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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
COMMISSION FILE NUMBER 1-13154
AMERICAN MEDICAL SECURITY GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WISCONSIN 39-1431799
(State of incorporation) (I.R.S. Employer Identification No.)
3100 AMS BOULEVARD
GREEN BAY, WISCONSIN 54313
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (920) 661-1111
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Stock, no par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
(associated with the Common Stock)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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 Registration S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No [ ]
The aggregate market value of the shares of outstanding Common Stock held by
non-affiliates of the registrant was approximately $251,000,000 as of June 30,
2003, assuming solely for purposes of this calculation that all directors and
executive officers of the Registrant are "affiliates." This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of February 29, 2004, there were outstanding 13,549,383 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of American Medical Security Group, Inc. Proxy Statement for its
Annual Meeting of Shareholders to be held on May 18, 2004 (Part III)
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AMERICAN MEDICAL SECURITY GROUP, INC.
INDEX TO
ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2003
PAGE
PART I
Item 1. Business............................................................3
Item 2. Properties.........................................................10
Item 3. Legal Proceedings..................................................10
Item 4. Submission of Matters to a Vote of Security Holders................11
Executive Officers of the Registrant..........................................11
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters...........................................13
Item 6. Selected Financial Data............................................14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...........................15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk ........26
Item 8. Financial Statements and Supplementary Data........................27
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................50
Item 9A. Controls and Procedures............................................50
PART III
Item 10. Directors and Executive Officers of the Registrant.................51
Item 11. Executive Compensation.............................................51
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters...............................51
Item 13. Certain Relationships and Related Transactions.....................51
Item 14. Principal Accountant Fees and Services.............................51
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K......................................................52
Schedule II - Condensed Financial Information of Registrant........54
Schedule III - Supplementary Insurance Information.................57
Schedule IV - Reinsurance..........................................58
Schedule V - Valuation and Qualifying Accounts.....................59
Signatures ...................................................................60
Exhibit Index...............................................................EX-1
PART I
ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
This document includes "forward-looking" statements within the meaning of the
safe harbor provisions of the United States Private Securities Litigation Reform
Act of 1995. When used, the terms "anticipate," "believe," "estimate," "expect,"
"may," "objective," "plan," "possible," "potential," "project," "will" and
similar expressions are intended to identify forward-looking statements.
Forward-looking statements are subject to inherent risks, uncertainties and
assumptions that may cause actual results or events to differ materially from
those that are described. In addition to the assumptions and other factors
referred to specifically in connection with such statements, factors that may
cause actual results or events to differ are described in Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Cautionary Factors." The Company does not undertake any obligation to update or
revise such statements as a result of new information, future events or
otherwise.
GENERAL
American Medical Security Group, Inc. is a provider of insurance products for
individuals and small employer groups. As used herein, "the Company" refers to
American Medical Security Group, Inc. and its subsidiaries. The Company's
principal product offering is medical insurance. The Company also offers life,
dental, prescription drug, disability and accidental death insurance, and
provides self-funded benefit administration. See the Company's Notes to
Consolidated Financial Statements, Note 13, "Segments of the Business" for
information concerning the Company's two reportable segments: health insurance
products (which accounted for approximately 98% of the Company's premium revenue
for the years ended December 31, 2003 and 2002) and life insurance products.
The Company's products are sold through independent licensed agents in 32 states
and the District of Columbia. The Company specializes in providing health and
other insurance products designed to maximize choice and control costs. The
Company principally markets health benefit products that provide discounts to
insureds that utilize preferred provider organizations ("PPOs"). PPO plans
differ from health maintenance organization ("HMO") plans in that they typically
provide a wider choice of health professionals, fewer benefit restrictions and
increased access to specialists at a somewhat higher premium cost.
American Medical Security Group, Inc. is a Wisconsin corporation organized in
1983. The Company's principal executive offices are located at 3100 AMS
Boulevard, Green Bay, Wisconsin 54313 and its telephone number at that address
is (920) 661-1111.
During the third quarter of 2003, the Company sold its preferred provider
organization network subsidiary, Accountable Health Plans of America, Inc.
("AHP") for $3.5 million. The sale was part of the Company's long-term strategy
to focus on its core business. The financial information contained in this Form
10-K for all prior periods presented has been restated to exclude the results of
discontinued networking business as a result of the sale of AHP.
AVAILABLE INFORMATION
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are
available free of charge through the "Investor" section of the Company's website
at WWW.EAMS.COM as soon as reasonably practicable after the Company
electronically files or furnishes such reports with the Securities and Exchange
Commission.
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PRODUCTS
The Company provides products tailored to meet the varied health insurance needs
of its primary markets, including small employer groups, individuals and their
families. Features commonly available in the Company's medical products include:
o Choice of co-payment, deductible and coinsurance levels
o Choice of PPO networks
o Availability of comprehensive prescription drug coverage
o Wellness and routine care coverage
o Nurse Healthline, Inc., the Company's 24 hour-a-day health information line
o Internet-based decision support tool to access health-related information
The Company is expanding its product portfolio to include products and services
to support consumer-driven health care, a concept emerging in response to the
burden of soaring health care costs on employers and individuals.
Consumer-driven health care requires individuals to take on a greater economic
stake and decision-making responsibility in their health care. In early 2004,
the Company introduced a series of health plans for individuals compatible with
tax deferred health savings accounts. The Company expects to introduce similar
plans for small employer groups later this year. To help members become more
knowledgeable consumers of health care services, in early 2004, the Company
expanded its product features to include an Internet-based support tool
containing a wide range of health related information as well as health care
provider and quality data.
SMALL EMPLOYER GROUP PRODUCTS
Small employer group medical insurance products are targeted to employer groups
with two to 50 employees. The Company's average in-force group size was
approximately seven employees as of December 31, 2003. Distributed through a
network of independent agents, small employer group products are customized for
businesses to offer their employees multiple health plan options in a single
package. This allows employers to provide a base benefit plan for their
employees that can be customized with differing benefit levels by individuals
within the same group. Although the premium cost of the plans may vary, the
ability to offer different plans to individual employees is without any
additional cost to the employer. In 2003, the Company continued the introduction
of small employer group products designed to provide for more patient
responsibility for routine health care. In addition, the Company began marketing
high-deductible health plans compatible with health reimbursement arrangements,
which are employer funded accounts used to reimburse employees for qualified
medical care expenses and health insurance premiums.
PRODUCTS MARKETED TO INDIVIDUALS
The Company's MedOne(R) health insurance products marketed to individuals and
their families are designed to meet the various health insurance needs and
budgets of consumers by offering a choice of deductible and co-payment features.
Sold through independent agents, MedOne(R) insurance products are designed for
cost-conscious consumers and provide protection from major medical costs and
increased patient responsibility for routine health expenses. The Company also
offers custom, private label products for individuals and families that are sold
through arrangements with select general agents. In mid-2003, the Company
extended its line of health benefit plans for individuals with the introduction
of MedOne(R)Security and Essential Choice, products designed for consumers
seeking core benefits at lower monthly premiums in exchange for higher
deductibles.
DENTAL PRODUCTS
The Company's dental products offer members a choice in benefit plans, with
access to any dental provider in most markets, and coverage for a complete range
of dental services from preventative maintenance to major dental expenses.
Dental coverage can be purchased with the Company's group medical insurance or
on a stand-alone basis. The Company's dental products are also available to the
individual market when purchased with the Company's MedOne(R) health insurance
products. Approximately 70% of the Company's dental members have stand-alone
plans.
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OTHER PRODUCTS
The Company augments its core business with a select line of products and
services. Ancillary benefits available with the Company's plans include term
life, short-term medical, short-term disability, accidental death and dependent
life insurance. Voluntary term life insurance products may be elected by
employees with no employer contribution requirements.
The Company also sells fully insured products to employers having in excess of
50 employees. These products have the same features as the Company's products
sold to small employer groups. In addition, the Company offers self-funded
benefit administration services for employers that want to assume a portion of
the financial risk for their own health plans. In conjunction with the Company's
benefit administration services, the Company offers excess loss insurance to
cover catastrophic losses of self-funded plans. Additionally, the Company offers
COBRA administration services to groups subject to regulations under the
Consolidated Omnibus Budget Reconciliation Act of 1985, as amended.
SALES AND MARKETING
The Company currently markets its products in 32 states and the District of
Columbia. The Company's leading markets at December 31, 2003, based on medical
membership, were Illinois, Michigan, Florida and Texas, each individually
representing approximately 10% of the Company's total medical membership.
Product sales are conducted through approximately 30,000 licensed independent
agents. During 2003, the Company continued to recruit quality agents to sell its
products to support the Company's initiative to increase sales. Agents are paid
commissions on premiums generated from new and renewal sales. The Company offers
financial incentives and an extensive variety of customer service support to
agents. To enhance its marketing approach for its small employer group products,
the Company provides agents with a computer-based quoting tool that allows
agents to rapidly calculate both employer and employee contribution rates for
multiple plan designs.
The Company's primary distribution channel for its products is through its
regional sales offices located throughout the United States. The sales offices
are staffed by approximately 75 sales managers and representatives who manage
the Company's relationship with independent agents. During 2003, the Company
realigned and strengthened its sales operations and streamlined certain
administrative operations to enhance agent support. Sales office staff provide
product training to agents and support local agent efforts. The Company's home
office also maintains a dedicated telephone support team to support and assist
regional sales offices with sales of certain products, primarily dental
products.
The Company also utilizes select general agents to sell custom, private label
products for individuals and their families. These independent agents produce
business through lead generation and independent sub-agents located throughout
the Company's sales territory. The Company has a relationship with a general
agent who, along with affiliated subagents, generated approximately 9% of the
Company's premium revenue in 2003. The Company also contracts with six regional
marketing centers that focus on sales of the Company's MedOne(R) products.
Regional marketing centers are independent agencies employing broad-based, mass
marketing techniques to sell health insurance to individuals and families. In
addition, the Company markets, on a limited basis, a MedOne(R) health insurance
product for individuals and their families over the Internet through several
online insurance agencies.
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COMPETITION
The market for the Company's insurance products is highly competitive. The major
competition for the Company's products comes from national and regional firms.
Many of the Company's competitors have larger membership in regional markets or
greater financial resources. The small employer group and individual health
insurance business is typically agency-controlled, highly price sensitive and
put out for bid more frequently than larger group business. In addition, because
most of the Company's products are marketed primarily through independent
agencies, most of which represent more than one company, the Company experiences
competition within each agency. The Company and other insurers in the small
group health insurance market compete primarily on the basis of price, benefit
plan design, strength of provider networks, quality of customer service,
reputation and quality of agency relations.
PROVIDERS
The Company contracts with approximately 60 commercial preferred provider
organization networks for its fully insured and self-funded product offerings.
The networks include doctors, clinics, hospitals and other health care providers
that provide medical services to the Company's members at negotiated fees. The
networks recruit and maintain providers representing a wide variety of specialty
areas. The Company also contracts with a national network of providers
specializing in organ transplants. In addition, the Company contracts with
national vendors to supply ancillary services and supplies (such as home health
aids and services, rehabilitation services, specialty injectable supplies and
services) primarily to members that choose non-network benefit products. The
Company generally does not contract directly with health care providers.
In the third quarter of 2003, the Company sold its sole commercial PPO network
subsidiary, AHP, which serviced approximately 13% of the Company's members at
that time. Subject to the terms of the sale agreement, AHP will continue to
provide network services to the Company for a minimum of five years.
The Company also contracts with an outside pharmacy benefit manager to provide
prescription drug benefits to its members. The Company entered into a five-year
pharmacy benefit management agreement that became effective January 1, 2003.
This arrangement allows members to access their prescription benefits at
thousands of retail outlets nationwide or through a mail-order service. The
pharmacy benefit manager focuses on disease management efforts for certain
conditions through patient education.
MEDICAL MANAGEMENT SERVICES AND COST CONTAINMENT
The Company utilizes a care management model that merges utilization review,
pre-certification, concurrent review and retrospective review with discharge
planning and case management. Under this model, patients with chronic, complex
or costly conditions are assigned a care manager to assist the insured with
coordination of care during the entire episode of care. This integrated model is
designed to support physician-directed treatment plans, improve cost savings,
promote quality of care for the Company's members and enhance member and
provider satisfaction. The Company also reviews hospital admission and medical
services for select medical conditions. Licensed physicians and nurse
professionals provide clinical direction for the Company's medical management
services. The Company's utilization review activities meet national standards
and are accredited by American Accreditation HealthCare Commission, an
organization that establishes standards for the health care industry.
Through its wholly owned subsidiary, Nurse Healthline, Inc., the Company
provides its members with a toll-free 24 hours a day, 365 days a year, health
information line staffed by registered nurses. Nurse Healthline uses a
computerized algorithm-based system to provide members with information to
assist them in gauging the relative severity of a problem and accessing
appropriate health care. Nurse Healthline also offers a maternal wellness
program designed to encourage expectant mothers to receive appropriate prenatal
care, to provide them with educational materials and, if appropriate, to refer
them to the Company's care management staff. In addition, Nurse Healthline has
implemented a Heart Healthy Program that targets and supports members with heart
conditions or who have had cardiac procedures.
The Company's subrogation department is responsible for investigating potential
liability for injury claims to determine if other insurance coverage is
available or considered primary. Claims are identified primarily through the
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use of a diagnosis code table built into the Company's claims processing
computer system, and are investigated via the telephone to expedite the process.
The majority of savings achieved are due to the identification of motor vehicle
accidents, as well as work-related injuries and illnesses.
The Company's special investigation team reviews questionable claims submitted
by providers and insureds for fraud and abuse. The Company is a corporate member
of the National Healthcare Anti-Fraud Association. When appropriate, information
is shared with the federal and state regulatory and law enforcement agencies. In
addition, the Company pursues recoveries post-adjudication when fraud or
misrepresentation has been established.
OPERATIONS AND INFORMATION TECHNOLOGY
The Company's core operational functions are supported by a single,
custom-built, fully integrated management information system. The Company's
current information system supports all operational functions, including
underwriting, billing, enrollment, claims processing, customer service, agent
licensing and compensation, utilization management, network analysis and sales
reporting. The Company uses extensive personal computer-based network and
software applications that are integrated with the Company's platform system.
The Company has integrated software into its system with specific functionality
for case management and for the repricing of claims in accordance with PPO
contracts.
The Company continuously explores ways to upgrade and enhance its technology and
software applications to meet business needs. To continue supporting business
growth, operational efficiencies, service improvements and future administrative
cost savings, the Company has undertaken an enterprise-wide information
technology modernization project. The project involves the purchase of software
applications and the utilization of internal and external technology and
consulting resources to support most of the Company's major business processes.
The design, development and implementation is scheduled to occur over the next
few years. During 2003, the Company began implementing new software for certain
administrative functions. The Company continues to enhance its systems to
maintain compliance with regulations as well as new product functionality
requirements.
CUSTOMER SERVICE
The Company provides members, employers, providers and agents with toll-free,
customer service 24 hours a day, 365 days a year. Customer service
representatives located at the Company's headquarters in Green Bay, Wisconsin,
personally answer calls. The Company also offers customer self-service via the
Internet where members can check the status of claims, order identification
cards, update addresses and locate medical providers. In addition, the Company
provides an Internet website for its independent sales agents. The website
allows agents to check enrollment, view new business status, review all active
and pending business, and access product materials, provider information and
administrative forms.
REINSURANCE
The Company has entered into a variety of reinsurance arrangements under which
it cedes business to other insurance companies through excess loss arrangements
to control exposure arising from large claims. This reinsurance permits the
Company to enhance its premium and asset growth while maintaining favorable
risk-based capital ratios. All excess loss reinsurers with which the Company
contracts are currently rated "A" (Excellent) or better by A.M. Best Company.
The Company also cedes, on a quota share basis, 100% of the risk on certain life
policies to a prior affiliate in exchange for a ceding commission. See the
Company's Notes to Consolidated Financial Statements, Note 1, "Organization and
Significant Accounting Policies - Reinsurance" for a summary of reinsurance
ceded.
INVESTMENTS
The Company attempts to minimize its business risk through conservative
investment policies. Investment guidelines set quality, concentration and return
parameters. The Company invests in securities authorized by applicable state
laws and regulations and follows investment policies designed to maximize yield,
preserve principal, provide liquidity and add value relative to a market index.
Individual fixed income issues must carry an investment grade rating at the time
of
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purchase, with an ongoing average portfolio rating of "A-" or better, based
on ratings of Standard & Poor's Corporation or another nationally recognized
securities rating organization. At December 31, 2003, approximately 99% of the
Company's investment portfolio was invested in debt securities with an average
quality rating of "AA" as measured by Standard and Poor's Corporation, and the
Company held no below investment grade securities. The Company's bond portfolio
contains no investments in mortgage loans, nonpublicly traded securities, real
estate held for investment or financial derivatives.
With the exception of short-term investments and securities on deposit with
various state regulators, investment responsibilities have been delegated to
external investment managers. Such investment responsibilities, however, must be
carried out within the investment parameters established by the Company, which
are amended from time to time. See Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Market Risk Exposure" and the
Company's Notes to Consolidated Financial Statements, Note 5, "Investments," for
additional information on the Company's investments.
REGULATION
Government regulation of employee benefit plans, including health care coverage
and health plans, is a changing area of law that varies from jurisdiction to
jurisdiction and generally gives responsible state and federal administrative
agencies broad discretion with respect to the regulation of health plans, health
insurers and related entities. The Company strives to maintain compliance in all
material respects with all federal and state regulations applicable to its
current operations. To maintain such compliance, it may be necessary for the
Company to make changes from time to time in the Company's services, products,
structure or operations. Additional governmental regulation or future
interpretation of existing regulations could increase the cost of the Company's
compliance or otherwise affect the Company's operations, products, profitability
or business prospects.
The Company is unable to predict what additional government regulations
affecting its business may be enacted in the future or how existing or future
regulations might be interpreted. Most jurisdictions have enacted small employer
group insurance and rating reforms that generally limit the ability of insurers
and health plans to use risk selection as a method of controlling costs for the
small employer group business. These laws sometimes limit or eliminate use of
pre-existing condition exclusions, use of health status in rating and use of
industry codes in rating, and limit the amount of rate increases that can be
given from year to year. Under these laws, cost control through provider
contracting and managing care may become more important, and the Company
believes its experience in these areas will allow it to compete effectively. The
Company regularly monitors state and federal legislative and regulatory activity
as it affects the Company's business.
