No, they have not understated their liabilities, the liabilities don't change - they have overstated their assets.
Let me give you an example. Let's say KCLI buys a $10 million bond yielding 6% and sell insurance which has expected liabilities of $500,000 per year, leaving $100,000 for admin/profit.
Interest rates go down (like they have), so the market value of that bond goes to $11 million, but the bond interest is still $600,000 per year covering their liabilities and the liabilities have not changed. The catch though is one their balance sheet the bond is valued at market value, so it appears their book value has gone up. NWLI stores bonds on their balance sheet at amortized cost, so their book value won't change. The reality is though, unless KCLI actually sell the bond, the value of it will reduce back to the $10 million at the end of the term when they cash it back in, so that additional book value will essentially be amortized over the term of the bond, so NWLI's way of doing is more accurate and more conservative.
To be fair, I think most companies do it like KCLI and they do disclose the amount in their OCCI, but you really should subtract it out if you are doing a P/B evaluation.
I think KCLI is fine as a stock - it has not debt and they run a good business. I believe it is doing better in the market because it pays a real dividend and people are chasing yield in the market these days. In the long run, all stocks go back to fair value, so I think NWLI has more upside for this and the other reasons discussed on this board.
Thanks for the explanation. I think I understand your position and agree with it except that if the bonds purchased by an insurance company are purchased at a discount, they do not have to go back to what they were purchased for. I, personally, very rarely buy bonds but the one time that I did, back in the 80's they were selling at BIG discounts from par and I had good capital gains as well as high coupon income from them. That would be very difficult to do today.