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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant To Section 13 Or 15(d) Of The Securities
Exchange Act Of 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
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
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, whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes __X__ No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock, no par value, outstanding as of June 30, 2004: 13,678,383 shares
AMERICAN MEDICAL SECURITY GROUP, INC.
INDEX
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
June 30, 2004 and December 31, 2003.........................3
Condensed Consolidated Statements of Operations
Three months ended June 30, 2004 and 2003;
Six months ended June 30, 2004 and 2003.....................4
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 2004 and 2003.....................5
Notes to Condensed Consolidated Financial Statements
June 30, 2004...............................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........18
Item 4. Controls and Procedures............................................18
PART II OTHER INFORMATION
Item 1. Legal Proceedings..................................................19
Item 4. Submission of Matters to a Vote of Security Holders................20
Item 6. Exhibits and Reports on Form 8-K...................................20
Signatures....................................................................21
Exhibit Index...............................................................EX-1
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(THOUSANDS, EXCEPT SHARE DATA) 2004 2003
- --------------------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Investments:
Fixed maturity securities available for sale, at fair value $ 296,890 $ 302,277
Fixed maturity securities held to maturity, at amortized cost 3,163 3,377
Trading securities, at fair value 1,700 1,424
- --------------------------------------------------------------------------------------------------------------------
Total investments 301,753 307,078
Cash and cash equivalents 19,610 17,289
Property and equipment, net 38,485 37,446
Goodwill 32,138 32,138
Other intangibles, net 1,631 1,957
Other assets 46,310 48,179
- --------------------------------------------------------------------------------------------------------------------
Total assets $ 439,927 $ 444,087
====================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Medical and other benefits payable $ 118,723 $ 129,809
Advance premiums 14,982 15,865
Payables and accrued expenses 20,281 24,099
Notes payable 30,158 30,158
Other liabilities 21,005 26,332
- --------------------------------------------------------------------------------------------------------------------
Total liabilities 205,149 226,263
Shareholders' equity:
Common stock (no par value, $1 stated value, 50,000,000 shares authorized,
16,654,315 issued and 13,678,383 outstanding at June 30, 2004,
16,654,315 issued and 13,511,183 outstanding at December 31, 2003) 16,654 16,654
Paid-in capital 195,548 194,431
Retained earnings 50,913 32,168
Accumulated other comprehensive income (net of taxes of
$1,128 at June 30, 2004 and $3,302 at December 31, 2003) 2,094 6,133
Treasury stock (2,975,932 shares at June 30, 2004
and 3,143,132 shares at December 31, 2003, at cost) (30,431) (31,562)
- --------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 234,778 217,824
- --------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 439,927 $ 444,087
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------
(THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 176,528 $ 178,776 $ 354,250 $ 357,831
Net investment income 3,454 3,345 6,992 6,747
Net realized investment gains (losses) (117) 91 (52) 466
Other revenue 4,155 3,845 8,404 7,885
- --------------------------------------------------------------------------------------------------------------------
Total revenues 184,020 186,057 369,594 372,929
EXPENSES
Medical and other benefits 117,392 119,315 230,558 239,913
Selling, general and administrative 53,992 55,202 108,519 110,305
Interest 221 324 442 663
Amortization of intangibles 163 239 326 477
- --------------------------------------------------------------------------------------------------------------------
Total expenses 171,768 175,080 339,845 351,358
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations,
before income tax expense 12,252 10,977 29,749 21,571
Income tax expense 4,506 4,151 11,004 8,148
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations 7,746 6,826 18,745 13,423
Loss from discontinued operations - (57) - (191)
- --------------------------------------------------------------------------------------------------------------------
Net income $ 7,746 $ 6,769 $ 18,745 $ 13,232
====================================================================================================================
Earnings (loss) per common share - basic:
Income from continuing operations $ 0.57 $ 0.52 $ 1.37 $ 1.03
Loss from discontinued operations - - - (0.01)
- --------------------------------------------------------------------------------------------------------------------
Net income $ 0.57 $ 0.51 $ 1.37 $ 1.01
====================================================================================================================