FEDERAL INSURANCE REGULATION
In recent years, federal legislation significantly expanded federal regulation
of small group health plans and health care coverage. The Health Insurance
Portability and Accountability Act of 1996 ("HIPAA") places restrictions on the
use of pre-existing conditions and eligibility restrictions based upon health
status, prohibits cancellation of coverage due to claims experience or health
status, and prohibits insurance companies from declining coverage to small
employers.
HIPAA also established new requirements regarding the confidentiality and
security of patient health information and standard formats for the electronic
transmission of health care data, including code sets. Final privacy rules
adopted in 2001 also required changes in the way health information is handled.
In 2003, final HIPAA security rules were adopted that require the
implementation, by April 2005, of a series of administrative, technical and
physical security procedures to assure the confidentiality of electronic,
personally-identifiable health information. In 2003, the Company continued to
implement new procedures related to the transmission of health care information
and to comply with the HIPAA privacy regulations and security rules. In recent
years, the Company also has implemented procedures to comply with the privacy
standards for personal information required by the Gramm-Leach-Bliley Act, and
to comply with U. S. Department of Labor regulations that revised claims
procedures for employee benefit plans governed by ERISA. The Department of Labor
regulations govern the time frame for making benefit decisions for claims and
appeals and for notification of claimants' rights under the regulations.
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Congress has proposed numerous other health care reform measures in recent
years. Congress is considering legislation to allow small employers to form
association health plans that would be exempt from state insurance regulations,
which might impact the risk profile of employers willing to purchase insurance
from the Company. Additionally, with the growing number of uninsured Americans,
there are proposals before Congress intending to create a national health
benefits program with little, if any, role for private insurers. These
legislative initiatives could affect various aspects of the Company's business.
The Company is unable to predict when or whether such legislation or any
additional federal proposals will be enacted or the effect of such developments
on the Company's operations and financial condition.
STATE INSURANCE REGULATION
The Company's insurance subsidiaries are subject to extensive regulation by
various insurance regulatory bodies in each state in which the respective
entities are licensed. This extensive supervisory power over insurance companies
is designed to protect policyholders, rather than investors, and relates to:
o the licensing of insurance companies;
o the approval of forms and insurance policies used, and, in some cases, the
rates charged in connection with those forms;
o the nature of, and limitation on, an insurance company's investments;
o policy administration and claim paying procedures;
o periodic examination of the operations of insurance companies;
o the form and content of annual financial statements and other reports required
to be filed on the financial condition of insurance companies;
o capital adequacy; and
o transactions with affiliates and changes in control.
The Company's insurance subsidiaries are required to file periodic statutory
financial statements in each jurisdiction in which they are licensed. In
addition, dividends paid by the Company's insurance subsidiaries to the
corporate parent may be limited by state insurance regulations. For additional
information on dividend restrictions, see the Company's Notes to Consolidated
Financial Statements, Note 10, "Shareholders' Equity--Restrictions on Dividends
From Subsidiaries."
The National Association of Insurance Commissioners has adopted risk-based
capital requirements for life and health insurers to evaluate the adequacy of
statutory capital and surplus in relation to investment and insurance risks
associated with asset quality, mortality and morbidity, asset and liability
matching and other business factors. State insurance regulators use the
risk-based capital formula as an early warning tool to identify insurance
companies that potentially are inadequately capitalized. At December 31, 2003,
the Company's insurance subsidiaries had risk-based capital ratios substantially
above the levels that would require action by the Company or a regulator.
On an ongoing basis, states consider various health care reform measures
relating to mandated benefits, rating limitations, risk classification, prompt
pay laws regulating the time in which insurers have to pay claims, universal
health coverage or creation of single-payer plans, high risk pools, network
management, administrative procedures and other matters. The Company is unable
to predict when or whether such legislation or any additional state proposals
will be enacted or the effect of such developments on the Company's operations
and financial condition.
INSURANCE HOLDING COMPANY SYSTEMS
The Company is an insurance holding company system under applicable state laws.
As such, the Company and its insurance subsidiaries are subject to regulation
under state insurance holding company laws and regulations in the states in
which the insurance subsidiaries are domiciled. The insurance holding company
laws and regulations generally require annual registration with the state
departments of insurance and the filing of reports describing capital structure,
ownership, financial condition, certain intercompany transactions and general
business operations. Various notice and reporting requirements often apply to
transactions between an insurer and its affiliated companies, depending on the
size and nature of the transactions. Certain state insurance holding company
laws and
9
regulations also require prior regulatory approval or notice of certain
material intercompany transactions. Direct or indirect acquisition of control of
an insurance company requires the prior approval of state regulators in the
insurer's state of domicile and sometimes other jurisdictions as well.
Acquisition of a controlling interest of the Company's common stock would
constitute an acquisition of a controlling interest in each of the Company's
insurance subsidiaries. Under applicable state law, control is generally
presumed to exist in any person who beneficially owns or controls greater than
10% of a company's shares.
OTHER STATE REGULATIONS
Certain of the Company's subsidiaries are licensed as third party
administrators. Regulations governing third party administrators, although
differing greatly from state to state, generally contain requirements for
administrative procedures, periodic reporting obligations and minimum financial
requirements. Certain of the operations of the Company's subsidiaries are also
subject to laws and/or regulations governing PPO, managed care and utilization
review activities. PPO and managed care regulations generally contain
requirements pertaining to grievance procedures, provider networks, provider
contracting and reporting requirements that vary from state to state.
Utilization review regulations generally require compliance with specific
standards for the performance of utilization review services including
confidentiality, staffing, appeals and reporting requirements. In some cases,
the regulated PPO, managed care and utilization review activities are delegated
by subsidiaries to a third party.
ERISA
The provision of goods and services to or through certain types of employee
health benefit plans is subject to the Employee Retirement Income Security Act
of 1974, as amended, which is commonly referred to as ERISA. ERISA is a complex
set of laws and regulations that is subject to periodic interpretation by the
United States Department of Labor and the Internal Revenue Service. ERISA
governs how the Company's business units may do business with employers whose
employee benefit plans are covered by ERISA, particularly employers who self
fund benefit plans. There have been legislative attempts to limit ERISA's
preemptive effect on state laws. If such limitations were to be enacted, they
might increase the Company's liability exposure under state law-based suits
relating to employee health benefits offered by the Company's health insurance
plans and could permit greater state regulation of other aspects of those
businesses' operations.
EMPLOYEES
As of December 31, 2003, the Company had 1,444 employees, 1,321 of which are
located at its home office facility in Green Bay, Wisconsin. None of its
employees is represented by a union.
TRADEMARKS
The Company has filed for and maintains various service marks, trademarks and
trade names at the federal level and in various states. Although the Company
considers its registered service marks, trademarks and trade names important,
the business of the Company is not dependent on any individual service mark,
trademark or trade name.
ITEM 2. PROPERTIES
The Company's headquarters are located in Green Bay, Wisconsin, in a 400,000
square foot office building owned by the Company and used by both of its
business segments. The Company also leases property at approximately 25
locations throughout the United States primarily for its field sales offices.
ITEM 3. LEGAL PROCEEDINGS
A class action lawsuit was filed against two of the Company's wholly owned
subsidiaries, American Medical Security, Inc. ("AMS") and United Wisconsin Life
Insurance Company ("UWLIC") in the Circuit Court for Palm Beach County, Florida,
by Evelyn Addison and others in February 2002 alleging that the Company failed
to follow Florida law when in 1998 it discontinued writing certain health
insurance policies and offered new policies to insureds. Plaintiffs claim that
the Company wrongfully terminated coverage, improperly notified insureds of
10
conversion rights and charged improper premiums for new coverage. Plaintiffs
also allege that UWLIC's renewal rating methodology violated Florida law. In a
judgment entered April 24, 2002, the Circuit Court Judge in the class action
lawsuit found, among other things, that the policy issued by the Company outside
Florida was not exempt from any Florida rating laws and ordered that the
question of damages be tried before a jury at a later date. The earliest the
Company expects the trial to be held is the second quarter of 2004. The Company
believes its practices were in full compliance with Florida law and is
vigorously defending itself in this lawsuit.
On March 10, 2004, AMS and UWLIC entered into a settlement agreement to certify
and settle a class action lawsuit, Gadson vs. AMS, et al. ("Gadson"), pending in
the Circuit Court of Montgomery County, Alabama. The lawsuit was filed in 2001
and involves issues relating to the rating methodology formerly used by the
Company for group health benefit plans marketed to individuals in Alabama and
Georgia. If the settlement receives final approval of the Court, all claims of
participating class members would be dismissed in exchange for consideration
from the Company valued at approximately $9 million. The Company believes it is
adequately reserved for the cost of the settlement, including related attorneys'
fees. It also believes a portion of the cost of settlement should be covered by
insurance. Any potential insurance recovery is not reflected as an asset on the
Company's balance sheet. The Company expects final approval or disapproval of
the settlement by the Circuit Court in the third quarter of 2004.
The Company's subsidiaries, AMS and UWLIC, are defendants in a number of
lawsuits in various states, primarily Alabama, alleging misrepresentation of the
rating methodology used by the Company with respect to certain MedOne(R)
products purchased by the plaintiffs. These lawsuits commonly seek unspecified
damages for misrepresentation and emotional distress in addition to punitive
damages. Some of these cases involve multiple plaintiffs. The cases are in
various stages of litigation. The Company believes that these lawsuits are
unfounded because the Company properly disclosed the nature of the products
sold. The Company also believes the subject matter of the lawsuits falls under
the primary jurisdiction of state insurance departments. The Company is
vigorously defending itself in these actions. If the class action settlement in
Gadson receives final approval, future lawsuits of this nature should be barred
in Alabama and Georgia, except with respect to lawsuits brought by persons who
opt out of the class settlement.
The Company is involved in various other legal and regulatory actions occurring
in the normal course of business. Based on current information, including
consultation with outside counsel, management believes any ultimate liability in
excess of amounts reserved that may arise from the above-mentioned and all other
legal and regulatory actions would not have a material adverse effect on the
Company's consolidated financial position or results of operations. However,
management's evaluation of the likely impact of these actions could change in
the future and an unfavorable outcome could have a material adverse effect on
the Company's consolidated financial position, results of operations or cash
flow of a future period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, who are elected for one year terms, are
as follows:
NAME AGE TITLE
- -------------------- --- -----------------------------------------------------
Samuel V. Miller 58 Chairman of the Board, President and Chief Executive
Officer
John R. Lombardi 55 Executive Vice President, Chief Financial Officer and
Treasurer
James C. Modaff 46 Executive Vice President and Chief Actuary
Thomas G. Zielinski 56 Executive Vice President, Operations
Timothy J. Moore 52 Senior Vice President of Corporate Affairs, General
Counsel and Secretary
Timothy F. O'Keefe 49 Senior Vice President and Chief Marketing Officer
Clifford A. Bowers 52 Vice President, Corporate Communications
John R. Wirch 50 Vice President, Human Resources
11
Samuel V. Miller has been Chairman of the Board, President and Chief Executive
Officer of the Company since September 1998. Prior to that time, he was an
Executive Vice President of the Company since December 1995. During 1994 and
1995, Mr. Miller was a member of the executive staff planning group with the
Travelers Group, serving as Chairman and Group Chief Executive of National
Benefit Insurance Company and Primerica Financial Services Ltd. of Canada. Prior
to 1994, Mr. Miller spent 10 years as President and Chief Executive Officer of
American Express Life Assurance Company.
John R. Lombardi has been Executive Vice President, Chief Financial Officer and
Treasurer of the Company since April 2003. Prior to joining the Company, he was
Executive Director and Chief Operating Officer of Nelson Mullins Riley &
Scarborough, a regional law firm from 2000 to 2002. From 1998 to 2000, he was
Senior Vice President of MedPartners, Inc. (n/k/a Caremark Rx, Inc.), a
pharmaceutical service company, and Chief Financial Officer of one of its
largest divisions. Prior to that time, he spent seven years as a Regional Chief
Financial Officer with Aetna Inc. and 11 years in various officer positions with
Cigna Corporation.
James C. Modaff has been Executive Vice President and Chief Actuary of the
Company since August 1999. Prior to joining the Company, he was a principal of
Milliman & Robertson, Inc. (a national actuarial and consulting firm) for the
majority of his 14-year career with the firm.
Thomas G. Zielinski has been Executive Vice President of Operations of the
Company since August 1999. Prior to joining the Company, he was a Vice President
of Humana, Inc. (a health services company) where he served as Executive
Director of the Wisconsin Service Center of Humana, Inc. and in various other
capacities, including Vice President, with a predecessor company of Humana, Inc.
since 1981.
Timothy J. Moore has been Senior Vice President of Corporate Affairs, General
Counsel and Secretary of the Company since September 1998. He also served in
that capacity with American Medical Security Holdings, Inc. since March 1997.
Prior to that time, Mr. Moore was a partner with the national law firm of Katten
Muchin & Zavis, practicing at the firm from 1987 to 1997.
Timothy F. O'Keefe has been Senior Vice President and Chief Marketing Officer of
the Company since January 2002. Prior to joining the Company, he was President
of the Major Medical Division of Conseco, Inc.'s insurance operations, having
served in other senior management positions from 1997 until he became President
in 1998. From 1991 to 1997 he held various positions, including Chief Marketing
Officer, with various subsidiaries of Pioneer Financial Services.
Clifford A. Bowers has been Vice President of Corporate Communications of the
Company since September 1998. He also served in that capacity with American
Medical Security, Inc. since October 1997. From 1988 to 1997, Mr. Bowers was
Director of Communications with Fort Howard Corporation (a paper manufacturer).
Prior to that time, Mr. Bowers held management positions with Tenneco, Manville
and Brunswick corporations.
John R. Wirch has been Vice President of Human Resources of the Company since
September 1998. He also served in that capacity with American Medical Security
Holdings, Inc. since February 1996. Prior to that time, Mr. Wirch was Vice
President of Human Resources for Little Rapids Corporation (a manufacturer of
specialty papers) from 1993 to 1996, having served as Director of Human
Resources of Little Rapids Corporation from 1980 to 1993.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of the Company is traded on the New York Stock Exchange
("NYSE") under the symbol "AMZ". The following table sets forth the per share
high and low sales prices for the common stock as reported on the NYSE.
2003 2002
----------------------------------------------------
Share Price Share Price
High Low High Low
- --------------------------------------------------------------------------------
Quarter Ended:
March 31 $ 14.91 $ 12.21 $ 18.15 $ 11.00
June 30 19.76 13.32 24.09 15.45
September 30 22.50 19.11 23.98 11.41
December 31 23.21 20.38 14.85 10.80
The Company did not pay any cash dividends during the periods indicated above
and is prohibited from declaring or paying any future cash dividends by debt
covenant restrictions on the Company's line of credit agreement. In addition,
dividends paid by the Company's insurance subsidiaries to the corporate parent
may be limited by state insurance regulations. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" for a detailed discussion of insurance
subsidiary dividend limitations.
As of February 29, 2004, there were 200 shareholders of record of common stock.
Based on information obtained from the Company's transfer agent and from
participants in security position listings and otherwise, the Company has reason
to believe there are approximately 3,200 beneficial owners of shares of common
stock.
13
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data as of and for the years ended December 31,
1999 through 2003 has been derived from the Company's consolidated financial
statements. The following data should be read in conjunction with the Company's
consolidated financial statements, the related notes thereto, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
As of and for the years ended December 31,
---------------------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002(a) 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
REVENUES
Insurance premiums $ 712,418 $ 754,460 $ 838,672 $ 951,071 $ 1,056,107
Total revenues 743,716 786,310 872,973 986,222 1,092,843
EXPENSES
Medical and other benefits 478,497 508,670 603,220 726,298 843,068
Total expenses 697,937 748,079 861,841 979,964 1,132,415
Income (loss) from continuing operations,
before income taxes 45,779 38,231 11,132 6,258 (39,572)
Income tax expense (benefit) 17,201 15,082 6,460 3,504 (13,265)
- --------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 28,578 23,149 4,672 2,754 (26,307)
Income (loss) from discontinued operations 732 (663) (497) (85) 361
Cumulative effect of a change in accounting
principle - (60,098) - - -
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 29,310 $ (37,612) $ 4,175 $ 2,669 $ (25,946)
====================================================================================================================
PER SHARE DATA:
Income (loss) from continuing operations per share:
Basic $ 2.15 $ 1.77 $ 0.33 $ 0.18 $ (1.60)
Diluted $ 2.03 $ 1.67 $ 0.33 $ 0.18 $ (1.60)
Weighted average common shares outstanding:
Basic 13,270 13,047 14,049 14,899 16,470
Diluted 14,100 13,835 14,228 15,049 16,470
Cash dividends per common share $ - $ - $ - $ - $ -
OTHER DATA:
Cash and investments $ 324,367 $ 314,056 $ 300,253 $ 284,982 $ 293,539
Total assets 444,087 428,940 473,015 471,923 503,094
Notes payable 30,158 33,858 40,058 41,258 42,523
Total shareholders' equity 217,824 182,750 229,400 221,177 220,280
Cash flow from operating activities 20,126 35,175 17,590 (3,159) 26,428
(a) During 2002, the Company changed its method of accounting for goodwill
and other intangible assets. See the Company's Notes to Consolidated
Financial Statements, Note 2, "Adopted Accounting Standard" for a
comprehensive discussion of the impact of the accounting standard.
Note: All prior periods have been restated for discontinued operations
resulting from the 2003 sale of Accountable Health Plans of America, Inc.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
American Medical Security Group, Inc., through its subsidiary companies (the
"Company"), is a provider of individual and small employer group insurance
products. The Company's principal product offerings are medical insurance for
small employer groups and medical insurance marketed to individuals and their
families ("MedOne(R)"). The Company also offers dental, life, prescription drug,
disability and accidental death insurance, and provides self-funded benefit
administration. The Company has two reportable segments: health insurance
products (which accounted for approximately 98% of the Company's total premium
revenues in 2003 and 2002) and life insurance products. The Company markets its
products in 32 states and the District of Columbia through independent agents.
