxes of $3.9 million for the three months ended March 31, 2018. This increased loss of $2.0 million (51.3%) was due to increases in life, annuity, and health claim benefits and general operating expenses, partially offset by higher net insurance premiums, and net realized investment gains.

Income Taxes

For the three months ended March 31, 2019, our income tax benefit was $0.3 million compared to an income tax loss of $0.6 million for the three months ended March 31, 2018.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Total Revenues

For the year ended December 31, 2018, total revenues were $124.0 million compared to $115.9 million for the year ended December 31, 2017. This increase of $8.1 million (7.0%) resulted from higher net insurance premiums, agency commissions and insurance lead sales revenue.

Benefits and Expenses

For the year ended December 31, 2018, total benefits and expenses were $140.2 million compared to $126.8 million for the year ended December 31, 2017. This increase of $13.4 million (10.5%) was primarily due to increases in general operating expenses as a result of increases in variable sales costs, commission expenses net of reinsurance allowances and variable policy issue and maintenance expenses, partially offset by decreases in net life insurance benefits.

Loss Before Income Taxes

For the year ended December 31, 2018, we had a loss before taxes of $16.2 million compared to a loss before taxes of $10.9 million for the year ended December 31, 2017. This increased loss of $5.3 million (48%) was due to increases in operating expenses, partially offset by higher net insurance premiums, lower life and annuity claim benefits, and higher lead sales revenue.

Income Taxes

For the year ended December 31, 2018, our income tax benefit was $2.4 million compared to an income tax benefit of $2.7 million for the year ended December 31, 2017. The decrease of $0.3 million reflected the changes in the corporate tax rate related to the Tax Act. The Tax Act reduced the federal tax rate for corporations to 21%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Income Taxes.”

 

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Analysis of Segment Results

Reconciliation of Segment Results to Consolidated Results

The following analysis reconciles the reported segment results to the MMHC total consolidated results. The main difference is the intercompany eliminations.

 

                                                           
     For the Three Months Ended
March 31,
     For the Years Ended
December 31,
 
           2019                    2018              2018      2017  
    

(dollars in thousands)

 

(LOSS) BEFORE INCOME TAXES BY SEGMENT

           

Agency operations

   $ (1,116    $ 47      $ (759    $ (624

Insurance operations

     (1,476      (549      (629      2,343  

Corporate operations

     (1,745      (1,263      (4,765      (4,713

Eliminations

     (1,584      (2,144      (10,044      (7,948
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) before income taxes

     (5,921      (3,909      (16,197      (10,942

Income tax (benefit)

     314        (643      (2,350      (2,701
  

 

 

    

 

 

    

 

 

    

 

 

 

NET (LOSS)

   $ (6,235    $ (3,266    $ (13,847    $ (8,241
  

 

 

    

 

 

    

 

 

    

 

 

 

Agency Segment

The results of our agency segment were as follows:

 

                                                           
     For the Three Months  Ended
March 31,
     For the Years Ended
December 31,
 
           2019                  2018            2018      2017  
    

(dollars in thousands)

 

REVENUE

           

Earned commissions

   $ 9,865      $ 10,393      $ 42,261      $ 34,796  

Insurance lead sales

     1,435        2,182        7,633        5,529  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     11,300        12,575        49,894        40,325  
  

 

 

    

 

 

    

 

 

    

 

 

 

EXPENSES

           

General operating expenses

     12,394        12,487        50,489        40,786  

Amortization of intangibles

     22        41        164        163  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     12,416        12,528        50,653        40,949  
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) before income taxes

   $ (1,116    $ 47      $ (759    $ (624
  

 

 

    

 

 

    

 

 

    

 

 

 

Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018

Earned Commissions

For the three months ended March 31, 2019, earned commissions were $9.9 million compared to $10.4 million for the three months ended March 31, 2018. This decrease of $0.5 million (4.8%) resulted from lower agent headcount, lower commission rates on certain Fidelity Life products and lower conversion rates, partially offset by recognition of renewal commissions as a result of adoption of new revenue recognition standards.

Insurance Lead Sales

For the three months ended March 31, 2019, insurance lead sales were $1.4 million compared to $2.2 million for the three months ended March 31, 2018. This decrease of $0.8 million (36.4%) was primarily due to lower data and click purchases from lead buyers and a decision to hold more leads for internal use.

General Operating Expenses

For the three months ended March 31, 2019, general operating expenses were $12.4 million compared to $12.5 million for the three months ended March 31, 2018. This decrease of $0.1 million (0.8%) was due to decreases in variable cost of sales of $0.2 million and increase in overhead expenses of $0.1 million. The variable cost of sales decrease consisted of both increased agents’ compensation and marketing costs.

 

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Net Income (Loss)

For the three months ended March 31, 2019, the agency segment incurred a net loss of $1.1 million compared to a net gain of $0.0 million for the three months ended March 31, 2018. This increase in net loss of $1.1 million was the result of lower lead sales revenue, lower commission rates and lower conversion rates.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Earned Commissions

For the year ended December 31, 2018, earned commissions were $42.3 million compared to $34.8 million for the year ended December 31, 2017. This increase of $7.5 million (21.6%) resulted from increased sales of certain Fidelity Life products, as reflected by the increase in annualized issued premium produced by the retail call center to $39.1 million from $31.0 million (26.1%) for the years ended December 31, 2018 and December 31, 2017, respectively, partially offset by a reduction in wholesale production.

Insurance Lead Sales

For the year ended December 31, 2018, insurance lead sales were $7.6 million compared to $5.5 million for the year ended December 31, 2017. This increase of $2.1 million (38.2%) was primarily due to an increase in data and click revenue in 2018 from 2017.

General Operating Expenses

For the year ended December 31, 2018, general operating expenses were $50.5 million compared to $40.8 million for the year ended December 31, 2017. This increase of $9.7 million (23.7%) was due to increases in variable cost of sales of $8.3 million and overhead expenses of $1.4 million. The variable cost of sales increase consisted of both increased agents’ compensation and marketing costs.

Net Income (Loss)

For the year ended December 31, 2018, the agency segment incurred a net loss of $0.8 million compared to a net loss of $0.6 million for the year ended December 31, 2017. This increase in net loss of $0.2 million was the result of higher general operating expenses, partially offset by increases in earned commissions and lead sales revenue.

Insurance Segment

The results of our insurance segment were as follows:

 

     Three Months Ended
March 31,
    For the Years Ended
December 31,
 
     2019      2018     2018      2017  
     (dollars in thousands)  

Revenue:

          

Net insurance premiums

   $ 23,089      $ 21,013     $ 88,573      $ 82,873  

Net investment income

     3,843        3,767       15,197        15,215  

Net realized investment gains

     1,048        (561     (967      571  

Other income

     55        113       236        264  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total revenues

     28,035        24,332     $ 103,039      $ 98,923  
  

 

 

    

 

 

   

 

 

    

 

 

 

Benefits and Expenses:

          

Life and annuity benefits

     16,244        13,052     $ 56,556      $ 56,035  

Interest credited to policyholder account balances

     801        922       3,598        3,776  

General operating expenses

     8,207        6,963       27,486        21,368  

Amortization of deferred policy acquisition costs

     4,259        3,944       16,028        15,401  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total benefits and expenses

     29,511        24,881       103,668        96,580  
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

   $ (1,476    $ (549     (629      2,343  
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018

Premium Revenues

For the three months ended March 31, 2019, net insurance premiums were $23.1 million compared to $21.0 million for the three months ended March 31, 2018. This increase of $2.1 million (10.0%) in net insurance premiums was primarily due to increases in our core and non-core lines of $3.0 million and $0.5 million, respectively, partially offset by a decrease in Closed Block and assumed life and annuities of $1.4 million.

Net Realized Investment Gains (Losses)

For the three months ended March 31, 2019, realized investment gains were $1.0 million compared with realized investment losses of $0.6 million for the three months ended March 31, 2018. This increase of $1.6 million was mainly due to higher mark-to-market gains on equity securities held as trading securities.

Life, Annuity and Health Claim Benefits

For the three months ended March 31, 2019, life, annuity and health claim benefits were $16.2 million compared with $13.1 million for the three months ended March 31, 2018. This increase of $3.2 million (24.5%) was mainly attributable to an increase of $5.6 million in benefits resulting from higher claims activity on certain core and non-core products, and growth of in-force business, partially offset by a $2.4 million decrease in reserves primarily related to the recapture of the majority of an assumed life block of business.

