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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
Commission File #0-11321
Universal American Financial Corp.
(Exact name of registrant as specified in its charter)
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New York 11-2580136
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(State of Incorporation) (I.R.S. Employer I.D. Number)
Mt. Ebo Corporate Park, Brewster, NY 10509
- - --------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (914) 278-4094
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Class on which Registered
- - --------------------------------------------- -------------------
Common Stock, par value $.01 per share NASDAQ
Common Stock Warrants, expire December 31, 1999 NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- ------
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 28, 1997 was approximately $7,949,412.
The number of shares outstanding of the Registrant's Common Stock and
Common Stock Warrants as of February 28, 1997 were 7,203,210 and 668,481,
respectively.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the
document is incorporated:
(1) Proxy Statement for the 1997 Annual Meeting incorporated by
reference into Part III.
(2) Exhibits listed in Item 14(b), Part IV, incorporated by reference
to Form S-1 filed March 30, 1990, Forms 10-K for 1994, 1993, 1991,
1989 and 1988 and Forms 8-K for July 24, 1992, May 31, 1991 and December
9, 1987.
PART I
ITEM 1 - BUSINESS
General
The Company is an insurance holding company, whose principal
subsidiaries are American Progressive Life and Health Insurance Company of New
York ("American Progressive") and American Pioneer Life Insurance Company
("American Pioneer"), each of which sells life insurance, accident and health
insurance and annuity products, and WorldNet Services Corp. ("WorldNet"), a
service firm that provides communication, managed care and claims adjudication
services to insurance companies and affinity groups. The references below to
insurance operations of the Company are to be understood as references to
activities of American Progressive and American Pioneer, the Company's
insurance subsidiaries. Financial items are reported on a Generally Accepted
Accounting Principles basis ("GAAP"), except where otherwise noted.
Strategic Focus
The Company has implemented, and plans to continue to pursue, the
following strategies:
Internal Growth
The Company has focused its efforts to reach targeted segments of the
insurance market as defined by product or by geography. These include:
* Senior market life, annuity and accident and health insurance
products designed for sale primarily in New York and Florida;
* Life insurance, annuity and accident and health insurance programs
sold through large independent marketing organizations.
External Growth
In the past five years, the Company has successfully acquired and
integrated two insurance companies and five blocks of business, most recently
in the fourth quarter of 1996 with the acquisition of $54 million of senior
market premium, primarily in Florida, and a senior market insurance processing
capability, in Pensacola, Florida (See Insurance Acquisitions Activity - First
National). The Company continues to seek out further acquisitions.
Insurance Marketing Activity
Historically, the Company has sold a broad range of insurance products
through a traditional general agency system. The Company has shifted its
emphasis to the senior market place and the sale of a narrower line of
products, particularly appealing to the senior market place, and largely
through marketing organizations with concentrations in this market. The
Company began to sell senior market life and accident and health insurance
products in 1993 in New York and has expanded its sales effort to Florida in
1996. The momentum into Florida was accelerated by the acquisition of
business from First National Life Insurance Company ("First National"). (See
Insurance Acquisitions Activity - First National).
1
Business In Force
The following table shows the Company's growth in the in force business
as of December 31, 1994, 1995 and 1996.
As of December 31,
---------------------------------------------
1994 1995 1996
---- ---- ----
Senior Market
Accident & Health Premiums
Medicare Supplement
Direct sales $ 1,230,000 $ 2,739,000 $ 4,851,000
Acquired from First National --- --- 54,000,000
Home Health Care, Nursing Home
Direct sales --- --- 878,000
Acquired from First National --- --- 1,400,000
Hospital Indemnity 1,986,000 2,588,000 2,239,000
----------- --------- ---------
Total Senior Market A & H $ 3,216,000 $ 5,327,000 $ 63,368,000
=========== =========== ============
Life Insurance Premiums
Asset Enhancer (Note 1) --- 2,201,000 3,191,000
SL2000 --- 929,000 1,131,000
----------- ----------- ------------
Total Senior Market Life $ --- $ 3,130,000 $ 4,322,000
=========== =========== ============
Policyholder Account Balances
Asset Enhancer --- 3,279,000 11,407,000
----------- ----------- ------------
Total $ --- $ 3,279,000 $ 11,407,000
=========== =========== ============
Other Markets
Specialty Group Accident & Health
Premiums
Dental 4,031,000 5,395,000 6,440,000
DBL (Note 2) 3,693,000 4,851,000 5,000,000
NAIU Accident Pool (Note 3) 9,000,000 8,250,000 8,000,000
------------ ------------ ------------
Total Specialty Group A&H $ 16,724,000 $ 18,496,000 $ 19,440,000
============ ============ ============
Other Accident & Health Premiums
(Note 4)
Major Medical and Hospital 8,731,000 8,237,000 7,028,000
Blanket Accident 3,028,000 2,337,000 1,981,000
Supplemental Medical 3,849,000 2,032,000 1,842,000
Other Supplemental 2,635,000 2,152,000 2,145,000
------------ ------------ ------------
Total Other A & H $ 18,243,000 $ 14,759,000 $ 12,996,000
============ ============ ============
Life Insurance Premiums
Interest Sensitive Life (Note 1) 7,045,000 7,627,000 6,518,000
Traditional Life 2,989,000 3,360,000 5,108,000
Group Life 3,120,000 3,478,000 4,150,000
------------ ------------ ------------
Total General Market Life $ 13,154,000 $ 14,465,000 $ 15,776,000
============ ============ ============
Policyholder Account Balances
Annuities 76,127,000 82,207,000 88,426,000
Other Interest Sensitive Life 32,650,000 33,123,000 34,706,000
------------ ------------ ------------
$108,777,000 $115,330,000 $123,132,000
============ ============ ============
-----------------------------------------
(1) These amounts are the estimated mortality charges in force.
(2) The DBL business in force was sold as of December 31, 1996. (See
"Restructuring Activity - Sale of DBL Block", below).
(3) The Company withdrew from participation in the NAIU Accident Pool as of
December 31, 1996. (See "Restructuring Activity - Withdrawal from
NAIU", below).
(4) These are blocks of business acquired by the Company that are not
actively marketed.
3
Senior Market
The following are the core products sold to the senior age market.
Medicare Supplement
The Company began to sell Medicare Supplement policies in January, 1994.
American Progressive has focused its marketing effort in New York State in
geographic areas where it is believed competition is less formidable. It
anticipates expanding gradually into other northeastern states, in a similar
manner. American Progressive has entered into Managing General Agency
relationships with three of the largest accident and health sales organizations
in upstate New York that specialize in the Senior Age market. The Medicare
supplement policies offered by both Insurance Subsidiaries are on plans A, B, C
and F and are underwritten on a simplified issue basis, except that the policies
sold in New York are on a guaranteed issue basis, subject to the community
rating laws of that state. See "Regulation-Health Care Reform". Sales
amounted to $0.8 million, $2.0 million and $3.1 million in 1994, 1995 and 1996,
respectively.
As a result of the First National acquisition (described below), American
Pioneer has been able to begin establishing sales relationships with
approximately 1,000 new agents in Florida. American Pioneer's new Medicare
Supplement policies have been approved by the Florida Insurance Department and
sales of this product are expected to begin in April, 1997. In addition, the
insurance subsidiaries are in the process of filing Medicare Select products
with the New York and Florida Insurance Departments.
Home Health Care and Nursing Home
American Progressive introduced Home Health Care and Nursing Home products in
New York in early 1996. In late 1996, American Pioneer introduced a managed
care home health care product in Florida that uses preferred provider
organization ("PPO") discounts and capitation with a home health care
network. Issued premium in 1996, the first year of sales, amounted to more
than $1.3 million.
Hospital Indemnity
American Progressive introduced a Senior Age Hospital Indemnity product in
mid-1993 and has written in excess of $2.5 million of premium as of December,
1996. Benefits under this product are fixed cash payments based upon the length
of hospital stays and are designed to provide money to meet needs ancillary to
hospitalization.
One, Five and Seven Pay Interest Sensitive Whole Life ("Asset Enhancer")
This program, marketed by National Financial Group of Scottsdale, Arizona, a
marketing organization under contract with American Pioneer, and a number of
other contracted large national marketing groups, began in 1994 and is now sold
4
actively in 18 states. The product is a simplified issue interest sensitive
whole life product with one, five or seven year payment options. It is designed
as a vehicle for seniors to pass assets to heirs in an income tax-advantaged
manner. In many states, the product provides an optional nursing care rider.
In addition to American Pioneer's sales of this product, in 1996, American
Pioneer entered into an arrangement with West Coast Life Insurance Company
("West Coast Life"), an unaffiliated A+ rated carrier, under which West Coast
issues this product and reinsures one-third of the risk to American Pioneer.
Under its contract with West Coast, American Pioneer administers the product
and the relationships with the producers on a fee basis.
As a result of the success of these programs, production of multiple pay life
insurance has increased from $1.0 million in 1995, to $1.6 million of premium
in 1996. Single pay life insurance was introduced in 1995 and had production
amounting to $2.1 million in its first year and $6.2 million of premium in 1996.
Senior Life (SL2000)
This series of products, introduced in late 1995, is sold by American
Progressive, as part of its senior market effort, and American Pioneer through
a new arrangement with an independent marketing organization that began in 1996.
The Company issued $462,000 of premium of SL2000 business in 1996.
Other Markets
Modified Premium Term Life Insurance (Flex-A-Vest 88)
This program, sold by American Pioneer and marketed exclusively by Interstate
Specialty Marketing, Inc. of Tustin, California, began in late 1994 and is now
being sold actively in 21 states. In states where American Pioneer is not
licensed, an arrangement has been made with Pennsylvania Life Insurance
Company ("Pennsylvania Life"), a subsidiary of PennCorp Financial, which issues
the product and reinsures a portion of each case to the Company. In this
arrangement, American Pioneer also administers the product and the relationship
with the producer on a fee basis.
The product is a 10 year term product with an endowment payable after the 10th
year. It is designed for the middle income market as a method to provide
insurance coverage and a vehicle for retirement or college tuition funding.
American Pioneer issued $1.5 million of premium under this program in 1996,
including the premium reinsured from Pennsylvania Life, and has $1.9 million
premium in force as of December 31, 1996.
Group Life Insurance (Andalusia)
Through an arrangement with Alabama Blue Cross that has persisted since 1989,
an American Pioneer group life insurance information package, including a
premium quotation, goes out with each Alabama Blue Cross small group major
medical insurance premium quotation. This program produced $3.2 million of
premium in 1996 (new and in-force).
Annuities
The Company markets Single and Flexible Premium Deferred Annuities now
primarily through sales organizations which concentrate in the Tax Shelter
Annuity I.R.C. 403(b) market. Annuity products generally focus on the senior
and retirement market. The Company=s Tax Shelter Annuities, sold largely to
school teachers, involve people of various ages, some of whom are senior, but
most all of whom are purchasing with retirement in mind. The American
Progressive single premium annuity sold in New York, which represents the
bulk of the Company's annuity production, has a seven year surrender charge,
a one year rate guarantee and a maximum commission of 6%. Further
penetration of the senior annuity market is now being considered.
All of the Company's annuity products provide minimum interest rate
guarantees. The minimum guaranteed rates on the Company's annuity products
currently range from 4.0% to 5.5% annually and the contracts are designed to
permit the Company to change the crediting rates annually subject to the minimum
guaranteed rate. The Company takes into account the profitability of its
annuity business and its relative competitive position in determining the
frequency and extent of changes to the interest crediting rates.
Production of annuities amounted to $8.4 million, $13.7 million and $13.6
million in 1994, 1995 and 1996, respectively.
Dental Insurance
American Pioneer markets competitive group dental insurance products in the
Southeast through a core group of payroll deduction marketers. This insurance
is sold by American Pioneer under an indemnity plan, which pays a stated
percentage of the dentist's charges up to an annual maximum of $2,000, and under
a scheduled plan, which pays amounts specified in the policy up to an annual
maximum limit of $1,000. These products allow the insured a free choice of
dentists. The in-force dental block as of the end of 1996 was more than $6.5
million, a 20% increase over the previous year.
Insurance Acquisitions Activity - First National
In the fourth quarter of 1996, the Company acquired, through an assumption
reinsurance agreement, approximately $56 million of annualized senior market
premium from First National Life Insurance Company ("First National"). American
Pioneer initially contracted with First National to assume $4 million of premium
on group Medicare Supplement coverage issued to the members of the Florida
5
Retired Educators Association ("FREA"). Then, after First National was placed
into Receivership by the Alabama Insurance Department in October, 1996, American
Pioneer assumed approximately an additional $50 million of Individual Medicare
Supplement premium, $1.2 million in Home Health Care premium and $0.8 million in
miscellaneous life and accident and health insurance premiums, under terms
negotiated with the Receiver. All of these assumptions were effective as of
October 1, 1996.
Simultaneously with the second assumption by American Pioneer, American
Pioneer entered into a reinsurance agreement with Transamerica Occidental Life
Insurance Company ("Transamerica"), ceding 90% of the $50 million individual
Medicare Supplement premium in force to Transamerica under reinsurance terms
believed to be favorable. American Pioneer will perform all the administration
on the reinsured business.
As part of the transaction negotiated with the Receiver, American Pioneer was
to receive assets equal to the liabilities assumed, primarily policy reserves.
However, as a result of the financial condition of First National, sufficient
assets were not available to fully cover these liabilities. In addition, the
Receiver was unable to cover certain post-closing adjustments due to American
Pioneer. The sum of the closing shortfall, the post-closing adjustments and the
costs of the transaction, total of approximately $3,400,000, constitutes the
purchase price of the transaction for GAAP purposes and will be amortized over
30 years. In addition to the premium acquired, First National had active
relationships with about 1,000 senior market producers in Florida and 2,000
agents in other states. American Pioneer is actively recruiting these producers
especially in Florida, to sell senior market products for American Pioneer.
Finally, in order to insure a smooth transition and to take advantage of the
relatively low cost operating environment in Pensacola, the Company acquired or
leased most of the physical operating assets used by First National, including
computer hardware and software, and hired many of First National's Pensacola
administrative employees.
Previous Acquisition Activity
As of January 1, 1994, American Progressive acquired by means of reinsurance a
block of supplemental health insurance with annualized premiums of
approximately $1,200,000. In this transaction, American Progressive assumed all
liability under the reinsured policies incurred after January 1, 1994, in
exchange for its receipt from the ceding company of cash equal to the unearned
premium and active lives reserves on the reinsured business, net of a $60,000
ceding commission, and future premium payments from the insureds.
In May 1993, American Progressive acquired 100% of the outstanding stock of
American Pioneer, based in Orlando, Florida, which sold life and accident and
health insurance in 32 states, primarily in the southeast. American Pioneer's
parent, American Pioneer Savings and Loan Association, had been under the
control of the Resolution Trust Company ("RTC") since May 1990. American
Pioneer had an adjusted statutory book value (book value plus asset valuation
reserve) of approximately $7,472,000, and a GAAP stockholder's equity of
approximately $14,367,000 when it was purchased by American Progressive for
$6,827,000 in cash. By December 31, 1996, American Pioneer's adjusted statutory
book value had increased to approximately $13,800,000 and its GAAP stockholder's
equity was $16,000,000.
In May 1991, the Company, through John Adams Life Insurance Company ("John
Adams"), then its only insurance company subsidiary, acquired 100% of the
outstanding common stock of American Progressive, into which John Adams then
merged on June 27, 1991, with American Progressive as the surviving company.
American Progressive was acquired from Midland National Life Insurance Company
("Midland") for (a) a cash payment of $4,197,231, and (b) 510,000 shares
($10 par value) of the Company's Series A cumulative, redeemable, convertible
preferred stock ("Series A Preferred Stock"), for a total purchase price of
$9,297,231. (The Series A Preferred Stock was redeemed by the Company on
December 30, 1994.) American Progressive's statutory book value immediately
prior to acquisition was approximately $9,200,000, its adjusted statutory book
value was approximately $9,290,000, and its GAAP stockholder's equity was
approximately $9,700,000. As of December 31, 1996, the adjusted statutory book
value was approximately $9,256,000 and the GAAP stockholder's equity was
approximately $26,442,000. American Progressive, domiciled in New York and
licensed in 24 other states, historically concentrated on the sale of individual
accident and health insurance products primarily in New York and the
northeastern United States.
Restructuring Activity
In 1996, the Company began a restructuring which will be completed by mid-
1997. As part of its decision to concentrate its marketing effort, the Company
decided to discontinue certain lines of business and reduce its emphasis on
others. In addition, the Company is taking steps to take advantage of the
lower-cost operating environment of its new location in Pensacola.
6
Consolidation of Administrative Operations
As part of the First National transaction, the Company acquired in Pensacola a
relatively low cost administrative operation with particular experience in the
senior market. This has given the Company an opportunity to consolidate many of
its administrative functions in Pensacola and save a significant amount of
fixed overhead.
In December, 1996, the Company formulated a plan to move most of the policy
administrative functions, particularly in its senior market business, from the
American Progressive office in Brewster to Pensacola. This, along with other
cost saving efforts, will result in a reduction in the work force at the
American Progressive office from 62 as of June 30, 1996 to approximately 32 as
of June 30, 1997 with a modest resultant increase in personnel in Pensacola,
including some personnel employed by American Progressive. These plans were
announced to the employees of the Company on March 14, 1997.
Consequently, American Progressive has exercised its right to cancel its lease
for 15,000 square feet in Brewster as of October 31, 1997 and is currently
negotiating to lease a smaller office. The cost of this consolidation,
including severance costs, relocation costs and the cancellation penalty on the
Brewster lease, will be approximately $250,000 and was expensed in the fourth
quarter of 1996. The Company estimates that it will save $750,000 annually as a
result of this reorganization.
Sale of DBL Block
Although American Progressive continued to achieve modest success in selling
New York State Statutory Disability Insurance ("DBL"), the Company determined
that the book of business was too small and growing too slowly to become a
major contributor to the profits of the Company. Therefore, American
Progressive sold the block, which had approximately $5 million of premium in
force, to an unaffiliated New York domiciled carrier as of December 31, 1996.
The purchase price will be a minimum of $550,000 and may reach as high as
$950,000 depending upon the persistency of the business over a twelve month
period. American Progressive continues to maintain the risk for claims incurred
prior to December 31, 1996 and has $500,000 in reserves for this risk. The
purchaser will be responsible for all risks and reserves for 1997 and beyond.
Withdrawal from NAIU Pool
Effective January 1, 1994, American Progressive entered into a pooling
agreement through National Accident Insurance Underwriters ("NAIU"), an
unaffiliated agency, and three unaffiliated insurers to underwrite travel
accident and student accident insurance policies. In August, 1996, the Company
notified the accident pool of its intention to withdraw effective December 31,
1996. As of December 31, 1996, American Progressive had approximately $8
million in premiums in force under this arrangement, all of which had been
assumed from the other pool participants. Although the Company made a modest
profit in this pool over the past three years, the results were erratic and the
Company decided to allocate its capital and efforts in its core business
segments. American Progressive continues to be exposed on business prior to
December 31, 1996 and has $2.5 million in reserves for this risk.
Major Medical Reinsurance
When American Pioneer was acquired by the Company in 1993, American Pioneer
actively marketed individual major medical and major hospital policies under
intensive underwriting guidelines. These policies have deductibles on a per
confinement basis ranging from $300 to $5,000, as to major hospital, and $150
to $10,000 as to major medical. Over the past three years, the Company has
reduced its marketing emphasis on this segment and has reduced its exposure
through reinsurance. In 1994, the Company had $8.7 million of premium in force
and carried 100% of the risk up to $60,000. By the beginning of 1997, the
Company had $7.0 million of premium in force and carried 50% of the risk up to
$60,000 per year.
Premium Revenue
Life Insurance and Annuities
The following table sets forth a summary of life premium revenues and annuity
considerations on first year and renewal basis for the last three years ended
December 31, 1996, as determined in accordance with statutory accounting
principles ("SAP"). These amounts differ from the premiums reported in the
7
accompanying consolidated statement of operations, since under GAAP, the annuity
and universal life insurance policies are reported under the retrospective
deposit method prescribed by Statement 97 "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sales of Investments". (See Note 2e of Notes to Consolidated
Financial Statements for further information).
Year Ended December 31,
----------------------------------------------
1994 1995 1996
---- ---- ----
(Amounts in accordance with statutory accounting principles)
Life Insurance
Premium received,
policies written in current year $ 1,912,569 $ 6,141,040 $ 10,437,377
Premium received,
policies written prior year 9,385,947 9,668,592 12,206,343
----------- ----------- ------------
Total Life Premium 11,298,516 15,809,632 22,643,720
----------- ----------- ------------
Annuities
Consideration received,
policies written in current year 7,886,462 13,377,924 13,004,354
Consideration received,
policies written in prior years 517,534 364,145 618,739
----------- ----------- -----------
Total Annuity Consideration $ 8,403,996 $ 13,742,069 $13,623,093
----------- ------------ -----------
Total Consideration and Premium $19,702,512 $ 29,551,701 $36,266,813
=========== ============ ===========
The following table presents information with respect to the Company's number
of policies in force and experience in terms of numbers of policies issued, and
reduced for surrenders, lapses or deaths for annuity and life insurance:
1994 1995 1996
---- ---- ----
Life Insurance Policies
In force, beginning of year 22,191 24,820 26,642
Acquired from First National --- --- 286
Issued during year 5,175 4,934 4,407
Lapsed or surrendered during year (2,353) (2,874) (3,193)
Deaths during year (193) (238) (212)
-------- -------- --------
In force, end of year 24,820 26,642 27,930
======== ======== ========
Annuity Policies
In force, beginning of year 4,041 4,090 5,437
Acquired from First National --- --- 40
Issued during year 494 1,956 2,119
Death and surrendered during year (445) (609) (763)
------- ------ ------
In force, end of year 4,090 5,437 6,833
======= ====== ======
8
Accident & Health Insurance
The following table sets forth a summary of accident and health premium
revenues for the three years ended December 31, 1996:
Year Ended December 31,
----------------------------------------
1994 1995 1996
---- ---- ----
Premium received on policies
written in current year $ 5,218,749 $ 5,982,178 $ 9,805,305
Premium received on policies
written in prior years (1) 22,016,287 22,313,927 35,047,929
------------ ----------- ------------
Total Accident & Health Premium $ 27,235,036 $ 28,296,105 $ 44,853,234
________________________
(1) The 1996 figures include the premium revenues of First National from October
1, 1996, the date of its assumption, which amounted to $13,498,122.
Pending Private Placement Financing
On January 9, 1997, the Company entered into a Stock Purchase Agreement with
AAM Capital Partners L.P. ("AAM"), an unaffiliated investment firm, providing
for the issuance and sale of at least $4 million of a new Series C Preferred
Stock, of which at least $3 million will be purchased by AAM, or purchasers
designated by AAM, and at least $1 million will be purchased by Richard A.