The Company has approximately 75 sales managers and representatives located in
sales offices throughout the United States to support the independent agents.
The Company's products generally provide discounts to members that utilize
preferred provider organizations with which the Company contracts.
SUMMARY OF 2003 RESULTS
The Company reported income from continuing operations of $28.6 million or $2.03
per diluted share for the twelve months ended December 31, 2003. This compares
to income from continuing operations of $23.1 million or $1.67 per diluted share
for 2002. The results for 2003 include net realized gains from the sale of
investment securities of $1.2 million (after-tax) or $0.08 per diluted share.
The improvement in profitability from the prior year resulted from the Company's
continued efforts to effectively manage administrative expenses and claims
costs. The Company's health segment expense ratio improved considerably in 2003,
compared to the prior year, due to a focused effort to control administrative
costs during a period of declining revenues. The Company's health segment loss
ratio also improved from the prior year as a result of disciplined pricing, a
cost-effective product portfolio and a strategic focus on markets with the
greatest prospects for profitability and future growth.
Throughout 2003, management's primary focus was on membership and revenue
growth, while maintaining the Company's positive trend in profitability. Over
the past several years, the Company experienced declining revenues and
membership resulting primarily from the Company's exit from unprofitable markets
and discontinuance of unprofitable products. In addition, the Company's growth
objectives have been hindered by a troubled economy, coupled with rapidly rising
health care costs. Total revenues were $743.7 million, $786.3 million and $873.0
million in 2003, 2002 and 2001, respectively. To help mitigate the impact of
rising health care costs, the Company has refined its product offerings, so that
insurance consumers have a greater financial stake in their health care
decisions. The Company's products offer more affordable premiums in exchange for
higher deductibles and copayments, which has also contributed to the Company's
decline in revenues.
In a continued effort to improve new member enrollment and revenue, the Company
rolled out new products and marketing campaigns during 2003 designed to be
responsive to the changing needs of today's insurance consumers. In addition,
the Company strengthened its distribution system by aligning its resources in
markets with the greatest prospects for profitable growth and by providing sales
agents with additional tools and support necessary to successfully market the
Company's products. Customer service-related actions were also taken to improve
retention of the Company's existing membership.
Although the expected positive results of these actions on revenue and
membership have been tempered somewhat by an economy that is slow to recover,
the Company has experienced recent trends that indicate the growth initiatives
may be starting to take hold. During 2003, new medical member enrollment
improved each quarter while termination rates on existing membership declined.
As a result, the Company reported improved membership and revenue during the
fourth quarter of 2003 compared to the previous quarter.
15
DISCONTINUED OPERATIONS
During the third quarter of 2003, the Company sold all of the outstanding common
shares of its preferred provider organization network subsidiary, Accountable
Health Plans of America, Inc. ("AHP") for $3.5 million. AHP contracted with more
than 900 hospitals and 100,000 physicians in eight primary states: Arizona,
Florida, Iowa, Nebraska, North Dakota, South Dakota, Texas and Wisconsin.
Subject to the terms of the agreement, AHP will continue to provide network
services to the Company for a minimum of five years. At the time of the sale,
AHP served approximately 13% of the Company's members. Including the gain on the
sale, income from discontinued operations was $0.7 million or $0.05 per diluted
share for the twelve months ended December 31, 2003. The Company incurred a loss
from discontinued operations of $0.7 million or $0.05 per diluted share in 2002
and a loss of $0.5 million or $0.04 per diluted share in 2001. All prior periods
presented have been restated to exclude the results of discontinued operations
and the amounts referred to in the foregoing and remainder of this discussion
reflect the results of the Company's continuing operations.
COMPARISON OF RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003 AND 2002
Insurance premium revenues decreased 5.6% to $712.4 million in 2003 from $754.5
million in 2002. Premium revenues decreased as a result of the Company's
membership decline. Total health membership, which includes medical and dental
members declined to 547,000 at the end of 2003 compared with 571,000 at the end
of 2002. Partially offsetting the membership decline was the effect of rising
premium rates on the continuing block of business. After the effect of buydowns
in coverage and terminations, average fully insured medical premium per month
for 2003 increased approximately 7% compared with 2002.
The health segment loss ratio remained relatively stable, improving 20 basis
points to 67.9% for 2003 compared to 68.1% for 2002. The health segment loss
ratio is impacted by a variety of factors including claim cost trends, product
pricing and the cost of litigation. The life segment, which represents less than
2% of the Company's premium revenue, experienced a favorable loss ratio at 23.6%
for 2003 compared with 29.1% for 2002.
Net investment income decreased to $13.5 million in 2003 from $15.0 million in
2002. The decrease resulted mainly from a decrease in the annual investment
yield. The annual investment yield was 4.8% for 2003 compared to 5.5% for the
prior year. During 2003, the Company realized $1.9 million of net pre-tax gains
on the sale of investment securities. Net realized gains in the prior year were
minimal.
Other revenue, which primarily consists of administrative fee income from claim
processing on self funded business and other administrative services, decreased
to $15.9 million in 2003 from $16.8 million in 2002. The decrease resulted from
the decrease in membership in 2003 compared to 2002.
The expense ratio includes commissions, general and administrative expenses,
premium taxes and assessments less other revenues. The health segment expense
ratio improved to 27.5% in 2003 from 28.2% in 2002. The decrease from the prior
year resulted from administrative cost containment actions taken in 2003 in a
continued effort to keep costs in line with revenues. A lower number of
employees in 2003 resulted in reduced compensation and related costs. Lower
commissions also contributed to the improved health segment expense ratio.
The effective tax rate for 2003 was 37.6% compared to 39.4% for 2002. The
effective tax rate in 2002 was higher due to the effect of non-deductible stock
issuance expenditures incurred in 2002 and the effect of other permanent
adjustments. The Company had deferred tax assets recorded, net of valuation
allowances, of $2.4 million related to state net operating loss carryforwards at
December 31, 2003, compared to $3.3 million at December 31, 2002. State net
operating loss carryforwards begin to expire in 2008. Management believes that
the deferred tax assets will be realized primarily through future taxable income
and specified tax planning strategies.
16
YEARS ENDED DECEMBER 31, 2002 AND 2001
Insurance premium revenues decreased 10.0% to $754.5 million in 2002 from $838.7
million in 2001. Premium revenues decreased as a result of the Company's
membership decline. Total medical and dental membership declined to 571,000 at
the end of 2002 compared with 637,000 at the end of 2001. In addition, premium
revenue was also impacted by the Company's change in its product mix. The
MedOne(R) business, which became a larger percentage of the Company's total
business in 2002, has a smaller premium per member compared with the small group
business, which was declining in the period. Partially offsetting the membership
decline was the effect of rising premium rates on the continuing block of
business. After the effect of buydowns in coverage and terminations, average
fully insured medical premium per month for 2002 increased 11% compared with
2001.
The health segment loss ratio improved 470 basis points to 68.1% for 2002
compared to 72.8% for 2001. The improvement in the health loss ratio was due in
part to improved performance on the Company's small group business resulting
from repricing efforts. In 2002, average premiums per member per month increased
at a higher rate than average claims costs per member resulting in a lower loss
ratio. The health loss ratio also benefited, to a lesser degree, from the change
in product mix to a larger percentage of MedOne(R) business, which has a lower
loss ratio. During 2002, the Company increased its reserves for litigation,
which are included in medical and other benefits payable. This increase was
offset by favorable claims experience on 2001 reserves during 2002. The life
segment, which represented less than 2% of the Company's premium revenues in
2002, experienced a favorable loss ratio at 29.1% for 2002 compared with 36.4%
for 2001.
Net investment income decreased to $15.0 million in 2002 from $17.4 million in
2001. The decrease resulted mainly from a decrease in the annual investment
yield. The annual investment yield was 5.5% for 2002 compared to 6.4% for the
prior year.
Other revenue, which primarily consists of administrative fee income from claim
processing on self funded business and other administrative services, decreased
to $16.8 million in 2002 from $17.6 million in 2001. The decrease resulted from
the decrease in membership during 2002.
The expense ratio includes commissions, general and administrative expenses,
premium taxes and assessments less other revenues. The health segment expense
ratio increased to 28.2% in 2002 from 27.5% in 2001. The increase from the prior
year largely reflected the decrease in premium volume in 2002 compared to 2001.
The change in the Company's product mix also contributed to the increase in the
health segment expense ratio. MedOne(R) business has higher agent commissions
and issue costs than small group products, but lower claim costs.
Interest expense on the outstanding balance of the Company's debt decreased to
$1.8 million in 2002 from $2.9 million in 2001. The decrease in interest expense
is largely due to a reduction in the amount of debt outstanding from $40.1
million at the end of 2001 to $33.9 million at the end of 2002. In addition, the
interest rate charged on the outstanding balance on the Company's line of credit
agreement is tied to the short-term borrowing rate, which declined throughout
most of 2002.
Amortization of goodwill and other intangible assets was $0.7 million for 2002
compared to $3.6 million for the prior year. Effective January 1, 2002, the
Company applied new accounting rules for goodwill and other intangible assets.
See the Company's Notes to Consolidated Financial Statements, Note 2, "Adopted
Accounting Standard" for a comprehensive discussion of the impact of this
accounting standard.
The effective tax rate for 2002 was 39.4% compared to 58.0% for 2001. The change
in the effective tax rate related to the elimination of amortization of goodwill
in 2002 and the effect of other permanent items.
17
ADOPTED ACCOUNTING STANDARD
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS ("Statement 142").
Statement 142 impacts the Company in two ways. First, goodwill is no longer
amortized. Second, goodwill was subject to an initial impairment test in
accordance with Statement 142, and the remaining balance of goodwill is subject
to continuing impairment testing on an annual basis and between annual tests if
an event occurs or circumstances change indicating a possible goodwill
impairment. As a result of this initial impairment test, the Company recognized
a non-cash goodwill impairment charge of $60.1 million. The impairment charge
was recorded as a cumulative effect of a change in accounting principle as of
January 1, 2002. The impairment charge had no impact on cash flows or the
statutory-basis capital and surplus of the Company's insurance subsidiaries.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management has identified the following items that represent the Company's most
sensitive and subjective accounting estimates that have or could have a material
impact on the Company's financial statements. These estimates required
management to make assumptions about matters that are highly uncertain at the
time the estimates are made. Changes to these estimates occur from period to
period and may have a material impact on the Company's financial statements.
Management has discussed the development, selection and disclosure of these
estimates with the Company's audit committee.
LIABILITIES FOR UNPAID CLAIMS
The Company recognizes claim costs in the period the service was provided to its
members. However, claim costs incurred in a particular period are not known with
certainty until after the Company receives, processes and pays the claim. The
receipt and payment date of claims may lag significantly from the date the
service was provided. Consequently, the Company must estimate its liabilities
for claims that are incurred but not yet paid.
Liabilities for unpaid claims are based on an estimation process that is complex
and uses information obtained from both company specific and industry data, as
well as general economic information. These estimates are developed using
actuarial methods based upon historical data for payment patterns, medical
inflation, product mix, seasonality, utilization of health care services and
other relevant factors. The amount recorded for unpaid claims liabilities is
sensitive to judgments and assumptions made in the estimation process. The most
significant assumptions used in the estimation process include determining
utilization and inflation trends, the expected consistency in the frequency and
severity of claims incurred but not yet reported, changes in the timing of
claims submission patterns from providers, changes in the Company's speed of
processing claims and expected costs to settle unpaid claims.
Actual conditions could differ from those assumed in the estimation process. Due
to the uncertainties associated with the factors used in these assumptions,
materially different amounts could be reported in the Company's statement of
operations for a particular period under different conditions or using different
assumptions. As is common in the health insurance industry, the Company believes
that actual results may vary within a reasonable range of possible outcomes.
Management believes that the Company's reasonable range of actual outcomes may
vary up to 10% to 15% of the total liabilities for unpaid claims recorded at the
end of a period.
Management believes that the recorded liabilities for unpaid claims at December
31, 2003 is in the higher end of a reasonable range of outcomes. Management
closely monitors and evaluates developments and emerging trends in claims costs
to determine the reasonableness of judgments made. A retrospective test is
performed on prior period claims liabilities and, as adjustments to the
liabilities become necessary, the adjustments are reflected in current
operations. Management believes that the amount of medical and other benefits
payable is adequate to cover the Company's liabilities for unpaid claims as of
December 31, 2003.
18
LIABILITIES FOR LITIGATION
The Company is involved in various legal and regulatory actions. Such actions
typically arise in the ordinary course of the Company's business as an insurer
and involve disputes relating to insurance policies or certificates including
policy coverage and benefits, premium rating methodology or misrepresentations,
agent and employment related issues, regulatory compliance and market conduct,
contractual relationships and other matters. These disputes are typically
resolved by settlement, dismissal or upon a decision rendered by a judge, jury,
arbitration panel or regulatory official.
In determining the amount to be recorded as a litigation reserve, judgments are
generally made by management on a case-by-case basis based on the facts and the
merits of the case, advice from outside legal counsel, the general litigation
and regulatory environment of the originating state, the Company's past
experience with outcomes of cases in a particular jurisdiction, historical
results of similar cases and other relevant factors. Management closely monitors
and evaluates developments and emerging facts of each case to determine the
reasonableness of the judgments and assumptions on which litigation reserves are
based. Such assumptions relate to matters that are highly uncertain. Estimates
could be made based on other reasonable assumptions or judgments that would
differ materially from those estimates recorded. Management's evaluation of the
likely outcome of these actions and the resulting estimate of the potential
liability are subject to periodic adjustments, which may have a material impact
on the Company's financial condition and results of operations of a future
period.
Management believes that legal matters relating to the Company's rating
practices involve significantly more variability than the Company's other legal
matters. Inherent uncertainties surround legal proceedings and actual results
could differ materially from those assumed in estimating the liabilities. The
possibility exists that a decision could be rendered against the Company, and in
some circumstances, include punitive or other damage awards in excess of amounts
reserved, which may have a material impact on the Company's financial condition,
results of operations or cash flow of a future period. See Item 3, "Legal
Proceedings" for a detailed discussion of the Company's material pending
litigation.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow consist primarily of insurance premiums,
administrative fee revenue and investment income. The primary uses of cash
include payments of medical and other benefits and selling, general and
administrative expenses. Positive cash flows are invested pending future
payments of medical and other benefits and other operating expenses. The
Company's investment policies are structured to provide sufficient liquidity to
meet anticipated payment obligations. At December 31, 2003 and 2002, the Company
had cash on deposit of $5.7 million and $6.1 million, respectively related to
self funded employer group policies.
The Company's cash provided by operations was $20.1 million for 2003 and $35.2
million for 2002. At the end of 2002, the Company received a $7.5 million
payment related to a pharmacy benefit management agreement. Also contributing to
the lower level of operating cash flow in 2003 were prepaid maintenance fees
related to the Company's technology modernization initiatives and a higher level
of annual employee compensation payments.
The Company maintains a revolving bank line of credit agreement with a maximum
available facility of $50.0 million. At December 31, 2003, the outstanding
balance of advances under the credit agreement was $30.2 million. The credit
agreement requires a lump-sum payment of the outstanding balance at the end of
2005. The credit agreement contains customary covenants which, among other
matters, require the Company to achieve certain minimum financial results,
prohibit the Company from paying future cash dividends and restrict or limit the
Company's ability to incur additional debt and dispose of assets outside the
ordinary course of business. The Company was in compliance with all such
covenants at December 31, 2003. The Company's obligations under the credit
agreement are guaranteed by its subsidiary, American Medical Security Holdings,
Inc. ("AMS Holdings"), and secured by pledges of stock of AMS Holdings and
United Wisconsin Life Insurance Company, the Company's principal insurance
subsidiary.
19
In an effort to continue supporting business growth, operational efficiency,
service improvements and future administrative cost savings, the Company's
management approved a plan to invest in an enterprise-wide information
technology modernization project. The project involves the purchase of software
applications and the utilization of internal and external technology and
consulting resources to support most of the Company's major business processes.
The design and development of the software applications began during the first
quarter of 2003, with a phased implementation scheduled over the next few years.
In 2002 and 2001, the Company's total capital expenditures averaged
approximately $6.7 million per year. As a result of the information technology
modernization project, total capital expenditures in 2003 increased to
approximately $12.0 million. Management believes that the Company's existing
working capital and operating cash flow will be sufficient to fund the Company's
anticipated future capital expenditures related to this project.
In January 2003, the Company's Board of Directors approved a share repurchase
program, which provides the Company with the authority to repurchase up to $10.0
million of its outstanding common shares. The plan allows the Company to buy
back its shares, from time to time, in open market or privately negotiated
transactions, subject to price and market conditions. During 2003, the Company
purchased 87,900 shares of its common stock at an average market price of $15.44
per share, and at an aggregate cost of $1.4 million. The share repurchase
program will continue to be supported through existing funds and future cash
flow.
Dividends paid by the insurance subsidiaries to the corporate parent may be
limited by state insurance regulations. The insurance regulator in the insurer's
state of domicile may disapprove any dividend which, together with other
dividends paid by an insurance company in the prior 12 months, exceeds the
regulatory maximum, computed as the lesser of 10% of statutory capital and
surplus or total statutory net gain from operations as of the end of the
preceding calendar year. During 2003, regulatory approval was obtained and
dividends paid to the parent company by an insurance subsidiary were $2.0
million in January 2003 and $11.0 million in December 2003. Based upon the
financial statements of the Company's insurance subsidiaries as of December 31,
2003, as filed with the insurance regulators, the amount available for dividend
without regulatory approval is $6.3 million until December 2004, when a dividend
of $17.3 million can be paid without regulatory approval.
The National Association of Insurance Commissioners has adopted risk-based
capital ("RBC") standards for life and health insurers designed to evaluate the
adequacy of statutory capital and surplus in relation to various business risks
faced by such insurers. The RBC formula is used by state insurance regulators as
an early warning tool to identify insurance companies that potentially are
inadequately capitalized. At December 31, 2003, each of the Company's insurance
subsidiaries had RBC ratios substantially above the levels that would require
Company or regulatory action.