Interest Credited to Policyholder Account Balances

For the three months ended March 31, 2019, interest credited was $0.8 million compared to $0.9 million for the three months ended March 31, 2018. This decrease of $0.1 million is due to reduced interest credited on lower assumed fixed annuity contract-holder account balances.

General Operating Expenses

For the three months ended March 31, 2019, general operating expenses were $8.2 million compared to $7.0 million for the three months ended March 31, 2018. This increase of $1.2 million (17.1%) was mainly due to a $0.4 million increase in commissions due to premium growth, reduction of ceding allowances of $0.3 million due to the run-off of the closed block, $0.5 million of higher variable policy issuance costs and maintenance expense due to increased sales and a larger in-force block of business.

Amortization of Deferred Acquisition Costs

For the three months ended March 31, 2019, amortization of deferred acquisition costs was $4.3 million compared to $3.9 million for the three months ended March 31, 2018. This increase reflects an increase from the Closed Block of $0.5 million mainly due to lapses. See “Business—Insurance Segment—Core Life.”

Net Income (Loss)

For the three months ended March 31, 2019, net loss was $1.5 million compared to net loss of $0.5 million for the three months ended March 31, 2018. The increase in net loss of $1.0 million resulted primarily from an increase in benefits of $3.2 million, an increase in general expenses of $1.2 million partially offset by net realized capital gains of $1.5 million and premiums of $2.0 million.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Premium Revenues

For the year ended December 31, 2018, net insurance premiums were $88.6 million compared to $82.9 million for the year ended December 31, 2017. This increase of $5.7 million (6.9%) in net insurance premiums was primarily due to increases in core net premiums of $4.6 million and $1.1 million in our non-core lines.

Net Investment Income

For the year ended December 31, 2018, net investment income was $15.2 million compared to $15.2 million for the year ended December 31, 2017. Interest income from fixed maturity securities decreased by $0.2 million as a result of a decrease

 

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in this invested asset base and a lower book yield. This decrease was offset by a $0.2 million increase in interest income from commercial mortgage loans due to increased purchases of new mortgage loans in 2018.

(Net) Realized Investment Gains (Loss)

For the year ended December 31, 2018, realized investment losses were ($1.0) million compared with realized investment gains of $0.6 million for the year ended December 31, 2017. This decrease of $1.6 million was mainly due to decreased realized gains on sales of fixed maturity securities of $0.7 million, a $0.2 million decrease in release of the mortgage loan valuation allowance and mark-to-market losses on equity securities held as trading securities and limited partnerships of $0.7 million.

Life, Annuity and Health Claim Benefits

For the year ended December 31, 2018, life and annuity claim benefits were $56.6 million compared with $56.0 million for the year ended December 31, 2017. This increase of $0.6 million (1.1%) was mainly attributable to an increase in future policyholder benefit reserves of $5.2 million, partially offset by a reduction in claim benefits and dividends of $4.7 million primarily from our core and non-core lines.

Interest Credited to Policyholder Account Balances

For the year ended December 31, 2018, interest credited was $3.6 million compared to $3.8 million for the year ended December 31, 2017. This decrease of $0.2 million is due to reduced interest credited on lower assumed fixed annuity contractholder account balances.

General Operating Expenses

For the year ended December 31, 2018, general operating expenses were $27.5 million compared to $21.4 million for the year ended December 31, 2017. This increase of $6.1 million (28.5%) was mainly due to a $1.7 million increase in commissions due to premium growth, reduction of ceding allowances of $1.6 million due to the run-off of the closed block, $2.6 million of higher variable policy issuance costs and maintenance expense due to increased sales and a larger in-force block of business, and a $0.2 million increase in reserve financing costs.

Amortization of Deferred Acquisition Costs

For the year ended December 31, 2018, amortization of deferred acquisition costs was $16.0 million compared to $15.4 million for the year ended December 31, 2017. This increase reflects an increase from the Closed Block of $0.7 million primarily due to lapses, partially offset by a $0.1 million decrease in our core and non-core lines.

Net (loss) income

For the year ended December 31, 2018, net loss was $0.6 million compared to net income of $2.3 million for the year ended December 31, 2017. The decrease in net income of $2.9 million resulted primarily from higher general operating expenses and decreases in net realized investment gains, offset by an increase in net insurance premium, and reductions in life and annuity benefits.

 

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Closed Block

The closed block was formed as of October 1, 2006 and contains all participating policies issued or assumed by Fidelity Life. The assets and future net cash flows of the closed block are available only for purposes of paying benefits, expenses and dividends of the closed block and are not available to the Company, except for an amount of additional funding that was established at inception. The additional funding was designed to protect the block against future adverse experience, and if the funding is not required for that purpose, it is subject to reversion to the Company in the future. Any reversion of closed block assets to the Company must be approved by the Illinois Department of Insurance. See “Note 6—Closed Block” in the accompanying audited condensed consolidated financial statements and “Note 9—Closed Block” in the accompanying audited consolidated financial statements included in this prospectus. The closed block is included in our insurance segment. The condensed financial statements of the closed block are as follows:

 

     As of March 31,      As of December 31,  
     2019      2018      2017  
     (dollars in thousands)  

Closed Block Liabilities

        

Future policy benefits and claims

   $ 55,163      $ 58,468      $ 74,540  

Policyholder account balances

     8,002        8,147        8,655  

Other policyholder liabilities

     2,743        3,856        5,837  

Policyholder dividend obligations

     10,196        9,383        11,097  

Other liabilities

     (1,055      (1,061      5,014  
  

 

 

    

 

 

    

 

 

 

Total Closed Block liabilities

     75,049        78,793        105,143  
  

 

 

    

 

 

    

 

 

 

Assets Designated to the Closed Block

        

Investments

        

Fixed maturity securities—available-for-sale (amortized cost $34,003, $34,631 and $36,080, respectively)

     36,597        36,104        39,763  

Policyholder loans

     1,282        1,321        1,490  
  

 

 

    

 

 

    

 

 

 

Total investments

     37,879        37,425        41,253  

Cash and cash equivalents

     4,182        2,664        3,330  

Premiums due and uncollected

     1,711        2,595        4,655  

Accrued investment income

     430        450        475  

Reinsurance recoverable

     33,039        36,900        54,933  

Deferred income tax assets, net

     4,641        5,314        5,783  
  

 

 

    

 

 

    

 

 

 

Total assets designated to the Closed Block

     81,882        85,348        110,429  
  

 

 

    

 

 

    

 

 

 

Excess of Closed Block assets over liabilities

     6,833        6,555        5,286  
  

 

 

    

 

 

    

 

 

 

Amounts included in accumulated other comprehensive income:

        

Unrealized investment gains, net of income tax

     2,050        1,164        2,430  

Allocated to policyholder dividend obligation, net of income tax

     (1,901      (565      (1,634
  

 

 

    

 

 

    

 

 

 

Total amounts included in accumulated other comprehensive income

  

 

149

 

     599        796  
  

 

 

    

 

 

    

 

 

 

Maximum future earnings to be recognized from Closed Block assets and liabilities

   $ (6,684    $ (5,956    $ (4,490
  

 

 

    

 

 

    

 

 

 

 

     For the Three Months Ended
March 31,
     For the Years Ended
December 31,
 
         2019              2018              2018              2017      
     (dollars in thousands)  

Policyholder Dividend Obligations

           

Balance at January 1,

   $ 9,383      $ 11,097      $ 11,097      $ 9,652  

Impact from earnings allocable to policyholder dividend obligations

  

 

(43

  

 

47

 

     47        987  

Change in net unrealized investment (losses) gains allocated to policyholder dividend obligations

     856        (1,761      (1,761      458  
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 10,196      $ 9,383      $ 9,383      $ 11,097  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     For the Three Months Ended
March 31,
    For the Years Ended
December 31,
 
       2019             2018             2018              2017      
     (dollars in thousands)  

Closed Block Revenue and Expenses

         

Revenues:

         

Net life insurance premiums

   $ 1,269     $ 1,808     $ 5,525      $ 4,889  

Net investment income

     389       411       1,611        1,734  

Net realized investment gains (losses)

     —         22       38        161  
  

 

 

   

 

 

   

 

 

    