Barasch, members of his family, and members and associates of the Company's
management. This transaction is scheduled to close upon receipt of the required
approval of the Florida Insurance Department, an application for which
approval is pending, (see "Regulation - General"). Management has no reason
to anticipate that such approval will not be forthcoming. The following summary
of the terms of the Stock Purchase Agreement is qualified in its entirety by
reference to the Stock Purchase Agreement which is being filed as an Exhibit to
this Form 10-K.
* The Series C Preferred shares will be convertible by the holders at any time
at a conversion price of $2.375 per share (subject to anti-dilution
adjustment).
* The Company can require conversion if it executes a public offering of
common stock at over $3.45 per share (or equivalent equity), with gross
proceeds in excess of $10 million, or if the average bid price of it's common
stock exceeds $3.45 per share for any 60 day period through December 31, 2001
In the event that the Company takes certain action without the consent of the
holders of a majority of the Series C Preferred Stock, those holders who
voted against such action have the right to require its redemption at the
Redemption Price or the Call Price, (which Prices are defined below)
depending on the nature of the action taken.
* The Company will also have the right to call all of the Series C Preferred
Stock at any time between January 1, 2000 and December 31, 2002, at a per
share call price (the "Call Price") of $150 in the year 2000 or $175 in the
years 2001 and 2002, in each case increased by the redemption accrual at the
rate of 8% of the par value.
* Unless converted or called earlier, the Series C Convertible Preferred Stock
will be redeemed on December 31, 2002, at a per share redemption price (the
"Redemption Price") equal to par, increased by a redemption accrual at the
rate of 8% per annum. The redemption price will be payable in two equal
installments on December 31, 2002 and December 31, 2003. The redemption
accrual is not payable upon any conversion.
9
* No dividends will be paid on the Series C Preferred Stock, unless
dividends are paid on the common stock, in which case the Series C
Preferred Stock will participate as if converted.
* The holders of the Series C Preferred Stock (excluding a portion
of such series which may be issued without voting rights) will
have the right to elect one director of the Company.
* At least $3 million of the proceeds of this sale are required to
be used to begin implementation of the conversion of American
Pioneer from being a direct subsidiary of American Progressive to
being a direct subsidiary of Universal. See "Unstacking," below.
* The Company, AAM, the holders of the Series C Preferred Stock,
Barasch Associates Limited Partnership ("BALP") and Richard A.
Barasch will enter into a shareholders agreement at the closing of
the transaction, under which the holder of the Series C Preferred
Stock are given registration rights and informational rights, the
Series C Preferred Stock holder agrees to vote their shares for
the election of a person designated by AAM as the director elected
by that Series, and BALP and Mr. Barasch grant the Series C
holders a co-sale right should they sell any shares of the
Company's common stock held by them, except to certain "permitted
transferees".
Unstacking
American Pioneer is now a direct subsidiary of American Progressive. As
a result of the way Risk Based Capital ("RBC") is computed (see "Regulation -
Risk Based Capital Requirements"), this "stacking" of the two insurance
companies results in American Progressive's RBC Ratio for 1996 being reduced
from the 492% it would have been, if its American Pioneer stock were replaced
by investment grade bonds, to 261%. This "stacking" also adversely affects
American Progressive's ability to increase its writings of new business and
its ratings by the insurance company rating services. (See "Ratings").
Because American Pioneer is able to pay dividends while American Progressive
is not able (see "Regulation - Dividends and Distributions"), the present
stacking requires all dividends be paid into American Progressive, effectively
precluding the application of any portion of American Pioneer's statutory
profits for general corporate purposes of the Company. For these reasons, the
Company has decided to "unstack" American Pioneer, and make it a direct
subsidiary of Universal.
The proposed unstacking will strengthen the financial condition of
American Progressive and is expected to result in an improvement of American
Progressive's RBC ratio and the ratings of both American Pioneer and American
Progressive, as well as making American Pioneer dividend paying potential
available to Universal. To comply with the requirements of the Holding
Company provisions of the New York Insurance Law (see "Regulation - General"),
Universal and American Pioneer on July 26, 1996 entered into a purchase
agreement (the "Unstacking Agreement"), which has been approved by the New
York Insurance Department, providing for:
* the sale of all of American Pioneer's stock to Universal, in one
or more segments, over a period of not more than five years, at a
fixed price per share determined by an appraisal performed by an
independent actuarial firm selected by the Department. This
appraisal is now in progress.
* the completion of the purchase of the first segment of American
Pioneer stock with a purchase price of at least $6 million, within
90 days after receipt of the appraisal report.
* payment of the purchase price for the initial segment and each
subsequent segment, one half in cash and one half by Universal's
five year debenture, bearing interest at the prime rate at the
time each debenture is issued, and secured by pledge of all of the
purchased stock.
It is intended that the proceeds of the pending sale of Series C
Preferred Stock, (see "Restructuring - Pending Private Placement Financing"),
will enable the funding of the cash portion of the purchase price for the
initial segment.
10
Marketing and Distribution
Historically, the Insurance Subsidiaries have sold their products
through a traditional general agency system. The Company now, however, seeks
to structure arrangements with independent marketing organizations, licensed
as general agents, that sell particular products and programs meeting
particular market niches or needs. One such arrangement, with an organization
that focuses on individual sales of deposit-term life insurance policies to
moderate income buyers, produced 14% of the Company's individual life
insurance sales in 1996. Another such arrangement with an organization that
makes individual sales of interest sensitive whole life insurance policies
through single or multi-year premium payments to middle age and senior age
buyers produced 73% of the Company's individual life insurance sales in 1996.
In 1996, American Pioneer entered into an agreement with West Coast Life, an
A+ life insurance subsidiary of Nationwide Insurance Company, to be the lead
company for the sale of the Asset Enhancer Series. The agreement calls for
American Pioneer, West Coast Life and Reinsurance Company of Hannover (ARCH@)
to each participate in one-third of the risk and for American Pioneer to be
the administrator of the product on a fee basis. A similar arrangement was
entered into with Pennsylvania Life with respect to the Flex-A-Vest 88 Term
Life Insurance product. An arrangement with a marketing organization in one
state, which primarily sells Blue Cross/Blue Shield health insurance,
accounted for almost all of the Company's group life sales.
The Company also maintains its traditional sales channels and has more
than 1,200 general agents and more than 2,500 producers under contract, most
of whom also sell similar products for other companies. In 1996, no general
agent produced as much as 5% of the Company's accident and health insurance
premiums or life insurance premiums and only one general agent produced more
than 5% of the Company's annuity premiums (42%). The agents, general agents
and producers are paid purely on a commission basis and are not Company
employees. In this marketing area, the Company believes that the Company
offers competitive commission rates and seeks to provide innovative products
and quality service to its independent general agents. In particular, the
Company believes that it provides a higher level of agent support and is more
responsive to its agents in the field than many larger organizations with
which it competes. Compensation of the Company's agents on certain products
is regulated by the various state Departments of Insurance.
The Company, through the Insurance Subsidiaries, is licensed to market
its products in 45 states and in the District of Columbia. However,
approximately 76% of its 1996 premium and annuity considerations came from the
states of New York (32%), Florida (23%), North Carolina (7%), Alabama (5%),
Texas (5%) and Georgia (4%).
Competition
The Company competes with other insurance and financial services
companies, including large multi-line organizations, both in connection with
the sale of insurance and asset accumulation products and in acquiring blocks
of business. Many of these organizations have substantially greater capital
and surplus, larger and more diversified portfolios of life and health
insurance policies, larger agency sales operations and higher ratings. In
addition, it has become increasingly difficult for small companies to compete
effectively with their larger competitors for traditional life and annuity
sales in part as a result of heightened consumer and agent awareness of the
financial size of companies.
The Company has met, and seeks to continue to meet, these competitive
pressures by offering a high level of service and accessibility to its field
force and by developing specialized products and marketing approaches.
Ratings
American Pioneer and American Progressive have been designated "B+(Very
Good)" and "B (Fair)", respectively, by A.M. Best. In evaluating a company's
financial and operating performance, A.M. Best reviews profitability, leverage
and liquidity as well as the quality of the book of business, the adequacy and
soundness of reinsurance programs, the quality and estimated market value of
assets, reserve adequacy and the experience and competence of management.
A.M. Best's ratings are based upon factors relevant to policyholders, agents,
11
insurance brokers and intermediaries and are not directed to the protection of
investors. According to A.M. Best's published material, a "B+" or "B" rating
is assigned to companies which, in its opinion, have demonstrated very good
(B+) or fair (B) overall performance when compared to the standards it has
established. Companies rated (B+) have a good ability to meet their
obligations to policyholders. "B" rated companies have an adequate ability to
meet their policyholder obligations, but their financial strength is
vulnerable to adverse changes in underwriting or economic conditions.
Standard and Poor's rates American Pioneer and American Progressive as "BBBq"
and "Bq", respectively, which means that, based on their publicly available
information, they are currently able to meet policyholder obligations,
although, as to "Bq", that ability is especially vulnerable to adverse
economic and underwriting conditions. The Insurance Subsidiaries are not
currently known to be rated by the Duff and Phelps or Moody's rating
organizations. Although a higher rating by A.M. Best or another insurance
rating organization could have a favorable effect on the Company's business,
management believes that its marketing has enabled, and will continue to
enable, the Insurance Subsidiaries to compete effectively.
Underwriting Procedures
Premiums charged on insurance products are based, in part, on
assumptions about the expected mortality and morbidity experience. In that
regard, the Company has adopted and follows detailed uniform underwriting
procedures designed to assess and quantify certain insurance risks before
issuing individual life insurance and certain health insurance policies and
certain annuity policies to individuals. These procedures are generally based
on industry practices, reinsurer underwriting manuals and the Company's prior
underwriting experience. To implement the procedures, each Insurance
Subsidiary employs an experienced professional underwriting staff.
Applications for insurance to be underwritten are reviewed to determine
if any additional information is required to make an underwriting decision,
which depends on the amount of insurance applied for and the applicant's age
and medical history. Such additional information may include medical
examinations, statements from doctors who have treated the applicant in the
past and, where indicated, special medical tests. If deemed necessary, the
Company uses investigative services to supplement and substantiate
information. For certain coverages, the Company may verify information with
the applicant by telephone. After reviewing the information collected, the
Company either issues the policy as applied for, issues the policy with an
extra premium charge due to unfavorable factors, issues the policy excluding
benefits for certain conditions for a period of time or rejects the
application. For certain of its coverages, the Company has adopted simplified
policy issue procedures in which the applicant submits a single application
for coverage typically containing only a few health related questions instead
of a complete medical history. In New York and other states, certain of the
Company's products, including Medicare supplement, are subject to "Community
Rating" laws which severely limit or prevent underwriting of individual
applications. See "Regulation-Health Care Reform".
Acquired Immune Deficiency Syndrome ("AIDS"), which has received wide
publicity because of its serious public health implications, presents special
concerns to the life and health insurance industry. The Company considers
AIDS information in underwriting and pricing decisions in accordance with
applicable laws. Applicants for life insurance coverage equal to or exceeding
$100,000 and for major medical and major hospital coverages must submit to a
blood or urine test, which includes AIDS antibody screening. The Company's own
mortality and morbidity experience to date reflects no unduly adverse impact
as a result of any acceleration of AIDS-related life insurance claims. The
Company is continuing to monitor developments in this area but is necessarily
unable to predict the long-term impact of this problem on the life insurance
industry, in general, or on the Company, in particular.
Investments
The Company's investment policy is to balance the portfolio between
long-term and short-term investments so as to continue to achieve investment
returns consistent with the preservation of capital and maintenance of
liquidity adequate to meet payment of policy benefits and claims. The Company
invests in assets permitted under the insurance laws of the various states in
which it operates, such laws generally prescribe the nature, quality of and
12
limitations on various types of investments which may be made. The Company
currently engages the services of an unrelated investment advisor, Asset
Allocation and Management Company, to manage the Company's fixed maturity
portfolio, under the direction of the management of the Insurance Subsidiaries
and in accordance with guidelines adopted by their respective Boards of
Directors. The Company's policy is not to invest in derivative programs or
other hybrid securities, except for GNMA's, FNMA's and investment grade
corporate collateralized mortgage obligations. It invests primarily in fixed
maturity securities of the U.S. Government and its agencies and in corporate
fixed maturity securities with investment grade ratings of "Baa3" (Moody's) or
"BBB-" (Standard & Poors) or better. However, the Company does own some
investments that are rated "BB" and one bond rated "D" (together 4.4% and 3.2%
of total fixed maturities as of both December 31, 1995 and 1996,
respectively). As of December 31, 1996, out of a securities portfolio of
$121,492,167, only one of the Company's investments with a carrying fair value
of $331,250 was in default.
In November, 1995, the Financial Accounting Standards Board ("FASB")
issued a Special Report titled "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities", which
report allowed enterprises to reassess the appropriateness of the
classifications of all securities held and account for any resulting
reclassifications between the investment accounts. This one-time reassessment
had to be made prior to December 31, 1995 and be appropriately disclosed in
the financial statements. In December, 1995, the Company did reassess the
appropriateness of the classifications of its securities and reclassified all
of the securities contained in the held to maturity account to the available
for sale account as they may be considered for sale prior to maturity as part
of the asset/liability management strategy. The carrying value of the
securities reclassed to available for sale amounted to $35,942,303 and the
fair value amounted to $36,098,026. This transfer resulted in the Company
increasing its unrealized gains by $155,723.
The following table summarizes the Company's investment portfolio as of
December 31, 1995 and 1996:
Investment Portfolio
December 31, 1995 December 31, 1996
------------------- -------------------
Percent of Percent of
Carrying Total Carrying Total
Value Carrying Value Carrying
(Fair Value) Value (Fair Value) Value
------------ ------- ------------ -------
Fixed Maturity Securities:
U.S. Government and
Government agencies $19,789,608 14.59% 12,177,564 8.42%
Mortgage-backed 22,114,810 16.31% 35,371,543 24.45%
Investment grade corporates 69,431,937 51.20% 70,092,550 48.44%
Non-investment grade corporates 5,092,566 3.76% 3,850,510 2.66%
----------- ------ ----------- ------
Total fixed maturity securities 116,428,921 85.86% 121,492,167 83.97%
Cash and cash equivalents 12,289,801 9.06% 15,403,450 10.65%
Other Investments:
Policy loans 5,622,136 4.15% 6,421,251 4.44%
Mortgage loans 1,067,605 0.79% 1,199,110 0.83%
Real property tax liens 178,908 0.13% 131,729 0.09%
Equity securities 15,297 0.01% 33,562 0.02%
------------ ------- ------------ -------
Total invested assets $135,602,668 100.00% $144,681,269 100.00%
============ ======= ============ =======
13
The following table shows the distribution of the contractual maturities
of the Company's portfolio of fixed maturity securities by carrying value as
of December 31, 1996. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties:
Contractual Maturities of Fixed Maturity Securities
Percent of
Carrying Total Fixed
Available for Sale Value Maturities
------------------ ----------- ----------
Due in 1 year or less $ 2,632,028 2.16%
Due after 1 year through 5 years 23,458,901 19.31%
Due after 5 years through 10 years 36,992,088 30.45%
Due after 10 years 19,264,750 15.86%
Mortgage-backed Securities 39,144,400 32.22%
------------ -------
$121,492,167 100.00%
============ =======
The following table shows the distribution by carrying value of the
Company's fixed maturity securities portfolio according to the ratings
assigned by Standard & Poor's Corporation, along with related estimated fair
values, as of December 31, 1995 and 1996:
Distribution of Fixed Maturity Securities by Rating
December 31, 1995 December 31, 1996
----------------------------------- ----------------------------------
% of % of
Total Total
Standard & Fixed Fixed
Poor's Carrying Invest- Estimated Carrying Invest- Estimated
Rating Value ments Fair Value Value ments Fair Value
- - ------ ---------- ------- ----------- ---------- ------- -----------
AAA $ 42,209,501 36.26% $ 42,209,501 $ 46,981,664 38.67% $ 46,981,664
AA 10,606,356 9.11% 10,606,356 7,598,298 6.25% 7,598,298
A 21,904,044 18.81% 21,904,044 21,383,442 17.60% 21,383,442
BBB 36,616,454 31.45% 36,616,454 41,678,253 34.31% 41,678,253
BB 4,848,816 4.16% 4,848,816 3,519,260 2.90% 3,519,260
D 243,750 0.21% 243,750 331,250 0.27% 331,250
------------ ------- ------------ ------------ ------- ------------
Total $116,428,921 100.00% $116,428,921 $121,492,167 100.00% $121,492,167
============ ======= ============ ============ ======= ============
14
At December 31, 1995 and 1996, 95.6% and 96.8%, respectively, of the
Company's investments were investment grade corporate fixed maturity
securities (i.e., those rated "BBB-" or higher by Standard & Poor's
Corporation or "Baa3" or higher by Moody's Investors Service). This included
approximately $29,946,626, at December 31, 1995, and $39,144,400, at December
31, 1996, of collateralized mortgage obligations secured by residential
mortgages. These amounts represented approximately 26% and 32% of the
Company's fixed maturity portfolio at December 31, 1995 and 1996,
respectively. Certain classes of mortgage-backed securities are subject to
significant prepayment risk. This is due to the fact that in periods of
declining interest rates, mortgages may be repaid more rapidly than scheduled,
as individuals refinance higher rate mortgages to take advantage of the lower
rates then available. As a result, holders of mortgage-backed securities may
receive higher prepayments on their investments which they may not be able to
reinvest at an interest rate comparable to the rate paid on such mortgage-
backed securities. At December 31, 1995 and 1996, less than investment grade
fixed maturity securities had aggregate carrying values (held at fair value)
of $5,092,566 and $3,850,510 respectively, amounting to 4.4% and 3.2%,
respectively, of total investments and 2.8% and 1.6%, respectively, of total
assets. The Company's holdings of less than investment grade corporate fixed
maturity securities are diversified and the investment in any one such
security at both December 31, 1995 and 1996 was less than $1,000,000, which
was approximately 0.5% and 0.4% of total assets, respectively. The Company
wrote down the value of certain securities, considered to have been subject to
an-other-than temporary decline in value, by $195,000 in 1995, which was
included in net realized gains on investments in the consolidated statements
of operations. The Company did not write down the value of any securities
during 1994 and 1996.
Investment Income
Investment income is an important part of the Company's total revenues
and profitability. Management cannot predict the impact that changes in
future interest rates will have on the Company's financial statements. The
following table shows the investment results of the Company's total invested
asset portfolio, for the three years ended December 31, 1996:
Investment Results
Years Ended December 31,
-----------------------------------------------
1994 1995 1996
---- ---- ----
Total invested assets, end of period $125,487,241 $135,602,668 $144,681,269
Net investment income before interest credited
to policyholders $9,238,789 $8,945,280 $9,850,083
Yield on average cash and investments 7.48% 6.97% 7.08%
Net realized investment gains $41,568 $673,868 $240,075
Reserves
In accordance with applicable insurance regulations, the Company has
established, and carries as liabilities in its statutory financial statements,
actuarially determined reserves that are calculated to satisfy its policy and
contract obligations. Reserves, together with premiums to be received on
outstanding policies and contracts and interest thereon at certain assumed
rates, are calculated to be sufficient to satisfy policy and contract
obligations. The actuarial factors used in determining such reserves are
based on statutorily prescribed mortality tables and interest rates. Reserves
maintained also include unearned premiums, premium deposits, reserves for
claims that have been reported but are not yet paid, reserves for management's
estimate for claims that have been incurred but have not yet been reported and
claims in the process of settlement.
15
The reserves reflected in the Company's consolidated financial
statements are calculated in accordance with GAAP. These reserves are based
upon the Company's best estimates of mortality and morbidity, persistency,
expenses and investment income, with appropriate provisions for adverse
statistical deviation. The Company uses the net level premium method for all
non-interest sensitive products and the retrospective deposit method for
interest sensitive products. GAAP reserves differ from statutory reserves due
to the use of different assumptions regarding mortality and morbidity, and
interest rates and the introduction of lapse assumptions into the GAAP reserve
calculation.
Reinsurance
Assumption from First National Life
In the fourth quarter of 1996, the Company acquired, through an
assumption reinsurance agreement, approximately $56 million of annualized
senior market premium from First National Life Insurance Company ("First
National"). American Pioneer initially contracted with First National to
assume $4 million of premium on group Medicare Supplement coverage issued to
the members of the Florida Retired Educators Association ("FREA"). Then,
after First National was placed into Receivership by the Alabama Insurance
Department in October, 1996, American Pioneer assumed approximately an
additional $50 million of Individual Medicare Supplement premium, $1.2 million
in Home Health Care premium and $0.8 million in miscellaneous life and
accident and health insurance premiums, under terms negotiated with the
Receiver. All of these assumptions were effective as of October 1, 1996. The
Company received approval from the Florida Insurance Department to report the
premiums assumed from First National as direct premium written.
Simultaneously with the second assumption by American Pioneer, American
Pioneer entered into a reinsurance agreement with Transamerica Occidental Life
Insurance Company ("Transamerica"), ceding 90% of the $50 million Individual
Medicare Supplement to Transamerica under reinsurance terms believed to be
favorable. American Pioneer will perform all the administration on the
reinsured business.
Ceded
Consistent with the general practice of the life insurance industry, the
Company reinsures portions of the coverage provided by its life insurance
products to unaffiliated insurance companies under various reinsurance
agreements. Such agreements allow the Company to write policies in amounts
larger than the risk it is willing to retain on any one life, and to continue
writing a larger volume of new business. The mortality risk retention limit
on each policy varies generally between $25,000 and $75,000. The Company
cedes insurance primarily on an "automatic" basis and receives allowances from
its reinsurers ranging from 100% to 142% of the reinsurers' premium in the
first policy year and at varying rates of up to 40% in renewal years.
Reinsurance is not maintained on any of the annuity policies in force.
The Company has "excess of loss" reinsurance agreements with
unaffiliated insurance companies on its accident and health insurance policies
to reduce the liability on individual risks to $60,000 at American Pioneer and
$200,000 at American Progressive. On June 30, 1995, the Company effected a
"quota share" reinsurance agreement with another unaffiliated reinsurer (rated
A+ by A.M. Best) to cede 75% of the remaining $60,000 of individual accident
and health insurance risk at American Pioneer. The Company received a ceding
commission of $862,000, $625,000 of which was offset by the amortization of
the deferred acquisition cost asset related to this business. The remaining
$237,000 was recorded as deferred revenue with $80,000 and $157,000 being
amortized as income during 1995 and 1996, respectively. In addition, the
Company has a quota share agreement on its Accidental Death and Dismemberment
policies under which the reinsurer receives 90% of all premiums and pays 90%
of all losses and the Company receives allowances ranging from 20%-30% of the
ceded premium. American Pioneer also reinsures all of the risk in excess of
two years of benefits on certain disability income policies.