The Company does not expect to pay any cash dividends in the foreseeable future
and intends to employ its earnings in the continued development of its business.
The Company's future dividend policy will depend on its earnings, capital
requirements, debt covenant restrictions, financial condition and other factors
considered relevant by the Company's Board of Directors.
OFF-BALANCE SHEET ARRANGEMENTS
The Company had no off-balance sheet arrangements as of December 31, 2003.
20
CONTRACTUAL OBLIGATIONS
Future payments due on the Company's contractual obligations as of December 31,
2003 are as follows:
Payments due by period
-----------------------------------------------------
Less than More than
(MILLIONS) Total 1 year 1-3 years 3-5 years 5 years
- --------------------------------------------------------------------------------
Line of credit agreement $ 32.2 $ 0.9 $ 31.3 $ - $ -
Operating leases 6.4 3.1 3.2 0.1 -
Purchase obligations 5.0 3.7 1.3 - -
- --------------------------------------------------------------------------------
Total $ 43.6 $ 7.7 $ 35.8 $ 0.1 $ -
================================================================================
In addition to the contractual obligations discussed above, the Company has a
variety of other contractual agreements related to acquiring materials and
services used in its operations. However, management believes these other
agreements do not contain material non-cancelable commitments.
MARKET RISK EXPOSURE
The primary investment objective of the Company is to maximize investment income
while minimizing risks and preserving principal. The Company uses outside
investment managers to manage its investment portfolio within the Company's
investment guidelines. The Company seeks to meet its investment objectives
through diversity of coupon rates, liquidity, investment type, industry, issuer,
duration and geographic location. The Company manages credit risk by seeking to
maintain high average quality ratings and by limiting investments in equity
securities. At December 31, 2003, approximately 99% of the Company's total
investment portfolio was invested in debt securities. The bond portfolio had an
average quality rating of "AA" at December 31, 2003 and 2002, as measured by
Standard & Poor's Corporation, and the Company held no below investment grade
securities at December 31, 2003.
Almost the entire portfolio was classified as available for sale. At December
31, 2003 and 2002, the net unrealized gain on available for sale securities was
$6.1 million and $7.6 million, respectively. The Company had no investments in
mortgage loans, nonpublicly traded securities, real estate held for investment
or financial derivatives.
The primary market risk affecting the Company is interest rate risk. Assuming an
immediate increase of 100 basis points in interest rates, the net hypothetical
decline in fair value of shareholders' equity is estimated to be $7.1 million
after tax at December 31, 2003. This amount represents approximately 3% of the
Company's shareholders' equity.
At December 31, 2003, the fair value of the Company's outstanding balance of
advances under the credit agreement approximated the carrying value. Market risk
was estimated as the potential increase in the fair value resulting from a
hypothetical 1% decrease in the Company's weighted average short-term borrowing
rate at December 31, 2003, and the resulting fair value was not materially
different from the year-end carrying value.
INFLATION
Health care costs have been rising and are expected to continue to rise at a
rate that exceeds the consumer price index. The Company's product pricing and
features are designed to reduce the adverse effect of medical cost inflation on
its operations. In addition, the Company uses its underwriting and medical
management capabilities to help control inflation in health care costs. However,
there can be no assurance that the Company's efforts will fully offset the
impact of inflation or that premium revenue increases will equal or exceed
increasing health care costs.
21
CAUTIONARY FACTORS
This report and other documents or oral presentations prepared or delivered by
and on behalf of the Company contain or may contain "forward-looking statements"
within the meaning of the safe harbor provisions of the United States Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
statements based upon management's expectations at the time such statements are
made. The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Forward-looking statements are subject to risks and
uncertainties that could cause the Company's actual results to differ materially
from those contemplated in the statements. Readers are cautioned not to place
undue reliance on the forward-looking statements. When used in written documents
or oral presentations, the terms "anticipate," "believe," "estimate," "expect,"
"may," "objective," "plan," "possible," "potential," "project," "will" and
similar expressions are intended to identify forward-looking statements. In
addition to the assumptions and other factors referred to specifically in
connection with such statements, factors that could impact the Company's
business and financial prospects include, but are not limited to, those
discussed below and those discussed from time to time in the Company's various
filings with the Securities and Exchange Commission or in other publicly
disseminated written documents:
MEDICAL CLAIMS AND HEALTH CARE COSTS. If the Company is unable to accurately
estimate medical claims and control health care costs, its results of operations
may be materially adversely affected.
The Company estimates the costs of its future medical claims and other expenses
using actuarial methods based upon historical data, medical inflation, product
mix, seasonality, utilization of health care services and other relevant
factors. The Company establishes premiums based on these methods. The premiums
the Company charges its customers generally are fixed for one-year periods, and
therefore, costs the Company incurs in excess of its medical claim projections
generally are not recovered in the contract year through higher premiums.
Certain factors may and often do cause actual health care costs to vary from
what the Company estimated and reflected in premiums. These factors may include,
but not be limited to: (1) an increase in the rates charged by providers of
health care services and supplies, including pharmaceuticals; (2) higher than
expected use of health care services by members; (3) the occurrence of
bioterrorism, catastrophes or epidemics; (4) changes in the demographics of
members and medical trends affecting them; and (5) new mandated benefits or
other regulatory changes that increase the Company's costs. The occurrence of
any of these factors, which are beyond the Company's control, could result in a
material adverse effect on its business, financial condition and results of
operations.
GOVERNMENT REGULATIONS. The Company conducts business in a heavily regulated
industry, and changes in government regulation could increase the costs of
compliance or cause the Company to discontinue marketing its products in certain
states.
The Company's business is extensively regulated by federal and state
authorities. Some of the new federal and state regulations promulgated under the
Health Insurance Portability and Accountability Act of 1996, or HIPAA, relating
to health care reform require the Company to implement changes in its programs
and systems in order to maintain compliance. The Company has incurred
significant expenditures as a result of HIPAA regulations and expects to
continue to incur expenditures as various regulations become effective.
The Company is subject to periodic changes in state laws and regulations
regarding the selection and pricing of risks and other matters. New regulations
regarding these issues could increase the Company's costs and decrease its
premiums. The Company has in the past decided, and may in the future decide, to
discontinue marketing its products in states that have enacted, or are
considering, various health care reform regulations that would impair the
Company's ability to market its products profitably.
Federal and state legislatures also are considering health care reform measures
which may result in higher health insurance costs. Congress is considering
legislation allowing small employers to form association health plans, exempt
from state insurance regulations, which may impact the risk profile of employers
willing to purchase insurance from the Company. In addition, the implementation
of "prompt pay" laws, whereby a claim must be paid in a certain number of days
regardless of whether it is a valid claim or not, subject to a right of
recovery, may have a negative effect on the Company's results of operations.
22
REGULATORY COMPLIANCE. The Company's failure to comply with new or existing
government regulation could subject it to significant fines and penalties.
The Company's efforts to measure, monitor and adjust its business practices to
comply with the law are ongoing. Failure to comply with enacted regulations,
including the laws mentioned above, could require the Company to pay refunds or
result in significant fines, penalties, or the loss of one or more of its
licenses. From time to time the Company is subject to inquiries related to its
activities and practices in states in which it operates. The Company has been
subject to regulatory penalties, assessments and restitution orders in a number
of states. Furthermore, federal and state laws and regulations continue to
evolve. The costs of compliance may cause the Company to change its operations
significantly, or adversely impact the health care provider networks with which
the Company does business, which may adversely affect its business and results
of operations.
LITIGATION. The Company is subject to class actions and other forms of
litigation in the ordinary course of its business, including litigation based on
new or evolving legal theories, which could result in significant liabilities
and costs.
For example, a Florida Circuit Court has found the Company liable for damages in
a class action lawsuit in Florida. The earliest the Company expects the trial to
be held to determine damages is the second quarter of 2004. Further, the Company
is involved in a number of lawsuits in various states that allege
misrepresentation by the Company of its renewal rating methodology. For
additional information, see Part I, Item 3, "Legal Proceedings."
The nature of the Company's business subjects it to a variety of legal actions
and claims relating but not limited to the following: (1) denial of health care
benefits; (2) disputes over rating methodology and practices or termination of
coverage; (3) disputes with agents over compensation or other matters; (4)
disputes related to claim administration errors and failure to disclose network
rate discounts and other fee and rebate arrangements; (5) disputes related to
managed care or cost containment activities, (6) disputes over co-payment
calculations; and (7) customer audits of compliance with the Company's plan
obligations.
The Company cannot predict with certainty the outcome of lawsuits against the
Company or the potential costs involved.
COMPETITION. Competition in the Company's industry may limit its ability to
attract new members or to maintain its existing membership in force.
The Company operates in a highly competitive environment. The Company competes
primarily on the basis of price, benefit plan design, strength of provider
networks, quality of customer service, reputation and quality of agent
relations. The Company competes for members with other health insurance
providers and managed care companies, many of whom have larger membership in
regional markets and greater financial resources. The Company cannot provide
assurance that it will be able to compete effectively in this industry. As a
result, the Company may be unable to attract new members or maintain its
existing membership and its revenues may be adversely affected.
BUSINESS GROWTH STRATEGY. The Company's future operating performance is largely
dependent on its ability to execute its growth strategy.
The Company has experienced a decline in membership over the last several years
as part of its strategy to improve profitability and exit certain markets. The
Company's challenge is to increase the number of individuals and small employer
groups purchasing its products and services while encouraging its current
membership to retain their business relationship with the Company. Also
impacting the Company's growth prospects is the affordability of health
insurance premiums as health care costs rise, as well as the downsizing or
restrained hiring among small employers as a result of economic uncertainty. If
the Company initiatives are not successful and the Company does not meet its
growth goals, the Company's future operating performance may be adversely
affected.
23
INFORMATION SYSTEMS. A failure of the Company's information system could
adversely affect its business.
Information processing is critical to the Company's business. The Company
depends on its information system for timely and accurate information. The
Company's failure to maintain an effective and efficient information system or
disruptions in its information system could cause disruptions in its business
operations, including any of the following: (1) failure to comply with prompt
pay laws; (2) loss of existing members; (3) difficulty in attracting new
members; (4) disputes with members, providers and agents; (5) regulatory
problems; (6) increases in administrative expenses; and (7) other adverse
consequences.
The Company is investing in an enterprise-wide information technology
modernization project involving the purchase of software applications to support
most of the Company's major processes. The design and development of the
software applications began in early 2003, with a phased implementation
scheduled over the next few years. Although the Company is taking measures to
safeguard against disruptions to its information systems during this process, it
cannot provide assurance that disruptions will not occur or that the project
will be successfully implemented or implemented on schedule.
INDEPENDENT AGENT RELATIONSHIPS. The Company depends on the services of
non-exclusive independent agents and brokers to market its products to potential
customers. These agents and brokers frequently market the health insurance
products of competitors as well as the Company's products. Most of the Company's
contracts with agents and brokers are terminable without cause upon 30-days'
notice by either party. The Company faces intense competition for the services
and allegiance of independent agents and brokers. The Company cannot provide
assurance that they will continue to market the Company's products in the future
or that they will not refer the Company's members to competitors.
In addition, the Company has a relationship with a general agent who, along with
affiliated subagents, generated 9% of the Company's premium revenue as of
December 31, 2003. The loss of this relationship could hamper the Company's
growth plans and, as a result, adversely affect the Company's future operating
performance.
NEGATIVE PUBLICITY. Negative publicity regarding the Company's business
practices and about the health insurance industry may harm the Company's
business and operating results.
In 2002, the Company was subject to negative national publicity surrounding its
MedOne(R) rating practices and related legal matters, which management believes
harmed the Company's MedOne(R) new member enrollment during the last half of
2002. The Company changed its rating practices in all MedOne(R) markets
effective January 1, 2003. Adverse publicity about the Company's rating
practices or other matters in the future may affect sales of the Company's
products, which could impede the Company's growth plans.
In addition, the health insurance industry, in general, has received negative
publicity and does not have a positive public perception. This publicity and
perception may lead to increased legislation, regulation, review of industry
practices and private litigation. These factors may adversely affect the
Company's ability to market its products and increase the regulatory burdens
under which the Company operates, further increasing the costs of doing business
and adversely affecting operating results.
INSURANCE RISK MANAGEMENT. If the Company's insurers or reinsurers do not
perform their obligations or offer affordable coverage with reasonable
deductibles or limits, the Company could experience significant losses.
The Company's risk management program includes several insurance policies it has
purchased to cover various property, business and other risks of loss. In
addition, the Company carries policies to cover its directors and officers. Many
of the carriers marketing these lines of coverage are experiencing unfavorable
claims experience and loss of, or increased costs for, their own reinsurance
coverage. Several carriers have exited markets and no longer offer certain lines
of coverage. Accordingly, there is no assurance that the Company will be able to
purchase insurance coverages for its own risk management at affordable premiums
or with reasonable deductibles and policy limits.
24
The Company has entered into and may continue to enter into a variety of
reinsurance arrangements under which it cedes business to other insurance
companies to mitigate large claims risk. Although reinsurance allows for greater
diversification of risk relating to potential losses arising from large claims,
the Company remains liable if these other insurance companies fail to perform
their obligations. As a result, any failure of an insurance company to perform
its obligations under an agreement could expose the Company to significant
losses. Also, there is no assurance that the Company will be able to purchase
reinsurance.
PERSONNEL. Loss of key personnel and the inability to attract and retain
qualified employees could have a material adverse impact on the Company's
operations.
The Company is dependent on the continued services of its management team,
including its key executives. Loss of such personnel without adequate
replacement could have a material adverse effect on the Company. Members of the
Company's senior management have developed relationships with some of the
Company's independent agents and brokers. If the Company is unable to retain
these employees, the loss of their services could adversely impact the Company's
ability to maintain relations with certain independent agents and brokers who
market the Company's products. Additionally, the Company needs qualified
managers and skilled employees with insurance industry experience to operate its
businesses successfully. From time to time there may be shortages of skilled
labor that may make it more difficult and expensive for the Company to attract
and retain qualified employees. If the Company is unable to attract and retain
qualified individuals or its costs to do so increase significantly, its
operations could be materially adversely affected.
PROVIDER NETWORK RELATIONSHIPS. The Company's inability to enter into or
maintain satisfactory relationships with provider networks could harm
profitability.
The Company's profitability could be adversely impacted by its inability to
contract on favorable terms with networks of hospitals, physicians, dentists,
pharmacies and other health care providers. The failure to secure cost-effective
health care provider network contracts may result in a loss of membership or
higher medical costs. In addition, the inability to contract with provider
networks, the inability to terminate contracts with existing provider networks
and enter into arrangements with new provider networks to serve the same market,
and/or the inability of providers to provide adequate care, could adversely
affect the Company's results of operations.
A.M. BEST INSURANCE RATING. If the Company's insurance subsidiaries are not able
to maintain their current rating by A.M. Best Company, the Company's results of
operations could be materially adversely affected.
The Company's insurance subsidiaries are assigned a rating by A.M. Best Company,
a nationally recognized rating agency. The rating reflects A.M. Best Company's
opinion of the insurance subsidiaries' financial strength, operating results and
ability to meet their ongoing obligations. Decreases in operating performance
and other financial measures may result in a downward adjustment of A.M. Best
Company's rating of the insurance subsidiaries. In addition, other factors
beyond the Company's control such as general downward economic cycles and
changes implemented by the rating agencies, including changes in the criteria
for the underwriting or the capital adequacy model, may result in a decrease in
the rating. A downward adjustment in A.M. Best's rating of the Company's
insurance subsidiaries could cause the Company's agents or potential customers
to look at the Company with less favor, which could have a material adverse
effect on the Company's results of operations.
REGULATION LIMITING TRANSFER OF FUNDS. Regulations governing the Company's
insurance subsidiaries could affect its ability to satisfy its obligations to
creditors as they become due, including obligations under the Company's credit
facility.
The Company's insurance subsidiaries are subject to regulations that limit their
ability to transfer funds to the Company. If the Company is unable to obtain
funds from its insurance subsidiaries, it will experience reduced cash flow,
which could affect the Company's ability to pay its obligations to creditors as
they become due. The Company will be required to make a lump-sum payment of the
outstanding balance under its credit facility at the end of 2005. The Company's
outstanding balance at December 31, 2003 was $30.2 million. If the Company's
insurance subsidiaries are unable to provide these funds, the Company could
default on its obligations under the credit facility.
25
CAPITAL AND SURPLUS REQUIREMENTS. If the Company's regulated insurance
subsidiaries are not able to comply with state capital standards, state
regulators may require the Company to take certain actions that could have a
material adverse effect on its results of operations and financial condition.
State regulations govern the amount of capital required to be retained in the
Company's regulated insurance subsidiaries and the ability of those regulated
subsidiaries to pay dividends. Those state regulations include the requirement
to maintain minimum levels of statutory capital and surplus, including meeting
the requirements of the risk-based capital standards promulgated by the National
Association of Insurance Commissioners. State regulators have broad authority to
take certain actions in the event those capital requirements are not met. Those
actions could significantly impact the way the Company conducts its business,
reduce its ability to access capital from the operations of its regulated
insurance subsidiaries and have a material adverse effect on its results of
operations and financial condition. Any new minimum capital requirements adopted
in the future through state regulation may increase the Company's capital
requirements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Market Risk Exposure" for information concerning
potential market risks related to the Company's investment portfolio.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Shareholders
American Medical Security Group, Inc.
We have audited the accompanying consolidated balance sheets of American Medical
Security Group, Inc. and its subsidiaries (the "Company") as of December 31,
2003 and 2002, and the related consolidated statements of operations, changes in
shareholders' equity and comprehensive income (loss) and cash flows for each of
the three years in the period ended December 31, 2003. Our audits also included
the financial statement schedules listed in the Index at Item 15. These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 consolidated financial position of the
Company as of December 31, 2003 and 2002, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.
As discussed in Note 2, in 2002 the Company changed its method of accounting for
goodwill and other intangible assets.