Earnings (loss) per common share - diluted:
Income from continuing operations $ 0.53 $ 0.49 $ 1.28 $ 0.97
Loss from discontinued operations - - - (0.01)
- --------------------------------------------------------------------------------------------------------------------
Net income $ 0.53 $ 0.48 $ 1.28 $ 0.96
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
AMERICAN MEDICAL SECURITY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended
June 30,
---------------------------------
(THOUSANDS) 2004 2003
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 18,745 $ 13,232
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,401 4,995
Net realized investment losses (gains) 52 (466)
Change in trading securities (276) (291)
Deferred income tax expense 2,664 750
Changes in operating accounts:
Other assets 1,482 (4,980)
Medical and other benefits payable (11,086) (3,456)
Advance premiums (883) 1,253
Payables and accrued expenses (3,818) (8,102)
Other liabilities (4,505) (4,532)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 6,776 (1,597)
INVESTING ACTIVITIES
Purchases of available for sale securities (47,404) (62,024)
Proceeds from sale of available for sale securities 40,080 56,532
Proceeds from maturity of available for sale securities 5,450 1,775
Proceeds from maturity of held to maturity securities 200 -
Purchases of property and equipment (4,103) (5,530)
Proceeds from sale of property and equipment - 2
- --------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (5,777) (9,245)
FINANCING ACTIVITIES
Issuance of common stock 1,322 3,518
Purchase of treasury stock - (660)
Repayment of notes payable - (600)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,322 2,258
- --------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
Net change 2,321 (8,584)
Balance at beginning of year 17,289 30,620
- --------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 19,610 $ 22,036
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JUNE 30, 2004
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States ("GAAP") for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the three and six months ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004. These condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements and footnotes
thereto included in the American Medical Security Group, Inc. (the "Company")
Annual Report on Form 10-K for the year ended December 31, 2003.
2. STOCK-BASED COMPENSATION
The Company has stock-based compensation plans for the benefit of eligible
employees and directors of the Company, which are described more fully in Note
11 in the Company's 2003 Annual Report on Form 10-K. During the first quarter of
2004, the Company granted 20,700 shares of restricted stock to outside members
of the Company's Board of Directors. As a result, the Company's statement of
operations for the three and six months ended June 30, 2004 includes
compensation expense of $24,000 and $48,000 respectively, net of tax.
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").
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------------------
(THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 7,746 $ 6,769 $ 18,745 $ 13,232
Add: Stock-based compensation expense included in
reported net income, net of tax 24 - 48 -
Deduct: Stock-based compensation expense in
accordance with the fair value method of
statement 123, net of tax (201) (427) (531) (811)
- --------------------------------------------------------------------------------------------------------------------
Pro forma net income $ 7,569 $ 6,342 $ 18,262 $ 12,421
====================================================================================================================
Net income per common share, as reported:
Basic $ 0.57 $ 0.51 $ 1.37 $ 1.01
Diluted $ 0.53 $ 0.48 $ 1.28 $ 0.96
Pro forma net income per common share:
Basic $ 0.55 $ 0.48 $ 1.34 $ 0.95
Diluted $ 0.51 $ 0.45 $ 1.25 $ 0.90
6
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 that 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. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value 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.
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, Accountable
Health Plans of America, Inc. ("AHP"). 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 at least until September 2008. At the time of the sale, AHP served
approximately 13% of the Company's members. The three and six-month periods
ended June 30, 2003 as presented in the Company's statements of operations have
been reclassified to exclude the results of the discontinued networking business
from reported income from continuing operations.
4. PHARMACY BENEFITS MANAGER SETTLEMENT
During the first quarter of 2004, the Company reached an agreement with its
former pharmacy benefits manager settling a dispute related to pricing and
prescription drug fees charged from 1995 through 2002. As a result of the
settlement, the Company received a cash payment of $5.9 million, and the results
for the six months ended June 30, 2004 include a one-time gain of approximately
$3.4 million or $0.23 per diluted share, net of taxes and other related
expenses. The settlement provided a refund of medical and other benefit
expenses, which resulted in an improvement in the Company's health segment loss
ratio of 1.5% for the six months ended June 30, 2004.