As part of its restructuring, American Progressive reinsured all of its
New York Statutory DBL Insurance in force and a major part of the risk on its
major medical policies to unaffiliated insurers. (See "Restructuring Activity
- - - Sale of DBL Block" and "Major Medical Reinsurance").
16
The Company is contingently liable to pay claims in the unlikely event
that a reinsurer fails to meet its obligations under the reinsurance
agreement. The Company's primary reinsurers are currently rated A+ (Superior)
and A (Excellent) by A.M. Best. To the Company's knowledge, no reinsurer of
business ceded by the Company has been unable to pay any policy claims on any
reinsured business. The reinsurance agreements are subject to cancellation on
90 days notice as to future business, but policies reinsured prior to such
cancellation remain reinsured as long as they remain in force. Management
believes that if its reinsurance agreements were canceled it would be able to
obtain other reinsurance arrangements on satisfactory terms to enable it to
continue writing new business.
Other Assumed
As part of its strategy of acquiring blocks of business, the Company has
acquired several blocks of business through reinsurance.
American Progressive participates in a modified coinsurance agreement
with an unaffiliated insurer under an agreement entered into in 1986. The
business assumed consists of non-participating premium-paying Whole Life and
increasing premium Whole Life policies. At December 31, 1996, premiums in
force ceded to American Progressive under this arrangement were approximately
$400,000, the amount of insurance in force was approximately $25.5 million and
the reserves assumed were approximately $4.5 million.
In 1994, the Company assumed 100% of the risk and premium on certain
accident and health insurance policies written by three insurers not
affiliated with the Company: North American Company for Life and Health
Insurance, North American Company for Life and Health Insurance of New York
and Baptist Life Insurance Company of New York. At December 31, 1996, the
premium in force on these policies was approximately $750,000 and the
associated reserves were approximately $830,000.
Accident Insurance Pool
Effective January 1, 1994, American Progressive entered into a pooling
agreement through National Accident Insurance Underwriters, an unaffiliated
agency, and three unaffiliated insurers to underwrite travel accident and
student accident insurance policies. In August, 1996, the Company notified
the accident pool of its intention to withdraw effective December 31, 1996.
As of December 31, 1996, American Progressive had approximately $8 million in
premiums in force under this arrangement, all of which had been assumed from
the other pool participants. Although the Company made a modest profit in
this pool over the past three years, the results were erratic and the Company
decided to allocate its capital and efforts in its core business segments (see
"Business - Strategic Focus"). American Progressive continues to have the
risk on business earned prior to December 31, 1996 and maintained $2.5 million
in reserves for this risk (see "Restructuring - Withdrawal from NAIU Pool").
WorldNet
As part of the transaction to acquire the business of First National,
the Company also acquired and leased through its WorldNet subsidiary, a
portion of the operating facility in Pensacola, Florida, formerly used by
First National. Included in this acquisition is hardware and software used to
process the business and the leasing of the office facility, furniture,
fixtures and equipment. In addition, WorldNet hired most of the
administrative employees of First National in Pensacola.
The Company has identified Pensacola as a relatively low cost operating
environment in which to build WorldNet as an efficient, high quality third
party administrator for the business written by American Progressive and
American Pioneer and for unrelated third parties.
After sustaining significant losses in WorldNet for the past few years,
management believes that WorldNet is responding to cost control and
restructuring efforts, reporting a cash loss of $135,000 for 1996 and, after
depreciation, a loss of $271,000.
17
Acquisitions
In January, 1992, WorldNet was a newly-formed subsidiary and acquired
certain assets and the client base of a firm that provided managed care,
travelers' medical assistance and claims administration to insurance companies
(foreign and domestic) and affinity groups, including credit card companies.
On April 1, 1994, WorldNet acquired certain assets of Health Assistance
for Travelers, Inc. ("HAT") (a subsidiary of Ontario Blue Cross of Canada
("OBC")) and an affiliated corporation for Can. $625,000 (approximately U.S.
$470,000), payable over five years. WorldNet also executed an agreement with
HAT and OBC by which WorldNet agreed to perform HAT's obligations under
certain service contracts between HAT and OBC, and other insurers. The assets
acquired included HAT's office in Miami Beach, Florida. In July 1994, the
WorldNet facility in Texas was closed and its functions and some of its
personnel were transferred to the Miami Beach facility acquired from HAT.
In 1995, substantially all of the assets of OBC (including the shares of
its subsidiary HAT) was acquired by Liberty Mutual Insurance Company ("Liberty
Health"). In February, 1996, WorldNet and Liberty Health agreed to terminate
the service agreement between OBC and WorldNet. In connection with the
termination of the service agreement, Liberty Health agreed to cancel the
promissory notes executed on April 1, 1994, which notes amounted to $370,000
at December 31, 1995. At the same time, the Company wrote off corresponding
assets, including the value of the service agreement, which assets amounted to
approximately $170,000. The resulting net income from this transaction was
approximately $200,000 and was reflected in the Company's financial statements
for the first quarter of 1996.
General
WorldNet is a fee-based company whose primary services are to provide
medical managed care and assistance to people traveling away from their homes
and to act as a third party administrator and service provider to the
Insurance Subsidiaries. These, and other related services, are sold by
WorldNet to insurance companies (for their insureds), credit card companies
(for their card members) and associations (for their members).
International Managed Care
WorldNet has achieved a significant portion of its revenue from the sale
of managed care, cost containment and claims adjudication services to foreign
(to date, primarily Canadian) insurers for their insureds while they are in
the United States. WorldNet arranges access to appropriate medical care,
manages the care and cost while the case is in process and often arranges
evacuation to the country of origin. WorldNet also provides complete claims
adjudication services including coordination of benefits, subrogation and
audits. The clients who use WorldNet's managed care services include a number
of large insurers in Canada and Europe.
Travel Assistance and Related Claims Adjudication
WorldNet's travel assistance product is sold as an enhancement for its
clients' cardholders, policyholders and members. The service provides 24-hour
telephone access to assistance for medical, legal and other problems that
arise especially while away from home. Related to this function, WorldNet
also provides claims adjudication for travel-related insurance products such
as baggage, collision damage waiver and trip-cancellations.
Operations
WorldNet operates a 24-hour multi-lingual communications center in
Miami, Florida and a third party administrative office in Pensacola, Florida.
The company has developed and acquired proprietary software applications that
have been customized for its market.
18
WorldNet's revenues for years ended December 31, 1994, 1995 and 1996
were as follows:
Year Ended December 31,
-----------------------------------------
1994 1995 1996
Managed care and claims
adjudication $2,812,519 $2,099,438 $1,513,962
Travel and other assistance 1,256,480 971,103 658,379
---------- ---------- ----------
$4,068,999 $3,070,541 $2,172,341
========== ========== ==========
Regulation
General
The Insurance Subsidiaries, like other insurance companies, are subject
to the laws, regulations and supervision of the states in which they are
domiciled (New York in the case of American Progressive and Florida in the
case of American Pioneer) and in various other states in which they are
authorized to transact business. The purpose of such laws and regulations is
primarily to provide safeguards for policyholders rather than to protect the
interest of shareholders.
The insurance laws regulate, among other things, capitalization,
permissible investments, premium rates on statutory disability insurance and
other health insurance policy forms, the form and content of policies which
may be offered, specified methods of accounting (statutory accounting or SAP)
for detailed financial statements submitted to the various Insurance
Departments and minimum capital and surplus required to continue in operation.
Most states have enacted legislation or adopted administrative
regulations covering such matters as the acquisition of control of insurance
companies and transactions between insurance companies and the persons
controlling them. Additional requirements are often imposed as a condition of
approval of the acquisition of an insurance company, as occurred in the case
of the Company's acquisition of both American Pioneer and American
Progressive. The nature and extent of the legislation and administrative
regulations now in effect vary from state to state and most states require
administrative approval of the acquisition of control of an insurance company
incorporated in the state, whether by tender offer, exchange of securities,
merger or otherwise, and require the filing of detailed information regarding
the acquiring parties and the plan of acquisition. The approval of the
domiciliary insurance department is also required before a controlling
interest (10% as to New York, 5% as to Florida) of an insurance company, or of
a holding company which owns such an insurance company, can be acquired or
transferred. Every insurance company which is authorized to do business in
the state and is a member of an "insurance holding company system" is
generally required to register as such with the insurance regulatory
authorities and file periodic reports concerning its relationships with the
insurance holding company. Material transactions between registered insurance
companies and members of the holding company system are required to be "fair
and reasonable" and in some cases are subject to administrative approval, and
the books, accounts and records of each party are required to be so maintained
as to clearly and accurately disclose the precise nature and details of the
transactions.
Each Insurance Subsidiary is required to file detailed reports with the
insurance department of each state in which it is licensed to conduct
business, and its books and records are subject to examination by each such
insurance department. In accordance with the insurance codes of their
domiciliary states and the rules and practices of the National Association of
Insurance Commissioners ("NAIC"), the Insurance Subsidiaries are examined
periodically by examiners of New York and Florida and by representatives (on
an "association" or "zone" basis) of the other states in which they are
19
licensed to do business. American Progressive was examined in 1995 for the
three years ended December 31, 1994 by the New York State Insurance
Department. American Pioneer was examined in 1993 for the year ended December
31, 1992 by the Florida Insurance Department and is currently under
examination for the three years ended December 31, 1995. The Company has
complied with all recommendations made on such reports, and no issues were
raised which the Company deems to be material.
Many states require deposits of assets for the protection of
policyholders either in those states or for all policyholders. At December
31, 1995 and 1996, securities totaling $6,468,000 and $7,779,000, respectively
(approximately 4.8% and 5.4 %, respectively, of the carrying value of the
Company's invested assets), were on deposit with various state treasurers or
custodians. Such deposits must consist of securities that comply with the
standards established by the particular state.
Insurance Regulatory Changes
The NAIC and state insurance regulators have recently become involved in
a process of re-examining existing laws and regulations and their application
to insurance companies. This re-examination has focused on insurance company
investment and solvency issues, risk-based capital guidelines, assumption
reinsurance, interpretations of existing laws, the development of new laws,
the interpretation of nonstatutory guidelines, and the circumstances under
which dividends may be paid. The NAIC has encouraged states to adopt model
NAIC laws on specific topics such as holding company regulations and the
definition of extraordinary dividends. It is not possible to predict the
future impact of changing state regulation on the operations of the Company.
The statutory filings of American Progressive and American Pioneer
require classifications of investments, the maintenance of an asset valuation
reserve ("AVR") and that investment gains and losses resulting from changes in
interest rate levels be deferred and taken into income over a period of years
through the interest maintenance reserve ("IMR"). Similar requirements are
not required under GAAP.
The AVR and IMR of the Insurance Subsidiaries as of December 31, 1995
and 1996 were:
December 31, 1995 December 31, 1996
----------------- -----------------
American Progressive
AVR $ 523,893 $ 456,362
IMR $ 442,394 $ 547,436
American Pioneer
AVR $ 618,676 $ 646,040
IMR(1) $(101,777) $ (94,025)
(1) For statutory accounting purposes, a negative IMR is
treated as a non-admitted asset.
New York State enacted legislation in 1992 that requires all health
insurance sold to individuals and groups with less than 50 employees, to be
offered on an open enrollment and community rated basis effective April 1,
1993. Such insurance may continue to be sold to groups with more than 50
employees on an underwriting basis, with premiums set to reflect expected or
actual expenses. The 1992 law prohibits the use of individual underwriting
techniques and health insurers must accept all who apply regardless of medical
condition. The community rating aspect of the law prohibits the use of age,
sex, health or occupational factors in rating and requires that the same
average rate be used for all persons with the same policy residing in the same
location. The Medicare supplement actively marketed by American Progressive
in New York State and some of its in force business is subject to the
community rating rules. The extension of such legislation to Florida, where
20
significant medically underwritten health insurance is offered, might cause a
reconsideration of the Company's existing health care coverage offerings.
Dividend and Distribution Restrictions
Under the New York State Insurance Law, the declaration or payment of a
dividend by American Progressive requires the approval of the New York
Superintendent of Insurance, who, as a matter of present policy, would not
approve such payment until American Progressive had generated sufficient
statutory profits to offset its entire negative unassigned surplus, which was
approximately $10,293,000 at December 31, 1996.
Under current Florida State insurance law, a life insurer may pay a
dividend or make a distribution without the prior written approval of the
department when:
(a) the dividend is paid from that portion of the accumulated
and available surplus of the Company as is derived from the net
operating profits of its business and its net realized capital gains;
(b) the dividend is no more than the greater of (i) 10% of the
insurer's surplus as to policyholders derived from net operating profits
on its business and net realized capital gains; or (ii) the insurer's
entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year;
(c) the insurer will have surplus as to policyholders equal to
or exceeding 115% of the minimum required statutory surplus as to
policyholders after the dividend or distribution is made; and
(d) the insurer has filed notice with the department at least 10
business days prior to the dividend payment or distribution.
American Pioneer has the capacity to pay dividends of approximately $950,000
during the year ending December 31, 1997. Dividends of $1,000,000, $500,000
and $500,000 were paid by American Pioneer to American Progressive in 1994,
1995 and 1996, respectively.
Risk-Based Capital Requirements
Effective December 31, 1993, the NAIC adopted new risk-based capital
("RBC") requirements, which have also been adopted in New York and Florida.
These are intended to provide for a measurement of statutory capital and
surplus needs based on the risks in a company's mix of products and investment
portfolio. As of December 31, 1995 and 1996, American Progressive's ratios of
total adjusted capital to RBC, based on the NAIC approved model, were
approximately 334% and 261% of the Authorized Control Level, respectively. As
of December 31, 1995 and 1996, American Pioneer's ratios of total adjusted
capital to RBC, based on the NAIC approved model, were approximately 756% and
795% of the Authorized Control Level, respectively.
Guaranty Association Assessments
All states require insurance companies to participate in guaranty
associations designed to cover certain claims against insolvent insurers. The
incurance and amount of such assessments have increased in recent years and
are generally expected to increase further in future years. American
Progressive and American Pioneer were assessed and paid approximately $12,000
and $152,000, respectively, in 1995 and $9,326 and $77,396, respectively in
1996. The likelihood and amount of any other future assessments are now
unknown and are beyond the control of the Company.
21
Health Care Reform
From time to time numerous proposals have been introduced in Congress
and the state legislatures to reform the current health care system.
Proposals have included, among other things, employer-based insurance systems,
subsidized premiums for lower income people, "managed competition" among
health plans, programs to regulate policy availability and affordability and
public and private programs. Changes in health care policy could
significantly affect the Company's health insurance business.
In 1996, Congress enacted the Kassenbaum-Kennedy Act which, among other
changes, restricts the ability of insurers to utilize medical underwriting and
pre-existing condition provisions in certain health insurance policies issued
to persons who were previously insured under qualifying policies. These
changes, which will become effective in stages, may have an effect on some of
the Company's policies. Whether or not Congress passes any further health
reform measures in the foreseeable future, it is likely that health reform
will continue to reappear on the legislative agenda in the future. Such
additional healthcare reform proposals also could require standardization of
major medical or long-term care coverages, impose mandated or target loss
ratios or rate regulation, require the use of community rating or other means
that further limit the ability of insurers to differentiate among risks, or
mandate ultilization review or other managed care concepts to determine what
benefits would be paid by insurers. These or other proposals could increase
or decrease the level of competition among health insurers. In addition,
changes could be made in Medicare that could necessitate revisions in the
Company's Medicare Supplement products. Other potential initiatives, designed
to tax insurance premiums or shift medical care costs from government to
private insurers, could have effects on the Company's business, some of them
adverse. The Company is unable to predict what changes to the country's
health care system will be enacted, if any, or their effects on the Company's
business. See "Regulation".
Other Possible Changes in Legislation
Since insurance is a regulated business, with a high public profile, it
is always possible that legislation may be enacted which would have an adverse
effect on the Company's business.
An important portion of the Company's insurance business is the sale of
deferred annuities and certain life insurance products, which are attractive
to purchasers in part because policyholders generally are not subject to
federal income tax increases in the value of an annuity or life insurance
contract until some form of distribution is made from the contract. From time
to time, Congress has considered proposals to reduce or eliminate the tax
advantages of annuities and life insurance which, if enacted, might have an
adverse effect on the ability of the Company to sell the affected products in
the future. The Company is not aware that Congress is actively considering
any legislation that would reduce or eliminate the tax advantages of annuities
or life insurance; however, it is possible that the tax treatment of annuities
or life insurance could change by legislation or other means (for example, by
Internal Revenue Service regulations or judicial decisions).
Certain changes in insurance and tax laws and regulations could have a
material adverse effect on the operations of insurance companies. Specific
regulatory developments which could have a material adverse effect on the
operation of the insurance industry include, but are not limited to, the
potential repeal of the McCarran-Ferguson Act (which exempts insurance
companies from a variety of federal regulatory requirements), and adoption of
laws, such as those already in force in New York, limiting an insurer's
ability to medically underwrite and rate health insurance policies or to
exclude pre-existing conditions from coverage. In addition, the
administration of such regulations is vested in state agencies which have
broad powers and are concerned primarily with the protection of policyholders.
Federal Income Taxation of the Company
The Company files a consolidated return for federal income tax purposes,
in which the Insurance Subsidiaries are not currently permitted to be
included. At December 31, 1996 the Company (exclusive of the Insurance
Subsidiaries) had a net operating tax loss carryforwards of approximately
$6,400,000 which expire in the years 1997 to 2011.
22
The Insurance Subsidiaries filed a separate consolidated federal income
tax return in which they are taxed as life insurance companies as provided in
the Tax Code. The Omnibus Budget Reconciliation Act of 1990 amended the Tax
Code to require a portion of the expenses incurred in selling insurance
products to be capitalized and amortized over a period of years, as opposed to
an immediate deduction in the year incurred. Instead of measuring actual
selling expenses, the amount capitalized for tax purposes is based on a
percentage of premiums. In general, the capitalized amounts are subject to
amortization over a ten-year period. Since this change only affects the
timing of the deductions, it does not, assuming stability of rates, affect the
provisions for taxes reflected in the Company's financial statements prepared
in accordance with GAAP. However, by deferring deductions, the change does
have the effect of increasing the current tax expense, thereby reducing
statutory surplus. Because of the Insurance Subsidiaries' net operating loss
carryforwards, there was no increase in the Company's current income tax
provision for the three years ended December 31, 1996 due to this change.
At December 31, 1996 American Progressive had net operating tax loss
carryforwards of approximately $5,000,000, which expire in the years 2003 to
2008.
At December 31, 1996 American Pioneer had net operating tax loss
carryforwards, all incurred prior to its acquisition by the Company, of
approximately $1,100,000 which expire in the years 2000 to 2002. As a result
of changes in ownership of American Pioneer in May 1993, use of all the loss
carryforwards of American Pioneer are subject to annual limitations.
Employees
At December 31, 1996, the Company employed approximately 200 employees,
none of whom is represented by a labor union. The Company considers its
relations with its employees to be satisfactory.
MANAGEMENT
Directors and Executive Officers of the Company and Officers of the
Subsidiaries
The following table sets forth certain information concerning the
Directors and Officers of the Company and the Officers of the subsidiaries:
Position with the Company,
Present Principal Occupation or Employment
Name Age and Past Five-Year Employment History
- - ---- --- ------------------------------------------
Richard A. Barasch 43 Director, President and Chief Executive
Officer of the Company; Director and
President of American Progressive; and
Chairman of the Board of American Pioneer
and WorldNet. Mr. Barasch has been a
director and executive officer of the
Company since July 1988, President since
April 1991 and Chief Executive Officer since
June 15, 1995. He has held his positions
with the Company's subsidiaries since their
acquisition or organization by the Company.
Term as a Director expires in 1997.
Marvin Barasch 74 Chairman of the Board of the Company and
Vice-Chairman of American Progressive (John
Adams) since July 1988, Chairman of American
Progressive since June 1996 and a director
of American Pioneer since May 1993. Mr.
Barasch was Chief Executive Officer of the
Company from July 1988 to June 15, 1995. He
has been in the insurance business as an
agent and broker for over 40 years. Term as
a Director expires in 1998.
23
Robert A. Waegelein, C.P.A. 36 Senior Vice President and Chief Financial
Officer of the Company (since October 1990)
and of the Company's subsidiaries since they
were acquired or organized. Prior to that,
Mr. Waegelein, a certified public
accountant, was employed by KPMG Peat
Marwick LLP, the Company's then independent
public accountants, in positions of
increasing responsibility, finally serving
as Senior Manager.
Gary W. Bryant, C.P.A. 47 President, CEO and Director of American
Pioneer since April 1983 and Senior Vice
President of the Company since June 15,
1995.
William E. Wehner 53 Executive Vice President and Chief Operating
Officer of American Progressive since May
1991. Mr. Wehner was employed for over
twenty years by Mutual Life Insurance
Company of New York and its affiliates in
positions of increasing responsibility,
finally serving as Vice President for Group
Insurance.
John C. Caton F.S.A. 59 Vice President of American Pioneer since May
1989.
Guy H. Hartman, FALU, CLU 61 Vice President and Chief Underwriter (since
January, 1986) and Secretary (since January,
1994) of American Pioneer.
Bradley Leonard, F.S.A.,
M.A.A.A. CLU, ChFC 52 Vice President of the Company and Senior
Vice President and Chief Actuary of American
Progressive and American Pioneer since
January, 1997. From December 1992 to
January 1997, Mr. Leonard was Vice President
& Actuary of the Federal Home Life Insurance
Companies. Prior to December 1992, he was
Senior Vice President and Chief Actuary of
American Heritage Life Insurance Company.
Sam Walden 57 Vice President-Information Systems of
American Pioneer since November, 1986.
Joan M. Ferrarone 57 Secretary of the Company and American
Progressive since June, 1995. Mrs.
Ferrarone has been employed by the Company
since 1991 and by American Progressive since
1984 in positions of increasing
responsibility.
Michael A. Barasch 41 Director of the Company since July, 1988 and
American Progressive (and its predecessor,
John Adams) from July, 1988 to June, 1995.
Since February 1995, Mr. Barasch has been a
member of the law firm of Barasch and
McGarry. He was a member of the law firm of
Altier and Barasch from February 1989 to
February 1995. Term as a Director expires
in 1999.
24
Stuart Becker, C.P.A. 53 Director of the Company since July 1990. A
partner in the accounting firm of Becker &
Company, LLC and predecessors, since 1990.
Mr. Becker has more than 30 years experience
as a certified public accountant. Term as a
Director expires in 1997.