Ernst & Young LLP
Milwaukee, Wisconsin
January 28, 2004
27
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------------
(THOUSANDS, EXCEPT SHARE DATA) 2003 2002
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Fixed maturity securities:
Available for sale, at fair value $ 302,277 $ 278,222
Held to maturity, at amortized cost 3,377 4,288
Trading securities, at fair value 1,424 926
- --------------------------------------------------------------------------------------------------------------------
Total investments 307,078 283,436
Cash and cash equivalents 17,289 30,620
Property and equipment, net 37,446 33,061
Goodwill 32,138 32,846
Other intangibles, net 1,957 2,860
Other assets 48,179 46,117
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 444,087 $ 428,940
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Medical and other benefits payable $ 129,809 $ 134,479
Advance premiums 15,865 15,200
Payables and accrued expenses 24,099 29,141
Notes payable 30,158 33,858
Other liabilities 26,332 33,512
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 226,263 246,190
Shareholders' equity:
Preferred stock (no par value, 477,121 shares authorized) - -
Common stock (no par value, $1 stated value, 50,000,000 shares authorized,
16,654,315 issued and 13,511,183 outstanding at December 31, 2003,
16,654,315 issued and 12,905,898 outstanding at December 31, 2002) 16,654 16,654
Paid-in capital 194,431 189,813
Retained earnings 32,168 2,858
Accumulated other comprehensive income (net of taxes
of $3,302 in 2003 and $4,117 in 2002) 6,133 7,646
Treasury stock (3,143,132 shares at December 31, 2003
and 3,748,417 shares at December 31, 2002, at cost) (31,562) (34,221)
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 217,824 182,750
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 444,087 $ 428,940
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
28
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 712,418 $ 754,460 $ 838,672
Net investment income 13,531 15,005 17,443
Net realized investment gains (losses) 1,910 39 (779)
Other revenue 15,857 16,806 17,637
- --------------------------------------------------------------------------------------------------------------------
Total revenues 743,716 786,310 872,973
EXPENSES
Medical and other benefits 478,497 508,670 603,220
Selling, general and administrative 217,282 236,831 252,116
Interest 1,255 1,848 2,877
Amortization of goodwill and other intangibles 903 730 3,628
- --------------------------------------------------------------------------------------------------------------------
Total expenses 697,937 748,079 861,841
Income from continuing operations, before income tax expense 45,779 38,231 11,132
Income tax expense 17,201 15,082 6,460
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations 28,578 23,149 4,672
Income (loss) from discontinued operations 732 (663) (497)
- --------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a change in
accounting principle 29,310 22,486 4,175
Cumulative effect of a change in accounting principle - (60,098) -
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 29,310 $ (37,612) $ 4,175
====================================================================================================================
Earnings (loss) per common share - basic:
Income from continuing operations $ 2.15 $ 1.77 $ 0.33
Income (loss) from discontinued operations 0.06 (0.05) (0.04)
Cumulative effect of a change in accounting principle - (4.61) -
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 2.21 $ (2.88) $ 0.30
====================================================================================================================
Earnings (loss) per common share - diluted:
Income from continuing operations $ 2.03 $ 1.67 $ 0.33
Income (loss) from discontinued operations 0.05 (0.05) (0.04)
Cumulative effect of a change in accounting principle - (4.34) -
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 2.08 $ (2.72) $ 0.29
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
29
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ 29,310 $ (37,612) $ 4,175
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Cumulative effect of a change in accounting principle - 60,098 -
Net gain from sale of subsidiary (950) - -
Depreciation and amortization 10,519 8,957 10,493
Net realized investment losses (gains) (1,910) (39) 779
Net change in trading securities (498) (409) (257)
Deferred income tax expense (benefit) 2,743 (13,374) 609
Changes in operating accounts:
Other assets (3,993) 7,206 7,722
Medical and other benefits payable (4,670) (1,025) (9,806)
Advance premiums 665 (1,537) (831)
Payables and accrued expenses (5,522) 1,109 2,130
Other liabilities (5,568) 11,801 2,576
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 20,126 35,175 17,590
INVESTING ACTIVITIES
Proceeds from sale of subsidiary 3,500 - -
Purchases of available for sale securities (147,719) (174,920) (143,148)
Proceeds from sale of available for sale securities 112,087 168,338 129,038
Proceeds from maturity of available for sale securities 9,350 6,550 15,417
Proceeds from maturity of held to maturity securities 600 1,925 -
Purchases of held to maturity securities - (1,925) -
Purchases of property and equipment (11,982) (6,756) (6,546)
Proceeds from sale of property and equipment 6 8 21
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (34,158) (6,780) (5,218)
FINANCING ACTIVITIES
Exercise of stock options 5,759 2,990 413
Purchase of treasury stock (1,358) (19,540) (2,216)
Proceeds from notes payable borrowings - 30,158 -
Repayment of notes payable (3,700) (36,358) (1,200)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 701 (22,750) (3,003)
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
Net increase (decrease) during year (13,331) 5,645 9,369
Balance at beginning of year 30,620 24,975 15,606
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 17,289 $ 30,620 $ 24,975
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
30
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
Accumulated
Other
Common Stock Paid-In Retained Comprehensive Treasury
(THOUSANDS, EXCEPT SHARE DATA) Shares Amount Capital Earnings Income (Loss) Stock Total
- --------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2001 16,654,315 $ 16,654 $ 187,956 $ 36,295 $ (3,948) $ (15,780) $ 221,177
Comprehensive income:
Net income 4,175 4,175
Change in net unrealized gain (loss) on
securities, net of taxes of $3,150 5,851 5,851
------------
Comprehensive income 10,026
------------
Exercise of stock options (29) 442 413
Purchase of treasury stock
(367,262 shares, at cost) (2,216) (2,216)
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 16,654,315 16,654 187,927 40,470 1,903 (17,554) 229,400
Comprehensive loss:
Net loss (37,612) (37,612)
Change in net unrealized gain (loss) on
securities, net of taxes of $3,093 5,743 5,743
------------
Comprehensive loss (31,869)
------------
Exercise of stock options 1,886 2,873 4,759
Purchase of treasury stock
(1,400,000 shares, at cost) (19,540) (19,540)
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 16,654,315 16,654 189,813 2,858 7,646 (34,221) 182,750
Comprehensive income:
Net income 29,310 29,310
Change in net unrealized gain (loss) on
securities, net of taxes of $815 (1,513) (1,513)
------------
Comprehensive income 27,797
------------
Exercise of stock options 4,618 4,017 8,635
Purchase of treasury stock
(87,900 shares, at cost) (1,358) (1,358)
- --------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 16,654,315 $ 16,654 $ 194,431 $ 32,168 $ 6,133 $ (31,562) $ 217,824
================================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
31
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
American Medical Security Group, Inc., through its subsidiary companies (the
"Company"), is a provider of individual and small employer group insurance
products. The Company's principal product offerings are medical insurance for
small employer groups and medical insurance marketed to individuals and their
families ("MedOne(R)"). The Company also offers dental, life, prescription drug,
disability and accidental death insurance, and provides self-funded benefit
administration. The Company has two reportable segments: health insurance
products (which accounted for approximately 98% of the Company's total premium
revenues in 2003, 2002 and 2001) and life insurance products. The Company
markets its products in 32 states and the District of Columbia through
independent agents. At December 31, 2003, the Company's leading states with
respect to medical membership were Illinois, Michigan, Florida and Texas, each
individually representing approximately 10% of the Company's total medical
membership. The Company has approximately 75 sales managers and representatives
located in sales offices throughout the United States to support the independent
agents. The Company has a relationship with a general agent who, along with
affiliated subagents, generated approximately 9% of the Company's premium
revenue in 2003. The Company's products generally provide discounts to members
that utilize preferred provider organizations with which the Company contracts.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. Significant intercompany accounts and transactions have been
eliminated. The accompanying consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States ("GAAP"). The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying
notes. These estimates are based on knowledge of current events and anticipated
future events, and accordingly, actual results may differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include operating cash and short-term investments with
original maturities of three months or less. These amounts are recorded at cost,
which approximates fair value.
INVESTMENTS
The Company's investments are classified in three categories. Investments that
the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity securities and are reported at amortized cost.
Assets which are invested for the purpose of supporting the Company's
nonqualified executive retirement plan are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings as
net investment income. All other investments are classified as
available-for-sale securities and are reported at fair value based on quoted
market prices. Unrealized gains and losses on available-for-sale securities are
excluded from earnings and reported as a separate component of shareholders'
equity as accumulated other comprehensive income or loss, net of income tax
effects.
The Company evaluates securities for other-than-temporary impairment on a
periodic basis and principally considers the type of security, the rating as
determined by a nationally recognized securities rating organization, the
severity of the decline in fair value and the duration of the decline in fair
value in determining whether a security's decline in fair value is other than
temporary. Realized gains and losses from the sale or write-down for
other-than-temporary impairments of available-for-sale securities are calculated
using the specific identification method.
32
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of investments are reported in Note 5, "Investments." The fair
values of all other financial instruments approximate their December 31, 2003
and 2002 carrying values.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Property and equipment includes capitalized costs to develop or obtain computer
software for internal use when such costs are specifically identifiable, have
determinate lives and relate to probable future economic benefits. Depreciation
is calculated using the straight-line method over the estimated useful lives of
assets. Estimated useful lives are 20 to 30 years for land improvements, 10 to
40 years for buildings and building improvements, three to five years for
computer equipment and software and three to 10 years for furniture and other
equipment.
The Company has various operating lease obligations primarily for office space
and equipment. The Company's total lease expense was $3,433,000 in 2003,
$4,197,000 in 2002 and $4,818,000 in 2001. Estimated future minimum lease
payment obligations as of December 31, 2003 for each of the next five years are
as follows:
2004: $ 3,138,000
2005: 1,971,000
2006: 939,000
2007: 292,000
2008: 121,000
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of cost over the fair market value of net assets
acquired. Effective January 1, 2002, goodwill is no longer amortized and is
subject to impairment testing as a result of the adoption of a new accounting
standard. See Note 2, "Adopted Accounting Standard" for a detailed discussion of
the impact of this accounting standard. The Company completed its annual
goodwill impairment test during the fourth quarter of 2003 and determined that
its remaining balance of goodwill was not impaired as of December 31, 2003.
Goodwill impairment tests are performed at least annually, and future goodwill
impairments, if any, will be classified as operating expenses in the Company's
statement of operations.
During 2003, the Company sold its preferred provider organization network
subsidiary, Accountable Health Plans of America, Inc. ("AHP"). Goodwill
associated with AHP of $708,000 was removed from the balance sheet in
conjunction with the sale of the subsidiary. See Note 3, "Discontinued
Operations" for further detail regarding the sale of this subsidiary and its
affect on the Company's consolidated financial statements.
As of December 31, 2003 and 2002, goodwill balances by segment amounted to
$12,722,000 for health insurance and $19,416,000 for life insurance. The
Company's other intangible asset is net of accumulated amortization of
$5,346,000 at December 31, 2003 and $4,443,000 at December 31, 2002.
Amortization expense is expected to be approximately $652,000 for each of the
next three years.
MEDICAL AND OTHER BENEFITS PAYABLE
The liabilities for medical and other benefits represent estimates of the
ultimate net cost of all reported and unreported claims that are unpaid at year
end. These estimates are developed using actuarial methods based upon historical
data for payment patterns, cost trends, product mix, seasonality, utilization of
health care services and other relevant factors. Estimated liabilities for
asserted claims and policy-related litigation, which are included in medical and
other benefits payable, reflect judgments made by management based on the facts
and merits of the case, advice from legal counsel, the general litigation and
regulatory environment of the originating state, the Company's past experience
with outcomes of cases in a particular jurisdiction, historical results of
similar cases and other relevant factors. The estimates are reviewed
periodically and, as adjustments to the liabilities become necessary, the
adjustments are reflected in current operations. Although considerable
variability is inherent in these estimates,
33
management believes that the amount of medical and other benefits payable is
adequate to cover the Company's liability for unpaid amounts as of December 31,
2003.
POLICY ACQUISITION COSTS
Policy acquisition costs consist of commissions and other administrative costs
that the Company incurs to acquire new business. The Company does not defer
policy acquisition costs. Premium is collected and billed and commissions and
other administrative costs are incurred on a month-to-month basis. Policy
acquisition costs are expensed in the period incurred.
PREMIUM DEFICIENCY RESERVES
The Company recognizes premium deficiency reserves on an existing group of
insurance contracts when the sum of expected future claim costs, claim
adjustment expenses and related maintenance expenses exceeds the expected future
premium revenue and investment income. Insurance contracts are grouped using a
methodology consistent with the Company's manner of acquiring, servicing and
measuring the profitability of its business. The Company continues to evaluate
assumptions used in the premium deficiency reserve analysis and records or
adjusts premium deficiency reserves as necessary. As of December 31, 2003 and
2002, no premium deficiency reserves were required.
REINSURANCE
Reinsurance premiums, commissions and expense reimbursements on reinsured
business are accounted for on a basis consistent with those used in accounting
for the original policies issued and the terms of the reinsurance contracts.
Premiums and benefits ceded to other companies have been reported as a reduction
of premium revenue and benefits in the Company's statement of operations.
Reinsurance receivables and prepaid reinsurance premiums are reported as other
assets on the Company's balance sheets.
The Company limits the maximum net loss that can arise from certain lines of
business by reinsuring (ceding) a portion of these risks with other insurance
organizations (reinsurers) on an excess of loss basis. The Company's retention
limit per covered life is $500,000 per policy year for medical claims and
$50,000 for life claims. The Company also cedes, on a quota share basis, 100% of
the risk on certain life policies to a prior affiliate in exchange for a ceding
commission. The Company is liable on reinsurance ceded in the event that the
reinsurers do not meet their contractual obligations.
A summary of reinsurance ceded is as follows:
Year ended December 31,
--------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------
Excess of loss reinsurance ceded:
Insurance premiums $ 3,505 $ 2,049 $ 2,364
Medical and other benefits 4,969 1,715 1,720
Quota share reinsurance ceded:
Insurance premiums $ 15,334 $ 18,975 $ 19,113
Medical and other benefits 12,375 15,001 12,251
34
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial statement
purposes and the amounts used for income tax purposes. A valuation allowance is
recognized when, based on available evidence, it is more likely than not that
the deferred tax asset may not be realized.
REVENUE RECOGNITION
Premiums for health and life policies are recognized ratably over the period
that insurance coverage is provided. Other revenue, including administrative fee
income from claim processing and other administrative services, is recognized in
the period the service is provided.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, the intrinsic
value method of accounting for stock-based compensation, where no compensation
expense is recorded when the exercise price of the Company's employee stock
options equals the market price of the underlying stock on the date of grant.
The following table illustrates the pro forma net income and pro forma net
income per share as if the Company had followed the fair value method of
accounting for stock-based compensation under Statement of Financial Accounting
Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement 123").
In determining compensation expense in accordance with Statement 123, the fair
value of options was estimated at the date of grant using the Black-Scholes
option valuation model, which is commonly used in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable.
Option valuation models require the input of highly subjective assumptions
including the expected stock price volatility and the expected life of the
options. Since 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 estimates, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The following assumptions were made in determining the compensation expense in
accordance with Statement 123:
Year ended December 31,
------------------------------------------------
2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Expected life of options 6 years 6 years 6 years
Risk-free interest rate 3.50% 4.89% 4.67%
Expected dividend yield 0.00% 0.00% 0.00%
Expected volatility factor 50% 51% 53%
Weighted average grant date fair value of options:
Exercise price equals market price $ 7.44 $ 6.64 $ 5.51
Exercise price is less than market price $ - $ - $ -
Exercise price exceeds market price $ - $ - $ -
35
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 is as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 29,310 $ (37,612) $ 4,175
Pro forma compensation expense
in accordance with Statement 123, net of tax (1,569) (1,332) (1,119)
- --------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) $ 27,741 $ (38,944) $ 3,056
====================================================================================================================
Net income (loss) per common share, as reported:
Basic $ 2.21 $ (2.88) $ 0.30
Diluted $ 2.08 $ (2.72) $ 0.29
Pro forma net income (loss) per common share:
Basic $ 2.09 $ (2.98) $ 0.22
Diluted $ 1.97 $ (2.83) $ 0.21
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is defined as net income (loss) plus or minus other
comprehensive income (loss). For the Company, under existing accounting
standards, other comprehensive income (loss) includes unrealized gains and
losses, net of income tax effects, on certain investments in debt and equity
securities. Comprehensive income (loss) is reported by the Company in the
consolidated statements of changes in shareholders' equity and comprehensive
income (loss).
EARNINGS PER COMMON SHARE ("EPS")
Basic EPS is computed by dividing earnings by the weighted average number of
common shares outstanding. Diluted EPS is computed by dividing earnings by the
weighted average number of common shares outstanding, adjusted for the effect of
dilutive stock options.
The following table illustrates the computation of EPS for income from
continuing operations and provides a reconciliation of the number of weighted
average basic and diluted shares outstanding:
Year ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Numerator:
Income from continuing operations $ 28,578 $ 23,149 $ 4,672
====================================================================================================================
Denominator:
Denominator for basic EPS 13,270,483 13,046,777 14,048,545
Effect of dilutive employee stock options 829,919 788,564 179,143
- --------------------------------------------------------------------------------------------------------------------
Denominator for diluted EPS 14,100,402 13,835,341 14,227,688
====================================================================================================================
Earnings per common share - income from continuing operations
Basic $ 2.15 $ 1.77 $ 0.33
Diluted $ 2.03 $ 1.67 $ 0.33
Options to purchase 2,635,762, 2,922,492 and 3,243,767 shares of common stock
were outstanding at December 31, 2003, 2002 and 2001, respectively. Of those
shares, approximately 5,000, 162,000 and 1,914,000 were excluded
36
from the computation of diluted earnings per common share for the respective
years because the option's exercise price was greater than the average market
price of common shares and, therefore, the effect would be antidilutive.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year amounts to conform to the
current year presentation.
2. ADOPTED ACCOUNTING STANDARD
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS ("Statement 142").