 

 

 

Total revenues

     1,658       2,241       7,174        6,784  
  

 

 

   

 

 

   

 

 

    

 

 

 

Benefits and expenses:

         

Life and annuity benefits—including policyholders’ dividends of $260, $315, $1,209 and $2,081 on March 31, 2019, March 31, 2018, December 31, 2018 and December 31, 2017, respectively

     1,402       1,361       5,044        3,692  

Interest credited to policyholder account balances

     49       50       207        223  

General operating expenses

     (120     (94     127        (2,125
  

 

 

   

 

 

   

 

 

    

 

 

 

Total benefits and expenses

     1,571       1,317       5,124        1,790  
  

 

 

   

 

 

   

 

 

    

 

 

 

Revenues, net of expenses before provision for income tax expense

     87       924       2,050        4,994  

Income tax expense

     18       194       430        5,143  
  

 

 

   

 

 

   

 

 

    

 

 

 

Revenue, net of expenses and provision for income tax expense

   $ 69     $ 730     $ 1,620      $ (149
  

 

 

   

 

 

   

 

 

    

 

 

 

The maximum future earnings to be recognized from closed block assets and liabilities represent the estimated future closed block profits that will accrue to the Company and is calculated as the excess of closed block liabilities over closed block assets. Included in closed block assets at March 31, 2019, December 31, 2018 and December 31, 2017 are $9.6 million, $9.5 million and $9.2 million, respectively, of additional closed block funding, plus accrued interest, that is eligible for reversion to the Company if not needed to fund closed block experience.

The closed block was funded based on a model developed to forecast the future cash flows of the closed block which is referred to as the “actuarial calculation.” The actuarial calculation projected the anticipated future cash flows of the closed block as established at the initial funding. We compare the actual results of the closed block to expected results from the actuarial calculation as part of the annual assessment of the current level of policyholder dividends. The assessment of policyholder dividends includes projections of future experience of the closed block policies and the investment experience of the closed block assets. The review of closed block experience also includes consideration of whether a policy dividend obligation should be recorded to reflect favorable closed block experience that has not yet been reflected in the dividend scales. The recorded policyholder dividend obligation at March 31, 2019, December 31, 2018 and December 31, 2017 totaled $10.2 million, $9.4 million and $11.1 million, respectively, and consisted of favorable policy experience on the closed block policies ($8.6 million, $8.7 million and $8.6 million, respectively) and unrealized gains on the closed block fixed maturity security portfolio holdings ($1.6 million, $0.7 million and $2.5 million, respectively).

Corporate Segment

The results of the corporate segment are as follows:

 

     Three Months Ended
March 31,
    For the Years Ended
December 31,
 
     2019     2018     2018     2017  
     (dollars in thousands)  

Revenue:

        

Net investment income

   $ 82     $ 51     $ 290     $ 210  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     82       51       290       210  

Expenses:

        

General operating expenses

     1,827       1,314       5,055       4,923  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     1,827       1,314       5,055       4,923  
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) before income taxes

   $ (1,745   $ (1,263   $ (4,765     (4,713
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018

General Operating Expenses

For the three months ended March 31, 2019, general operating expenses were $1.8 million compared to $1.3 million for the three months ended March 31, 2018. This increase in general operating expenses of $0.5 million (38.5%) was due to an increase in allocated employee expenses in 2019.

Net Income (Loss)

Our net loss for the three months ended March 31, 2019 increased $0.4 million (30.8%) to $1.7 million from a net loss of $1.3 million for the three months ended March 31, 2018. The increase in net loss was mainly due to an increase in employee costs from 2018.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

General Operating Expenses

For the year ended December 31, 2018, general operating expenses were $5.1 million compared to $4.9 million for the year ended December 31, 2017. This increase in general operating expenses of $0.2 million (4.1%) was due to an increase in allocated employee expenses in 2018.

Net Loss

The net loss for the year ended December 31, 2018 increased $0.1 million (2.1%) to $4.8 million from a net loss of $4.7 million for the year ended December 31, 2017. The increase in the net loss was mainly due to an increase in employee costs from 2017.

Intercompany Eliminations

The impact of the eliminations for intercompany transactions primarily consists of the sales by our agency segment of life products of our insurance segment. The eliminations represent the amounts required to eliminate the intercompany transactions as recorded in our segment results, and in particular, to eliminate any intersegment profits resulting from such transactions. Our segment results follow the accounting principles and methods applicable to each segment as if the intercompany transactions were with unaffiliated organizations:

Revenue—our agency segment recognizes all commission revenue to be paid for the first year that the policy is in force at the date that the insurance policy goes in force at the carrier.

Expense—our insurance segment recognizes the first-year commission as a policy acquisition cost, in proportion to the premiums earned from providing insurance coverage throughout the first year that the policy is in force. In addition, our insurance segment defers the amount by which the first-year commission acquisition costs exceed the ultimate renewal commission and records this amount as deferred acquisition cost that is amortized over the expected life of the policy.

 

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Viewed at the segment level, because of the timing difference between the agency segment’s immediate recognition of commission revenue and the insurance segment’s deferral and amortization of the commission expense over the expected life of the policy, all else being equal, the sale of a policy through our agency segment results in an intersegment profit in an amount equal to the difference between the commission paid and the related amortization expense. However, in consolidation, two impacts occur. First, the intercompany revenue recognized by our agency segment and the related deferred acquisition expense recorded by our insurance segment are eliminated. Second, we record deferred acquisition costs equal to that portion of Commission DAC that can be tied directly to Efinancial’s expenses incurred in the successful placement of a policy. Therefore, in consolidation, the Commission DAC recorded in our insurance segment is effectively reduced to reflect the elimination of that portion of Commission DAC that results from Efinancial expenses that cannot be directly tied to the successful placement of a policy. The amount of eliminated Commission DAC, which represents a majority of the Commission DAC, is charged to current expense, and acquisition cost DAC is recorded at a reduced amount, which represents the amount of Commission DAC that is eligible for deferral under GAAP. See “—Critical Accounting Policies—Deferred Policy Acquisition Costs (DAC)” and “Factors Affecting our Results—Strategic Goals and Financial Impact of Sales of Policies Produced by Efinancial” for more information. The results of these elimination entries were as follows:

 

     For the Three Months Ended
March 31,
    For the Years Ended
December 31,
 
         2019             2018             2018             2017      
     (dollars in thousands)  

Revenue:

        

Net investment (loss) income

   $ (105   $ (74   $ (386   $ (306

Earned commissions

     (6,119     (7,059     (28,857     (23,282
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     (6,224     (7,133     (29,243     (23,588
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

        

Commission expense

     (3,135     (3,870     (14,291     (10,859

General operating expenses

     (386     —         (386     (306

Amortization of deferred policy acquisition costs

     (1,119     (1,119     (4,522     (4,475
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     (4,640     (4,989     (19,199     (15,640
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) before income taxes

   $ (1,584   $ (2,144   $ (10,044     (7,948
  

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2019 Compared to Three Months Ended March 31, 2018

For the three months ended March 31, 2019, intercompany eliminations resulted in a $1.6 million reduction in pre-tax income compared to a $2.1 million reduction in pre-tax income for the three months ended March 31, 2018. This increase of $0.5 million (23.8%) was mainly due to a lower volume of sales of Fidelity Life policies by Efinancial period-over-period.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

For the year ended December 31, 2018, intercompany eliminations resulted in a $10.0 million reduction in pre-tax income compared to a $7.9 million reduction in pre-tax income for the year ended December 31, 2017. This decrease of $2.1 million (26.6%) was mainly due to a higher volume of sales of Fidelity Life policies by Efinancial period-over-period.

Investments

Investment Returns

We invest our available cash and funds that support our regulatory capital, surplus requirements and policy reserves in investment securities that are included in our insurance and corporate segments. We earn income on these investments in the form of interest on fixed maturity securities (bonds and mortgage loans) and dividends (equity holdings). Investment income is recorded net of investment related expenses as revenue. The amount of net investment income that we recognize will vary depending on the amount of invested assets that we own, the types of investments we own, the interest rates earned and amount of dividends received on our investments.

Gains and losses on sales of investments are classified as “realized investment gains (losses)” and are recorded as revenue. Capital appreciation and depreciation caused by changes in the market value of investments classified as “available-for-sale” is recorded in accumulated other comprehensive income. The amount of investment gains and losses that we recognize depends on the amount of and the types of invested assets we own and the market conditions related to those investments. Our cash needs can vary from time to time and could require that we sell invested assets to fund cash needs.