David F. Bolger 64 Director of the Company since December,
1992. Since 1966, Mr. Bolger has been Chief
Executive Officer of Bolger & Co., Inc., an
investment banking firm. Term as a Director
expires in 1999.
Mark M. Harmeling 44 Director of the Company since July 1990 and
Director of American Progressive since
December, 1992. Mr. Harmeling has been
President of Bay State Realty Advisors since
January 1994 and previously President of
Intercontinental Real Estate Corporation, a
real estate management and development
company for more than the past five years.
Mr. Harmeling is also a Director of the
following companies: Rochester Shoetree
Corporation (since 1988) and Applied
Extrusion Technologies (since 1987). Term
as a Director expires in 1998.
Bertram Harnett 73 Elected director of the Company and American
Pioneer in June 1996 and had been a director
of the Company previously (July 29, 1988 to
February 9, 1989). Mr. Harnett is President
of the law firm of Harnett Lesnick & Ripps
P.A., Boca Raton, Florida, and its
predecessors since 1988, and a practicing
lawyer since 1948. He is the author of
treatises on insurance law and is a former
Justice of New York State Supreme Court.
Term as a director expires in 1998.
Walter L. Harris 45 Director of the Company since July 1993 and
of American Progressive (and its
predecessor, John Adams) since July 1988.
Since 1979, Mr. Harris has been President of
Tanenbaum-Harber Company, Inc., a general
insurance brokerage firm. Term as a
Director expires in 1999.
Harry B. Henshel 78 Director of the Company since June 1992.
Mr. Henshel has been Chairman of the Board
of the Bulova Corporation, a manufacturer of
timepieces located in New York City, for
more than the past five years. Mr. Henshel
is also a Director of Ponce Hotel
Corporation (since 1973) and Ampal
Industries, Inc. (since 1983). Term as a
Director expires in 1997.
25
Patrick J. McLaughlin 38 Director of the Company since January 1995.
Mr. McLaughlin has been Managing Director
of Emerald Capital Group, Ltd., an asset
management and consulting firm specializing
in the insurance industry, since April 1993.
Prior to that he was an Executive Vice
President and Chief Investment Officer of
Life Partners Group, Inc. (April 1990 to
April 1993), Managing Director of Conning &
Company (August 1989 to April 1990) and
Senior Vice President and Chief Investment
Officer of ICH Corporation (March 1987 to
August 1989). Term as a Director expires in
1997 .
Michael Barasch is Marvin Barasch's son. Richard Barasch is Marvin
Barasch's nephew.
All of the executive officers listed above devote their full business
time to the Company.
All of the Company's and its subsidiaries' officers are elected
annually. The Company's directors are elected for three year terms,
classified into three classes with the Directors in each class serving for
three years, with the terms staggered by class so that one class is elected at
each annual meeting of shareholders for a full three year term. All officers
and directors hold office until their successors are duly elected and
qualified, subject to early removal by the Board.
Mr. Becker was a partner in Laventhol & Horwath from 1988 to 1990 and
Mr. Wehner was an officer of JT Moran Financial Corp. and Moran & Co.
(collectively "Moran") from 1987 to 1990. In November 1990, Laventhol &
Horwath filed a petition for reorganization under Chapter 11 of the Federal
Bankruptcy Code. In July 1992, as a result of obligations arising out of the
Laventhol & Horwath failure, Mr. Becker filed personally for reorganization
under Chapter 11 of the Federal Bankruptcy Code. Moran declared bankruptcy in
January 1990, and in July 1992 the SEC instituted a civil suit against six
former officers of Moran, including Mr. Wehner. Mr. Wehner settled the SEC
suit by consenting to the entry of an injunction relating to his future
activity in the securities business, without admitting any of the allegations
of the SEC's Complaint.
The By-laws of the Company provide that the number of directors shall be
set by the Board of Directors and that the number of directors in each class
shall be equal, or as nearly as practical. The Company's Board of Directors
consists of nine directors and one vacancy.
The Board of Directors has an Audit Committee which also acts as a
Transactions Committee, consisting of Messrs. Becker, Bolger, Henshel, and
McLaughlin, a Compensation Committee consisting of Messrs. Becker, Harmeling
and Harris and an Executive Committee consisting of Messrs. Marvin, Richard
and Michael Barasch, Mr. Bolger and Mr. Harnett. The Audit Committee is
empowered to consult with the Company's independent auditors with respect to
their audit plans and to review their audit report and the accompanying
management letters and, as the Transactions Committee, reviews and makes
recommendations to the Board on certain capital transactions entertained by
the Company. The Compensation Committee reviews and recommends compensation,
including incentive stock option grants, of officers of the Company. The
Executive Committee has the authority to act between Board meetings on behalf
of the Board, on all matters allowed by law.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company and Wand Partners L.P., an affiliate of Wand/Universal
Investments L.P., I and II, the holders of all of the outstanding Series B
Preferred Stock, entered into a financial advisory agreement, dated December
30, 1994, under which such Wand affiliate renders advisory services to the
Company and is paid a fee of $100,000 per year for such services reduced by
any director's fees paid to the director designated by Wand. Such services
and fees are to continue as long as Wand owns 500,000 shares of Common Stock
or common stock equivalent.
Bertram Harnett, a director of the Company, is a shareholder in Harnett,
Lesnick & Ripps P.A. of Boca Raton, Florida, which was paid $228,284 in 1996
on account of its legal services to, as well as reimbursement for
disbursements made on behalf of the Company.
26
ITEM 2 - PROPERTIES
The Company currently leases from unaffiliated parties (i) approximately
15,000 square feet of office space in Brewster, New York, under a lease
expiring in October 2001, with an earlier termination on October 31, 1997 at
the sole option of the Company (the Company notified the landlord of its
intention to terminate the lease as of October 31, 1997), (ii) 18,000 square
feet in Orlando, Florida, under a lease expiring in January, 2002; (iii)
22,000 square feet in Pensacola, Florida, under a lease expiring in November,
1997, with annual renewals at the Company's option for a period of three years
and (iv) 8,000 square feet in Miami, Florida, under a month to month lease
arrangement. These leases represent the principal offices of American
Progressive, American Pioneer and WorldNet, respectively, and carry an
aggregate annual rental of approximately $688,000. The Company also leases a
smaller office in Andalusia, Alabama, for an aggregate annual rental of
approximately $17,000.
ITEM 3 - LEGAL PROCEEDINGS
No reportable litigation was pending at December 31, 1996. The Company
is party to various lawsuits arising out of the ordinary conduct of its
business, none of which, the Company believes, would have a material adverse
effect upon the business of the Company if it were to be adversely determined.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted by the Company to a vote of
stockholders, through the solicitation of proxies or otherwise, during the
fourth quarter of the fiscal year for which this report is filed.
27
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Publicly Traded Securities
The Company's Common Stock has been traded in the over-the-counter market and
quoted on the Nasdaq National Market under the symbol UHCO since May 12,
1983. The 1999 Warrants have been so traded and so quoted, under the symbol
UHCOW, since September 1990. The following table sets forth the high and low
sales prices per share of Common Stock and 1999 Warrants as reported on the
Nasdaq National Market for the periods indicated.
Common Stock 1999 Warrants
------------ -------------
High Low High Low
1994
First Quarter 5 3-1/8 4-3/8 2-1/4
Second Quarter 4-1/8 2-5/8 2 1-3/4
Third Quarter 3-1/2 2-3/8 1-3/4 1-3/4
Fourth Quarter 3-1/2 2-1/16 1-3/4 1-3/4
1995
First Quarter 3-3/8 2-1/8 1-3/4 1-3/4
Second Quarter 3-3/4 2-5/8 1-3/4 1-3/4
Third Quarter 3-5/8 2-5/8 1-3/4 1-1/4
Fourth Quarter 3-1/8 2-1/8 1-1/4 1-1/4
1996
First Quarter 3-1/8 2-1/4 1-1/2 1-1/2
Second Quarter 3-1/8 2 1-1/4 1-1/4
Third Quarter 3-1/8 2-31/32 1-3/4 1-1/4
Fourth Quarter 2-11/16 1-1/2 1-3/8 1-1/4
1997
First Quarter (through February 28) 2-31/64 1-3/4 1-1/8 1-1/8
As of February 28, 1996, there were approximately 1,700 holders of the Common
Stock and 100 holders of the 1999 Warrants. On February 28, 1997, the bid
and ask sales prices for the Common Stock were $1-7/8 and $2-1/4. On January
30, 1997, the last date on which the 1999 Warrants were traded, the sales
price was $1-1/8.
Dividends
The Company has neither declared nor paid dividends on its Common Stock and
no such dividends are likely in the foreseeable future. Any future decision
to pay dividends will be made by the Board of Directors in light of
conditions then existing, including the Company's results of operations,
financial condition and requirements, loan covenants, insurance regulatory
restrictions, business conditions and other factors. In addition, the ability
of the Company to pay cash dividends, if and when it should wish to do so, may
depend on the ability of its subsidiaries to pay dividends to the Company.
See "Regulation--Dividend and Distribution Restrictions".
28
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below should be read in
conjunction with the consolidated financial statements of the Company, the
related notes thereto and the auditors' report thereon and "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
The selected consolidated financial data presented below for, and at the end
of, each of the years from December 31, 1992 through 1995 are derived from the
consolidated financial statements of the Company, which have been audited and
reported upon by KPMG Peat Marwick LLP, independent certified public
accountants. The selected consolidated financial data presented below for,
and at the end of December 31, 1996, have been audited and reported upon by
Ernst & Young LLP, independent certified public accountants. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations".
Year ended December 31,
----------------------------------------
1992 1993 1994 1995 1996
(In thousands, except for per share data)
Income Statement Data:
Gross premium and policyholder
fees $10,588 $24,885 $40,652 $46,145 $55,287
Reinsurance premium assumed 671 616 13,564 8,866 10,522
Reinsurance premium ceded (1,515) (3,975) (13,564) (18,200) (25,664)
------- ------- ------- ------- -------
Net premium and other policyholder
fees 9,744 21,526 40,324 36,811 40,145
Net investment income 5,997 7,974 9,239 8,945 9,850
Realized gains (losses) (193) 676 42 674 240
Fee income 1,554 2,466 4,126 3,137 2,872
Other income -- 801 219 244 280
Total revenues 17,102 33,443 53,950 49,811 53,387
Total benefits, claims and other
deductions 16,709 31,818 51,712 47,161 53,014
Net income after taxes and before
extraordinary credit 145 1,553 2,228 2,642 104
Net income after taxes and
extraordinary credit(1) 393 1,553 2,228 2,642 104
Net income (loss) applicable
to common shareholders(2) (94) 1,024 3,173 2,642 104
Net income (loss) per share of
Common Stock after taxes and
extraordinary credit (0.02) 0.14 0.37 0.25 0.01
December 31,
-----------------------------------------------
1992 1993 1994 1995(3) 1996
(In thousands, except for per share data)
Balance Sheet Data:
Total investments $77,551 $123,038 $125,487 $135,603 $144,681
Total assets 95,616 153,687 164,862 182,994 242,237
Policyholder account balances 64,780 105,091 108,777 118,609 134,539
Series A Preferred Stock 6,034 6,564 -- -- --
Series B Preferred Stock -- -- 4,000 4,000 4,000
Stockholders' equity 13,902 16,377 15,321 24,114 22,079
Stockholders' equity per share
of Common Stock(4) 1.71 1.87 1.83 2.89 2.53
---------------------------
(1) The extraordinary credit reported in the year ended December 31, 1992
represents the realization of the tax benefit for operating loss
carryforwards accounted for prior to Financial Accounting Standards Board
Statement 109, "Accounting for Income Taxes," which Statement was adopted by
the Company as of January 1, 1993.
(2) After provision for Series A Preferred Stock dividends of $487,000,
$529,000 and $576,000 for the years ended December 31, 1992, 1993 and 1994,
respectively.
(3) See "Management's Discussion and Analysis of Financial Condition and
Results of OperationsCEffects of Accounting Pronouncements" for a discussion
of the impact of changes in accounting principles.
(4) Stockholders' equity per share of common stock represents stockholders'
equity less the Series A and Series B Preferred Stock divided by outstanding
shares of common stock.
29
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company is an insurance holding company representing the strategic
combination of two life insurance companies, American Progressive and American
Pioneer, and WorldNet, an international managed care company. These companies
were assembled in 1991-1993, with the Insurance Subsidiaries each being
acquired at prices approximately equal to or below their adjusted statutory
book value. Management is now focused on growth, both internal, through
aggressive marketing and product development programs directed at specialty
life and accident and health insurance products, and by seeking further
acquisitions of insurance companies or blocks of business. It also has
embarked on a program to rationalize operations through consolidation of
administrative and processing facilities.
The Insurance Subsidiaries had revenues of approximately $43.9 million,
$40.5 million and $44.5 million for the years ended December 31, 1994, 1995
and 1996, respectively, representing 91%, 93% and 95%, of the Company's
total revenues for each period, respectively. Although American Progressive,
domiciled in New York, primarily sells its products in New York and the
northeastern United States and American Pioneer, domiciled in Florida,
primarily sells its products in Florida and the southeastern United States,
one or both of the Insurance Subsidiaries is licensed in 45 states and in the
District of Columbia. American Pioneer and American Progressive have been
rated "B+" and "B" by A.M. Best, respectively. A.M. Best's ratings are based
upon factors relevant to policyholders, agents, insurance brokers and
intermediaries and are not directed to the protection of shareholders in the
rated company. See "BusinessCRatings".
Results of Operations
Years Ended December 31, 1995 and 1996
The results of operations for the year ended December 31, 1995 and 1996
include the operations of American Progressive, American Pioneer and WorldNet.
Net Income. For the year ended December 31, 1996, the Company earned
net income of approximately $104,000 resulting in an earnings per share
applicable to common shareholders of $0.01. For the year ended December 31,
1995, the Company earned net income of approximately $2,642,000, resulting in
an earnings per share of $0.25.
Operating income before income taxes decreased $2,278,000 from
$2,651,000 in 1995 to $373,000 in 1996. Certain individually large items
account for a significant amount of this decrease, including (i) a decrease in
the operating results of the NAIU accident pool participated in by American
Progressive, which decrease was $1,100,000; (ii) a decrease in realized gains
on investment of $434,000 and (iii) the $250,000 expense accrual made at
December 31, 1996 for the restructuring activity of the Company. These three
items represent $1,784,000 of the $2,278,000 decrease.
Revenues. Total revenues increased approximately $3,576,000 from total
revenues of approximately $49,811,000 for the year ended December 31, 1995 to
approximately $53,387,000 for the year ended December 31, 1996. Net premiums
and policyholder fees earned increased approximately $3,334,000. Supplemental
health insurance premiums at American Progressive increased approximately
$1,258,000 (primarily Medicare supplement, hospital indemnity and home health
care) and its life premiums grew approximately $30,000, while American
Pioneer's life premiums grew approximately $374,000 and its group dental
premiums grew approximately $919,000. The increase in these life and
supplemental health premiums of $2,581,000 was offset by the decrease of
approximately $547,000 in American Pioneer's major hospital and major medical
premiums and the decrease in American Progressive's premiums from its other
accident and health products that are no longer being actively marketed by the
Company (approximately $754,000). The Company had an increase in premiums
from the NAIU pool of $1,798,000 and the NYS DBL business of $256,000.
Realized gains on investments decreased approximately $434,000 to
approximately $240,000, compared to a gain of approximately $674,000 for the
prior year. Net investment income increased approximately $905,000 from
31
$8,945,000 in 1995 to $9,850,000 in 1996. This increase is attributed to
higher invested assets in 1996 compared to 1995.
Fee income for the year ended December 31, 1996 reflects the fees earned
by WorldNet for managed care, travel assistance, claims administration and
communication services and the $450,000 deposit received by American
Progressive in connection with the sale of the New York DBL business.
WorldNet's fee income decreased by $716,000 which reduction primarily results
from the Company's termination of its service agreement with Liberty Mutual in
February, 1996. For the year ended December 31, 1996, the Company amortized
approximately $280,000 of deferred revenue compared to $244,000 amortized in
the same period in 1995.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions increased approximately $5,754,000 to $53,014,000 for the year
ended December 31, 1996. The change in future policy benefits amounted to an
increase of approximately $3,192,000. The increase in reserves for the year
ended December 31, 1996 was $1,855,000 and primarily relates to the increase
in life reserves at American Pioneer of $971,000, the increase in the unearned
premium reserve at NAIU of $256,000 and the increase in the senior market
supplemental health insurance unearned premium reserves of $628,000. This
increase compares to a decrease in 1995 of approximately $1,337,000, which
decrease in 1995 primarily relates to the reduction in the 1995 NAIU premium
($491,000), the runoff accident and health business of American Progressive
($827,000) and the major hospital and major medical of American Pioneer
($430,000) offset by an increase in the senior market supplemental health
insurance reserves ($559,000). Claims and other benefits increased
approximately $1,676,000. This increase is a result of increased mortality of
approximately $516,000, increased American Progressive's senior market
supplemental health benefits of approximately $1,062,000 and the claims
incurred on the First National business acquired of $1,077,000, and increased
morbidity of $388,000 on the group dental business. The runoff health
business at both insurance companies had a reduction in benefits totalling
$3,145,000 due to the decision to reinsure 75% of the major hospital and major
medical benefits at American Pioneer. The benefits incurred on the NAIU
business increased $1,083,000 and NYS DBL benefits increased $695,000. The
increase in deferred acquisition costs decreased approximately $1,106,000 and
was due to the decrease in capitalized expenses of $228,000 and the increase
in amortization of $878,000.
Commissions decreased $265,000 to $5,076,000 for the year ended December
31, 1996. The increase in gross commissions of $4,967,000 was due to the
increase in gross premiums noted above, offset by a corresponding increase in
reinsurance allowances of $5,231,000. Other operating costs and expenses
decreased approximately $175,000. Expenses incurred by the insurance
subsidiaries during 1996 exceeded the 1995 amount by approximately $1,405,000.
New business expenses and premium taxes increased approximately $166,000, the
expenses incurred on the administration of the acquired First National
business amounted to $550,000, while the expense incurred by the NAIU accident
pool decreased $397,000. The general overhead expenses of the insurance
companies increased approximately $1,086,000 which increase directly relates
to the increase in business being administered by the Company. These
administrative general expense increases are partially recovered from the
increase in this reinsurance allowances noted above. The remaining decrease
of $1,580,000 results from a decrease of continuing operation expenses
incurred by WorldNet (approximately $1,292,000) and a decrease in the Parent
Company expenses ($288,000). Amortization of the present value of future
profits was approximately $205,000 for 1995, which amount fully amortized the
asset.
Years Ended December 31, 1994 and 1995
The results of operations for the year ended December 31, 1994 and 1995
include the operations of American Progressive, American Pioneer and WorldNet.
Net Income. For the year ended December 31, 1995, the Company earned
net income of approximately $2,642,000 resulting in an earnings per share
applicable to common shareholders of $0.25. For the year ended December 31,
1994, the Company earned net income of approximately $2,228,000 before its
dividend requirement on the Series A Preferred Stock, which dividend amounted
to approximately $576,000, resulting in an earnings per share of $0.20. On
31
December 30, 1994, the Company redeemed the Series A Preferred Stock at a
discount of approximately $1,522,000 ($0.17 per share), which discount
increased the 1994 net income applicable to common shareholders to
approximately $3,173,000, or $0.37 per share.
Revenues. Total revenues decreased approximately $4,138,000 from total
revenues of approximately $53,950,000 for the year ended December 31, 1994 to
approximately $49,812,000 for the year ended December 31, 1995. Total
premiums and policyholder fees earned decreased approximately $3,514,000.
Supplemental health insurance premiums at American Progressive increased
approximately $1,842,000 (primarily in NYS DBL, Medicare supplement and
hospital indemnity) and its life premiums grew approximately $340,000, while
American Pioneer's life premiums grew approximately $656,000 and its group
dental premiums grew approximately $892,000. The increase in these life and
supplemental health premiums of $3,730,000 was offset by the decrease of
approximately $4,757,000 in American Pioneer's major hospital and major
medical premiums and the decrease in American Progressive's premiums from its
participation in NAIU accident pool (approximately $1,531,000) and other
accident and health products that are no longer being actively marketed by the
Company (approximately $956,000). Realized gains on investments increased
approximately $632,000 to approximately $674,000, compared to a gain of
approximately $42,000 for the prior year, and are primarily attributed to
increasing interest rates throughout 1995. As a result of realizing these
investment gains, net investment income decreased approximately $293,000.
Fee income for the year ended December 31, 1995 decreased approximately
$988,000 which reflects the fees earned by WorldNet for managed care, travel
assistance, claims administration and communication services. This reduction
is a result of the Company's termination of certain nonprofitable contracts.
For the year ended December 31, 1995, the Company amortized approximately
$244,000 of the deferred revenue compared to the $219,000 amortized in the
same period in 1994, which increase is attributable to the $80,000 of
additional amortization generated by the 75% quota share reinsurance agreement
effected on July 1, 1995. See "Business-Reinsurance Ceded".
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions decreased approximately $4,551,000 to $47,161,000 for the year
ended December 31, 1995. The change in future policy benefits amounted to a
decrease of approximately $4,267,000. The decrease in reserves for the year
ended December 31, 1995 was $1,337,000 and primarily relates to the reduction
in the 1995 NAIU premium, (approximately $491,000) the non-marketed accident
and health business of American Progressive ($827,000) and the major hospital
and major medical of American Pioneer ($430,000) offset by an increase in the
supplemental health insurance reserves currently being sold (approximately
$559,000). This decrease compares to an increase in 1994 of approximately
$2,930,000, which increase in 1994 primarily relates to the increase in
reserves of American Progressive when it entered the NAIU accident pool and
assumed the North American Company businesses of approximately $2,556,000 (See
"Business - Reinsurance"). Claims and other benefits increased approximately
$1,247,000. This increase is a result of increased mortality of approximately
$344,000 at American Progressive and increased supplemental health benefits of
approximately $2,456,000 and increased morbidity of approximately $651,000 on
the non-marketed health business at both insurance companies. This increase
was offset by a reduction of approximately $2,204,000 in major hospital and
major medical benefits at American Pioneer, which reduction is a result of the
lower premium revenue discussed above. Interest credited to policyholders
increased $173,000 to $6,090,000 due to higher outstanding policyholder
account balances in 1995. The increase in deferred acquisition costs
increased approximately $386,000 and was due to the increase in new business
production noted above.