Statement 142 impacts the Company in two ways. First, goodwill is no longer
amortized. Second, goodwill was subject to an initial impairment test in
accordance with Statement 142, and any remaining balance of goodwill is subject
to continuing impairment testing at least annually.
The Company completed the initial goodwill impairment test during the second
quarter of 2002. The Company's measurement of fair value was based on an
evaluation of ranges of future discounted cash flows, public company trading
multiples and market comparisons of similar assets and liabilities. This
evaluation utilized assumptions and projections based on the best information
available to management. Certain key assumptions considered included forecasted
trends in membership, revenue, medical costs, operating expenses and effective
tax rates. As a result of this initial impairment test, the Company recognized a
non-cash goodwill impairment charge of $60,098,000. The impairment charge was
recorded as a cumulative effect of a change in accounting principle as of
January 1, 2002. The impairment charge had no impact on cash flows or the
statutory-basis capital and surplus of the Company's insurance subsidiaries.
Also on January 1, 2002, in accordance with Statement 142, the Company
reclassified an intangible asset into goodwill because it did not meet the new
recognition criteria for an intangible asset to be recognized apart from
goodwill. The reclassification had the effect of reducing goodwill by
$7,399,000, representing the elimination of the deferred tax liability related
to the reclassified intangible asset. The amortization period used prior to 2002
for this intangible asset was the same as the amortization period for goodwill.
The following table illustrates net income (loss) and net income (loss) per
share adjusted to exclude the effects of amortizing goodwill:
Year Ended December 31,
------------------------------------------------
(THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Reported net income (loss) $ 29,310 $ (37,612) $ 4,175
Add back: goodwill amortization - - 2,685
- --------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 29,310 $ (37,612) $ 6,860
====================================================================================================================
Basic earnings (loss) per common share:
Reported net income (loss) $ 2.21 $ (2.88) $ 0.30
Goodwill amortization - - 0.19
- --------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 2.21 $ (2.88) $ 0.49
====================================================================================================================
Diluted earnings (loss) per common share:
Reported net income (loss) $ 2.08 $ (2.72) $ 0.29
Goodwill amortization - - 0.19
- --------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 2.08 $ (2.72) $ 0.48
====================================================================================================================
37
3. DISCONTINUED OPERATIONS
During the third quarter of 2003, the Company sold all of the outstanding common
shares of its preferred provider organization network subsidiary, AHP for
$3,500,000. The network contracted with more than 900 hospitals and 100,000
physicians in eight primary states: Arizona, Florida, Iowa, Nebraska, North
Dakota, South Dakota, Texas and Wisconsin. Subject to the terms of the
agreement, AHP will continue to provide network services to the Company for five
years. At the time of the sale, AHP served approximately 13% of the Company's
members.
Included in income (loss) from discontinued operations are net operating results
of the AHP networking business sold. The sale transaction resulted in a gain of
$1,950,000, or $950,000 net of tax, which is included in income from
discontinued operations in the Company's statement of operations for 2003. The
operating results from discontinued operations in 2003, 2002 and 2001 included
revenues of $1,923,000, $3,219,000 and $3,648,000 and income tax benefits of
$165,000, $406,000 and $203,000, respectively. As a result of the sale
transaction, goodwill on the Company's December 31, 2003 balance sheet was
reduced by $708,000. All prior periods presented in the Company's statement of
operations have been reclassified to exclude the results of the discontinued
networking business from reported income from continuing operations.
4. MEDICAL AND OTHER BENEFITS PAYABLE
Activity related to liabilities for unpaid claims included in medical and other
benefits payable is summarized as follows:
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------
Balance at January 1 $ 126,477 $ 128,330 $ 134,690
Less reinsurance recoverables 312 1,351 476
- --------------------------------------------------------------------------------
Net balance at January 1 126,165 126,979 134,214
Incurred related to:
Current year 493,513 516,229 613,769
Prior years (14,659) (7,881) (12,026)
- --------------------------------------------------------------------------------
Total incurred 478,854 508,348 601,743
Paid related to:
Current year 373,776 391,414 488,678
Prior years 110,181 117,748 120,300
- --------------------------------------------------------------------------------
Total paid 483,957 509,162 608,978
- --------------------------------------------------------------------------------
Net balance at December 31 121,062 126,165 126,979
Plus reinsurance recoverables 1,326 312 1,351
- --------------------------------------------------------------------------------
Balance at December 31 $ 122,388 $ 126,477 $ 128,330
================================================================================
The incurred amounts related to prior years represent the differences between
the Company's estimated medical and other benefits payable for prior years'
claims and the actual or remaining estimated amounts required to satisfy such
claims. Actual amounts differ from previously recorded liabilities due primarily
to inherent variabilities associated with estimating health insurance benefits
payable and litigation liabilities. The liabilities for unpaid claims at
December 31, 2002, 2001 and 2000 developed redundant in the subsequent years by
$14,659,000, $7,881,000 and $12,026,000, respectively. The developed redundancy
on the December 31, 2002 liability resulted primarily from lower than
anticipated health care utilization and claim costs.
38
In determining the liability for unpaid claims at December 31, 2001, management
anticipated increased utilization by the general population of mental health and
other health care services in the fourth quarter of 2001 due to various factors
including the indirect impact of the September 11, 2001 events and subsequent
bio-terrorism threats and attacks. The Company did not experience a discernable
adverse impact from these factors and events during 2002 or 2003, which accounts
for the developed redundancy on the liability as of December 31, 2001. The
reserves related to September 11, 2001 events are no longer held as of December
31, 2003 and 2002. The developed redundancy on the liability as of December 31,
2000 was due to an improvement as compared to previous years in the Company's
average medical claims cost per member in late 2000. No additional premiums are
collected or returned as a result of incurred claims from prior years.
5. INVESTMENTS
The amortized cost and estimated fair values of investments are as follows:
Gross Gross
Amortized Unrealized Unrealized Estimated
(THOUSANDS) Cost Gains Losses Fair Value
- --------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 2003:
Fixed maturity securities available for sale:
U.S. Treasury securities $ 34,644 $ 670 $ (29) $ 35,285
Corporate debt securities 136,210 6,028 (128) 142,110
Foreign government securities 10,745 615 (33) 11,327
Government agency mortgage-backed securities 95,171 2,064 (301) 96,934
Municipal securities 16,072 600 (51) 16,621
- --------------------------------------------------------------------------------------------------------------------
292,842 9,977 (542) 302,277
Fixed maturity securities held to maturity:
U.S. Treasury securities 3,377 185 - 3,562
- --------------------------------------------------------------------------------------------------------------------
$ 296,219 $ 10,162 $ (542) $ 305,839
====================================================================================================================
Gross Gross
Amortized Unrealized Unrealized Estimated
(THOUSANDS) Cost Gains Losses Fair Value
- --------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 2002:
Fixed maturity securities available for sale:
U.S. Treasury securities $ 56,781 $ 2,519 $ - $ 59,300
Corporate debt securities 100,664 5,272 (335) 105,601
Foreign government securities 11,657 674 - 12,331
Government agency mortgage-backed securities 87,709 3,028 - 90,737
Municipal securities 9,648 605 - 10,253
- --------------------------------------------------------------------------------------------------------------------
266,459 12,098 (335) 278,222
Fixed maturity securities held to maturity:
U.S. Treasury securities 4,288 277 - 4,565
- --------------------------------------------------------------------------------------------------------------------
$ 270,747 $ 12,375 $ (335) $ 282,787
====================================================================================================================
39
The amortized cost and estimated fair values of debt securities at December 31,
2003 by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations.
AVAILABLE-FOR-SALE HELD-TO-MATURITY
------------------ ----------------
Amortized Estimated Amortized Estimated
(THOUSANDS) Cost Fair Value Cost Fair Value
- --------------------------------------------------------------------------------------------------------------------
Due in one year or less $ 16,903 $ 17,025 $ 474 $ 480
Due after one through five years 84,500 88,414 2,903 3,082
Due after five through ten years 62,960 65,941 - -
Due after ten years 33,308 33,963 - -
- --------------------------------------------------------------------------------------------------------------------
197,671 205,343 3,377 3,562
Government agency mortgage-backed securities 95,171 96,934 - -
- --------------------------------------------------------------------------------------------------------------------
$ 292,842 $ 302,277 $ 3,377 $ 3,562
====================================================================================================================
For temporarily impaired securities, the following table illustrates the fair
value and gross unrealized losses, aggregated by investment category and length
of time that individual securities have been in a continuous unrealized loss
position, at December 31, 2003.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
------------------- ----------------- -----
Fair Unrealized Fair Unrealized Fair Unrealized
(THOUSANDS) Value Loss Value Loss Value Loss
- --------------------------------------------------------------------------------------------------------------------
U.S. Treasury securities $ 4,485 $ (29) $ - $ - $ 4,485 $ (29)
Corporate debt securities 15,848 (124) 303 (4) 16,151 (128)
Foreign government securities 765 (33) - - 765 (33)
Government agency mortgage-backed 24,290 (301) - - 24,290 (301)
Municipal securities 1,064 (51) - - 1,064 (51)
- --------------------------------------------------------------------------------------------------------------------
Total temporarily impaired securities $ 46,452 $ (538) $ 303 $ (4) $ 46,755 $ (542)
====================================================================================================================
The Company believes that all unrealized losses on individual securities are the
result of normal price fluctuations due to market conditions and are not an
indication of an other-than-temporary impairment. This determination is based
upon the relatively small levels of losses and the fact that all securities are
rated investment grade as determined by Standard & Poor's Corporation.
Unrealized gains (losses) are computed as the difference between estimated fair
value and amortized cost for fixed maturities and equity securities classified
as available for sale. A summary of the net change in unrealized gains (losses),
which is included in accumulated other comprehensive income (loss), is as
follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Fixed maturities $ (2,328) $ 8,850 $ 8,847
Equity securities - (14) 154
- --------------------------------------------------------------------------------------------------------------------
Net change in unrealized gains (losses) $ (2,328) $ 8,836 $ 9,001
====================================================================================================================
40
Changes in accumulated other comprehensive income (loss) related to changes in
unrealized gains and losses on securities are as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Change in net unrealized gain (loss) on securities, net of taxes $ (272) $ 5,768 $ 5,345
Less: reclassification adjustment for gains (losses) included in
net income (loss), net of tax expense of $669 and $14 in 2003 and
2002, respectively, and net of tax benefit of $273 in 2001 1,241 25 (506)
- --------------------------------------------------------------------------------------------------------------------
Change in net unrealized gain (loss) on securities, net of taxes $ (1,513) $ 5,743 $ 5,851
====================================================================================================================
Net investment income and net realized investment gains (losses) include the
following:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Net investment income:
Interest on fixed maturities $ 13,162 $ 14,290 $ 15,728
Dividends on equity securities - 18 148
Unrealized gain (loss) on trading securities 144 (66) (34)
Interest on cash equivalents and other investment income 933 1,384 2,223
Investment expenses (708) (621) (622)
- --------------------------------------------------------------------------------------------------------------------
Net investment income $ 13,531 $ 15,005 $ 17,443
====================================================================================================================
Net realized investment gains (losses):
Realized investment gains $ 2,617 $ 2,972 $ 1,544
Realized investment losses (707) (2,933) (2,323)
- --------------------------------------------------------------------------------------------------------------------
Net realized investment gains (losses) $ 1,910 $ 39 $ (779)
====================================================================================================================
At December 31, 2003, the Company's insurance subsidiaries had fixed securities
on deposit with various state insurance departments with carrying values of
$3,377,000.
6. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are summarized as follows:
December 31,
--------------------------------
(THOUSANDS) 2003 2002
- --------------------------------------------------------------------------------------------------------------------
Land and land improvements $ 3,942 $ 3,930
Building and building improvements 24,693 24,489
Computer equipment and software 31,257 22,771
Furniture and other equipment 16,467 14,826
- --------------------------------------------------------------------------------------------------------------------
76,359 66,016
Less accumulated depreciation (38,913) (32,955)
- --------------------------------------------------------------------------------------------------------------------
$ 37,446 $ 33,061
====================================================================================================================
The Company recognized depreciation expense on property and equipment of
$6,816,000, $7,064,000 and $5,555,000 in 2003, 2002 and 2001, respectively.
41
7. DEBT
Notes payable consists of the following:
December 31,
--------------------------
(THOUSANDS) 2003 2002
- --------------------------------------------------------------------------------
Line of credit, commercial banks, adjusted
periodically, interest payments due quarterly
through December 2005 $ 30,158 $ 30,158
Mortgage payable, commercial bank, 9.05% interest - 3,700
- --------------------------------------------------------------------------------
$ 30,158 $ 33,858
================================================================================
The Company maintains a revolving bank line of credit agreement with maximum
available credit of $50,000,000. At December 31, 2003, the outstanding balance
of advances under the credit agreement was $30,158,000. Interest is charged on
the outstanding balance based upon an indexed floating rate of interest. The
credit agreement provides for a lump-sum repayment of the outstanding balance at
the end of 2005. During 2003, 2002 and 2001, interest paid on the Company's
outstanding debt totaled $1,060,000, $1,856,000 and $2,931,000, respectively.
The credit agreement contains customary covenants which, among other matters,
require the Company to achieve certain minimum financial results, prohibit the
Company from paying future cash dividends, and restrict or limit the Company's
ability to incur additional debt and dispose of assets outside the ordinary
course of business. The Company was in compliance with all such covenants at
December 31, 2003. The Company's obligations under the credit agreement are
guaranteed by its subsidiary, American Medical Security Holdings, Inc. ("AMS
Holdings"), and secured by pledges of stock of AMS Holdings and United Wisconsin
Life Insurance Company, the Company's principal insurance subsidiary.
8. INCOME TAXES
The Company and most of its subsidiaries file a consolidated federal income tax
return. The Company and its subsidiaries file separate state franchise, income
and premium tax returns as applicable.
The Company had a net current federal income tax payable of $1,818,000 and
$6,520,000 at December 31, 2003 and 2002, respectively. The Company and its
subsidiaries had state net business loss carryforwards totaling $94,326,000 at
December 31, 2003, which will begin to expire in the year 2008.
The components of income tax expense are as follows:
Year ended December 31,
------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------
Current:
Federal $ 14,213 $ 26,774 $ 5,602
State 245 1,682 249
- --------------------------------------------------------------------------------
14,458 28,456 5,851
Deferred:
Federal 1,320 (12,575) (335)
State 280 (809) (342)
Valuation allowance 1,143 10 1,286
- --------------------------------------------------------------------------------
2,743 (13,374) 609
- --------------------------------------------------------------------------------
Income tax expense $ 17,201 $ 15,082 $ 6,460
================================================================================
42
The differences between income tax expense computed at the federal statutory
rate and recorded income tax expense are as follows:
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Income tax expense at federal statutory rate $ 16,023 $ 13,380 $ 3,896
Goodwill amortization - - 829
Stock issuance costs - 250 -
State income and franchise taxes, net of federal benefit 648 612 529
Other, net 530 840 1,206
- --------------------------------------------------------------------------------------------------------------------
Income tax expense $ 17,201 $ 15,082 $ 6,460
====================================================================================================================
Significant components of the Company's federal and state deferred tax
liabilities and assets are as follows:
December 31, 2003 December 31, 2002
----------------------------------------------------------------
(THOUSANDS) Federal State Federal State
- --------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Insurance liabilities $ 13,717 $ 705 $ 13,030 $ 670
Unearned income 2,691 151 3,139 175
Employee compensation and benefits 3,216 567 3,221 568
Accrued expenses 1,430 276 1,542 297
Acquisition costs 1,557 257 1,790 289
Net business loss carryforwards 1,068 6,668 1,047 6,789
Other deductible temporary differences 34 185 968 506
- --------------------------------------------------------------------------------------------------------------------
23,713 8,809 24,737 9,294
Valuation allowances (1,068) (4,258) (1,918) (3,441)
- --------------------------------------------------------------------------------------------------------------------
22,645 4,551 22,819 5,853
Deferred tax liabilities:
Intangibles 685 155 1,001 226
Prepaid assets 908 92 853 88
Depreciation and amortization 2,558 491 998 189
Unrealized gain on investments 3,302 - 4,117 -
Other taxable temporary differences 1,089 (6) 1,668 8
- --------------------------------------------------------------------------------------------------------------------
8,542 732 8,637 511
- --------------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ 14,103 $ 3,819 $ 14,182 $ 5,342
====================================================================================================================
The federal deferred benefit arising from the deductibility of state deferred
taxes is included as a component of other federal deferred taxes. The net
deferred taxes are included in other assets in the accompanying consolidated
balance sheets. During 2003 and 2002, the Company recognized, as an adjustment
to additional paid-in capital, an income tax benefit of $2,881,000 and
$1,769,000, respectively, resulting from the deduction received by the Company
upon the exercise of employee stock options. The Company paid net federal and
state income taxes of $18,498,000 and $22,903,000 in 2003 and 2002, respectively
and received net federal and state income tax refunds of $739,000 in 2001.
43
9. CONTINGENCIES
In February 2000, a class action lawsuit was filed against the Company in the
state of Florida alleging that the Company failed to follow Florida law when in
1998 it discontinued writing certain health insurance policies and offered new
policies to insureds. Plaintiffs claim that the Company wrongfully terminated
coverage, improperly notified insureds of conversion rights and charged improper
premiums for new coverage. Plaintiffs also allege that the Company's renewal
rating methodology violated Florida law. On April 24, 2002, a Circuit Court
Judge ruled against the Company and ordered the question of damages be tried at
a later date. The earliest the Company expects the trial to be held is the
second quarter of 2004. The Company believes its practices were in full
compliance with Florida law and is vigorously defending this lawsuit.
The Company is a defendant in a number of lawsuits in various states, primarily
Alabama, alleging misrepresentation of the rating methodology used by the
Company with respect to certain MedOne(R) products purchased by the plaintiffs.
These lawsuits commonly seek unspecified damages for misrepresentation and
emotional distress in addition to punitive damages. Some of these cases involve
multiple plaintiffs. The cases are in various stages of litigation. The Company
believes that these lawsuits are unfounded because the Company properly
disclosed the nature of the products sold. The Company also believes the subject
matter of the lawsuits falls under the primary jurisdiction of state insurance
departments. The Company is vigorously defending itself in these actions.