 

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Investment Guidelines

Our investment strategy and guidelines are developed by management and approved by the investment committee of Fidelity Life’s board of directors. Our investment strategy related to our insurance segment is designed to maintain a well-diversified, high quality fixed income portfolio that will provide adequate levels of net investment income and liquidity to meet our policyholder obligations under our life insurance policies and our assumed annuity deposits. To help maintain liquidity we establish the duration of invested assets within a tolerance to the policy liability duration. The investments of our insurance segment are managed with an emphasis on current income within quality and diversification constraints. The focus is on book yield of the fixed income portfolio as the anticipated portfolio yield is a key element used in pricing our insurance products and establishing policyholder crediting rates on our annuity contracts.

We apply our overall investment strategy and guidelines on a consolidated basis for purposes of monitoring compliance with our overall guidelines. Almost all of our investments are owned by Fidelity Life and are maintained in compliance with insurance regulations. Critical guidelines of our investment plan include:

 

   

Asset concentration guidelines that limit the amount that we hold in any one issuer of securities,

 

   

Asset quality guidelines applied on a portfolio basis and for individual issues that establish a minimum asset quality standard for portfolios and establish minimum asset quality standards for investment purchases and investment holdings,

 

   

Liquidity guidelines that limit the amount of illiquid assets that can be held at any time, and

 

   

Diversification guidelines that limit the exposure at any time to the total portfolio by investment sectors.

Our investment portfolios are all managed by third party investment managers that specialize in insurance company asset management and in particular these managers are selected based upon their expertise in the particular asset classes that we own. We contract with an investment management firm to provide overall assistance with oversight of our portfolio managers, evaluation of investment performance and assistance with development and implementation of our investment strategy. This investment management firm reports to our Chief Financial Officer and to the Investment Committee of Fidelity Life’s board of directors. On a quarterly basis, or more frequently if circumstances require, we review the performance of all portfolios and portfolio managers with the Investment Committee.

The following table shows the distribution of the fixed maturity securities classified as available-for-sale by quality rating using the rating assigned by Standard & Poor’s, a nationally recognized statistical rating organization. Over the periods presented, we have maintained a consistent weighted average bond quality rating of “A.” The percentage allocation of total investment grade securities has increased to 94.4% at March 31, 2019 from 94.0% at December 31, 2018 due to the S&P ratings on certain new securities acquired in our portfolio of distressed residential mortgage-backed securities.

 

     Estimated Fair Value  
     March 31, 2019     December 31, 2018     December 31, 2017  
     (dollars in thousands)  

S&P Rating

               

AAA

   $ 81,438        26.6   $ 80,606        26.4   $ 74,535        22.1

AA

     43,204        14.1     40,583        13.2     33,988        10.1

A

     90,296        29.4     93,214        30.4     115,585        34.2

BBB

     59,081        19.2     57,599        18.8     58,240        17.2

Not rated

     15,729        5.1     16,076        5.2     24,047        7.1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investment grade

     289,748        94.4     288,078        94.0     306,395        90.7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

BB

     10,536        3.4     11,895        3.8     18,399        5.5

B

     5,748        1.9     4,802        1.6     12,874        3.8

CCC

     951        0.3     1,802        0.6     0        0.0

D

     8        0.0     8        0.0     0        0.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total below investment grade

     17,243        5.6     18,508        6.0     31,273        9.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 306,991        100.0   $ 306,586        100.00   $ 337,668        100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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The following table sets forth the maturity profile of our debt securities at March 31, 2019, December 31, 2018 and December 31, 2017. Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without penalty.

 

    March 31, 2019     December 31, 2018     December 31, 2017  
    Amortized
Cost
    %     Estimated
Fair Value
    %     Amortized
Cost
    %     Estimated
Fair Value
    %     Amortized
Cost
    %     Estimated
Fair
Value
    %  
    (dollars in thousands)  

Due in one year or less

  $ 9,164       3.1   $ 9,219       3.0   $ 7,395       2.4   $ 7,434       2.4   $ 18,748       5.9   $ 18,975       5.6

Due after one year through five years

    50,052       16.9     51,501       16.8     53,759       17.7     54,239       17.7     63,495       19.9     65,808       19.5

Due after five years through ten years

    39,028       13.1     39,905       13.0     41,125       13.5     40,866       13.3     45,615       14.3     47,514       14.1

Due after ten years

    82,298       27.7     89,505       29.2     85,398       28.1     88,461       28.9     90,703       28.4     103,749       30.7

Securities not due at a single maturity date-primarily mortgage and asset-backed securities

    116,406       39.2     116,861       38.0     116,626       38.3     115,586       37.7     100,405       31.5     101,622       30.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total debt securities

  $ 296,948       100.0     $306,991       100.0   $ 304,303       100.00   $ 306,586       100.00   $ 318,966       100.0   $ 337,668       100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Every quarter, we review all investments where the market value is less than the carrying value to ascertain if the impairment of the security’s value is other than temporary (“OTTI”). The quarterly review is targeted to focus on securities with larger impairments and that have been in an impaired status for longer periods of time. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Polices—Other-Than-Temporary Impairments on Available-For-Sale Securities.”

Net Investment Income

One key measure of our investment income is the book yield on our holdings of fixed maturity securities classified as available-for-sale, which holdings totaled $297 million, $304 million and $319 million, and represented 80.0%, 83.2% and 85.9% of our invested assets, as of March 31, 2019, December 31, 2018 and December 31, 2017, respectively. Book yield is the effective interest rate, before investment expenses, that we earn on these investments. Book yield is calculated as the percent of net investment income to the average amortized cost of the underlying investments for the period. For the three months ended March 31, 2019, and the years ended December 31, 2018 and December 31, 2017, our book yield on fixed maturity securities available-for-sale was 4% for each period.

Interest Credited on Contractholder Deposits

Included with the future policy benefits is the liability for contractholder deposits on deferred annuity contracts assumed through two reinsurance agreements effective in 1991 and 1992 and certain other policy funds left on deposit with the Company. The aggregate liability for deposits is as follows:

 

     March 31, 2019     December 31, 2018     December 31, 2017  
     Ending
Balance
     Year to
Date
Interest
Credit
     Average
Credit
Rate
    Ending
Balance
     Year to
Date
Interest
Credited
     Average
Credit
Rate
    Ending
Balance
     Year to Date
Interest
Credited
     Average
Credit
Rate
 
                         (dollars in thousands)                      

Annuity contractholder deposits—assumed

   $ 82,031      $ 742        4.0   $ 83,299      $ 3,353        4.0   $ 88,725      $ 3,518        4.0

Dividends left on deposit

     8,002        49        2.4     8,147        207        2.5     8,655        223        2.6

Other

     1,559        10        2.4     1,605        38        2.4     1,519        35        2.3
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

Total

   $ 91,632      $ 801        3.6   $ 93,051      $ 3,598        3.9   $ 98,899      $ 3,776        3.8
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

The liability for deferred annuity deposits represents the contractholder account balances. Due to the declines in market interest rates and the book yield on our investment portfolio, we credit interest on all contractholder deposit liabilities at contractual rates that are currently at the minimum rate allowed by the contract or by state regulations.

Our insurance segment realizes operating profit from the excess of our book yield realized on fixed maturity securities that support our contractholder deposits over the amount of interest that we credit to the contractholder. We refer to this operating profit as the “spread” we earn on contractholder deposits. Our book yields on fixed maturity investments have declined in recent periods due to current market conditions. If book yields continue to decline, the amount of spread between the interest earned and credited will be reduced.

 

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Net Realized Investment Gains (Losses)

Realized investment gains and losses are subject to general economic trends and in particular correlate generally with movements in the major equity market indexes. The amounts classified as realized gains and losses in our statement of operations include amounts realized from sales of investments, mark-to-market adjustments on investments classified as trading securities, equity holdings and investments that use the equity method of accounting (limited partnerships) and other-than-temporary impairments of individual securities related to credit impairments.