Commissions and other operating costs and expenses decreased
approximately $1,286,000. Expenses incurred by the insurance subsidiaries
during 1995 exceeded the 1994 amount by approximately $151,000. Commissions,
new business expenses and premium taxes increased approximately $509,000,
while the general overhead expenses decreased approximately $358,000. The
remaining decrease of $1,437,000 results from a decrease of continuing
operation expenses incurred by WorldNet (approximately $1,708,000) resulting
from the termination of certain unprofitable contracts, (approximately
$1,208,000) and the relocation of WorldNet to Florida from Texas in 1994
(approximately $500,000) offset by an increase by the Parent Company
32
(approximately $271,000). Amortization of the present value of future profits
was approximately $205,000 for 1995 compared to $237,000 in 1994, which
decrease is due to the lower amount of insurance in force.
Liquidity and Capital Resources
The Company's need for capital has historically been to maintain or
increase the surplus of its Insurance Subsidiaries and to support the Company
as an insurance holding company, including the maintenance of its status as a
public company. In addition, the Company requires capital to fund its
anticipated growth through acquisitions of other companies and blocks of
insurance business.
The Company
The Company requires cash to pay the operating expenses necessary to
support its status as an insurance holding company (which under applicable
Insurance Department regulations must bear its own expenses) and to meet the
cost involved in being a publicly-owned company and will require cash to meet
Universal's obligations under the Unstacking Agreement and the debentures to
be issued thereunder. The $3 million of cash required to fund the initial
segment of the Unstacking Agreement is expected to be provided by the sale of
at least $4 million of Series C Preferred Stock, the completion of which is
awaiting approval of the transaction by the Florida Insurance Department.
On September 30, 1996, the Company amended its loan agreement with its
commercial bank, under which amendment, the Company borrowed $800,000 on a one
year term loan, extendable by the Company for a second year. The loan is
secured by the pledge of 100% of the outstanding common stock of Quincy
Coverage Corp. ("Quincy"), an immaterial subsidiary engaged in the insurance
brokerage business, the receivables of Quincy and WorldNet and 9.9% of the
outstanding common stock of American Progressive. As of December 31, 1995 and
December 31, 1996, $800,000 was outstanding on this loan agreement, which
bears interest at 1.0% over prime.
Insurance Subsidiaries
American Progressive and American Pioneer are required to maintain
minimum amounts of capital and surplus as determined by statutory accounting.
The minimum statutory capital and surplus requirements of American
Progressive and American Pioneer as of December 31, 1996 for the maintenance
of authority to do business were $2,500,000 and $2,130,000, respectively, but
substantially more than this is needed to permit continued writing of new
business. At December 31, 1996 the adjusted statutory capital and surplus,
including asset valuation reserve, of American Progressive and American
Pioneer were $7,920,366 and $13,379,191 respectively.
The NAIC has adopted risk based capital ("RBC") rules which became
effective December 31, 1993 and have been adopted by both New York and
Florida. See "RegulationCRisk-Based Capital Requirements" The new RBC rules
provide for various actions when the ratio of a company's total adjusted
surplus to its RBC falls below 200%. At December 31, 1996, American
Progressive and American Pioneer had RBC ratios of approximately 261% and 795%
of the Authorized Control Level, respectively. Consummation of the Unstacking
Agreement is expected to increase American Progressive's RBC ratio.
Liquidity for the life insurance subsidiaries is measured by their
ability to pay scheduled contractual benefits, pay operating expenses, and
fund investment commitments. Sources of liquidity include scheduled and
unscheduled principal and interest payments on investments, premium payments
and deposits and the sale of liquid investments. These sources of liquidity
for the insurance subsidiaries significantly exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including
death benefits, benefits under accident and health policies and interest-
sensitive policy surrenders and withdrawals. The amount of surrenders and
withdrawals is affected by a variety of factors such as credited interest
rates for similar products, general economic conditions and events in the
33
industry which affect policyholders' confidence. Although the contractual
terms of substantially all of the Company's in force life insurance policies
and annuities give the holders the right to surrender the policies and
annuities, the Company imposes penalties for early surrenders. At December
31, 1996 the Company held reserves that exceeded the underlying cash surrender
values of its in force life insurance and annuities by more than $12.9
million. The insurance companies have not experienced any material changes in
surrender and withdrawal activity in recent years.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity,
unanticipated surrenders and withdrawals in a changed interest rate
environment could adversely affect earnings if the Company were required to
sell investments at reduced values in order to meet liquidity demands. The
Company manages the asset and liability portfolios in order to minimize the
adverse earnings impact of changing market rates. The Company seeks to invest
in assets which have duration and interest spread characteristics similar to
the liabilities which they support.
The net yield on cash and invested assets increased from 6.97% in 1995
to 7.08% in 1996. A significant portion of these securities are held to
support the liabilities for policyholder account balances, which liabilities
are subject to periodic adjustments to their credited interest rates. The
credited interest rates of the interest-sensitive policyholder account
balances are determined by management based upon factors such as portfolio
rates of return and prevailing market rates and typically follow the pattern
of yields on the assets supporting these liabilities.
At December 31, 1996, the investment portfolios of the life insurance
subsidiaries included cash and short-term investments totaling $15,044,000, as
well as fixed maturity securities that could readily be converted to cash with
carrying values (and fair values) of $121,492,000. The fair values of these
liquid investments totalled more than $136,536,000 and constituted
approximately 94% of the Company's investments at December 31, 1996. At
December 31, 1996, all of the Company investments were income producing and
current in interest and principal payments except for one security with a
carrying value of $331,250. In addition, the Company has no investment in any
derivative instruments or other hybrid securities that contain any off balance
sheet risk or investments in other securities whose fair values and principal
repayments would be highly volatile to changes in interest rates, except for
GNMA's, FNMA's and investment grade corporate collateralized mortgage
obligations.
WorldNet
In February, 1996, the service agreement between WorldNet and Ontario
Blue Cross ("OBC"), which had been entered into in 1994 in connection with
WorldNet's purchase of certain assets from subsidiaries of OBC was terminated.
The termination of the service agreement was the result of the acquisition of
OBC by Liberty Mutual Insurance Company ("Liberty Health") in 1995.
Simultaneously with the termination of the service agreement, Liberty Mutual
agreed to cancel certain promissory notes executed on April 1, 1994 as part
payment for the acquired assets, which had a balance of $370,000 at December
31, 1996. At the same time, the Company wrote off the corresponding assets,
including the value of the $170,000. The resulting net income from this
transaction was approximately $200,000.
Through December 31, 1995, the Company had provided approximately $3.4
million to WorldNet with no additional funding required during 1996. These
funds were used to support WorldNet's start-up costs, a portion of the costs
of acquiring the HAT assets and the cost of acquiring WorldNet's Dallas, Texas
facility and later closing it and relocating certain of its operations to the
facility purchased from HAT in Miami Beach, Florida. WorldNet's revenues were
$4,068,000, $3,071,000 and $2,172,000 for 1994, 1995 and 1996, respectively.
WorldNet incurred a net loss of approximately $1,375,000, $665,000 and
$271,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
The 1996 loss included certain non-cash expenses amounting to $136,000.
34
Effects of Accounting Pronouncements
In May 1993, the Financial Accounting Standards Board ("FASB") issued
Statement 115, "Accounting for Certain Debt and Equity Securities", which is
effective for fiscal years beginning after December 15, 1993, with earlier
adoption permitted. Statement 115 requires that debt and equity securities be
classified into three categories and accounted for as follows:
* Debt securities that the Company has the positive intent and
the ability to hold to maturity would be classified as "held to
maturity" and reported at amortized cost.
* Debt and equity securities that are held for current resale
would be classified as "trading securities" and reported at fair value,
with unrealized gains and losses included in earnings.
* Debt and equity securities not classified as held to
maturity or as trading securities would be classified as "available for
sale" and reported at fair value. Unrealized gains and losses would not
be reflected in earnings but would be reported as a separate component
of stockholders' equity.
The Company adopted Statement 115 on January 1, 1994, the effect of
which increased its unrealized gains by $494,541. In November, 1995, the FASB
issued a Special Report titled "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities", which
report allows enterprises to reassess the appropriateness of the
classifications of all securities held and account for any resulting
reclassifications between the investment accounts. This one-time reassessment
had to be made prior to December 31, 1996 and be appropriately disclosed in
the financial statements. In December, 1995, the Company did reassess the
appropriateness of the classifications of its securities and reclassified all
of the securities contained in the held to maturity account to the available
for sale account as they may be considered for sale prior to maturity as part
of the asset/liability management strategy. The carrying value of the
securities reclassed to available for sale amounted to $35,942,303 and the
fair value amounted to $36,098,026. This transfer resulted in the Company
increasing its unrealized gains by $155,723. As changes in interest rates
occur, the carrying value of the securities classified as available for sale,
as well as any securities which may in the future be classified as held for
maturity, will be impacted. Typically, as interest rates rise, the carrying
value of these securities may decline. Conversely, if interest rates decline,
the carrying value of these securities may increase. Management cannot
predict the impact that changes in future interest rates will have on the
Company's financial statements.
In October, 1995, the FASB issued Statement 123, "Accounting for Stock-
Based Compensation" (Statement 123) which requires companies to recognize
compensation expense for stock options based on their fair value on the date
of grant and is effective for financial statements for fiscal years beginning
after December 15, 1995, with earlier adoption permitted. Statement 123
allows companies to remain under the existing method of accounting for stock
options, Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB 25). If companies elect to remain under APB 25 then
the companies are required to disclose the pro forma effects of Statement 123
on their net income and earnings per share resulting from the grant of these
options and other stock awards. Under APB 25, to the extent the exercise
price of the Company's stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized. The
Company has elected to follow APB 25 and related interpretations in accounting
for its stock options and will disclose the pro forma effects of Statement 123
on the Company's net income and earnings per share in the footnotes to the
financial statements. The pro forma effects of Statement 123 result in
additional compensation expense for December 31, 1995 and 1996 of $10,756 and
$133,208, respectively. The results of which reduce earnings per share for
December 31, 1995 and 1996, on a pro forma basis, $0.00 and $0.01,
respectively.
35
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary schedules are listed in the
accompanying Index to Consolidated Financial Statements and Financial
Statement Schedules on Page F - 1.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 15, 1996, the Board of Directors of the Company approved the
engagement of Ernst & Young, LLP as its independent auditors for the fiscal
year ending December 31, 1996 to replace the firm of KPMG Peat Marwick, LLP,
who were dismissed as auditors of the Company effective July 15, 1996. The
audit committee of the Board of Directors approved the change in auditors on
July 15, 1996.
The reports of KPMG Peat Marwick LLP on the Company=s financial
statements for the two fiscal years ended December 31, 1995 did not contain an
adverse opinion or a disclaimer of opinion and were not qualified or modified
as to uncertainty, audit scope, or accounting principles.
In connection with the audits of the Company=s financial statements for
each of the two fiscal years ended December 31, 1995 and 1994, and in the
subsequent interim period, there were no disagreements with KPMG Peat Marwick
LLP on any matters of accounting principles or practices, financial statement
disclosure, or auditing scope and procedures which, if not resolved to the
satisfaction of KPMG Peat Marwick LLP, would have caused KPMG Peat Marwick LLP
to make reference to the matter in their report.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of the Registrant
is set forth in Part I, Item 1, under the caption "Executive Officers and
Directors".
ITEM 11 - EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated by
reference to Universal American Financial Corp.'s definitive proxy statement
to be filed pursuant to Regulation 14A under the Securities Exchange Act of
1934 within 120 days after the end of the Company's fiscal year ended December
31, 1996.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding beneficial ownership of Universal American
Financial Corp.'s voting securities by directors, officers and persons who, to
the best knowledge of the Company, are known to be the beneficial owners of
more than 5% of the Company's voting securities as of December 31, 1996, is
incorporated by reference to Universal American Financial Corp.'s definitive
proxy statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934 within 120 days after the end of the Company's fiscal
year ended December 31, 1996.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
incorporated by reference to Universal American Financial Corp.'s definitive
proxy statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934 within 120 days after the end of the Company's fiscal
year ended December 31, 1996.
36
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 and 2 Financial Statements and Financial Statement Schedules
See separate index to Financial Statements and Financial Statement
Schedules on Page F - 1.
3 Exhibits and Reports on Form 8-K
(a) Exhibits
3(a) Restated Certificate of Incorporation, consisting of :
(i) Restated Certificate of Incorporation filed October 4,
1993, is hereby incorporated by reference to Exhibit
3(a)(3) to Form 10-Q dated November 11, 1994.
(ii) Certificate of Correction of Restated Certificate of
Incorporation, dated December 13, 1993, is hereby
incorporated by reference to Exhibit 3(a)(2) to Form
10-K dated March 28, 1994.
(iii) Certificate of Amendment to Restated Certificate of
Incorporation relating to Series B Peferred Stock, is
hereby incorporated by reference to Exhibit 3.2(III)
to Form 8-K dated January 18, 1995.
3(b) By-Laws, as amended, are hereby incorporated by
reference to Exhibit 3(b) to Form 10-K for 1989.
4(a) Form of Warrant Certificate:
(i) for Warrants registered under the Exchange Act of
1934, as amended, is hereby incorporated by reference
to Exhibit 4 to Current Report on Form 8-K dated July
24, 1992; and
(ii) for Warrants not so registered under the Exchange Act
of 1934, is hereby incorporated by reference to
Exhibit 4.2 to Form S-1 filed March 30, 1990, as
amended by the Warrant Exchange Agreement dated July
15, 1992, filed as Exhibit 28(I) to Current Report on
Form 8-K dated July 24, 1992.
10(a) Agreement dated March 7, 1994 among Registrant and Midland with
Exhibit A is hereby incorporated by reference to Exhibit 10(d)(1)
to Form 10-K for 1993.
10(b) Stock Subscription Agreement as of August 12, 1994, between
Registrant and Wand/Universal L.P., as amended by Agreement dated
November 23, 1994 is incorporated by reference to Exhibit 10(e) to
Current Report on Form 8-K dated August 12, 1994 and Exhibit
10.4(1) to Current Report on Form 8-K dated January 18, 1995.
10(c) Financial Advisory Agreement as of September 1, 1994 between
Registrant and Wand Partners L.P. is incorporated by reference to
Exhibit 10(f) to Current Report on Form 8-K dated August 12, 1994.
37
10(d) Shareholder Agreement among the Registrant, Wand/Universal
Investments L.P., Barasch Associates Limited Partners and Others,
dated December 30, 1994 is incorporated by reference to Exhibit
10(d) to Form 10-K for 1994.
10(e) Special Commitments to the Superintendent of Insurance of the
State of New York, dated January 6, 1995, signed by:
(i) the Registrant, American Progressive, BALP and NMRB
Corp. and
(ii) WAND, Wand (Universal) Inc., David S. Callard and
Bruce W. Schnitzer are incorporated by reference to
Exhibit 10(e) to Form 10-K for 1994.
10(f) Loan Agreement between Registrant and Country Bank, dated
September 30, 1994, incorporated by reference to Exhibit 10(e) of
Form 10-Q dated November 11, 1994.
10(g) Stock purchase agreement between Registrant and AAM Capital
Partners, L.P. dated July 7, 1997, including:
(i) Exhibit 10, proposed Certificate of Amendment of
Incorporation relating to Series C Preferred Stock;
and
(ii) Exhibit 11, proposed shareholder agreement. The
other exhibits and schedules to this agreement are
omitted and will be furnished upon request.
11 Computation of primary earnings per share.
22 List of Subsidiaries:
Name Place of Incorporation
---------------------------------- ----------------------------
American Progressive Life & Health
Insurance Company of New York New York
American Pioneer Life Insurance Co. Florida
Amerifirst Insurance Company Indiana
Quincy Coverage Corporation New York
WorldNet Services Corporation Florida
WorldNet Services Corporation Ontario, Canada
23(a) Consent of Ernst & Young, LLP
23(b) Consent of KPMG Peat Marwick LLP
(b) Reports on Form 8-K
On October 21, 1996 and December 20, 1996 the Company filed
Current Reports on Form 8-K to report the assumption of business
from First National Life Insurance Company.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 28th day of
March 1997.
UNIVERSAL AMERICAN FINANCIAL CORP.
(Registrant)
By: /s/ Richard A. Barasch
----------------------
Richard A. Barasch
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on March 28, 1997 by the following persons
in the capacities indicated:
Signatures Title
---------- -----
/s/ Richard A. Barasch President and Chief Executive Officer
- - ----------------------- and Director
Richard A. Barasch (Principal Executive Officer
/s/ Marvin Barasch Chairman of the Board and Director
- - -----------------------
Marvin Barasch
/s/ Robert A. Waegelein Senior Vice President and Chief
- - ----------------------- Financial Officer
Robert A. Waegelein (Principal Accounting Officer)
/s/ Michael A. Barasch Director
- - -----------------------
Michael A. Barasch
/s/ Stuart Becker Director
- - -----------------------
Stuart Becker
Director
- - -----------------------
David F. Bolger
/s/ Mark M. Harmeling Director
- - -----------------------
Mark M. Harmeling
/s/ Bertram Harnett Director
- - -----------------------
Bertram Harnett
/s/ Walter L. Harris Director
- - -----------------------
Walter L. Harris
Director
- - -----------------------
Harry B. Henshel
/s/ Patrick J. McLaughlin Director
- - -------------------------
Patrick J. McLaughlin
38
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULES OF THE REGISTRANT:
Independent Auditors' Reports F-2 & F-3
Consolidated Balance Sheets as of December 31, 1995 and 1996 F-4
Consolidated Statements of Operations
for the Three Years Ended December 31, 1996 F-5
Consolidated Statements of Stockholders' Equity
for the Three Years Ended December 31, 1996 F-6
Consolidated Statements of Cash Flows
for the Three Years Ended December 31, 1996 F-7
Notes to Consolidated Financial Statements F-9
Schedule I -- Summary of Investments - other than investments in
related parties (incorporated in Note 4 to Consolidated Financial
Statements)
Schedule II -- Condensed Financial Information of Registrant F-30
Schedule III -- Supplementary Insurance Information F-33
Schedule IV -- Reinsurance (incorporated in Note 8 of Notes to
Consolidated Financial Statements)
Independent Auditors' Report
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated balance sheet as of December 31,
1996 and the related consolidated statements of operations, stockholders'
equity and cash flows for the year ended December 31, 1996 of Universal
American Financial Corp. and subsidiaries. Our audit also included the
consolidated financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statements
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedules based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Universal
American Financial Corp. and subsidiaries as of December 31, 1996, and the
results of their operations and their cash flows for the year ended December
31, 1996 in conformity with generally accepted accounting principles. Also in
our opinion, the related financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects, the information set forth therein.
Ernst & Young, LLP
New York, New York
March 26, 1997
F-2
Independent Auditors' Report
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated balance sheet as of December 31,
1995 and the related statements of operations, stockholders' equity and cash
flows for the years ended December 31, 1995 and 1994 of Universal American
Financial Corp. and subsidiaries. In connection with our audits of the
consolidated financial statements, we also have audited the consolidated
financial statement schedules for the periods indicated above as listed in the
accompanying index. These consolidated financial statements and financial
statements schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Universal
American Financial Corp. and subsidiaries as of December 31, 1995, and the
results of their operations and their cash flows for each of the years in the
two year period ended December 31, 1995 in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly, in all material respects, the
information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for debt and equity securities in 1994 to
adopt the provisions of the Financial Accounting Standards Board's Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities".
KPMG Peat Marwick LLP
New York, New York
March 26, 1996
F-3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1995 and 1996
ASSETS 1995 1996
----------- -----------
Investments (Notes 2c and 4)
Cash and cash equivalents $ 12,289,801 $ 15,403,450
Fixed maturities available for sale, at fair
value (amortized cost $114,112,556 and
$122,511,012, respectively) 116,428,921 121,492,167
Equity securities, at fair value (cost $46,133
and $46,133, respectively) 15,297 33,562
Policy loans 5,622,136 6,421,251
Property tax liens 178,908 131,729
Mortgage loans 1,067,605 1,199,110
----------- -----------
Total investments 135,602,668 144,681,269
Accrued investment income 2,412,576 2,875,497
Deferred policy acquisition costs (Note 2d) 16,564,450 19,091,514
Amounts due from reinsurers 17,635,580 60,838,289
Due and unpaid premiums 2,826,833 2,712,021
Deferred income tax asset (Note 5) 1,328,314 2,069,876
Goodwill --- 3,529,529
Other assets 6,623,966 6,438,743
----------- -----------
Total assets 182,994,387 242,236,738
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances (Note 2e) 118,608,836 134,538,954
Reserves for future policy benefits 22,099,350 40,156,185
Policy and contract claims - life 693,679 1,186,702
Policy and contract claims - health 8,681,136 24,628,019
Short-term debt (Note 9) 800,000 800,000
Notes payable (Notes 3 & 6) 369,698 ---
Amounts due to reinsurers 1,294,295 11,129,232
Deferred revenues 638,293 357,957
Other liabilities 5,694,824 7,361,163
----------- -----------
Total liabilities 158,880,111 220,158,212
Commitments and contingencies (Note 10) --- ---
STOCKHOLDERS' EQUITY (Note 6)
Series B preferred stock (Issued and outstanding
400 and 400, respectively) 4,000,000 4,000,000
Common stock (Authorized 20,000,000; issued and
outstanding 6,957,532 and 7,149,221, respectively) 69,575 71,492
Common stock warrants (Authorized, issued and
outstanding 679,621 and 668,481, respectively --- ---
Additional paid-in capital 15,849,542 16,049,888
Net unrealized investment gains (losses) (Note 4) 1,369,651 (972,237)
Retained earnings 2,825,508 2,929,383
----------- -----------
Total stockholders' equity 24,114,276 22,078,526
----------- -----------
Total liabilities and stockholders' equity $182,994,387 $242,236,738
=========== ===========
See notes to consolidated financial statements.
F-4
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Years Ended December 31, 1996
REVENUES: (Notes 2e and f) 1994 1995 1996
---------- ---------- ----------
Gross premium and policyholder fees earned $40,652,820 $46,145,360 $55,286,610
Reinsurance premiums assumed 13,563,982 8,866,010 10,521,987
Reinsurance premiums ceded (13,892,322) (18,200,433) (25,663,224)
---------- ---------- ----------
Net premiums and policyholders
fees earned (Note 8) 40,324,480 36,810,937 40,145,373
Net investment income (Note 4) 9,238,789 8,945,280 9,850,083
Realized gains on investments (Note 4) 41,568 673,868 240,075
Fee income 4,125,753 3,137,294 2,871,319
Amortization of deferred revenue (Note 2g) 219,261 244,202 280,335
---------- ---------- ----------
Total revenues 53,949,851 49,811,581 53,387,185
BENEFITS, CLAIMS AND OTHER DEDUCTIONS:
Increase (decrease) in future policy benefits 2,929,747 (1,337,161) 1,854,539
Claims and other benefits 21,120,441 22,367,066 24,042,876
Interest credited to policyholders 5,916,936 6,089,860 6,614,176
Increase in deferred acquisition costs (2,977,769) (3,317,523) (2,257,617)
Amortization of present value of future profits 236,716 204,564 ---
Commissions 7,471,754 5,340,278 5,075,622
Other operating costs and expenses 17,014,295 17,813,643 17,684,697
---------- ---------- ----------
Total benefits, claims and other deductions 51,712,120 47,160,727 53,014,293
---------- ---------- ----------
Operating income before income taxes 2,237,731 2,650,854 372,892
Federal income tax expense (Note 5) 9,974 9,032 269,017
---------- ---------- ----------
Net income 2,227,757 2,641,822 103,875
Dividends on Series A preferred stock (Note 6) (575,961) --- ---
Discount on the redemption of Series A
preferred stock (Note 6) 1,521,695 --- ---
---------- ---------- ----------
Net income applicable to common shareholders $ 3,173,491 $ 2,641,822 $ 103,875
========== ========== ==========
Earnings per common share:
Net income per common share $ 0.37 $ 0.25 $ 0.01
========== ========== ==========
See notes to consolidated financial statements.