The Company is involved in various other legal and regulatory actions occurring
in the normal course of business. Based on current information, including
consultation with outside counsel, management believes any ultimate liability in
excess of amounts reserved that may arise from the above-mentioned and all other
legal and regulatory actions would not have a material adverse effect on the
Company's consolidated financial position or results of operations. However,
management's evaluation of the likely impact of these actions could change in
the future and an unfavorable outcome could have a material adverse effect on
the Company's consolidated financial position, results of operations or cash
flow of a future period.
10. SHAREHOLDERS' EQUITY
STATUTORY FINANCIAL INFORMATION
State insurance laws and regulations prescribe accounting practices for
determining statutory net income and equity for insurance companies. These
regulations require, among other matters, the filing of financial statements
prepared in accordance with statutory accounting practices prescribed or
permitted for insurance companies. The statutory capital and surplus of the
Company's insurance subsidiaries, United Wisconsin Life Insurance Company and
American Medical Security Insurance Company of Georgia, at December 31, 2003 and
2002, was $173,141,000 and $157,487,000, respectively. The combined statutory
net income of the Company's insurance subsidiaries was $26,538,000, $13,150,000
and $18,052,000 for 2003, 2002 and 2001, respectively.
State insurance regulations also require the maintenance of a minimum compulsory
surplus based on a percentage of premiums written. At December 31, 2003, the
Company's insurance subsidiaries were in compliance with these compulsory
regulatory requirements.
RESTRICTIONS ON DIVIDENDS FROM SUBSIDIARIES
Dividends paid by the insurance subsidiaries to the parent Company are limited
by state insurance regulations. The insurance regulator in the insurer's state
of domicile may disapprove any dividend which, together with other dividends
paid by an insurance company in the prior 12 months, exceeds the regulatory
maximum, computed as the lesser of 10% of statutory capital and surplus or total
statutory net gain from operations as of the end of the preceding calendar year.
During 2003, regulatory approval was obtained and dividends paid to the parent
company by an insurance subsidiary were $2,000,000 in January 2003 and
$11,000,000 in December 2003. Based upon the financial statements of the
Company's insurance subsidiaries as of December 31, 2003, as filed with the
insurance regulators, the amount available for dividend without regulatory
approval is $6,300,000 until December 2004, when a dividend of $17,300,000 can
be paid without regulatory approval.
44
SHAREHOLDERS' RIGHTS AGREEMENT
In August 2001, the Board of Directors of the Company adopted a shareholders'
rights agreement (the "rights agreement") and declared a dividend of one
preferred share purchase right for each outstanding share of common stock of the
Company. When exercisable, each right entitles the registered holder to purchase
from the Company a unit consisting of one ten-thousandth of a share of Series B
Junior Cumulative Preferred Stock of the Company at a price of $30.00. The
rights agreement, as amended, is designed to deter takeover initiatives not
considered to be in the best interests of the Company's shareholders. In the
event that a person or a group has become the beneficial owner of 16% or more of
the common shares then outstanding, in certain circumstances the rights become
exercisable, and each holder of a right will have the right to receive, upon
exercise, common shares having a value equal to two times the exercise price of
the right. The rights are redeemable by action of the Company's Board of
Directors at any time prior to their becoming exercisable. The rights expire on
August 20, 2011.
11. EMPLOYEE BENEFIT PLANS
RETIREMENT SAVINGS PLAN
The Company's employees are included in a qualified defined contribution plan
(the "Retirement Savings Plan") with profit sharing and discretionary savings
provisions covering all eligible salaried and hourly employees. Participant
contributions up to 6% of the participant's compensation were matched 70% by the
Company in 2003 and 2002 and 60% in 2001. Profit sharing contributions to the
Retirement Savings Plan are determined annually by the Company. Participants
vest in Company contributions in three years. The Company recognized expense
associated with the Retirement Savings Plan of $2,079,000, $3,711,000 and
$1,881,000 in 2003, 2002 and 2001, respectively. For 2002, the expense includes
a profit sharing contribution of $1,287,000 or 2% of eligible wages. No profit
sharing contributions were made in 2003 and 2001.
NONQUALIFIED EXECUTIVE RETIREMENT PLAN
The Company has a nonqualified executive retirement plan (the "Nonqualified
Plan") to provide key management with the opportunity to accumulate deferred
compensation which cannot be accumulated under the Retirement Savings Plan due
to compensation limitations imposed by the Internal Revenue Service. The
Nonqualified Plan is funded through a rabbi trust and has contribution and
investment options similar to those of the Retirement Savings Plan. The Company
recognized expense associated with the Nonqualified Plan of $111,000, $116,000
and $53,000 during 2003, 2002 and 2001, respectively.
STOCK BASED COMPENSATION PLANS
The Company has a stock-based compensation plan, the Equity Incentive Plan (the
"Plan"), for the benefit of eligible employees and directors of the Company. The
Plan permits the grant of nonqualified stock options ("NQSO"), incentive stock
options, stock appreciation rights, restricted stock awards and performance
awards. Persons eligible to participate in the Plan include all full-time active
employees and outside directors of the board of directors. The Plan allows for
the granting of up to 4,000,000 shares of which 41,413 shares are available for
grant as of December 31, 2003. The Company's 1995 Director Stock Option Plan
also permits the grant of NQSOs. The plan allows for the granting of up to
75,000 shares of which 9,000 shares are available for grant as of December 31,
2003.
45
The terms of incentive stock options and nonqualified stock options granted
under the Plan cannot exceed more than 10 and 12 years, respectively, and the
option exercise price generally cannot be less than the fair market value of the
Company's common stock on the date of grant. The exercise price equaled the fair
market value of the Company's common stock at the date of the grant for all of
the Company's stock option grants. Incentive stock options and NQSOs are not
exercisable in any event prior to six months following the grant date. The
Company's outstanding NQSOs generally vest 25% per year for employees and 33.3%
per year for directors beginning on the first anniversary of the date of grant
and each subsequent anniversary date thereafter provided the employee or
director remains in service.
Stock appreciation rights generally have a grant price at least equal to 100% of
the fair market value of the Company's common stock. The term of the stock
appreciation rights cannot exceed 12 years. Stock appreciation rights are not
exercisable prior to six months following the grant date.
Restricted stock generally may not be sold or otherwise transferred for certain
periods based on the passage of time, the achievement of performance goals or
the occurrence of other events. However, participants may exercise full voting
rights and are entitled to receive all dividends and other distributions with
respect to restricted stock. Restricted stock does not vest prior to six months
following the date of grant.
The Company has a deferred compensation plan for the benefit of outside
directors of the Company who wish to defer the receipt of eligible compensation
which they may otherwise be entitled to receive from the Company. Directors who
choose to participate in the plan may elect to have their deferred compensation
credited to, in whole or in part, either an interest account or a Company stock
unit account.
During 1998, the Company and a key executive entered into a deferred stock
agreement. Under the agreement the Company has an obligation to issue 73,506
shares of the Company's common stock in the year after employment terminates. As
the vesting requirements under this agreement were fully satisfied during 2002,
the Company did not incur any expenses related to this agreement in 2003. In
2002 and 2001, expenses of $197,000 and $225,000, respectively, were incurred
related to this agreement.
On July 9, 2001, the Company and a key executive entered into a restricted stock
agreement. Under the agreement, the Company granted the executive 25,000 shares
of common stock, subject to certain rights and restrictions, in exchange for the
surrender or cancellation of 443,857 shares of the executive's nonqualified
stock options. The 25,000 shares of restricted stock vested in December 2001
upon the occurrence of certain triggering events, as specified under the
restricted stock agreement. The Company incurred expense of $139,000 during 2001
related to this agreement.
At December 31, 2003 and 2002, the Company has total deferred compensation
payable to employees of $4,574,000 and $4,057,000, respectively.
46
Stock option activity for all plans is as follows:
Year ended December 31,
-----------------------------------------------------
2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL NUMBER OF NQSOS
Outstanding at beginning of year 2,922,492 3,243,767 3,460,130
Granted 457,200 245,000 426,000
Exercised (693,430) (350,459) (26,756)
Forfeited (50,500) (215,816) (615,607)
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 2,635,762 2,922,492 3,243,767
===========================================================================================================================
Exercisable at end of year 1,801,533 2,004,846 1,826,017
Available for grant at end of year 50,413 457,113 486,297
WEIGHTED AVERAGE EXERCISE PRICE OF NQSOS
Outstanding at beginning of year $ 9.28 $ 9.11 $ 9.86
Granted - Exercise price equals market price on grant date 14.52 12.24 9.97
Granted - Exercise price is less than market price on grant date - - -
Granted - Exercise price exceeds market price on grant date - - -
Exercised 8.30 8.53 5.15
Forfeited 8.21 11.27 14.09
Outstanding at end of year 10.47 9.28 9.11
Exercisable at end of year 9.50 9.48 10.33
NQSOS BY EXERCISE PRICE RANGE
Range of exercise prices $ 3.01 - $8.88 $ 3.01 - $8.88 $ 3.01 - $8.88
Weighted average exercise price $6.03 $5.85 $5.75
Weighted average remaining contractual life (years) 8.30 10.33 10.08
Exercisable at end of year 667,996 775,396 605,954
Outstanding at end of year 737,058 1,165,000 1,471,454
Weighted average exercise price of options exercisable at end of year $6.11 $5.94 $5.77
Range of exercise prices $10.20 - $14.67 $10.20 - $14.38 $10.20 - $14.38
Weighted average exercise price $12.02 $11.18 $11.07
Weighted average remaining contractual life (years) 8.14 9.16 8.78
Exercisable at end of year 1,076,921 1,114,602 964,984
Outstanding at end of year 1,837,088 1,637,644 1,517,234
Weighted average exercise price of options exercisable at end of year $13.88 $13.45 $11.48
Range of exercise prices $15.34 - $22.74 $15.34 - $22.74 $15.76 - $22.74
Weighted average exercise price $17.34 $16.74 $16.83
Weighted average remaining contractual life (years) 5.41 7.66 6.45
Exercisable at end of year 56,616 114,848 255,079
Outstanding at end of year 61,616 119,848 255,079
Weighted average exercise price of options exercisable at end of year $16.95 $16.80 $16.83
===========================================================================================================================
47
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial data for the years ended December 31, 2003 and 2002
are as follows:
Quarter
---------------------------------------------------------
(THOUSANDS, EXCEPT PER SHARE DATA) First Second Third Fourth Total
- --------------------------------------------------------------------------------------------------------------------
2003
Total revenues $ 186,872 $ 186,057 $ 185,261 $ 185,526 $ 743,716
Income from continuing operations 6,597 6,826 7,888 7,267 28,578
Net income 6,463 6,769 8,811 7,267 29,310
Earnings per common share - basic:
Income from continuing operations $ 0.51 $ 0.52 $ 0.59 $ 0.54 $ 2.15
Net income 0.50 0.51 0.66 0.54 2.21
Earnings per common share - diluted:
Income from continuing operations $ 0.49 $ 0.49 $ 0.55 $ 0.50 $ 2.03
Net income 0.48 0.48 0.61 0.50 2.08
===================================================================================================================
2002
Total revenues $ 202,851 $ 198,750 $ 194,927 $ 189,782 $ 786,310
Income from continuing operations 5,654 5,388 5,814 6,293 23,149
Income before cumulative effect of a
change in accounting principle 5,430 5,241 5,738 6,077 22,486
Net income (loss) (54,668) 5,241 5,738 6,077 (37,612)
Earnings per common share - basic:
Income from continuing operations $ 0.41 $ 0.43 $ 0.45 $ 0.49 $ 1.77
Income before cumulative effect of a
change in accounting principle 0.39 0.42 0.45 0.47 1.72
Net income (loss) (3.96) 0.42 0.45 0.47 (2.88)
Earnings per common share - diluted:
Income from continuing operations $ 0.39 $ 0.39 $ 0.42 $ 0.47 $ 1.67
Income before cumulative effect of a
change in accounting principle 0.37 0.38 0.42 0.45 1.63
Net income (loss) (3.77) 0.38 0.42 0.45 (2.72)
====================================================================================================================
During the third quarter of 2003, the Company sold its networking subsidiary and
reported the sale transaction and the subsidiary's operating results in
discontinued operations. See Note 3, "Discontinued Operations" for further
discussion regarding the sale.
13. SEGMENTS OF THE BUSINESS
The Company has two reportable segments: 1) health insurance products; and 2)
life insurance products. The Company's health insurance products consist of the
following coverages related to small group PPO products: MedOne(R) and small
group medical, self-funded medical, dental and short-term disability. Life
products consist primarily of group term life insurance. The "All Other"
category includes operations not directly related to the business segments and
unallocated corporate items (i.e., corporate investment income, interest expense
on corporate
48
debt, amortization of goodwill and intangibles and unallocated
overhead expenses). The reportable segments are managed separately because they
differ in the nature of the products offered and in profit margins.
The Company evaluates segment performance based on income or loss before income
taxes, excluding realized gains and losses on the Company's investment
portfolio. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies. Significant
intercompany transactions have been eliminated prior to reporting reportable
segment information.
Selected financial data for the Company by segment is as follows:
YEAR ENDED DECEMBER 31, 2003:
Health Life Total
(THOUSANDS) Insurance Insurance All Other Consolidated
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 700,242 $ 12,176 $ - $ 712,418
Net investment income 6,669 512 6,350 13,531
Net realized investment gains - - 1,910 1,910
Other revenue 15,573 284 - 15,857
- --------------------------------------------------------------------------------------------------------------------
Total revenues 722,484 12,972 8,260 743,716
EXPENSES
Medical and other benefits 475,646 2,874 (23) 478,497
Selling, general and administrative 208,459 4,126 4,697 217,282
Interest - - 1,255 1,255
Amortization of other intangibles - - 903 903
- --------------------------------------------------------------------------------------------------------------------
Total expenses 684,105 7,000 6,832 697,937
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations, before tax $ 38,379 $ 5,972 $ 1,428 $ 45,779
====================================================================================================================
As of December 31, 2003:
Segment assets $ 252,367 $ 39,497 $ 152,223 $ 444,087
====================================================================================================================
YEAR ENDED DECEMBER 31, 2002:
Health Life Total
(THOUSANDS) Insurance Insurance All Other Consolidated
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 740,677 $ 13,780 $ 3 $ 754,460
Net investment income 6,671 559 7,775 15,005
Net realized investment gains - - 39 39
Other revenue 16,685 113 8 16,806
- --------------------------------------------------------------------------------------------------------------------
Total revenues 764,033 14,452 7,825 786,310
EXPENSES
Medical and other benefits 504,645 4,006 19 508,670
Selling, general and administrative 225,480 4,559 6,792 236,831
Interest - - 1,848 1,848
Amortization of other intangibles - - 730 730
- --------------------------------------------------------------------------------------------------------------------
Total expenses 730,125 8,565 9,389 748,079
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations, before tax $ 33,908 $ 5,887 $ (1,564) $ 38,231
====================================================================================================================
As of December 31, 2002:
Segment assets $ 225,502 $ 39,452 $ 163,986 $ 428,940
====================================================================================================================
49
YEAR ENDED DECEMBER 31, 2001:
Health Life Total
(THOUSANDS) Insurance Insurance All Other Consolidated
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 820,658 $ 17,424 $ 590 $ 838,672
Net investment income 9,197 656 7,590 17,443
Net realized investment losses - - (779) (779)
Other revenue 17,449 154 34 17,637
- --------------------------------------------------------------------------------------------------------------------
Total revenues 847,304 18,234 7,435 872,973
EXPENSES
Medical and other benefits 597,089 6,334 (203) 603,220
Selling, general and administrative 242,902 5,446 3,768 252,116
Interest - - 2,877 2,877
Amortization of goodwill and other intangibles - - 3,628 3,628
- --------------------------------------------------------------------------------------------------------------------
Total expenses 839,991 11,780 10,070 861,841
- --------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations,
before tax $ 7,313 $ 6,454 $ (2,635) $ 11,132
====================================================================================================================
As of December 31, 2001:
Segment assets $ 299,149 $ 41,939 $ 131,927 $ 473,015
====================================================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures as of December 31, 2003.
Based on that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of December 31, 2003. There were no material
changes in the Company's internal control over financial reporting during the
fourth quarter of 2003 that have materially affected, or are reasonably likely
to materially affect, the Company's internal control over financial reporting.
50
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item with respect to directors and executive
officers is incorporated herein by reference to the information included under
the headings "Proposal 1 - Election of Directors" and "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's definitive Proxy Statement
relating to the Annual Meeting of Shareholders scheduled for May 18, 2004 (the
"2004 Proxy Statement") and the information under the heading "Executive
Officers of the Registrant" in Part I of this report. Information required by
this item with respect to the Audit Committee and code of ethics is incorporated
herein by reference to the information included under the headings "Corporate
Governance - Committees of the Board of Directors - Audit Committee," and
"Corporate Governance - Code of Ethics," respectively, in the 2004 Proxy
Statement, which sections are hereby incorporated by reference. The 2004 Proxy
Statement will be filed with the Securities and Exchange Commission not later
than 120 days after the end of the Company's fiscal year.
The Company's Code of Ethical Conduct for Senior Financial Officers is available
on the Company's website, WWW.EAMS.COM, in the "Investor" section under
"Corporate Governance." Any amendments to, or waivers from, the Code of Ethical
Conduct for Senior Financial Officers will be disclosed on the Company's website
or in a current report on Form 8-K. The Company's website at this location also
contains the Company's Code of Ethical Conduct applicable to all of its
directors, officers and employees; the Company's Corporate Governance
Principles; and the charters of the Company's Audit, Compensation, Corporate
Governance and Nominating, and Finance Committees. The Code of Ethical Conduct
for Senior Financial Officers, as well as the Code of Ethical Conduct for all
officers, directors and employees; Corporate Governance Principles; and
committee charters are also available without charge to any shareholder of
record or beneficial owner of the Company's common stock by writing to the
corporate secretary at the Company's principal business office, 3100 AMS
Boulevard, P. O. Box 19032, Green Bay, Wisconsin, 54307-9032.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is included under the headings "Executive
Compensation" and "Corporate Governance - Compensation of Directors" in the 2004
Proxy Statement, which sections are hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required by this item is included under the heading "Security
Ownership of Certain Beneficial Owners and Management" and "Equity Compensation
Plan Information" in the 2004 Proxy Statement, which sections are hereby
incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the heading "Certain
Transactions" in the 2004 Proxy Statement, which section is hereby incorporated
by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by this item is included under the heading "Auditors and
Principal Accounting Firm Fees" in the 2004 Proxy Statement, which section is
hereby incorporated by reference.