5. 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:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------------------
(THOUSANDS, EXCEPT PER COMMON SHARE DATA) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Numerator:
Income from continuing operations $ 7,746 $ 6,826 $ 18,745 $ 13,423
====================================================================================================================
Denominator:
Denominator for basic EPS 13,690 13,160 13,658 13,071
Effect of dilutive employee stock options 976 855 967 724
- --------------------------------------------------------------------------------------------------------------------
Denominator for diluted EPS 14,666 14,015 14,625 13,795
====================================================================================================================
Earnings per common share - income from continuing
operations:
Basic $ 0.57 $ 0.52 $ 1.37 $ 1.03
Diluted $ 0.53 $ 0.49 $ 1.28 $ 0.97
====================================================================================================================
7
Certain options to purchase shares of common stock were not included in the
computation of diluted earnings per common share for the three and six months
ended June 30, 2003 because the options' exercise prices were greater than the
average market price of the outstanding common shares for the period and,
therefore, the effect would be antidilutive.
6. COMPREHENSIVE INCOME
Under existing accounting standards, comprehensive income for the Company
includes net income and unrealized gains and losses on certain investments in
debt and equity securities, net of tax effects. Comprehensive income for the
Company is calculated as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------
(THOUSANDS) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Net income $ 7,746 $ 6,769 $ 18,745 $ 13,232
Unrealized gain (loss) on available for sale securities (6,775) 1,874 (4,039) 2,318
- --------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 971 $ 8,643 $ 14,706 $ 15,550
====================================================================================================================
7. 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. In 2002, a Circuit Court Judge ruled
against the Company and ordered the question of damages be tried at a later
date. The Company believes a trial could not be held before the fourth quarter
of 2004. The Company believes its practices were in full compliance with Florida
law and is vigorously defending itself in 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 has reached an agreement of settlement regarding a
class action lawsuit involving these issues in Alabama and Georgia. Preliminary
approval of the settlement has been received from an Alabama Circuit Court. A
Georgia Superior Court, in a separate matter, enjoined the Company from settling
with Georgia residents who are members of the class. The Company has appealed to
the Georgia Supreme Court and expects the injunction to be overturned. The
Company expects final approval of the settlement by the Alabama Circuit Court in
September 2004. The Company is vigorously defending itself in the other pending
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.
8
8. SEGMENT INFORMATION
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 preferred provider organization products:
MedOne(R) (for individuals and families) 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 debt, amortization of
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 used to report the Company's consolidated financial statements.
Significant intercompany transactions have been eliminated prior to reporting
reportable segment information.
A reconciliation of segment income (loss) before income taxes to consolidated
income from continuing operations is as follows:
Three Months Ended Six Months Ended
SEGMENT SUMMARY June 30, June 30,
------------------------------------------------------------
(THOUSANDS) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
Health segment $ 10,420 $ 9,608 $ 25,881 $ 18,605
Life segment 1,548 1,524 3,070 2,927
All other 284 (155) 798 39
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations, before tax $ 12,252 $ 10,977 $ 29,749 $ 21,571
====================================================================================================================
Operating results and statistics for each of the Company's segments are as
follows:
Three Months Ended Six Months Ended
HEALTH SEGMENT June 30 June 30,
--------------------------------------------------------
(THOUSANDS, EXCEPT MEMBERSHIP DATA) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 173,673 $ 175,703 $ 348,483 $ 351,627
Net investment income 1,496 1,683 3,064 3,398
Other revenue 4,104 3,772 8,297 7,737
- --------------------------------------------------------------------------------------------------------------------
Total revenues 179,273 181,158 359,844 362,762
EXPENSES
Medical and other benefits 116,833 118,637 229,398 238,420
Selling, general and administrative 52,020 52,913 104,565 105,737
- --------------------------------------------------------------------------------------------------------------------
Total expenses 168,853 171,550 333,963 344,157