F-5
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Three Years Ended December 31, 1996
NET
SERIES A SERIES B ADDITIONAL UNREALIZED RETAINED
PREFERRED PREFERRED COMMON PAID-IN INVESTMENT EARNINGS
STOCK STOCK STOCK CAPITAL GAIN (LOSS) (DEFICIT) TOTAL
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1993 $ 6,563,796 $ --- $ 52,463 $12,538,935 $ 211,451 $(2,989,805) $16,376,840
Issuance of common stock --- --- 9,300 1,962,954 --- --- 1,972,254
Implementation of
Statement No. 115 --- --- --- --- 494,541 --- 494,541
Change in net unrealized
investment gain(loss) --- --- --- --- (4,132,738) --- (4,132,738)
Net income --- --- --- --- --- 2,227,757 2,227,757
Series A preferred stock dividends 575,961 --- --- --- --- (575,961) ---
Redemption of Series
A preferred stock (7,139,757) --- --- --- --- 1,521,695 (5,618,062)
Issuance of Series
B preferred stock --- 4,000,000 --- --- --- --- 4,000,000
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1994 --- 4,000,000 61,763 14,501,889 (3,426,746) 183,686 $15,320,592
Issuance of common stock --- --- 7,812 1,347,653 --- --- 1,355,465
Transfer of investments from
held to maturity to available
for sale --- --- --- --- 155,723 --- 155,723
Change in net unrealized
investment gain(loss) --- --- --- --- 4,640,674 --- 4,640,674
Net income --- --- --- --- --- 2,641,822 2,641,822
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1995 --- 4,000,000 69,575 15,849,542 1,369,651 2,825,508 24,114,276
Issuance of common stock --- --- 1,917 200,346 --- --- 202,263
Change in net unrealized
investment gain (loss) --- --- --- --- (2,341,888) --- (2,341,888)
Net income --- --- --- --- --- 103,875 103,875
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1996 $ --- $ 4,000,000 $ 71,492 $16,049,888 $ (972,237) $ 2,929,383 $22,078,526
=========== =========== =========== =========== =========== =========== ===========
See notes to consolidated financial statements.
F-6
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Years Ended December 31, 1996
1994 1995 1996
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 2,227,757 $ 2,641,822 $ 103,875
Adjustments to reconcile net
income to net cash used by
operating activities:
Change in reserves for future policy
benefits 6,459,856 (575,449) 3,526,269
Change in policy and contract claims 86,385 (158,474) 677,167
Change in deferred policy acquisition
costs (2,977,769) (3,317,523) (2,257,617)
Amortization of present value of
future profits 236,716 204,564 ---
Change in deferred revenue (219,261) (244,202) (280,336)
Change in policy loans (618,900) (111,995) (746,103)
Change in accrued investment income (184,583) (260,817) (427,870)
Change in reinsurance balance (3,618,516) (4,596,165) (11,773,467)
Realized gains on investment (41,568) (673,868) (240,075)
Other, net (1,224,772) 1,010,861 1,509,292
----------- ----------- -----------
Net cash (used by) provided from
operating activities 125,345 (6,081,246) (9,908,865)
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sale of fixed
maturities available for sale 53,509,107 50,442,336 18,329,599
Proceeds from sale of fixed
maturities held to maturity 187,500 928,180 ---
Proceeds from redemption of fixed
maturities available for sale 6,250,281 8,049,240 25,436,976
Proceeds from redemption of fixed
maturities held to maturity 7,084,125 2,210,089 ---
Cost of fixed maturities purchased
available for sale (65,538,303) (68,529,621) (48,466,456)
Cost of fixed maturities purchased
held to maturity (15,306,019) (795,741) ---
Proceeds from sale of equity
securities --- --- 506,250
Cost of equity securities purchased (46,133) --- (501,250)
Change in other invested assets 4,761,115 76,571 269,702
Purchase of business, net of cash
acquired (502,843) --- 1,685,010
----------- ----------- -----------
Net cash used by investing activities (9,601,170) (7,618,946) (2,740,169)
----------- ----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of
common stock 1,972,254 1,355,465 202,263
Proceeds from the issuance of
Series B preferred stock 4,000,000 --- ---
Redemption of the Series A
preferred stock (4,000,000) --- ---
Increase in policyholder account
balances 3,686,182 9,831,827 15,930,118
Change in short-term debt 400,000 --- ---
Change in notes payable 369,698 (1,618,062) (369,698)
----------- ----------- -----------
Net cash provided from financing
activities 6,428,134 9,569,230 15,762,683
----------- ----------- -----------
Net (decrease) increase in cash and
cash equivalents (3,047,691) (4,130,962) 3,113,649
Cash and cash equivalents at
beginning of year 19,468,454 16,420,763 12,289,801
----------- ----------- -----------
Cash and cash equivalents at end of year $16,420,763 $12,289,801 $15,403,450
=========== =========== ===========
(Continued)
F-7
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS, Continued
For the Three Years Ended December 31, 1996
1994 1995 1996
----------- ----------- -----------
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 38,650 $ 96,289 $ 83,852
=========== =========== ===========
Income taxes $ --- $ --- $ ---
=========== =========== ===========
Supplemental schedule of non-cash investing and
financing activities:
Implementation of Statement 115 (Note 2c):
Transfer of securities from available
for sale to held to maturity $16,624,288 $ --- $ ---
=========== ============ ===========
Transfer of securities held to
maturity to available for sale $18,780,607 $ 36,098,026 $ ---
=========== ============ ===========
On December 30, 1994, the Company redeemed the Series A preferred stock at a
discount for part cash and issuanceof a debenture (see Note 6).
Liquidation preference $ 7,139,757
Cash paid (4,000,000)
Fair value of debenture issued (1,618,062)
-----------
Amount credited to retained earnings $ 1,521,695
===========
See notes to consolidated financial statements.
F-8
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND COMPANY BACKGROUND:
------------------------------------
Universal American Financial Corp. (the "Company" formerly Universal
Holding Corp.) was incorporated under the laws of the State of New York in
August 1981, for the purpose of conducting insurance and related business
primarily through its then wholly-owned subsidiary, John Adams Life Insurance
Company of New York ("John Adams"). On May 17, 1991, the Company acquired
100% of the outstanding common stock of American Progressive Life & Health
Insurance Company of New York ("American Progressive") and on June 27, 1991
merged John Adams into American Progressive. In 1988, the Company organized
Quincy Coverage Corp. ("Quincy") an insurance agent and broker. In January,
1992, the Company began operations in WorldNet Services Corp. ("WorldNet"), a
provider of managed care and assistance to travelers. On May 26, 1993, the
Company acquired 100% of the outstanding common stock of American Pioneer Life
Insurance Company ("American Pioneer") (see Note 3).
The Company's marketing emphasis is to sell a narrow line of products,
particularly appealing to the senior market place, and largely through
marketing organizations with concentrations in this market. The Company began
to sell senior market life and accident and health insurance products in 1993
in New York and has expanded its sales effort to Florida. The momentum into
Florida was accelerated by the acquisition of business from First National
Life Insurance Company. (See Note 3). The core products sold to the senior
age market include Medicare supplement, home health care, nursing home,
hospital indemnity and senior life insurance. In addition, the Company sells
certain program life insurance and annuity products through independent
marketing organizations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
a. Basis of Presentation: The significant accounting policies
followed by Universal American Financial Corp. and subsidiaries
that materially affect financial reporting are summarized below.
The accompanying consolidated financial statements have been
prepared in accordance with generally accepted accounting
principles (GAAP) which, as to American Progressive and American
Pioneer, differ from statutory accounting practices prescribed or
permitted by regulatory authorities. The preparation of financial
statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the
reported revenues and expenses during the reporting period.
Actual results could differ from those estimates.
b. Principles of Consolidation: The accompanying consolidated
financial statements include the accounts of Universal American
Financial Corp. and its wholly-owned subsidiaries. All material
intercompany transactions and balances have been eliminated.
c. Investments: Investments are shown on the following bases:
In May, 1993, the Financial Accounting Standards Board ("FASB")
issued Statement 115, "Accounting for Certain Debt and Equity
Securities" and is effective for fiscal years beginning after
December 15, 1993, with earlier adoption permitted. Statement 115
requires that debt and equity securities be classified into three
categories and accounted for as follows: Debt securities that the
Company has the positive intent and the ability to hold to
maturity would be classified as "held to maturity" and reported at
amortized cost. Debt and equity securities that are held for
current resale would be classified as "trading securities" and
reported at fair value, with unrealized gains and losses included
in earnings. Debt and equity securities not classified as held to
maturity or as trading securities would be classified as
"available for sale" and reported at fair value. Unrealized gains
and losses would be excluded from earnings and reported as a
separate component of stockholders' equity, net of tax.
F-9
The Company adopted Statement 115 on January 1, 1994, the effect
of which was an increase in unrealized gains of $494,541. In
November, 1995, the FASB issued a Special Report titled "A Guide
to Implementation of Statement 115 on Accounting for Certain
Investments in Debt and Equity Securities", which report allows
enterprises to reassess the appropriateness of the classifications
of all securities held at the time of the Special Report issuance.
In December, 1995, the Company did reassess the appropriateness
of the classifications of its securities and reclassified all of
the securities contained in the held to maturity account to the
available for sale account as they may be considered for sale
prior to maturity as part of the asset/liability management
strategy. The carrying value of the securities reclassed to
available for sale amounted to $35,942,303 and the fair value
amounted to $36,098,026. This transfer resulted in the Company
increasing its unrealized gains by $155,723, net of tax and
deferred policy acquisition cost adjustment.
Fixed maturity securities classified as investments held to
maturity prior to reclassification were carried at amortized cost
because the Company had the positive intent and ability to hold
such investments until maturity. All other fixed maturity
securities were classified as available for sale and were carried
at fair value, with the unrealized gain or loss, net of tax and
other adjustments (deferred policy acquisition costs), included in
stockholders' equity. As of December 31, 1995 and 1996, all fixed
maturity securities were classified as available for sale. Equity
securities are carried at current fair value. Policy loans and
mortgage loans are stated at the unpaid principal balance. Short
term investments are carried at cost which approximates fair
value. Property tax liens are carried at cost. Investment income
is recorded when earned. Realized investment gains and losses on
the sale of securities are based on the specific identification
method. Unrealized gains and losses from revaluation of equity
investments and fixed maturity securities to current market value
are reflected in stockholders' equity.
d. Deferred Policy Acquisition Costs: The cost of acquiring new
business, principally commissions and certain expenses of the
policy issuance and underwriting departments, all of which vary
with, and are primarily related to the production of new and
renewal business, have been deferred. These costs are being
amortized in relation to the present value of expected gross
profits on the policies arising principally from investment,
mortality and expense margins for FASB Statement No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments", (Statement No. 97") products and in
proportion to premium revenue using the same assumptions used in
estimating the liabilities for future policy benefits for FASB
Statement No. 60, "Accounting and Reporting by Insurance
Enterprises", (Statement No. 60") products. Deferred policy
acquisition costs would be written off to the extent that it is
determined that future policy premiums and investment income or
gross profits would not be adequate to cover related losses and
expenses. There were no write offs for the years ended December
31, 1994, 1995 and 1996. Details with respect to deferred policy
acquisition costs for the three years ended December 31, 1996 are
as follows:
Balance at January 1, 1994 $11,104,667
Capitalized costs 4,653,342
Adjustment relating to unrealized
loss on available for sale securities 403,414
Amortization (1,675,573)
-----------
Balance at December 31, 1994 14,485,850
Capitalized costs 5,270,498
Adjustment relating to unrealized
gain on available for sale securities (613,715)
Amortization (2,578,183)
-----------
Balance at December 31, 1995 16,564,450
Capitalized costs 5,042,137
Adjustment relating to unrealized
loss on available for sale securities 269,447
Amortization (2,784,520)
-----------
Balance at December 31, 1996 $19,091,514
===========
F-10
e. Recognition of Revenues, Contract Benefits and Expenses for
Investment and Universal Life Type Policies: Revenues for
universal life-type policies and investment products consist of
mortality charges for the cost of insurance and surrender charges
assessed against policyholder account balances during the period.
Benefit claims incurred in excess of policyholder account
balances are expensed. The liability for policyholder account
balances for universal life-type policies and investment products
under Statement No. 97 are determined following a "retrospective
deposit" method and consist principally of policy account values
before any applicable surrender charges. Credited interest rates
for these products range from 5.00% to 7.25%. For the three years
ended December 31, 1994, 1995 and 1996, one general agency of
American Progressive produced $3,645,611, $4,477,034 and
$5,813,765 of annuity receipts, respectively, which represented
approximately 41%, 41% and 43%, respectively, of total annuity
receipts of American Progressive.
f. Recognition of Premium Revenues and Policy Benefits for Accident
and Health Insurance Products: Premiums are recorded when due and
recognized as revenue over the period to which the premiums
relate. Benefits and expenses are associated with earned premiums
so as to result in recognition of profits over the life of the
policies. This association is accomplished by recording a
provision for future policy benefits, establishing an unearned
premium reserve and amortizing deferred policy acquisition costs.
Claim reserves are established for future payments not yet due on
claims already incurred, primarily relating to individual
disability insurance and group long-term disability insurance
products. These reserves are established based on past experience
and are continuously reviewed and updated with any related
adjustments recorded to current operations. Claim liabilities
represent policy benefits due but unpaid at year end and primarily
relate to individual health insurance products. Activity in the
accident and health policy and contract claim liability is as
follows:
1994 1995 1996
----------- ----------- -----------
Balance at beginning of year $ 8,001,097 $ 8,698,434 $ 8,681,136
Less reinsurance recoverables (1,532,736) (1,947,218) (2,650,646)
----------- ----------- -----------
Net balance at beginning of year 6,468,361 6,751,216 6,030,490
----------- ----------- -----------
Balance acquired with First National --- --- 3,374,535
Incurred related to:
Current year 19,423,563 33,533,192 23,029,175
Prior years (1,737,163) (14,743,820) (2,511,056)
----------- ----------- -----------
Total incurred 17,686,400 18,789,372 20,518,119
----------- ----------- -----------
Paid related to:
Current year 13,107,971 14,830,355 15,671,699
Prior years 4,295,574 4,679,743 4,892,735
----------- ----------- -----------
Total paid 17,403,545 19,510,098 20,564,434
----------- ----------- -----------
Net balance at end of year 6,751,216 6,030,490 9,358,710
Plus reinsurance recoverables 1,947,218 2,650,646 15,269,309
------------ ----------- -----------
Balance at end of year $ 8,698,434 $ 8,681,136 $24,628,019
============ =========== ===========
g. Deferred Revenue: The Company entered into a 75% quota share
reinsurance agreement with an unaffiliated reinsurer on the
F-11
$60,000 retention of certain individual accident & health
insurance policies in force as of June 30, 1995. The Company
received $862,000 as a ceding commission, $625,000 of which was
offset by the amortization of the deferred acquisition cost asset
related to this business. The remaining $237,000 was recorded as
deferred revenue and will be recognized as income over the
expected life of the reinsured business. The Company amortized
$79,098 and $157,902 of this deferred revenue during 1995 and
1996, respectively.
The Company entered into a 90% quota share reinsurance agreement
with an unaffiliated reinsurer on certain life insurance policies
in force as of June 30, 1993. The Company ceded $3,696,101 of
life insurance reserves and received $1,665,000 as a ceding
commission, which ceding commission was recorded as deferred
revenue. The Company amortized $219,261, $165,104 and $122,433 of
deferred revenue during 1994, 1995 and 1996 respectively.
h. WorldNet Services Corp.: WorldNet began operations in early 1992
and, on January 15, 1992, it purchased certain assets of
Interclaim Services Corp. by assuming related liability
commitments which totaled approximately $150,000. In 1993,
WorldNet began operations in Canada to market its services.
During 1993 and 1994, WorldNet capitalized $144,247 and $189,749,
respectively, of organizational expenses, which expenses were
being amortized over a five year period. The Company wrote off an
additional $100,000 of these capitalized expenses at December 31,
1996.
i. Income Taxes: The Company's method of accounting for income taxes
is the asset and liability method. Under the asset and liability
method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment
date.
j. Reinsurance Accounting: Amounts paid for a recoverable under
reinsurance contracts are included in total assets as reinsurance
recoverable amounts. The cost of reinsurance related to long-
duration contracts is accounted for over the life of the
underlying reinsured policies using assumptions consistent with
those used to account for the underlying policies.
k. Earnings Per Common Share: Net income per common share was
computed by dividing the net income applicable to common share-
holders by the weighted average number of common equivalent shares
outstanding during each period. Income before extraordinary
credit and net income were adjusted to deduct the dividend
requirements of the Series A preferred stock for the year ended
December 31, 1994 and includes the discount earned on the
redemption of the Series A preferred stock in 1994.
l. Cash Flow Information: Included in cash and cash equivalents are
cash on deposit, money market funds, and short term investments
which had an original maturity of three months or less from the
time of purchase.
m. Reclassifications: Certain reclassifications have been made to
prior years' financial statements to conform with current period
classifications.
F-12
3. RECENT ACQUISITIONS:
--------------------
First National Life
In the fourth quarter of 1996, the Company acquired, through an
assumption reinsurance agreement, approximately $56 million of annualized
senior market premium from First National Life Insurance Company (AFirst
National@). American Pioneer initially contracted with First National to
assume $4 million of premium on group Medicare Supplement coverage issued to
the members of the Florida Retrired Educators Association ("FREA"). Then,
after First National was placed into Receivership by the Alabama Insurance
Department in October, 1996, American Pioneer assumed approximately an
additional $50 million of Individual Medicare Supplement premium, $1.2 million
in Home Health Care premium and $0.8 million in miscellaneous life and
accident and health insurance premiums, under terms negotiated with the
Receiver. All of these assumptions were effective as of October 1, 1996.
Simultaneously with the second assumption by American Pioneer, American
Pioneer entered into a reinsurance agreement with Transamerica Occidental Life
Insurance Company ("Transamerica"), ceding 90% of the $50 million Individual
Medicare Supplement to Transamerica.
As part of the transaction negotiated with the Receiver, American
Pioneer was to receive assets equal to the liabilities assumed, primarily
policy reserves. However, as a result of the financial condition of First
National, sufficient assets were not available to fully cover these
liabilities. In addition, the Receiver was unable to cover certain amounts
due to American Pioneer. The sum of the closing shortfall and the costs of
the transaction, net of deferred tax benefits, amounted to $3,529,529, which
constitutes the purchase price of the transaction, and will be amortized over
30 years.
As part of the First National transaction, the Company acquired in
Pensacola a relatively low cost administrative operation with particular
experience in the senior market. This has given the Company an opportunity to
consolidate many of its administrative functions in Pensacola and save a
significant amount of fixed overhead.
In December, 1996, the Company formulated a plan to move most of the
policy administrative functions, particularly in its senior market business,
from the American Progressive office in Brewster to Pensacola. This, along
with other cost saving efforts, will result in a reduction in the work force
at the American Progressive office from 62 as of June 30, 1996 to
approximately 32 as of June 30, 1997 with a modest resultant increase in
personnel in Pensacola, including some personnel employed by American
Progressive. These plans were announced to the employees of the Company on
March 14, 1997.
Consequently, American Progressive has exercised its right to cancel its
lease for 15,000 square feet in Brewster as of October 31, 1997 and is
currently negotiating to lease a smaller office. The cost of this
consolidation, including severance costs, relocation costs and the
cancellation penalty on the Brewster lease, will be approximately $250,000 and
was expensed in the fourth quarter of 1996.
WorldNet
On April 1, 1994, the Company, through WorldNet Services Corp., a newly
formed Florida corporation (WorldNet - Florida), purchased from Health
Assistance for Travelers, Inc. ("HAT") (a subsidiary of Ontario Blue Cross of
Canada ("OBC")) certain assets of HAT and an affiliated corporation for
Canadian $625,000 (approximately US $470,000), payable over five years. The
note payable to HAT requires annual payments of Canadian $125,000 plus accrued
interest beginning on April 1, 1994 and bears interest at 6%. WorldNet -
Florida also executed an agreement with HAT for the subcontracting of HAT's
obligations under certain service contracts between HAT and OBC, and other
insurers. For the year ended December 31, 1994 and 1995 the Company received
$1,036,639 and $1,204,270, respectively, under these service agreements. In
1995, substantially all of the assets of OBC (including the shares of OBC's
subsidiary HAT) was acquired by Liberty Mutual Insurance Company ("Liberty
Health"). In February, 1996, WorldNet and Liberty Health agreed to terminate
the service agreement between OBC and WorldNet. In connection with the
termination of the service agreement, Liberty Health agreed to cancel the
promissory notes executed on April 1, 1994, which notes amounted to $370,000
at December 31, 1996. At the same time, the Company wrote off corresponding
assets, including the value of the service agreement, which assets amounted to
approximately $170,000. The resulting net income from this transaction was
F-13
approximately $200,000 and was reflected in the Company's financial statements
for the first quarter of 1996.