51
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 and 2. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE IN
FORM 10-K
REPORT
The following consolidated financial statements of American Medical Security Group, Inc. and
subsidiaries are included in Item 8:
Report of Independent Auditors..........................................................................27
Consolidated Balance Sheets at December 31, 2003 and 2002...............................................28
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001..............29
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001..............30
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Loss)
for the years ended December 31, 2003, 2002 and 2001.................................................31
Notes to Consolidated Financial Statements..............................................................32
PAGE IN
FORM 10-K
REPORT
The following financial statement schedules of American Medical Security Group, Inc. and
subsidiaries are included in Item 15(d):
Schedule II - Condensed Financial Information of Registrant.............................................54
Schedule III - Supplementary Insurance Information......................................................57
Schedule IV - Reinsurance...............................................................................58
Schedule V - Valuation and Qualifying Accounts..........................................................59
All other schedules for which provision is made in applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
3. EXHIBITS
See the Exhibit Index included as the last page of this report, which is
incorporated herein by reference. Each management contract and compensatory plan
or arrangement required to be filed as an exhibit to this report is identified
in the Exhibit Index by an asterisk following its exhibit number.
(b) REPORTS ON FORM 8-K
The Company filed or submitted the following reports on Form 8-K during the
fourth quarter of 2003:
o A Form 8-K dated October 6, 2003, was filed on October 6, 2003, to
update the description of the Company's common stock and associated
preferred share purchase rights. This description was incorporated by
reference into the Company's Form S-8 Registration Statement filed with
the Securities and Exchange Commission on October 6, 2003, for the
Company's Directors Deferred Compensation Plan.
o A Form 8-K dated November 3, 2003, was submitted on November 3, 2003,
to furnish the Company's earnings release for the quarter ended
September 30, 2003. This Form 8-K was "furnished" and shall not be
deemed "filed" for purposes of Section 18 of the Securities Act of
1934, nor shall it be deemed incorporated by reference in this Form
10-K.
After the end of the quarter, a Form 8-K dated February 2, 2004, was submitted
on February 2, 2004, to furnish the Company's earnings release for the year and
quarter ended December 31, 2003. This Form 8-K was "furnished" and shall not be
52
deemed "filed" for purposes of Section 18 of the Securities Act of 1934, nor
shall it be deemed incorporated by reference in this Form 10-K.
(c) EXHIBITS
See the Exhibit Index following the Signature page of this report.
(d) FINANCIAL STATEMENT SCHEDULES
The financial statement schedules referenced in Item 15(a) are as follows.
53
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31,
(THOUSANDS) 2003 2002
- --------------------------------------------------------------------------------
ASSETS
Investments:
Fixed maturity securities available for sale,
at fair value $ 14,168 $ -
Cash and cash equivalents 6,862 972
Other assets:
Investment in consolidated subsidiaries 192,846 175,835
Goodwill 32,138 32,138
Other intangibles, net 1,957 2,860
Due from affiliates 3,000 4,388
Other assets 1,221 510
- --------------------------------------------------------------------------------
Total other assets 231,162 215,731
- --------------------------------------------------------------------------------
Total assets $ 252,192 $ 216,703
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Notes payable $ 30,158 $ 30,158
Taxes payable 2,967 2,819
Other liabilities 1,243 976
- --------------------------------------------------------------------------------
Total liabilities 34,368 33,953
Shareholders' equity:
Common stock 16,654 16,654
Paid-in capital 194,431 189,813
Retained earnings 32,168 2,858
Accumulated other comprehensive income 6,133 7,646
Treasury stock (31,562) (34,221)
- --------------------------------------------------------------------------------
Total shareholders' equity 217,824 182,750
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 252,192 $ 216,703
================================================================================
54
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF OPERATIONS
Year ended December 31,
-------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------
REVENUES
Fees from consolidated subsidiaries $ 4,604 $ 4,752 $ 4,427
Other revenue 122 27 103
- --------------------------------------------------------------------------------
Total revenues 4,726 4,779 4,530
EXPENSES
General and administrative 2,767 3,068 563
Interest 976 1,458 2,377
Amortization of goodwill and other
intangibles 903 365 563
- --------------------------------------------------------------------------------
Total expenses 4,646 4,891 3,503
- --------------------------------------------------------------------------------
Income (loss) before the following items 80 (112) 1,027
Income tax expense (benefit) (467) 1,777 874
- --------------------------------------------------------------------------------
Income (loss) before the following items 547 (1,889) 153
Equity in net income of subsidiaries,
including income (loss) from
discontinued operations 28,763 24,375 4,022
- --------------------------------------------------------------------------------
Income before cumulative effect of a
change in accounting principle 29,310 22,486 4,175
Cumulative effect of a change in
accounting principle - (60,098) -
- --------------------------------------------------------------------------------
Net income (loss) $ 29,310 $(37,612) $ 4,175
================================================================================
55
SCHEDULE II
AMERICAN MEDICAL SECURITY GROUP, INC.
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31,
------------------------------------------------
(THOUSANDS) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ 29,310 $ (37,612) $ 4,175
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Due from affiliates 1,508 (5,022) -
Cumulative effect of change in accounting principle - 60,098 -
Equity in net income of subsidiaries (28,763) (24,375) (4,022)
Dividends received from subsidiaries 13,000 25,000 -
Amortization of intangibles 903 365 563
Deferred income tax expense (benefit) (522) (38) 72
Changes in operating accounts:
Net other assets and liabilities 223 969 2,481
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 15,659 19,385 3,269
INVESTING ACTIVITIES
Purchases of available for sale securities (14,170) - -
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (14,170) - -
FINANCING ACTIVITIES
Exercise of stock options 5,759 2,990 413
Purchase of treasury stock (1,358) (19,540) (2,216)
Proceeds from notes payable borrowings - 30,158 -
Repayment of notes payable - (35,158) -
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 4,401 (21,550) (1,803)
Cash and cash equivalents:
Net increase (decrease) during year 5,890 (2,165) 1,466
Balance at beginning of year 972 3,137 1,671
- --------------------------------------------------------------------------------------------------------------------
Balance at end of year $ 6,862 $ 972 $ 3,137
====================================================================================================================
56
SCHEDULE III
AMERICAN MEDICAL SECURITY GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
Deferred Medical and
Policy Other Other
SEGMENT Acquisition Benefits Advance Policyholder
(THOUSANDS) Costs Payable Premiums Funds
- --------------------------------------------------------------------------------
DECEMBER 31, 2003:
Health $ - $ 119,891 $ 15,245 $ -
Life - 9,848 620 -
All Other - 70 - -
- --------------------------------------------------------------------------------
Total $ - $ 129,809 $ 15,865 $ -
================================================================================
DECEMBER 31, 2002:
Health $ - $ 123,797 $ 14,412 $ -
Life - 10,570 788 -
All Other - 112 - -
- --------------------------------------------------------------------------------
Total $ - $ 134,479 $ 15,200 $ -
================================================================================
DECEMBER 31, 2001:
Health $ - $ 125,834 $ 15,912 $ -
Life - 9,480 825 -
All Other - 190 - -
- --------------------------------------------------------------------------------
Total $ - $ 135,504 $ 16,737 $ -
================================================================================
Amortization of
Medical and Deferred
Net Other Policy Other
SEGMENT Premium Investment Benefit Acquisition Operating Premiums
(THOUSANDS) Revenue Income Expenses Costs Expenses Written
- --------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2003:
Health $ 700,242 $ 6,669 $ 475,646 $ - $ 208,459 $ 701,075
Life 12,176 512 2,874 - 4,126
All Other - 6,350 (23) - 4,697 -
- ----------------------------------------------------------------------------------------------------
Total $ 712,418 $ 13,531 $ 478,497 $ - $ 217,282
====================================================================================================
DECEMBER 31, 2002:
Health $ 740,677 $ 6,671 $ 504,645 $ - $ 225,480 $ 739,177
Life 13,780 559 4,006 - 4,559
All Other 3 7,775 19 - 6,792 3
- ----------------------------------------------------------------------------------------------------
Total $ 754,460 $ 15,005 $ 508,670 $ - $ 236,831
====================================================================================================
DECEMBER 31, 2001:
Health $ 820,658 $ 9,197 $ 597,089 $ - $ 242,902 $ 819,756
Life 17,424 656 6,334 - 5,446
All Other 590 7,590 (203) - 3,768 590
- ----------------------------------------------------------------------------------------------------
Total $ 838,672 $ 17,443 $ 603,220 $ - $ 252,116
====================================================================================================
57
SCHEDULE IV
AMERICAN MEDICAL SECURITY GROUP, INC.
REINSURANCE
Percentage
Ceded to Assumed Of Amount
Direct Other from Other Net Assumed
(THOUSANDS) Business Companies Companies Amount to Net
- --------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2003:
Life insurance in force $ 6,813,836 $ 5,005,726 $ - $ 1,808,110 0.0%
Premiums:
Accident and Health $ 703,683 $ 3,458 $ 17 $ 700,242 0.0%
Life 27,557 15,381 - 12,176 0.0%
- -------------------------------------------------------------------------------------------------------
Total Premiums $ 731,240 $ 18,839 $ 17 $ 712,418 0.0%
=======================================================================================================
YEAR ENDED DECEMBER 31, 2002:
Life insurance in force $ 8,101,953 $ 6,114,861 $ - $ 1,987,092 0.0%
Premiums:
Accident and Health $ 741,653 $ 1,973 $ 1,000 $ 740,680 0.1%
Life 32,831 19,051 - 13,780 0.0%
- -------------------------------------------------------------------------------------------------------
Total Premiums $ 774,484 $ 21,024 $ 1,000 $ 754,460 0.1%
=======================================================================================================
YEAR ENDED DECEMBER 31, 2001:
Life insurance in force $ 9,351,321 $ 6,913,662 $ - $ 2,437,659 0.0%
Premiums:
Accident and Health $ 822,203 $ 2,408 $ 1,453 $ 821,248 0.2%
Life 36,491 19,069 2 17,424 0.0%
- -------------------------------------------------------------------------------------------------------
Total Premiums $ 858,694 $ 21,477 $ 1,455 $ 838,672 0.2%
=======================================================================================================
58
SCHEDULE V
AMERICAN MEDICAL SECURITY GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance at Charged to
Beginning Costs and Balance at
(THOUSANDS) of Period Expenses Deductions End of Period
- --------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2003:
Allowance for bad debts $ 120 $ 26 $ 133 $ 13
Valuation allowance for deferred taxes 5,359 1,757 1,790 5,326
- --------------------------------------------------------------------------------------------------------------------
Total $ 5,479 $ 1,783 $ 1,923 $ 5,339
====================================================================================================================
YEAR ENDED DECEMBER 31, 2002:
Allowance for bad debts $ 1,292 $ - $ 1,172 $ 120
Valuation allowance for deferred taxes 5,394 13 48 5,359
- --------------------------------------------------------------------------------------------------------------------
Total $ 6,686 $ 13 $ 1,220 $ 5,479
====================================================================================================================
YEAR ENDED DECEMBER 31, 2001:
Allowance for bad debts $ 344 $ 1,250 $ 302 $ 1,292
Valuation allowance for deferred taxes 3,861 1,810 277 5,394
- --------------------------------------------------------------------------------------------------------------------
Total $ 4,205 $ 3,060 $ 579 $ 6,686
====================================================================================================================
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AMERICAN MEDICAL SECURITY GROUP, INC.
Date: March 12, 2004 By: /s/ SAMUEL V. MILLER
Samuel V. Miller, Chairman, President,
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.*
SIGNATURE TITLE
/s/ SAMUEL V. MILLER Chairman of the Board, President and Chief
Samuel V. Miller Executive Officer; Director
/s/ JOHN R. LOMBARDI Executive Vice President, Chief Financial
John R. Lombardi Officer and Treasurer (Principal Financial
Officer and Principal Accounting Officer)
/s/ ROGER H. BALLOU Director
Roger H. Ballou
/s/ W. FRANCIS BRENNAN Director
W. Francis Brennan
/s/ MARK A. BRODHAGEN Director
Mark A. Brodhagen
/s/ LOUIS C. FORNETTI Director
Louis C. Fornetti
/s/ EUGENE A. MENDEN Director
Eugene A. Menden
/s/ EDWARD L. MEYER, JR Director
Edward L. Meyer, Jr.
/s/ MICHAEL T. RIORDAN Director
Michael T. Riordan
/s/ H.T. RICHARD SCHREYER Director
H.T. Richard Schreyer
/s/ FRANK L. SKILLERN Director
Frank L. Skillern
/s/ J. GUS SWOBODA Director
J. Gus Swoboda
*Each of the above signatures is affixed as of March 12, 2004.
60
AMERICAN MEDICAL SECURITY GROUP, INC.
(COMMISSION FILE NO. 1-13154)
EXHIBIT INDEX
TO
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 2003
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
3.1 Amended and Restated Articles of Exhibit 3.1 to the Registrant's Form
Incorporation of Registrant dated as 10-Q for the quarter ended June 30,
of May 27, 2003 2003 (the "6/30/03 10-Q")
3.2 Bylaws of Registrant as amended and Exhibit 3.2 to the 6/30/03 10-Q
restated May 21, 2003
4.1 Credit Agreement dated as of Exhibit 4.1(a) to the Registrant's
December 30, 2002, among the Form 10-K for the year ended December
Registrant, LaSalle Bank National 31, 2002 (the "2002 10-K")
Association and other Lenders
4.2(a) Rights Agreement, dated as of August Exhibit 1 to the Registrant's
9, 2001, between the Registrant and Registration Statement on Form 8-A
Firstar Bank, N.A., as Rights Agents filed August 14, 2001 and Exhibit 4
(the "Rights Agreement'), including to the Registrant's Current Report on
the form of Rights Certificate as Form 8-K dated August 9, 2001, and
Exhibit B thereto filed on August 14, 2001
4.2(b) Appointment and Assumption Agreement Exhibit 4.2 to the Registrant's Form
dated December 17, 2001, between the 8-K dated February 1, 2002 (the
Registrant and Firstar Bank, N.A., "2/1/02 8-K")
appointing LaSalle Bank, N.A. as
Rights Agent for the Rights Agreement
4.2(c) Amendment dated as of February 1, Exhibit 4.1 to 2/1/02 8-K
2002, to the Rights Agreement
4.2(d) Amendment dated as of June 4, 2002, Exhibit 4.4(d) to the Registrant's
to the Rights Agreement Form 8-K dated June 4, 2002, and
filed on June 19, 2002
10.1* Equity Incentive Plan as amended X
through February 18, 2004
10.2* Form of Nonqualified Stock Option Exhibit 10.2 to the Registrant's Form
Award Agreement for Officers 10-K for the year ended December 31,
1998 (the "1998 10-K")
10.3* Form of Nonqualified Stock Option Exhibit 10.3 to Registrant's Form
Award Agreement for Directors 10-K for the year ended December 31,
1999 (the "1999 10-K")
EX-1
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
10.4* Form of Restricted Stock Agreement X
for Directors
10.5* Deferred Stock Agreement between the Exhibit 10.3 to 1998 10-K
Registrant and Samuel V. Miller
10.6* 1995 Director Stock Option Plan as Exhibit 10.5 to the Registrant's Form
amended November 29, 2001 10-K for the year ended December 31,
2001 (the "2001 10-K")
10.7* Directors Deferred Compensation Plan Exhibit 10.6 to 1999 10-K
adopted November 17, 1999
10.8* Voluntary Deferred Compensation Plan Exhibit 10.7 to 1999 10-K
as Amended and Restated effective
September 25, 1998
10.9(a)* Deferred Compensation Trust Exhibit 10.48 to the Registrant's
Form 10-K for the year ended
December 31, 1997
10.9(b)* First Amendment to the Deferred Exhibit 10.9 to 1999 10-K
Compensation Trust
10.10* Executive Reimbursement Group Exhibit 10.8 to 1998 10-K
Insurance Policy
10.11* Change of Control Severance Benefit Exhibit 10.11(b) to 2001 10-K
Plan as amended and restated
November 29, 2001
10.12* Severance Benefit for Certain Exhibit 10.10 to 1998 10-K
Executive Officers
10.13* Description of Executive Management X
Incentive Program
10.14* Executive Annual Incentive Plan as Exhibit 10.14 to 2002 10-K
amended through February 19, 2003
10.15(a)* Employment Agreement of Chief Exhibit 10 to the Registrant's Form
Executive Officer ("CEO") dated 10-Q for the quarter ended
September 28, 2000 September 30, 2000
10.15(b)* Amendment dated as of November 29, Exhibit 10.15(b) to 2001 10-K
2001 to Employment Agreement of CEO
10.15(c)* Amendment dated as of January 1, X
2004 to Employment Agreement of CEO
EX-2
EXHIBIT INCORPORATED HEREIN FILED
NUMBER DOCUMENT DESCRIPTION BY REFERENCE TO HEREWITH
10.16(a)* Nonqualified Executive Retirement Exhibit 10 to the Registrant's Form
Plan effective April 1, 2000 10-Q for the quarter ended March 31,
2000
10.16(b)* Amendment No. 1 dated January 20, Exhibit 10.16(b) to 2002 10-K
2003 to Nonqualified Executive
Retirement Plan
21 Subsidiaries of the Registrant X
23 Consent of Ernst & Young LLP X
31.1 Certification of Chief Executive X
Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities
Exchange Act of 1934, as amended
31.2 Certification of Chief Financial X
Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities
Exchange Act of 1934, as amended
32 Certification of Chief Executive X
Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
* Indicates compensatory plan or arrangement.
EX-3