Net realized investment gains (losses) that we recognize are influenced to a great degree by the mark-to-market on our trading securities portfolios and the adjustments resulting from the application of equity method accounting for our limited partnership investments. The period to period changes in the investments reflect the impact of market volatility on our reported results, as can be seen from the following table. We hold these trading securities portfolios to diversify our invested assets. Most of these investments are either direct equity securities or have a good degree of correlation to the results of the equity markets.

 

     For the Three Months Ended
March 31,
    For the Years Ended
December 31,
 
         2019             2018             2018             2017      
     (dollars in thousands)  

Net Realized Investment Gains (Losses)

        

Sales of Investments:

        

Fixed maturity securities, available-for-sale

   $ 111     $ 117     $ 134     $ 843  

Limited partnerships

     (7     37       22       89  

Other-than-temporary impairment losses on fixed maturity securities, available-for-sale—net

     —         —         —         —    

Trading securities—(losses) gains:

        

Equity securities

     778       (705     (1,140     (609

Investment expenses

     (8     (11     (52     (22

Mortgage loan impairments

     174       1       32       214  

Equity method—limited partnerships

     —         —         37       56  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net realized investment (losses) gains

   $ 1,048     $ (561   $ (967   $ 571  
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized Holding Gains (Losses)

We also record capital appreciation/depreciation on our available-for-sale fixed maturity securities. The following table shows the annual increase in equity from mark-to-market adjustments on our available-for-sale fixed maturity securities. These adjustments result from the low current market interest rates which cause the market value of our holdings, which overall carry higher interest rates than available in the market, to increase.

 

     For the Three Months
Ended March 31,
    For the Years
Ended December 31,
 
         2019              2018             2018             2017      
     (dollars in thousands)  

Other Comprehensive Income (Loss)

         

Unrealized holding gains from changes in the market value of securities, including the related impact to future policy benefit liabilities, the policyholder dividend obligation and deferred policy acquisition cost balances

   $ 5,947      $ (6,567   $ 12,870     $ 2,058  

Income tax effect

     1,249        1,379       (2,704     (597
  

 

 

    

 

 

   

 

 

   

 

 

 

Net increase (decrease) in accumulated other comprehensive income

   $ 4,698      $ (5,188   $ 10,166     $ 1,461  
  

 

 

    

 

 

   

 

 

   

 

 

 

At March 31, 2019, March 31, 2018, December 31, 2018 and December 31, 2017, we had accumulated other comprehensive income (loss) from mark-to-market adjustment of our available-for-sale fixed income securities totaling $4.7 million, $(5.2 million), $10.2 million and $1.5 million (net of federal income taxes and reserve), respectively.

Financial Position

At March 31, 2019, we had total assets of $662.9 million compared to total assets at December 31, 2018 of $655.0 million, an increase of $7.9 million. The invested asset base increased $3.1 million primarily due to increases in market value

 

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changes. Commissions receivable increased by $9.8 million primarily due to the adoption of certain accounting standards (see “Note 1—Summary of Significant Accounting Policies—Revenue Recognition” in the accompanying unaudited condensed consolidated financial statements included in this prospectus). Reinsurance recoverables increased $3.4 million primarily due to the timing of settlements of reinsurance receivables and payables, offset by cash decreases of $7.6 million. The remaining increase of $0.4 million is largely attributable to other assets and net deferred income tax assets.

At March 31, 2019, we had total liabilities of $483.7 million compared to total liabilities of $482.8 million at December 31, 2018. The increase in total liabilities of $0.9 million was primarily due to an increase in commission financing liabilities of $1.7 million and policyholder and reinsurance liabilities of $0.4 million, offset by a decrease in other liabilities of $1.2 million.

At March 31, 2019, total equity increased to $179.2 million from $172.2 million at December 31, 2018. This increase of $7.0 million (4.1%) consists of a net gain in other comprehensive income for the period of $4.7 million which is due to unrealized net gains on our fixed maturity available-for-sale securities portfolio. Retained earnings increased by $2.4 million which includes a net loss of $6.2 million and an increase of $8.6 million related to the revenue recognition accounting standard adoption. (See Note 1 and the Consolidated Statements of Changes in Equity for additional information related to the accounting standard adoption.)

At December 31, 2018, we had total assets of $655.0 million compared to total assets at December 31, 2017 of $666.4 million. The decrease in total assets of $11.4 million primarily results from a decrease in the value of fixed maturity securities due to increasing market interest rates.

At December 31, 2018, we had total liabilities of $482.8 million compared to total liabilities of $470.2 million at December 31, 2017. The increase in total liabilities of $12.6 million was primarily due to an increase in future policy benefits of $17.6 million resulting from a growing block of business, an increase in commission financing liabilities of $13.4 million, other liabilities of $0.8 million, offset by decreases in the closed block policyholder dividend obligation of $1.7 million, policyholder account balances of $5.9 million, other policyholder liabilities of $10.3 million due to lower pending claims, and lower reinsurance payables of $1.3 million.

At December 31, 2018, total equity decreased to $172.2 million from $196.2 million at December 31, 2017. This decrease in equity of $24.0 million (12.2%) consists of the net loss of $13.8 million and other comprehensive loss of $10.2 million. The other comprehensive loss for the period was due to unrealized net losses on our fixed maturity available-for-sale securities portfolio. This decrease was caused by an increase in market interest rates at December 31, 2018 when compared to market interest rates at December 31, 2017.

Liquidity and Capital Resources

Our principal sources of funds are from premium revenues, commission revenues, investment income and proceeds from the sale and maturity of investments. The Company’s primary uses of funds are for payment of life policy benefits, contractholder withdrawals on assumed annuity contracts, new business acquisition costs for our insurance operations (i.e., commissions, underwriting and issue costs), cost of sales for agency operations (i.e., agent compensation, purchased lead and lead generation costs), general operating expenses and purchases of investments. Our investment portfolio is structured to provide funds periodically over time, through investment income and maturities, to provide for the payment of policy benefits and contractholder withdrawals.

Under our commission financing arrangement with Hannover Life, Fidelity Life is able to pay level annual commissions instead of first-year-only commissions to Efinancial for sales of RAPIDecision® Life policies, and Hannover Life advances to Efinancial amounts approximately equal to first-year-only commissions for sales of those policies. This arrangement reduces Fidelity Life’s surplus strain associated with issuing RAPIDecision® Life business while helping to provide liquidity for Efinancial through the receipt of larger first-year-only commissions. We are able to obtain advances up to $20 million under our arrangement with Hannover Life. As of March 31, 2019, we had net advances of $15.0 million under this arrangement.

We are a member of the Federal Home Loan Bank of Chicago (the “FHLBC”). As a member we are able to borrow on a collateralized basis from the FHLBC. We own FHLBC common stock with a book value of $99,000, which allows us to borrow up to $2.2 million. Interest on borrowed funds is charged at variable rates established from time to time by the FHLBC based on the interest rate option selected at the time of the borrowing. There have been no borrowings under this facility.

Fidelity Life’s ability to pay dividends to Vericity Holdings is limited by the insurance laws of the State of Illinois. All shareholder dividends are subject to notice filings with the Illinois Insurance Director. The maximum amount of dividends that

 

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can be paid by Illinois life insurance companies to stockholders without 30 days prior notice to the director of the Illinois Department of Insurance is the greater of (i) statutory net income for the preceding year or (ii) 10% of statutory surplus as of the preceding year-end. However, under Illinois insurance statutes, dividends may be paid only from surplus, excluding unrealized appreciation in value of investments, without prior approval. Dividends in excess of these amounts require advance approval of the Illinois Department of Insurance. There are no limitations on the amount of dividends that Efinancial can pay.

During the three months ended March 31, 2019, and the years ended 2018 and 2017, the board of directors of Fidelity Life approved the payment of $5.0 million, $7.0 million and $7.0 million, respectively, in dividends to Vericity Holdings. The dividends provided operating funds to Vericity Holdings to support corporate operations and initiatives. Following the conversion, Fidelity Life has agreed not to pay any common stock dividends without the approval of a majority of the company designees. See —“The Conversion and Offering—Description of the Standby Purchase Agreement—Post-Closing Covenants-Standstill Period.” In connection with the approval of the conversion by the Illinois Director of Insurance, we agreed, for a period of twenty-four months following the completion of the offerings, to seek the prior approval of the Illinois Department of Insurance for any declaration of an ordinary dividend by Fidelity Life.