4. INVESTMENTS:
------------
As of December 31, 1995 and 1996, investments consisted of the
following:
December 31, 1995
----------------------------------------------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- - -------------- ------------ ------------ ------------ ------------
Cash and cash equivalents $ 12,289,801 $ 12,289,801 $ 12,289,801
US Treasury bonds and notes $ 11,565,000 11,719,311 11,957,792 11,957,792
Corporate bonds 103,056,601 102,393,245 104,471,129 104,471,129
Common stocks 46,133 15,297 15,297
------------ ------------ ------------
Sub-total $126,448,490 $128,734,019 $128,734,019
============
Property tax liens 178,908 178,908
Policy loans 5,622,136 5,622,136
Mortgage loans 1,067,605 1,067,605
------------ ------------
Total investments $133,317,139 $135,602,668
============ ============
December 31, 1996
------------------------------------------------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- - -------------- ------------ ------------ ------------ ------------
Cash and cash equivalents $ 15,403,450 $ 15,403,450 $ 15,403,450
US Treasury bonds and notes $ 8,383,814 8,516,908 8,505,972 8,505,972
Corporate bonds 113,722,375 113,994,104 112,986,195 112,986,195
Common stocks 46,133 33,562 33,562
------------ ------------ ------------
Sub-total 137,960,596 $136,929,179 $136,929,179
============
Property tax liens 131,729 131,729
Policy loans 6,421,251 6,421,251
Mortgage loans 1,199,110 1,199,110
------------ ------------
Total investments $145,712,686 $144,681,269
============ ============
F-14
The amortized cost and fair value of debt securities classified as
available for sale investments as of December 31, 1995 and 1996 are as
follows:
December 31, 1995
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- - -------------- ------------ ---------- ----------- ------------
US Treasury securities
and obligations of
US government $ 19,546,697 $ 393,356 $ (150,445) $ 19,789,608
Corporate debt securities 72,149,554 2,669,249 (294,300) 74,524,503
Mortgage-backed securities 22,416,305 373,429 (674,924) 22,114,810
------------ ---------- ----------- ------------
$114,112,556 $3,436,034 $(1,119,669) $116,428,921
============ ========== =========== ============
December 31, 1996
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- - -------------- ------------ ---------- ----------- ------------
US Treasury securities
and obligations of
US government $ 12,141,823 $ 121,631 $ (85,890) $ 12,177,564
Corporate debt securities 74,020,305 1,167,066 (1,244,311) 73,943,060
Mortgage-backed securities 36,348,884 414,210 (1,391,551) 35,371,543
------------ ---------- ----------- ------------
$122,511,012 $1,702,907 $(2,721,752) $121,492,167
============ ========== ============ ============
The amortized cost and fair value of fixed maturities at December
31, 1996 by contractual maturity are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
---------- ----------
Due in 1 year or less $ 2,608,064 $ 2,632,028
Due after 1 year through 5 years 23,328,057 23,458,901
Due after 5 years through 10 years 36,638,197 36,992,088
Due after 10 years 19,860,589 19,264,750
Mortgage-backed securities 40,076,105 39,144,400
----------- -----------
$122,511,012 $121,492,167
=========== ===========
Included in fixed maturities at December 31, 1995 and 1996 were
securities with carrying values of $6,467,700 and $7,779,124, respectively,
held by various states as security for the policyholders of American Pioneer
and American Progressive within such states.
F-15
The details of net investment income for the three years ended December
31, 1996 are as follows:
1994 1995 1996
--------- --------- ---------
Investment Income:
Fixed maturities $ 7,920,429 $ 8,389,695 $ 9,048,143
Short-term investment 633,052 531,572 731,924
Property tax liens 832,038 58,920 (1,297)
Policy loans 340,711 363,390 487,740
Mortgage loans 99,946 102,293 86,858
--------- --------- ----------
Gross investment income 9,826,176 9,445,870 10,353,368
Investment expenses 587,387 500,590 503,285
--------- --------- ----------
Net investment income $ 9,238,789 $ 8,945,280 $ 9,850,083
========= ========= ==========
There was one fixed maturity with a carrying value of $331,250 that was
non-income producing as of December 31, 1996.
Gross realized gains and gross realized losses included in the
consolidated statements of operations for the three years ended December 31,
1996 are as follows:
1994 1995 1996
Realized gains:
Fixed maturities, available for sale $ 384,517 $ 1,070,230 $ 363,927
Fixed maturities, held to maturity --- 6,921 ---
Equity securities --- --- 5,000
------- --------- -------
Total realized gains 384,517 1,077,151 368,927
------- --------- -------
Realized losses:
Fixed maturities, available for sale (273,967) (385,223) (128,852)
Fixed maturities, held to maturity (62,500) (3,060) ---
Equity securities --- (15,000) ---
Real estate (6,482) --- ---
------- ------- -------
Total realized losses (342,949) (403,283) (128,852)
------- ------- -------
Net realized gains $ 41,568 $ 673,868 $ 240,075
======= ========= =======
During the year ended December 31, 1995, the Company wrote down the
value of certain fixed maturity securities by $194,955 which was included in
realized gains on investments.
The components of the change in unrealized gains and losses included in
the consolidated statements of stockholders' equity for the three years ended
December 31, 1996 are as follows:
1994 1995 1996
------------ --------- ----------
Change in net unrealized gains (losses):
Fixed maturities $ (4,508,521) $ 5,963,167 $ (3,335,207)
Equity securities (27,631) (3,205) 18,264
Implementation of Statement No. 115 494,541 155,723 ---
Adjustment relating to deferred
policy acquisition costs 403,414 (613,710) 269,477
--------- --------- ---------
Change in net unrealized gains
(losses) before income tax (3,638,197) 5,501,975 (3,047,466)
Income tax expense (benefit) --- 705,578 (705,578)
--------- --------- ---------
Change in net unrealized losses $ (3,638,197) $ 4,796,397 $ (2,341,888)
========= ========= =========
F-16
Gross unrealized gains and gross unrealized losses of equity securities
as of December 31, 1995 and 1996 are as follows:
1995 1996
------- ------
Gross unrealized gains $ --- $ ---
Gross unrealized losses (30,836) (12,572)
------ ------
Net unrealized losses $ (30,836) $ (12,572)
====== ======
5. INCOME TAXES:
The Company and its non-life subsidiaries file a consolidated federal
income tax return. The life insurance subsidiaries file a separate
consolidated federal income tax return.
The Company's federal income tax expense consisted of:
Year Ended December 31,
---------------------------
1994 1995 1996
----- ----- -------
Current $ 9,974 $ 9,032 $ ---
Deferred --- --- 269,017
----- ----- -------
Total tax expense $ 9,974 $ 9,032 $269,017
===== ===== =======
A deferred tax asset related to the acquisition of certain business from
First National amounted to $305,000. A deferred tax benefit for 1995 was
$1,642,819, which amount was charged directly to the present value of future
profits since the benefit was derived from the recognition of acquired tax
loss carryforwards of American Pioneer that previously were included in the
valuation allowance.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying value of assets and liabilities for financial
reporting purposes and the amount used for income tax purposes. The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at December 31, 1995 and 1996
are as follows:
Deferred tax assets: 1995 1996
---------- ----------
Reserves for future policy benefits $ 2,695,120 $ 4,689,676
Deferred revenues 217,020 121,705
Net operating loss carryforwards 4,893,375 4,507,233
AMT credit carryforward 95,760 106,947
Investment valuation differences 138,899 185,849
Unrealized losses on investments --- 319,569
Other --- 147,061
---------- ----------
Total gross deferred tax assets 8,040,174 10,078,040
Less valuation allowance (1,134,555) (1,641,538)
---------- ----------
Net deferred tax assets 6,905,619 8,436,502
---------- ----------
Deferred tax liabilities:
Deferred policy acquisition costs (4,800,279) (5,226,080)
Unrealized gains on investments (705,578) ---
Goodwill --- (1,140,546)
Other (71,448) ---
--------- ---------
Total gross deferred tax liabilities (5,577,305) (6,366,626)
--------- ---------
Net deferred tax asset $ 1,328,314 $ 2,069,876
========= =========
At December 31, 1995 and 1996, the Company has established valuation
allowances of $1,134,555 and $1,641,538, respectively, with respect to its
deferred tax assets. Based on the Company's future expectation of adjusted
taxable income and through its ability to change its investment strategy and
F-17
use of prudent and feasible tax planning strategies, management believes it is
more likely than not that the Company will realize the recorded net deferred
tax assets.
A reconciliation of the "expected" tax expense at 34% with the Company's
actual tax expense applicable to operating income before taxes reported in the
Consolidated Statements of Operations is as follows:
Year Ended December 31,
------------------------------
1994 1995 1996
------- ------- -------
"Expected" tax expense $ 760,828 $ 901,294 $ 126,783
Change in the beginning of the
year balance of the valuation
allowance for deferred tax assets
allocated to income tax expense (811,915) (903,878) 187,414
Tax exempt interest income (1,415) (1,415) ---
Other 62,476 13,031 (45,180)
------- ------- -------
Actual tax expense $ 9,974 $ 9,032 $ 269,017
======= ======= =======
As of December 31, 1996, the Company (exclusive of American Progressive
and American Pioneer) has net operating tax loss carryforwards of
approximately $6,400,000 which expire in the years 1997 to 2011.
As of December 31, 1996, American Progressive has net operating tax
loss carryforwards of approximately $5,000,000 which expire in the years 2003
to 2008.
As of December 31, 1996, American Pioneer has net operating tax loss
carryforwards of approximately $1,100,000 which expire in the years 2000 to
2002. As a result of the change in ownership of American Pioneer in May,
1993, use of all these loss carryforwards are subject to annual limitations.
6. STOCKHOLDERS' EQUITY:
Preferred Stock
The Company has 2,000,000 authorized shares of preferred stock to be
issued in series with 400 shares issued and outstanding at December 31, 1995
and 1996, respectively.
Series A Preferred Stock
On May 17, 1991, the Company issued 510,000 shares of Series A
cumulative, redeemable, convertible preferred stock ("Series A preferred
stock") to Midland National Life Insurance Company in connection with the
acquisition of American Progressive (see note 3). The Series A Preferred
Stock had an initial liquidating preference of $5,263,714 (which included
accrued dividends of $163,714 for the period January 1 to May 17, 1991), with
dividends payable quarterly at 8.5% per year on a cumulative basis since
January 1, 1991. Dividends were not required to be paid in cash and any
unpaid dividend accumulated as part of the Series A Preferred Stock
liquidating preference. During the two years ended December 31, 1993,
$486,784 and $529,497, respectively, of dividends accumulated and were added
to the outstanding balance of Series A Preferred Stock. At December 31, 1993,
the Series A Preferred Stock had a liquidating preference of $6,563,796.
Prior to March, 1994, such preferred stock was redeemable by the company at
any time at its liquidating preference, plus any accumulated dividends and
preferred stock with liquidating preference of up to $1,500,000 was
convertible at any time into common stock at $1.00 per share, subject to anti-
dilution adjustments. These redemption and conversion features would have
been reinstated if the Series A Preferred Stock had not been redeemed by
February 28, 1995. In addition, two-thirds of such preferred stock
outstanding at the end of five years from its issuance on May 17, 1991 (or
earlier upon the occurrence of defined events) was convertible into an amount
of common stock equal to two-thirds of the common stock outstanding
immediately after the conversion. The Series A Preferred Stock was non-
voting.
F-18
In March, 1994 Midland granted the Company the right, exercisable at any
time prior to March 1, 1995, to redeem the preferred stock in exchange for
$4,000,000 in cash and a $1,000,000 five year debenture, convertible to either
666,667 shares of common stock (if the preferred stock was redeemed prior to
August 1, 1994) or 750,000 shares of common stock (if the preferred stock was
redeemed on or after August 1, 1994, but prior to March 1, 1995). The
liquidation preference of the Series A Preferred Stock as of December 30, 1994
was $7,139,757, and such stock was redeemed on that date for an aggregate
redemption price of $5,618,062 (the "Redemption Price"), paid by a cash
payment of $4,000,000 and the issuance of a convertible debenture with a fair
value of $1,618,062 and a face amount of $1,000,000 (the "Debenture"). The
Debenture was called for redemption on February 12, 1995, at which time
$106,496 of principal was paid in cash and the balance of the principal was
converted into 671,807 shares of Common Stock.
Series B Preferred Stock
As of December 30, 1994, the Company sold 400 shares of Series B
Convertible Preferred Stock, with a par value of $10,000 per share, to
Wand/Universal Investments L.P. ("Wand") for $4 million pursuant to a stock
subscription agreement entered into on August 12, 1994, under which Wand
agreed to purchase, at the Company's option, either 400 or 500 shares of
Series B Preferred Stock for a total purchase price of $4 million or $5
million, respectively. Pursuant to the Stock Subscription Agreement, the
Company paid Wand $225,000 for its services and expenses incurred in
structuring the Wand Transaction and in due diligence related thereto. The
proceeds of the sale were used to redeem all of the Series A Preferred Stock
discussed above.
The Series B Preferred Stock is convertible into Common Stock at $2.25
per share (subject to adjustment) and is entitled to dividends as if already
converted, only when and if dividends are declared on the Common Stock. The
holder of the Series B Preferred Stock may not require the Company to redeem
it unless the Company engages in certain defined transactions. The Company
has the right to require a conversion if it raises additional equity from the
public on pricing terms that meet certain criteria.
The holders of the Series B Preferred Stock have the right to elect one
Director of the Company, and have the right to vote on all other matters
submitted to the vote of the holders of the Common Stock, as if their Series B
Preferred Stock had been converted to Common Stock. In addition, under the
New York Business Corporation Law, any amendment to the Certificate of
Incorporation which would make certain changes affecting the Series B
Preferred Stock must be approved by the holders of a majority of the
outstanding Series B Preferred Stock, voting separately as a class.
Pursuant to the stock subscription agreement, Wand, the Company and
certain shareholders of the Company, including Barasch Associates Limited
Partnership (ABALP@), entered into a shareholders' agreement contemporaneously
with the issuance of the Series B Preferred Stock to Wand. Under the
shareholders' agreement, the holder of the Series B Preferred Stock agreed to
vote such shares, and the Common Stock issued upon their conversion, for the
nominees of BALP for election as directors of the Company and, after the
conversion of the Series B Preferred Stock to Common Stock, all parties agreed
to vote their shares for the election of one director designated by Wand. The
shareholders' agreement also contained "stand still," "tag along" and
registration rights provisions. The stand still provision will prohibit Wand
from acquiring more than an additional 5% of the Company's outstanding Common
Stock without the Company's consent, as long as BALP and certain partners in
BALP continue to hold at least certain percentages of the Company's Common
Stock, on an outstanding and fully diluted basis. The tag along will prohibit
BALP and certain of its partners from making private sales of their shares of
Common Stock unless Wand is given the opportunity to sell a proportionate part
of its holding on the same terms.
The Company and Wand Partners L.P., an affiliate of Wand, have also
entered into a financial advisory agreement, under which such Wand affiliate
is to render advisory services to the Company and is to be paid a fee of
$100,000 per year for such services as long as Wand owns 500,000 shares of
Common Stock, or its common stock equivalent, reduced by any directors' fee
paid to the director designated by Wand.
In connection with the determination by the New York Superintendent of
Insurance (the "Superintendent") that Wand is not a controlling shareholder of
F-19
Company, within the meaning of the New York Insurance Law (see "Regulation"),
certain commitments were made to the Superintendent. These commitments
included a commitment by Wand, Wand's general partner and Wand's general
partner's shareholders that, as long as Wand owns 10% or more of the voting
power of Universal's outstanding stock, Wand will not acquire any additional
shares of Universal, except by exercise of its conversion rights, and will not
attempt to obtain or exercise control of Universal, without the consent of the
Superintendent. Universal, American Progressive, BALP, BALP's general partner
and certain limited partners, and the shareholders of BALP's general partner
also entered into commitments, including commitments that as long as Wand owns
10% or more of the voting power of Universal's outstanding shares, the size of
Universal's Board would not be reduced below ten directors and that no
transaction between Universal or American Progressive, on the one hand, and
Wand or its partners of controlling parties, on the other hand, would be
entered without the approval of the Superintendent, except for the
shareholders agreement and the financial advisory agreement referred to
herein.
Common Stock
The par value of common stock is $.01 per share with 20,000,000 shares
authorized for issuance. The shares issued and outstanding at December 31,
1995 and 1996 were 6,957,532, and 7,149,221, respectively. During the years
ended December 31, 1994, 1995 and 1996, the Company issued 930,017, 781,242
and 191,689 shares, respectively, of its common stock.
Common Stock Warrants
The Company had 679,621 and 668,481 common stock warrants issued and
outstanding at December 31, 1995 and 1996, respectively, which are registered
under the Securities Exchange Act of 1934. During the years ended December
31, 1995 and 1996, 10,250 and 11,140 warrants, respectively, were converted
into common shares at $1.00. At December 31, 1996 the Company had 2,015,760
warrants outstanding which are not registered under the Securities Exchange
Act of 1934. The warrants have no par value, have an exercise price to
purchase common stock on a one to one basis at $1.00 and expire on December
31, 1999.
Incentive Stock Option Plan
In 1983, the Company adopted an incentive stock option plan which, as
amended, reserves 1,000,000 shares of common stock. Since its adoption,
256,500 shares have been exercised, leaving 743,500 shares reserved as of
December 31, 1996. Stock options totaling 273,000 and 297,000 expire five
years and ten years, respectively, after the date granted or upon the earlier
termination of employment. Options are exercisable one year after grant, and
at December 31, 1996, 429,000 options are exercisable. Additional information
with respect to the Company's stock option plan is as follows:
Shares Under
Options Exercise
Outstanding Price
----------- --------
Balance, December 31, 1993 551,000
Options granted in 1994 159,000 $2.50 - $3.33
Options exercised in 1994 (63,000) $0.50 - $0.80
Options terminated in 1994 (39,000) $0.80 - $3.25
------
Balance, December 31, 1994 607,500
Options granted in 1995 65,000 $2.25 - $2.48
Options exercised in 1995 (34,500) $0.50 - $0.80
Options terminated in 1995 (27,000) $0.80 - $3.12
------
Balance, December 31, 1995 611,000
Options granted in 1996 141,000 $2.00 - $2.20
Options exercised in 1996 (135,000) $0.50 - $1.35
Options terminated in 1996 (47,000) $2.87 - $3.25
-------
Balance, December 31, 1996 570,000 $1.25 - $3.33
=======
F-20
Stock Option Plan for Directors
At the 1992 Annual Shareholders' Meeting, the Universal American
Financial Corp. non-employee Directors Plan ("Stock Option Plan for
Directors") was approved. This stock option plan for Directors reserves
75,000 shares of common stock and provides that options shall be granted on
June 30 of each year to each eligible Director, then in office, at the rate of
1,000 options for each additional year of service completed since the last
grant. Options are exercisable one year after grant.
Options Exercise
Outstanding Price
----------- --------
Balance, December 31, 1993 14,000
Options granted in 1994 6,000 $3.12
Options exercised in 1994 (5,000) $0.56 - $1.38
------
Balance, December 31, 1994 15,000
Options granted in 1995 6,000 $3.12
------
Balance, December 31, 1995 21,000
Options granted in 1996 7,000 $2.50
------
Balance, December 31, 1996 28,000 $0.56 - $3.50
======
Other Stock Options
On December 15, 1995, the Board of Directors approved a plan under which
up to 200,000 options may be granted to agents of the Company's subsidiaries
(subject to insurance law restrictions) and to other persons as to whom the
Board of Directors believes the grant of such options will serve the best
interests of the Corporation, provided that no options may be granted under
this plan to officers, directors or employees of the Company or of any
subsidiary, while they are serving as such. On December 15, 1995, the
Board of Directors granted options to three individuals, two of whom are
members of the Company's law firm and the other of whom is a consultant to the
Company, to purchase a total of 40,000 shares of the Company's common stock,
at a price of $2.50 per share, which was the quoted market price for the such
shares at the time of the grant. Such options will expire 10 years from the
date of the grant.
Accounting for Stock-Based Compensationn
The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
The Company's Incentive Stock Option Plan has authorized the grant of
options for up to 1,000,000 shares of the Company's common stock. Under the
Company's Stock Option Plan for Directors 75,000 shares of the Company's
common stock have been reserved. The Company has also reserved 200,000 shares
of the Company's stock under the Agents Stock Option Plan. All options expire
five years or ten years from the date of grant and have a vesting period of
one year for the date of grant.
F-21
Pro forma information regarding net income and earnings per share is required
by statement 123, and has been determined as if the Company had accounted for
its employee stock option under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1995 and 1996, respectively,: risk-free interest rates of
6.21% - 6.27% and 6.32% - 6.38%; dividend yields of 0% and 0%; volatility
factors of the expected market price of the Company's common stock of 51.58%
- - - 51.75% and 52.20% - 52.74%; and a weighted-average expected life of the
option of 4.5 years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input
of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
option.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows (in thousands except for earnings per
share information):
1995 1996
----------- -----------
Net Income $2,641,822 $ 103,875
Less: Pro forma estimated fair value
options granted 10,756 133,208
---------- ------------
Pro forma net income $2,631,066 $ (29,333)
========== ============
Pro forma earnings per common share $ 0.25 $ 0.00
========== ============
A summary of the status of the Company's three stock option plans as of
December 31, 1995 and 1996, and changes during the years ending on those dates
is presented below:
1995 1996
---------------------------- -----------------------------
Weighted-Average Weighted-Average
Fixed Options Options Exercise Price Options Excercise Price
- - ------------- ------- ---------------- ------- -----------------
Outstanding
beginning of
year 622,500 $1.67 672,000 $1.83
Granted 111,000 2.46 148,000 2.08
Exercised (34,500) 0.52 (135,000) 0.66
Forfeited (27,000) 2.49 (47,000) 3.03
-------- ---- --------- ----
Outstanding
end of year 672,000 1.83 638,000 2.03
======= ==== ======= ====
Options exercisable
at end of year 561,000 490,000
======= =======
Weighted-average
fair value of
options granted
during the year $ 1.18 $ 1.01
======== ========
F-22
The following table summarizes information about fixed stock options outstanding
at December 31, 1996:
Weighted Weighted Weighted
Range of Number Average Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices at 12/31/96 Life Price at 12/31/96 Price
- - -------- ------------ ----------- -------- ----------- ---------
$ .56 to .72 4,000 5.0 years $ .64 4,000 $ .64
1.25 to 1.63 271,000 1.4 1.43 271,000 1.43
2.00 to 2.50 247,000 9.5 2.17 99,000 2.31
3.12 to 3.50 116,000 7.4 3.20 116,000 3.20
------- -------
$ .56 to 3.50 638,000 5.7 2.03 490,000 2.02
======= =======
7. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS:
American Progressive and American Pioneer are required to meet minimum
statutory capital requirements imposed by the Insurance Departments of the
states in which they are licensed in order to operate as an insurance company
without restrictions. The minimum statutory capital and surplus requirements
of American Pioneer and American Progressive for the maintenance of authority
to do business at December 31, 1996 was $2,130,247 and $2,500,000,
respectively. As of December 31, 1995 and 1996 the statutory capital and
surplus amounts of American Pioneer and American Progressive were $13,196,681
and $12,733,157, respectively (American Pioneer) and $8,731,953 and $7,464,004,
respectively (American Progressive). Their statutory gain (loss) for the
years ended December 31, 1994, 1995 and 1996 were $1,672,923, $1,694,711 and
$955,714, respectively (American Pioneer) and $(228,821), $(262,049) and
$(672,127), respectively (American Progressive). The insurance companies
have calculated their risk-based capital (ARBC@) requirements and, as of
December 31, 1996, both American Pioneer and American Progressive's ratios of
total adjusted capital to RBC are sufficiently in excess of the authorized
control levels.