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations, before tax $ 10,420 $ 9,608 $ 25,881 $ 18,605
====================================================================================================================
Loss ratio 67.3% 67.5% 65.8% 67.8%
Expense ratio 27.6% 28.0% 27.6% 27.9%
- --------------------------------------------------------------------------------------------------------------------
Combined ratio 94.9% 95.5% 93.5% 95.7%
====================================================================================================================
Health membership at end of period:
Fully-insured medical 270,538 275,323
Self-funded medical 44,538 42,568
Dental 218,758 228,610
- ------------------------------------------------------------------------------------
Total health membership 533,834 546,501
====================================================================================
9
Three Months Ended Six Months Ended
LIFE SEGMENT June 30, June 30,
--------------------------------------------------------
(THOUSANDS, EXCEPT MEMBERSHIP DATA) 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------------
REVENUES
Insurance premiums $ 2,855 $ 3,073 $ 5,767 $ 6,204
Net investment income 114 129 235 262
Other revenue 51 73 107 148
- --------------------------------------------------------------------------------------------------------------------
Total revenues 3,020 3,275 6,109 6,614
EXPENSES
Medical and other benefits 559 679 1,160 1,516
Selling, general and administrative 913 1,072 1,879 2,171
- --------------------------------------------------------------------------------------------------------------------
Total expenses 1,472 1,751 3,039 3,687
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations, before tax $ 1,548 $ 1,524 $ 3,070 $ 2,927
====================================================================================================================
Loss ratio 19.6% 22.1% 20.1% 24.4%
Expense ratio 30.2% 32.5% 30.7% 32.6%
- --------------------------------------------------------------------------------------------------------------------
Combined ratio 49.8% 54.6% 50.8% 57.0%
====================================================================================================================
Life membership at end of period 130,418 141,930
====================================================================================
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS OVERVIEW
American Medical Security Group, Inc., together with 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 for the six months ended June 30, 2004 and 2003) and life insurance
products. The Company markets its products in 33 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.
FINANCIAL RESULTS SUMMARY
The Company reported net income of $7.7 million or $0.53 per diluted share for
the three months ended June 30, 2004, compared to net income of $6.8 million or
$0.48 per diluted share for the corresponding quarter in the prior year. The
improvement in quarterly earnings is attributable to improved profit margins
primarily from a lower loss ratio and slightly lower expense ratio. For the six
months ended June 30, 2004, the Company reported net income of $18.7 million or
$1.28 per diluted share compared to net income for the first six months of the
prior year of $13.2 million or $0.96 per diluted share. During the first quarter
of 2004, the Company settled a dispute with its former pharmacy benefits manager
related to pricing and prescription drug fees charged to the Company from 1995
through 2002 (the "PBM settlement"). As a result of the PBM settlement, the
Company received a cash payment of $5.9 million and the Company's financial
results for the six months ended June 30, 2004 include a one-time gain of $3.4
million or $0.23 per diluted share, net of taxes and other related expenses. Of
the $5.5 million increase in earnings from the first six months of the prior
year, $3.4 million resulted from the PBM settlement and the remaining
improvement was attributed to improved profit margins.
INSURANCE PREMIUM REVENUE AND MEMBERSHIP
Insurance premium revenue for the three months ended June 30, 2004 decreased
1.3% to $176.5 million from $178.8 million for the corresponding period in 2003.
For the six months ended June 30, 2004, insurance premium revenue declined to
$354.3 million from $357.8 million for the same period of the prior year. The
decrease in premium revenue was caused by a decline in membership, coupled with
a trend of members choosing lower priced products with higher deductibles and
copayments, resulting in lower premiums per member per month. Total health
membership, which includes medical and dental members, declined 12,667 members
from 546,501 members at June 30, 2003 to 533,834 members at June 30, 2004. The
Company's dental membership declined by 9,852 members from June 30, 2003. In
addition, small employer group medical membership declined from June 30 of the
prior year. While membership was down in the dental and small group lines of
business, the Company has seen an increase in new member enrollment and inforce
membership in its MedOne or individual line of business. Management believes
this increase is due to the Company's product offerings featuring more
affordable products with higher deductibles and copayments and competitive
pricing.