Fidelity Life is a party to various services and cost sharing agreements with Vericity Holdings and Efinancial pursuant to which certain costs and expenses incurred by Vericity Holdings and Efinancial on behalf of Fidelity Life are allocated to Fidelity Life and reimbursed to the entity incurring the expense.

As an Illinois-domiciled mutual holding company, Members Mutual is subject to the same minimum statutory capital and surplus levels as Fidelity Life. However, Members Mutual is not authorized to transact insurance business and cannot issue or reinsure insurance policies. Accordingly, the level of statutory capital and surplus at Members Mutual has no material effect on the ability of Fidelity Life to write insurance or on the Company’s consolidated results of operations, financial position or liquidity. Although Members Mutual is subject to minimum capital and surplus requirements, it is not subject to RBC requirements. Our other operating subsidiaries are not subject to regulatory capital requirements or RBC.

We have experienced net negative cash flows in the three months ended March 31, 2019 and in most prior periods due to continued growth in sales of our life insurance products and in our agency operations and through continued net withdrawals on assumed annuity contractholder deposits. Our annuity deposits are in run-off because we do not market annuity contracts to generate annuity deposits to offset the withdrawal activity on in-force contracts.

Cash uses in our insurance segment result in negative operating cash flows related to sales of new insurance policies because:

 

   

Policy acquisition costs (consisting of agent commissions, policy underwriting and issue costs) exceed the amount of first year premium received from the policyholder,

 

   

Depending on the product sold, a portion or all of the agent’s commission may be paid as a cash advance to the agent and most of the underwriting and policy issue costs are paid at the time the initial policy is issued, whereas the premiums may be paid throughout the policy year, and

 

   

Amounts due from reinsurers to reimburse claims paid are usually paid at some date after the claim has been paid.

The resulting negative first year cash flows from sales of new policies is partially offset by positive cash flows from insurance policy renewals. The continued sales growth in our insurance operations has resulted in a net cash decrease from operations. Cash flows from reinsurance collections will vary from period to period based on claims activity.

Our corporate segment experienced negative cash flows as a result of the payment of allocated overhead expenses.

Cash flows from investing includes our fixed maturity securities and equity holdings that are classified as available-for-sale securities. Period to period, the cash flows associated with the changes in these portfolios will vary between cash sources and cash uses depending on portfolio trading due to investment market conditions and other factors.

Cash flows from financing activities primarily consists of the assumed annuity contractholder deposits. The annuity liabilities are reducing each period due to cash withdrawals by contractholders on this block of annuities that were primarily written in the late 1980s. Cash deposits to these annuity contracts are minimal compared to cash withdrawal activity. Also included in financing cash flows is net proceeds from our commission financing program.

Cash flows from investing activities represents our primary source of cash. We use cash flows from investments to fund the withdrawals from the assumed annuity deposits and to fund the negative cash flows from operating activities.

 

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Cash Flows

 

    For the Three Months Ended
March 31,
     For the Years Ended
December 31,
 
            2019                      2018              2018      2017  
    (dollars in thousands)  

Consolidated Summary of Cash Flows

          

Cash flows provided by (used for) operating activities

  $  (11,232    $  (2,084    $ 4,203      $ 9,480  

Cash flows provided by (used for) investing activities

    4,300        (1,851      2,540        (8,550

Cash flows provided by (used for) financing activities

    (720      2,795        2,475        (8,586
 

 

 

    

 

 

    

 

 

    

 

 

 

Net increase (decrease) in cash and cash equivalents

  $ (7,652    $  (1,140    $ 9,218      $ (7,656
 

 

 

    

 

 

    

 

 

    

 

 

 

For the three months ended March 31, 2019, we had a net decrease in cash of $7.7 million compared to a net decrease of $1.1 million for the three months ended March 31, 2018. Cash from operating activities decreased by $9.1 million mainly due to higher life, annuity, and health claim benefits and higher general operating expenses, partially offset by increases in premiums. Cash provided by financing activities increased due to implementation of commission financing.

For the year ended December 31, 2018, we had a net increase in cash of $9.2 million compared to net decrease of $7.7 million for the year ended December 31, 2017. Cash from operating activities decreased by $5.2 million mainly due to higher premium volume offset by higher general operating expenses. Cash provided by financing activities increased due to implementation of commission financing.

Risk-Based Capital

Fidelity Life is subject to regulatory guidelines related to the ratio of its capital level compared to its RBC level as determined by formulas adopted by state insurance departments and applicable to all life insurance companies. A company’s “authorized control level RBC” is a measure of the amount of capital appropriate for an insurance company to support its overall business operations in light of its size, growth and risk profile. RBC standards are used by regulators to determine appropriate regulatory actions for insurers that show signs of weak or deteriorating conditions. Companies that do not maintain total adjusted risk-based capital in excess of 200% of the company’s authorized control level risk-based capital may be required to take specific actions at the direction of state insurance regulators. Fidelity Life’s total adjusted capital at December 31, 2018 and 2017 was well in excess of 200% of its authorized control level. See “Business—Regulation—Risk-Based Capital (RBC) Requirements.”

Due to the continued growth in Fidelity Life’s sales of new insurance policies and the dividends to Vericity Holdings ($5.0 million in 2019 and $7.0 million in both 2018 and 2017 to provide working capital), Fidelity Life’s statutory surplus has been declining. The accounting principles applicable to regulatory reporting require that insurance companies expense all policy acquisition costs as incurred. Acquisition expenses attributable to Fidelity Life’s increasing new business growth have resulted in net losses being reported for regulatory reporting purposes. Regulatory accounting principles allow limited recognition of the future benefits of deferred tax assets. Accordingly, we recognize no income tax benefit that would offset our operating losses for regulatory reporting purposes.

Fidelity Life is also subject to the model regulation entitled “Valuation of Life Insurance Policies” commonly known as “Regulation XXX.” This regulation requires life insurance companies that issue insurance policies with level premium guarantees to carry reserves that can greatly exceed the amount that the insurance company believes is necessary to reflect its liability for future claims payments. Such reserves are sometimes referred to as “non-economic reserves.” Many insurance companies use reinsurance, financing, formation of captive reinsurers and other reserve financing transactions to reduce the regulatory capital needs under Regulation XXX. Generally these solutions have only been available to carriers with much larger amounts of affected liabilities than Fidelity Life. To mitigate the future impact on regulatory capital from Regulation XXX and help stabilize our regulatory capital position in light of anticipated sales increases, we entered into a reserve financing agreement with Hannover Life effective July 1, 2013 that covered certain products with policies written on or before September 30, 2012. This agreement was amended and restated as of July 1, 2016 to extend the issue date of policies for products covered under the existing reserve financing through December 31, 2015 and also included additional Fidelity Life products. The agreement is indefinite in length, but allows Fidelity Life to fully recapture the ceded business for approximately one year beginning on or after December 31, 2026. The agreement also provides for the payment of experience refunds, if any, to Fidelity Life with respect to the ceded business through December 31, 2026. As of March 31, 2019, the reserve credit under this arrangement was approximately $90.0 million.

 

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Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity or capital expenditures.

Quantitative and Qualitative Information about Market Risk

We own a diversified portfolio of investments including cash, bonds, preferred stocks, commercial mortgages, and common stock. Each of these investments is subject, in varying degree, to market risk that can affect their return and their fair value. Bonds are the majority of our investments and include debt issues of corporations, residential and commercial mortgage-backed securities or other asset-backed securities, U.S. Treasury securities, or obligations of U.S. Government Sponsored Enterprises and are classified as fixed maturity investments in our financial statements. Our investment portfolios are subject to market risks.

Market risk is the risk that we will incur losses due to adverse changes in market rates and prices on the fair value of the investment securities that we own. We have exposure to market risk through our investment activities, including interest rate risk, credit risk, equity risk and foreign currency risk. We have not and do not plan to enter into any derivative financial instruments for trading or speculative purposes.

Interest Rate Risk

Interest rate risk arises from the price sensitivity of investments to changes in interest rates. The changes in the fair value of our fixed maturity investments are inversely related to changes in market interest rates. As market interest rates fall the fixed income streams of fixed maturity investments held become more valuable and market values rise. As market interest rates rise, the opposite effect occurs. Interest rate risk can also arise if market rates fall, which can result in lower interest spreads on our assumed annuity deposits, which are our primary interest rate sensitive liability.