Dividend payments from American Progressive to the Company would require
regulatory approval which, in all likelihood, would not be obtained until
American Progressive generated enough statutory profits to offset its entire
negative unassigned surplus, which was approximately $10,293,280 at December
31, 1996. American Pioneer may pay a dividend or make a distribution without
the prior written approval of the Florida Insurance Department when (a) the
dividend is equal to or less than the greater of (1) 10% of the insurer's
surplus as to policyholders derived from net operating profits on its business
and net realized capital gains ("policyholder surplus from operations"); or
(2) the insurer's entire net operating profits and realized net capital gains
derived during the immediately preceding calendar year but not more than its
policyholder surplus from operations; (b) the insurer will have surplus as to
policyholders equal to or exceeding 115% of the minimum required statutory
surplus as to policyholders after the dividend or distribution is made; and
(c) the insurer has filed notice with the department at least 10 business days
prior to the dividend payment or distribution. American Pioneer paid American
Progressive $1,000,000, $500,000 and $500,000 in dividends during 1994, 1995
and 1996, respectively. No dividends or distributions were made by American
Progressive during 1994 through 1996.
8. REINSURANCE:
The Company is party to several reinsurance agreements on its life and
accident and health insurance risks. The Company's senior market accident and
health insurance products are reinsured under coinsurance treaties with
unaffiliated insurers, while the life insurance risks are reinsured under
either coinsurance or yearly-renewable term treaties with unaffiliated
insurers. Under coinsurance treaties, the reinsurer receives an agreed upon
percentage of all premiums and reimburses the Company that same percentage of
the losses. In addition, the Company receives certain allowances from the
reinsurers to cover commissions, expenses and premium taxes. Under yearly-
renewable term treaties, the reinsuring company receives premiums at an agreed
upon rate and holds the required reserves for its share of the risk on a
yearly-renewable term basis. A contingent liability exists with respect to
reinsurance which may become a liability of the Company in the unlikely event
that the reinsurers should be unable to meet the obligations which they
assumed. The Company evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk to minimize its exposure to significant
losses from reinsurer insolvencies. At December 31, 1996, amounts due from
reinsurers with a total carrying value of $41,089,163 were associated with
three reinsurers, which reinsurers were rated A+ by A.M. Best.
F-23
A summary of reinsurance activity for the three years ended December 31, 1996
is presented below:
Life insurance in force As of December 31,
---=----------------------------------------
(amounts in thousands) 1994 1995 1996
----------- ----------- ------------
Gross amount $ 1,760,000 $ 1,955,809 $ 2,118,265
Ceded to other companies (754,124) (944,697) (889,132)
Assumed from other companies 28,943 27,294 25,484
----------- ----------- ------------
Net amount $ 1,034,819 $ 1,038,406 $ 1,254,617
=========== =========== ============
Percentage of assumed to net 3% 3% 2%
Year Ended December 31,
---------------------------------------------
Premiums 1994 1995 1996
----------- ----------- -----------
Life insurance $ 12,925,886 $ 17,231,562 $ 9,923,021
Accident and health 27,235,036 28,290,413 44,853,225
------------ ------------ ------------
Total gross premiums 40,160,922 45,521,975 54,776,246
------------ ------------ ------------
Ceded to other companies
Life insurance (3,323,496) (10,703,350) (2,870,540)
Accident and health (10,568,826) (7,497,083) (22,792,684)
------------ ------------ ------------
Total ceded premiums (13,892,322) (18,200,433) (25,663,224)
------------ ------------ ------------
Assumed from other companies
Life insurance 402,875 386,254 391,456
Accident and health 13,161,107 8,479,756 10,130,531
------------ ----------- ------------
Total assumed premium 13,563,982 8,866,010 10,521,987
Net amount
Life insurance 10,005,265 6,914,466 7,443,937
Accident and health 29,827,317 29,273,086 32,191,072
------------ ------------ -----------
Total net premium $ 39,832,582 $ 36,187,552 $39,635,009
Percentage of assumed to net
Life insurance 4% 6% 5%
============ ============ ===========
Accident and health 44% 29% 31%
============ ============ ===========
Total assumed to total net 34% 25% 27%
============ ============ ===========
9. SHORT-TERM DEBT:
On September 30, 1996, the Company amended its loan agreement with its
commercial bank, under which amendment the Company borrowed $800,000 on a one
year term loan extendable by the Company for a second year. The loan is
secured by the pledge of 100% of the outstanding common stock of Quincy, a
subsidiary engaged in the insurance brokerage business, the receivables of
Quincy and WorldNet and 9.9% of the outstanding common stock of American
Progressive. As of December 31, 1996, $800,000 was outstanding on this loan
agreement. The loan bears interest at 1.0% over prime. The following table
sets forth summary information with respect to short-term borrowings of the
Company for the three years ended December 31, 1996:
F-24
As of December 31, Year Ended December 31,
- - ---------------------- ------------------------------------
Weighted
Maximum Average(a) Average
Amount Interest Amount Amount Interest Interest
Outstanding Rate Outstanding Outstanding Rate (b) Expense
---------- -------- ----------- ----------- --------- --------
1994 $800,000 10.50% $800,000 $533,333 7.25% $38,650
======== ====== ======== ======== ====== =======
1995 $800,000 10.50% $800,000 $800,000 10.94% $87,539
======== ====== ======== ======== ====== =======
1996 $800,000 9.50% $800,000 $800,000 10.48% $83,852
======== ====== ======== ======== ====== =======
(a) The average amounts of short term borrowings outstanding were computed
by determining the arithmetic average of the months' end short term borrowings.
(b) The weighted average interest rates were determined by dividing interest
expense related to short term borrowings by the average amounts outstanding
of such borrowings.
10. COMMITMENTS:
The Company is obligated on a lease for its executive and administrative
offices in Brewster, New York, which expires on October 31, 2001 with an
earlier termination on October 31, 1997 at the sole option of the Company and
carries a base annual rent of $150,000. In February, 1997, The Company
exercised its option to terminate the lease. The Company is obligated on a
lease for its American Pioneer operations in Orlando, Florida, which expires
in January, 2002 and carries an annual base rent of approximately $220,000.
The Company is obligated on a lease for administrative offices in Pensacola,
Florida, which expires in November, 1997 with annual renewals at the sole
option of the Company through November, 1999 and carries a base annual rent of
$220,000. The Company is obligated on a month to month lease for its WorldNet
operations in Bay Harbor Island in Miami, Florida and carries an approximate
monthly base rent of $12,000.
Rent expense for the three years ended December 31, 1994, 1995 and 1996 was
$852,124, $721,848 and $640,524, respectively. The minimum rental
commitments, subject to escalation clauses, at December 31, 1996 under non-
cancelable operating leases are as follows:
Pensacola, Orlando, Miami,
Brewster Florida Florida Florida Total
1997 $ 125,000 $ 220,000 $ 233,000 -- $ 578,000
1998 -- -- 238,000 -- 238,000
1999 -- -- 246,000 -- 246,000
2000 -- -- 252,000 -- 252,000
2001 -- -- 258,000 -- 258,000
2002 -- -- 21,000 -- 21,000
--------- ---------- ---------- -------- -----------
Totals $ 125,000 $ 220,000 $1,248,000 $ -- $ 1,593,000
========= ========== ========== ======== ===========
11. UNIVERSAL AMERICAN FINANCIAL CORP. 401(K) SAVINGS PLAN:
Effective April 1, 1992, the Company adopted the Universal American Financial
Corp. 401(k) Savings Plan ("Savings Plan"). The Savings Plan is a voluntary
contributory plan under which employees may elect to defer compensation for
federal income tax purposes under Section 401(k) of the Internal Revenue Code
of 1986. The employee is entitled to participate in the Savings Plan by
contributing through payroll deductions up to 20% of the employee's
compensation. The Company may match the employee's contribution up to 1% of
the employee's compensation which contribution will be made with Company
common stock. As of December 31, 1996, 199,745 shares of the Company's
common stock were held by the Savings Plan.
F-25
The participating employee is not taxed on these contributions until
they are distributed. Moreover, the employer's contributions vest at the rate
of 25% per plan year. Amounts credited to employee's accounts under the
Savings Plan are invested by the employer-appointed investment committee.
Generally, a participating employee is entitled to distributions from the
Savings Plan upon termination of employment, retirement, death or disability.
Savings Plan participants who qualify for distributions may receive a single
lump sum, have the assets transferred to another qualified plan or individual
retirement account, or receive a series of specified installment payments.
Total matching contributions by the Company under the Savings Plan were
$51,048, $42,325 and $38,478 in 1994, 1995 and 1996, respectively.
12. FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK:
For the three years ended December 31, 1996, the Company held unrated
or less-than-investment grade corporate debt securities with carrying and
estimated fair values as follows:
1994 1995 1996
----------- ----------- -----------
Carrying value $ 4,446,205 $ 5,092,566 $ 3,850,510
=========== =========== ===========
Estimated fair value $ 4,314,977 $ 5,092,566 $ 3,850,510
=========== =========== ===========
Percentage of total assets 2.7% 2.8% 1.6%
=========== =========== ===========
The holdings of less-than-investment grade securities are widely
diversified and the investment in any one such security is currently less than
$1,000,000, which is approximately 0.4% of total assets.
13. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
a. Fixed maturities held to maturity and available for sale: For
those securities held to maturity and available for sale, fair
value equals quoted market price, if available. If a quoted
market price is not available, fair value is estimated using
quoted market prices for similar securities.
b. Equity securities: For equity securities carried at fair value,
fair value equals quoted market price.
c. Cash and cash equivalents: For short-term investments, the
carrying amount is a reasonable estimate of fair value.
d. Investment contract liabilities: For annuity and universal life
type contracts, cash surrender value is a reasonable estimate of
fair value due to the deposit nature of the account.
e. Short term debt and notes payable: For short-term borrowings and
notes payable, the carrying value is a reasonable estimate of fair
value due to their short-term nature.
f. Accounts receivable and uncollected premiums: Accounts receivable
and uncollected premiums are primarily insurance contract related
receivables which are determined based upon the underlying
insurance liabilities and added reinsurance amounts.
F-26
The estimated fair values of the Company's financial instruments as of
December 31, 1995 and 1996 are as follows:
1995
--------------------------------
Carrying
Amount Fair Value
------------- -------------
Financial assets:
Fixed maturities available for sale $116,428,921 $116,428,921
Equity securities 15,297 15,297
Policy loans (a) 5,622,136
Property tax liens (b) 178,908
Mortgage loans (c) 1,067,605
Cash and cash equivalents 12,289,801 12,289,801
Financial liabilities:
Investment contract liabilities 118,608,836 108,636,182
Short-term debt 800,000 800,000
Notes payable 369,698 369,698
1996
---------------------------------
Carrying
Amount Fair Value
------------- -------------
Financial assets:
Fixed maturities available for sale $121,492,167 $121,492,167
Equity securities 33,562 33,562
Policy loans (a) 6,421,251
Property tax liens (b) 131,729
Mortgage loans (c) 1,199,110
Cash and cash equivalents 15,403,450 15,403,450
Financial liabilities:
Investment contract liabilities 134,538,954 121,649,219
Short-term debt 800,000 800,000
(a) It is not practicable to estimate the fair value of policy loans as
they have no stated maturity and their rates are set at a fixed spread to
related policy liability rates. Policy loans are carried at the aggregate
unpaid principal balances in the consolidated balance sheets, and earn
interest at rates between 6% to 8%. Individual policy liabilities, in all
cases, equal or exceed outstanding policy loan balances.
(b) Property tax liens are carried at cost. The determination of fair
value for these invested assets is not practical because there is no active
trading market for such invested assets. Individual liens in all cases are
first priority liens with collateral in excess of 300% of the carrying value
of the lien.
(c) Mortgage loans are carried at the aggregate unpaid balances and the
fair market value was not determined as the amount involved was considered to
be immaterial.
F-27
14. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The quarterly results of operations for the three years ended December
31, 1996 are presented below:
1994 Three Months Ended
- - ---- ----------------------------------------------------------
March 31, June 30, September 30, December 31,
----------- ----------- ------------- ------------
Total revenue $12,466,438 $12,930,193 $13,381,250 $15,171,970
Total benefits,
claims & other
expenses 11,804,791 12,477,134 12,847,742 14,582,453
----------- ----------- ----------- -----------
Operating income
before income taxes 661,647 453,059 533,508 589,517
Federal income tax
expense --- --- --- 9,974
---------- ---------- ---------- ----------
Net income 661,647 453,059 533,508 579,543
Dividends on Series A
preferred stock (139,481) (142,445) (145,472) (148,563)
Discount on the
redemption of
Series A
preferred stock --- --- --- 1,521,695
---------- ----------- ----------- ----------
Net income applicable
to common
shareholders $ 522,166 $ 310,614 $ 388,036 $ 1,952,675
=========== =========== =========== ===========
Net income per
common share $ 0.07 $ 0.03 $ 0.05 $ 0.22
=========== =========== =========== ===========
1995 Three Months Ended
- - ---- ---------------------------------------------------------
March 31, June 30, September 30, December 31,
---------- ----------- -------------- -------------
Total revenue $12,264,057 $12,518,785 $12,891,128 $12,137,611
Total benefits,
claims & other
expenses 11,671,626 11,461,004 12,405,619 11,622,468
----------- ----------- ----------- -----------
Operating income
before income taxes 592,431 1,057,781 485,509 515,143
Federal income tax
expense (benefit) 201,426 359,646 165,073 (717,113)
----------- ----------- ------------ ------------
Net income applicable
to common
shareholders $ 391,005 $ 698,135 $ 320,436 $ 1,232,246
=========== =========== =========== ============
Net income per
common share $ 0.03 $ 0.07 $ 0.03 $ 0.12
=========== =========== =========== ============
1996 Three Months Ended
- - ---- ----------------------------------------------------------
March 31, June 30, September 30, December 31,
--------- ---------- ------------- ------------
Total revenue $12,257,842 $11,737,328 $14,199,901 $15,192,114
Total benefits,
claims & other
expenses 11,930,299 11,550,317 14,049,636 15,484,041
----------- ----------- ----------- -----------
Operating income
before income taxes 327,543 187,011 150,265 (291,927)
Federal income tax
expense (benefit) 45,948 63,584 49,011 110,474
----------- ----------- ----------- ------------
Net income (loss)
applicable to common
shareholders $ 281,595 $ 123,427 $ 101,254 $ (402,401)
=========== =========== =========== ============
Net income per
(loss) common share $ 0.03 $ 0.01 $ 0.01 $ (0.04)
=========== =========== =========== ============
During the fourth quarter of 1996 the Company accrued $250,000 for its
restructuring (see Note 3) and $500,000 for its withdrawal from its
participation in the National Accident Insurance Underwriters accident pool as
of December 31, 1996. Offsetting these amounts was the amount received by the
Company on the sale of its New York State DBL business, which amounted to
$200,000, net of additional reserves established.
F-28
15. SUBSEQUENT EVENT:
On January 9, 1997, the Company entered into a Stock Purchase Agreement
with AAM Capital Partners L.P. ("AAM"), an unaffiliated investment firm,
providing for the issuance and sale of at least $4 million of a new Series C
Preferred Stock, of which at least $3 million will be purchased by AAM, or
purchasers designated by AAM, and at least $1 million will be purchased by
Richard A. Barasch, members of his family, and members and associates of the
Company's management. This transaction is scheduled to close upon receipt of
the required approval of the Florida Insurance Department, an application for
which approval is pending. The following summary of the terms of the Stock
Purchase Agreement is qualified in its entirety by reference to the Stock
Purchase Agreement which is being filed as an Exhibit to this Form 10-K.
* The Series C Preferred shares will be convertible by the holders at any
time at a conversion price of $2.375 per share (subject to anti-dilution
adjustment).
* The Company can require conversion if it executes a public offering of
common stock at over $3.45 per share (or equivalent equity), with gross
proceeds in excess of $10 million, or if the average bid price of it's
common stock exceeds $3.45 per share for any 60 day period through
December 31, 2001. In the event that the Company takes certain action
without the consent of the holders of a majority of the Series C
Preferred Stock, those holders who voted against such action have the
right to require its redemption at the Redemption Price or the Call
Price, (which Prices are defined below) depending on the nature of the
action taken.
* The Company will also have the right to call all of the Series C
Preferred Stock at any time between January 1, 2000 and December 31,
2002, at a per share call price (the "Call Price") of $150 in the year
2000 or $175 in the years 2001 and 2002, in each case increased by the
redemption accrual at the rate of 8% of the par value.
* Unless converted or called earlier, the Series C Convertible Preferred
Stock will be redeemed on December 31, 2002, at a per share redemption
price (the "Redemption Price") equal to par, increased by a redemption
accrual at the rate of 8% per annum. The redemption price will be
payable in two equal installments on December 31, 2002 and December 31,
2003. The redemption accrual is not payable upon any conversion.
* No dividends will be paid on the Series C Preferred Stock, unless
dividends are paid on the common stock, in which case the Series C
Preferred Stock will participate as if converted.
* The holders of the Series C Preferred Stock (excluding a portion of such
series which may be issued without voting rights) will have the right to
elect one director of the Company.
* At least $3 million of the proceeds of this sale are required to be used
to begin implementation of the conversion of American Pioneer from being
a direct subsidiary of American Progressive to being a direct subsidiary
of Universal.
* The Company, AAM, the holders of the Series C Preferred Stock, BALP and
Richard A. Barasch will enter into a shareholders agreement at the
closing of the transaction, under which the holder of the Series C
Preferred Stock are given registration rights and informational rights,
the Series C Preferred Stock holder agrees to vote their shares for the
election of a person designated by AAM as the director elected by that
Series, and BALP and Mr. Barasch grant the Series C holders a co-sale
right should they sell any shares of the Company's common stock held by
them, except to certain "permitted transferees".
F-29
Schedule II - Condensed Financial Information of Registrant
UNIVERSAL AMERICAN FINANCIAL CORP.
(Parent Company)
CONDENSED BALANCE SHEETS
December 31, 1995 and 1996
1995 1996
-------- --------
ASSETS
Cash and cash equivalents $ 19,963 $ 76,844
Investments in subsidiaries at equity 24,332,016 22,382,683
Due from subsidiary 259,974 290,974
Deferred tax asset 883,077 883,077
Other assets 71,046 77,597
----------- -----------
Total assets 25,566,076 23,711,175
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt 800,000 800,000
Due to subsidiary 587,530 794,690
Amounts payable and other liabilities 64,270 37,959
------------ ------------
Total liabilities 1,451,800 1,632,649
------------ ------------
Total stockholders' equity 24,114,276 22,078,526
------------ ------------
Total liabilities and stockholders' equity $ 25,566,076 $ 23,711,175
============ ============
See notes to consolidated financial statements.
F-30
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(Parent Company)
CONDENSED STATEMENTS OF OPERATIONS
For the Three Years Ended December 31, 1996
1994 1995 1996
--------- --------- ---------
REVENUES:
Net investment income $ 991 $ 165 $ 75
--------- --------- ---------
Total revenues 991 165 75
--------- --------- ---------
EXPENSES:
Selling, general and administrative expenses 367,027 640,632 301,235
--------- --------- ---------
Total expenses 367,027 640,632 301,235
--------- --------- ---------
Operating loss before provision for federal
income taxes and equity income (366,036) (640,467) (301,160)
Federal income taxes . . . . . - - -
--------- --------- ---------
Net loss before equity income (366,036) (640,467) (301,160)
Equity in undistributed income 2,593,791 3,282,289 405,035
---------- ---------- ----------
Net income $2,227,755 $2,641,822 $ 103,875
========== ========== ==========
See notes to consolidated financial statements.
F-31
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(Parent Company)
CONDENSED STATEMENTS OF CASH FLOWS
For the Three Years Ended December 31, 1996
1994 1995 1996
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 2,227,757 $ 2,641,822 $ 103,875
Adjustments to reconcile net income to
net cash used by operating activities:
Amortization and depreciation, net 8,293 4,147 -
Increase in investment in subsidiaries (2,593,893) (5,476,975) (392,557)
Change in amounts due to/from subsidiaries (1,863,217) 2,904,984 176,160
Change in other assets and liabilities (254,157) 200,050 (32,860)
------------ ---------- ------------
Net cash (used by) provided from operating activities (2,475,217) 274,028 (145,382)
------------ ---------- ------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 1,972,254 1,355,465 202,263
Proceeds from issuance of Series B preferred stock 4,000,000 - -
Redemption of the Series A preferred stock (4,000,000) - -
Redemption of note payable - (1,618,062) -
Change in short-term debt 400,000 - - C
----------- ---------- -----------
Net cash provided from (used by) financing activities 2,372,254 (262,597) 202,263
----------- ---------- -----------
Net increase (decrease) in cash and cash equivalents (102,963) 11,431 56,881
Cash and cash equivalents:
At beginning of year 111,495 8,532 19,963
----------- ---------- -----------
At end of year $ 8,532 $ 19,963 $ 76,844
=========== ========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 38,650 $ 96,289 $ 83,852
=========== ========== ===========
Income taxes $ - $ - $ -
=========== ========== ===========
Supplemental schedule of non-cash investing and financing activities:
On December 30, 1994, the Company redeemed the Series A preferred stock
at a discount for part cash and issuance of a debenture (see Note 6).
Liquidation preference $ 7,139,757
Cash paid (4,000,000)
Fair value of debenture issued (1,618,062)
------------
Amount credited to retained earnings $ 1,521,695
============
See notes to consolidated financial statements
F-32
Schedule III - Supplementary Insurance Information
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
1994 1995 1996
------------ ------------ ------------
Deferred policy acquisition costs $ 14,485,850 $ 16,564,450 $ 19,091,514
============ ============ ============
Policyholder account balances $108,777,009 $118,608,836 $134,538,954
============ ============ ============
Policy and contract claims $ 9,533,289 $ 9,374,815 $ 25,814,721
============ ============ ============
Premiums and policyholder fees earned $ 40,324,480 $ 36,810,937 $ 40,145,373
============ ============ ============
Net investment income $ 9,238,789 $ 8,945,280 $ 9,850,083
============ ============ ============
Interest credited to policyholders $ 5,916,936 $ 6,089,860 $ 6,614,176
============ ============ ============
Claims and other benefits and
change in future policy benefits $ 24,050,188 $ 21,029,905 $ 25,897,415
============ ============ ============
Increase in deferred acquisition costs $ 2,977,769 $ 3,317,523 $ 2,257,617
============ ============ ============
Commissions and other operating costs
and expenses $ 24,486,049 $ 23,153,921 $ 22,760,319
============ ============ ============
F-33