We review the interest rate sensitivity of our available-for-sale fixed maturity securities by calculating the impact on the market value of our holdings that would result from a hypothetical instantaneous shift in market interest rates across all maturities, which we consider to be reasonably possible. The impact of such a parallel shift upward in the yield curve of 200 basis points would reduce the market value of our fixed maturity security portfolio by $36.9 million (12.1%), $39.2 million (12.4%) and $42.7 million (12.7%) as of March 31, 2019, December 31, 2018 and December 31, 2017, respectively. The estimated market value changes assume all other factors are held constant and do not attempt to estimate any offsetting change in the value of our liabilities.

With regard to our assumed annuity deposits, we are subject to risk from contractholder behavior resulting from changes in interest rates. The assumed annuity contracts have virtually no surrender charges remaining that could be assessed against withdrawals. When market interest rates exceed the amount that we are crediting on deposits, we are subject to higher contractholder withdrawals or an increase in contract loans, both of which could force the company to sell assets prematurely and could lead to the realization of capital losses on such sales. As of March 31, 2019, we were crediting interest at the minimum contract interest rate, which on a composite basis is approximately 3.9% annually. We manage our exposure to rising interest rates through our ability to increase the contract crediting rate. Our ability to increase our crediting rate is constrained by our portfolio yield at the time of the decision to increase rates. Increases in the contract crediting rates could reduce our income unless we are able to maintain a constant interest spread on our assets.

Credit Risk

Credit risk is risk of loss due to adverse change in the financial condition of a specific debt issuer or, in the case of a securitized investment, adverse change in the assets being securitized. We address credit risk by establishing minimum rating standards for investments that our portfolio managers can acquire and, in the case of a downgrade, continue to hold the investment. For our core fixed income portfolio, which comprises approximately 88.8% of our invested assets, only investment grade securities (minimum credit rating for new investments is BBB- as established by Standard & Poor’s or a comparable nationally recognized statistical rating organization) can be purchased and such portfolio managers must maintain an overall credit rating for the portfolio of at least A-. Through our portfolio managers we monitor the financial condition of all the issues of securities that we own. As an additional step to reduce our exposure to credit risk, we have established diversification guidelines limiting the total amount of holding by issuer and by investment sector.

Equity Market Risk

Equity market risk is the risk that we will incur economic losses due to adverse changes in equity prices. Adverse changes in equity prices can arise from both the movements of broad markets based on investor behavior or other general

 

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economic factors and also from adverse changes in an individual company’s stock price. We manage our equity market risk primarily by limiting our exposure to individual issuers and by maintaining liquid holdings such that we are able to find a ready market should we want to lower our exposure to equity markets. Our individual stock holdings are managed by a specialty manager with portfolio guidelines that include limits on industry exposures and the size of investments in individual issuers. As of March 31, 2019, December 31, 2018 and December 31, 2017, we had $5.8 million, $4.9 million and $5.6 million of exposure to equity market risk in our insurance segment through holdings of individual equity securities, respectively.

Recent Accounting Pronouncements

All applicable adopted accounting pronouncements have been reflected in our condensed consolidated financial statements as of and for the three months ended March 31, 2019, and the years ended December 31, 2018 and December 31, 2017.

 

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BUSINESS

Overview

We provide life insurance protection targeted to the middle American market. We believe there is a substantial unmet need for life insurance, particularly among domestic households with annual incomes of between $50,000 and $125,000, a market we refer to as our target Middle Market. We strive to deliver to this market affordable, easy to understand term and whole life insurance products through a consumer-friendly and efficient sales process. Through innovation in product design and distribution that provides access to the Middle Market, including call center and web-enabled sales and underwriting processes, quick issuance of policies and an emphasis on products not medically underwritten at the time of sale, we believe we are well positioned to make life insurance more affordable and accessible to the Middle Market.

We conduct our business through our two operating subsidiaries, Fidelity Life Association, an Illinois-domiciled life insurance company chartered in 1896, and Efinancial, LLC, a call center-based insurance agency. Fidelity Life distributes life insurance products through Efinancial and other unaffiliated agents and is licensed in the District of Columbia and every state except New York and Wyoming. A.M. Best has assigned an “A-” (Excellent) rating to Fidelity Life, which is the fourth highest out of fifteen ratings. Fidelity Life is located in Chicago, Illinois.

Efinancial markets life products for Fidelity Life and, as of December 31, 2018, had agency relationships with 25 unaffiliated insurance companies. Efinancial’s primary operations are conducted through employee agents from two call center locations in Bellevue, Washington and Chicago, Illinois, which we refer to as our retail channel, and through independent agents and other marketing organizations, which we refer to as our wholesale channel. In addition to offering Fidelity Life products, Efinancial also sells insurance products of unaffiliated carriers. Efinancial’s principal office is located in Bellevue, Washington.

We believe our ability to unconditionally issue policies either during or within 24 to 48 hours of the initial call differentiates us from our competitors. Leveraging our patented RAPIDecision® sales and underwriting processes, we can sell a life insurance policy to a consumer before medical underwriting is complete. We are able to complete an initial underwriting process for most of our life insurance applicants either during or shortly after the initial call, and if not, within 24 to 48 hours after that initial call. For the three months ended March 31, 2019, approximately 90% of our policy applications processed through our RAPIDecision® underwriting process received an underwriting disposition on or shortly after the initial sales call. Approximately one-half of the remaining applications received final underwriting decisions within the next 24 to 48 hours.

Our RAPIDecision®Life product provides coverage at the point of issue that is a blend of all-cause term life insurance for part of the coverage and accidental death insurance for the remainder of the total face amount. If a policyholder completes medical underwriting after the initial sale of the RAPIDecision®Life product, the policy benefits may be improved based on the underwriting results to increase the proportion of all-cause term life insurance coverage, typically with no increase in premium. In some instances, based upon the results of predictive analytic models, the consumer can qualify for the full amount of all-cause coverage without medical testing.

For the three months ended March 31, 2019, and the years ended December 31, 2018 and 2017, we had total consolidated revenue of $33.2 million, $123.9 million and $115.9 million, net life premium revenue of $23.1 million, $88.6 million and $82.9 million, and a net loss of $6.2 million, $13.8 million and $8.2 million, respectively. As of March 31, 2019, we had total assets of $662.9 million and equity of $179.2 million.

Our Approach

Our business model is predicated upon gaining cost effective access to the Middle Market, engaging consumers in our sales process for life insurance with products that have higher placement rates than traditional fully underwritten term life insurance in a call center environment, and issuing those products quickly. We require access to a large quantity of quality sales leads to keep our retail call center agents productive. Currently, we acquire most of our sales leads from third party lead vendors. We supplement that lead flow with leads we generate ourselves. More significantly, we are rapidly increasing our affinity business with non-life insurance partners that provide their customers or prospects as leads, and we market and sell life insurance products to those leads.

We tend to sell policies with lower face amounts, resulting in more affordable options for our customers. Although not the lowest priced, our products are competitive and they represent an attractive consumer value considering the coverage they provide and the relative simplicity of our sales and underwriting processes. Our business model allows us to capture

 

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end-to-end data beginning with the acquisition of sales leads through the final disposition of life insurance policies. With this data, we plan to develop and apply predictive analytics to realize efficiencies at various points in the sales process.

Our Competitive Strengths

We believe that we are strategically positioned to take advantage of the following competitive strengths:

 

   

Middle Market access. The sales contacts made through Efinancial’s call centers are focused on the Middle Market. This stands in contrast to the life insurance industry at large, which tends to market to a more affluent clientele.

 

   

Multi-channel distribution. We reach Middle Market consumers through multiple distribution channels. Through our retail channel, we engage consumers through Efinancial’s call centers using sales leads that we acquire or generate ourselves, and we leverage our product and sales processes with affinity partners to extend our reach to Middle Market consumers seeking affordable, accessible life insurance. Through our wholesale channel, we offer other carriers’ products through unaffiliated distributors. In addition, Fidelity Life also offers its products through select unaffiliated distributors.

 

   

Patented products and processes. Our RAPIDecision® Life product features a system-and-method patented process that affords higher and faster placement rates than traditional fully underwritten term life insurance in a call center environment. Through our process, policy placement usually occurs during the initial interaction, which leads to customer satisfaction and improved economics in our call centers. Our efficient process contrasts with much of the industry, where the underwriting process extends well beyond the initial interaction. In addition, our flagship RAPIDecision® Life product uses predictive analytics at certain ages and face amounts to place all-cause coverage products during the initial interaction without a medical examination for qualified customers. The product is priced to be profitable even at lower policy amounts, which allows us to align our offerings with Middle Market consumers’ ability to afford life insurance.

 

   

End-to-end lead and policy data. As a life insurance company and a direct distributor, we are positioned to gather end-to-end lead and policy data to develop predictive analytical models that can be applied to identify the characteristics of prospects who are more likely to exhibit favorable placement, persistency and mortality experience. We plan to apply this insight to optimize our marketing, sales and underwriting processes and product development.

Our Growth Strategies

We intend to use our competitive strengths to grow our business through the following strategies:

 

   

Capitalize on the unmet need for life insurance in our target market. We believe we are well positioned to meet demand where there is currently a substantial unmet need for life insurance in the Middle Market. Using our quick-issue products together with our distribution platform, we plan to increase sales to Middle Market consumers by providing a convenient experience to purchase life insurance at an affordable price.

 

   

Use predictive analytics to generate more productive sales leads. By converting data we generate through our distribution platform into actionable insight using statistical analysis, we will seek to be more efficient in our acquisition and use of leads, improving our call center placement ratios and overall profitability.

 

   

Enhance and extend affinity partnerships. We plan to continue and selectively deepen our existing affinity partnerships and develop new and complementary affinity relationships and partnerships. We expect this will expand and diversify our sources of quality leads.

 

   

Expand call center operations and improve efficiency. To drive sustainable premium and Efinancial commission growth, we plan to expand our Efinancial call center operations by hiring additional agents. In addition, we evaluate our product offerings and product providers in order to examine whether we are addressing the needs and preferences of the Middle Market.

 

   

Explore alternative means of distribution. We are currently exploring distribution alternatives beyond our call center and independent distributors, including digital and on-line sales.

 

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Business Segments

We manage our business through three segments:

 

   

Agency. Our agency segment operates through Efinancial. Efinancial sells insurance products through its call center distribution platform and through its independent agents and other marketing organizations.

 

   

Insurance. Our insurance segment operates through Fidelity Life. Fidelity Life engages in the principal business lines of core life, non-core life, closed block, and annuities and assumed life. In its core life and non-core life business lines, Fidelity Life offers primarily term life insurance products, and to a lesser extent accidental death and final expense products. We currently do not offer annuity contracts, separate account variable products or universal life products.

 

   

Corporate. Our corporate segment consists primarily of a small amount of capital required to be maintained for regulatory purposes, and also includes certain expenses considered to be corporate and not allocated to our agency or insurance segments.

Agency Segment

Overview

The agency segment consists of the operations of Efinancial. Efinancial is a call center-based insurance agency that markets life insurance for Fidelity Life and unaffiliated insurance companies. Efinancial’s primary operations are conducted through employee agents from two call center locations, which we refer to as our retail channel. In addition, Efinancial operates as a wholesale agency, assisting independent agents that seek to produce business for the carriers that Efinancial represents, which we refer to as our wholesale channel.

The agency segment’s main source of revenue is commissions earned on the sale of insurance policies sold through our retail channel. Efinancial’s employee agents utilize insurance sales leads to contact potential customers and then work with the customers to complete the sales process, which can occur during the initial contact or within 24 to 48 hours for non-medically underwritten policies. In our wholesale channel, in consideration for using our carrier contracts, access to leads and case management services, we receive a portion of the commission earned by the independent agent from the carrier. Efinancial also generates insurance lead sales revenue through its eCoverage web presence, and through the resale of leads that are not well suited for our call center.

Agents

Our agents in the agency segment are either employed by Efinancial or are independent agents who sell through our wholesale distribution channel.

Our Employee Agents

Efinancial operates primarily through two retail call center locations. One retail call center is located at the Efinancial corporate office in Bellevue, Washington, and the other retail call center is located at our office in Chicago, Illinois.

In each of our retail call center facilities, our employee agents, or call center insurance agents, conduct outbound telephone sales using insurance sales leads obtained from sales leads vendors or generated by our own marketing efforts or through our affinity partner relationships. To a much lesser extent, the call center insurance agents also handle inbound telephone and web-based inquiries directly from consumers. Our patented ALISS® platform provides a structured environment in which our call center insurance agents are able to efficiently handle both in-bound and out-bound sales traffic.

Efinancial is reliant on a capable and well-trained sales force of insurance agents to effectively operate its call centers. It is therefore important for Efinancial’s business to attract, retain and develop its call center insurance agents. Efinancial primarily recruits individuals with little or no prior experience in the insurance industry. We seek to develop a career path for our recruits by providing a comprehensive training program designed to assist new recruits in becoming licensed agents and achieving success with call center marketing. In a process that typically takes between six to eighteen weeks, a new hire will receive training, learn to develop leads and work towards receiving the required insurance sales licenses. Following licensure and promotion to retail call center agent, a new agent is placed on the sales floor, where monitoring and coaching continue. As an agent develops sales experience, the level of supervision of that agent decreases and the agent is able to handle more sophisticated sales opportunities.

 

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As of March 31, 2019, Efinancial had 88 call center insurance agents in Bellevue and 109 call center insurance agents in Chicago. For the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, Efinancial’s retail call centers generated a total of $9.2 million, $9.6 million, $39.0 million and $31.0 million, respectively, in commission revenues, of which $6.8 million, $7.8 million, $28.8 million and $23.2 million, respectively, were generated from sales of Fidelity Life products.

Our Independent Agents

Efinancial has developed capabilities that allow us to expand sales operations beyond the call center insurance agents traditionally associated with a direct sales operation. Efinancial also operates as a wholesale agency and recruits independent agents to market insurance products using Efinancial’s platform. Through our wholesale channel, we subcontract with our independent agents to sell through Efinancial’s contracts with its insurance carriers. Efinancial offers services to these independent agents, including access to our ALISS® technology, marketing platform, case management services, insurance sales leads and sales education. Efinancial earns a portion of the commission revenue on independent agent sales. For the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, Efinancial generated $0.7 million, and $0.5 million, $3.2 million and $3.9 million, respectively, in revenue from our affiliation with our independent agents.

Our Partners

We partner with unaffiliated insurance carriers to market their products through our agency distribution platform. We also have marketing relationships with third party businesses and member organizations, which we call our affinity partners, under which Efinancial provides their customers and members with access to the insurance products we market, either under their brand or Efinancial’s brand.

Other Insurance Carriers.

Our agency segment also generates revenue from the sales of insurance products issued by unaffiliated companies, or carriers. We typically enter into contractual agency relationships with carriers that are non-exclusive and terminable on short notice by either party for any reason. As of March 31, 2019, Efinancial had agency contracts with 26 life insurance carriers, including Fidelity Life. Efinancial’s retail call center agents help consumers select among these carriers based on that consumer’s needs, insurance product features, cost and other factors. The mix of insurance carrier sales will vary over time based on client preferences, carrier strategies, availability of new product features, premium cost, commissions paid, carrier placement rates, and ease of doing business.

For the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, Efinancial generated $3.6 million, $2.9 million, $13.4 million and $11.5 million, respectively, in total commission revenue from agency contracts with unaffiliated life insurance carriers. By comparison, for the three months ended March 31, 2019 and March 31, 2018, and the years ended December 31, 2018 and December 31, 2017, Efinancial generated $5.8 million, $7.2 million, $28.9 and $23.3 million, respectively, in total commission revenue from Fidelity Life.

The following tables show our total earned commissions for our retail and wholesale channels:

Retail Channel:

 

     For the Three Months Ended
March 31,
     For the Years Ended
December 31,
 
             2019                      2018              2018      2017  
     (dollars in thousands)  

Carrier

           

Fidelity Life Association

   $ 6,785      $ 7,798      $ 28,788      $ 23,161  

All other Carriers

     2,411        1,768        10,251        7,799  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Earned Commissions

   $ 9,196      $ 9,566      $ 39,039      $ 30,960  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Wholesale Channel:

 

     Three Months Ended
March 31
     For the Years Ended
December 31,
 
         2019              2018          2018      2017  
     (dollars in thousands)  

Carrier

           

Fidelity Life Association

   $ 15      $ —        $ 69      $ 122  

All other Carriers

     839        865        3,566        4,361