The impact of rapidly rising health care costs and the cost of health insurance
coverage continues to be a major challenge faced by individuals and small
business owners, the Company's primary markets. To help alleviate the impact of
rising health care costs, the Company has designed product offerings that
provide insurance consumers with a greater financial stake in their health care
decisions. In exchange for higher deductibles and copayments, the Company's
products attempt to offer more affordable premiums. To mitigate the increasing
cost of healthcare, small employers are offering health insurance plans with
more limited benefits. Management believes this trend is contributing to the
decline in dental membership as fewer small businesses are offering dental
benefits to employees. Also, employee attrition among existing small employer
groups continues to negatively impact the Company's ability to increase
membership in the small employer group market.
11
INVESTMENT INCOME
Net investment income was $3.5 million for the three months ended June 30, 2004,
compared to $3.3 million for the same period in 2003. Net investment income
increased for the six month period ended June 30, 2004 to $7.0 million from $6.7
million for the same period of the prior year. The increase in net investment
income is due primarily to an increase in average invested assets during the
period. Realized investment losses from the sale of securities for the three
months ended June 30, 2004 were $0.1 million compared to realized investment
gains of $0.1 million in the second quarter of the prior year. For the six
months ended June 30, 2004, realized investment losses were $0.1 million
compared to realized gains of $0.5 million for the same period of 2003. Realized
investment gains and losses fluctuate as the Company takes advantage of market
opportunities and realigns its investment portfolio from time to time.
OTHER REVENUE
Other revenue, which primarily consists of administrative fee income from claims
processing on self-funded business and other administrative services, increased
to $4.2 million for the three months ended June 30, 2004 from $3.8 million for
the three months ended June 30, 2003. For the first six months of 2004, other
revenue increased to $8.4 million from $7.9 million for the same period of the
prior year. The increase in other revenue is due to an increase in self-funded
membership.
LOSS RATIO
The health segment loss ratio improved slightly in the second quarter of 2004 to
67.3%, compared to 67.5% for the second quarter of 2003. For the first six
months, the health segment loss ratio was 65.8% in 2004, compared to 67.8% in
2003. The improvement from the first six months of the prior year is due
primarily to the 1.5% impact of the PBM settlement. The health segment loss
ratio is also impacted by a variety of other factors including claims cost
trends, product pricing and the cost of litigation. Management closely monitors
developments in litigation and emerging trends in claims costs to determine the
adequacy and reasonableness of the Company's related reserves, and adjusts such
reserves when necessary. The loss ratio for the life segment was favorable at
19.6% for the three months ended June 30, 2004, compared with 22.1% for the
corresponding period of the prior year. For the six months ended June 30, 2004
the life segment improved to 20.1% from 24.4% for the same period of the prior
year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE RATIO
The selling, general and administrative ("SG&A") expense ratio includes
commissions and selling expenses, administrative expenses net of other revenues,
and premium taxes and assessments. The SG&A expense ratio for the health segment
for the three months ended June 30, 2004 was 27.6%. This compares favorably to
the second quarter of 2003 health segment SG&A expense ratio of 28.0%. General
and administrative expenses decreased resulting from the Company's continued
focus on administrative cost containment and process efficiencies in an effort
to keep costs in line with revenues. Offsetting this decrease was an increase in
commissions and selling expenses due to improved MedOne new member enrollment
and the Company's investment in sales resources to support the Company's growth
efforts.
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 payment of medical and other benefits and SG&A expenses. Positive cash
flows are invested pending future payments of operating expenses; primarily
medical and other benefits. The Company's investment policies are structured to
provide sufficient liquidity to meet anticipated payment obligations.
12
The Company's investment portfolio consists almost exclusively of investment
grade bonds and has limited exposure to equity securities. At June 30, 2004 and
December 31, 2003, greater than 99% of the Company's investment portfolio was
invested in debt securities. The bond portfolio had an average quality rating of
AA at June 30, 2004 and December 31, 2003, as measured by Standard & Poor's
Corporation, and the Company held no below investment grade securities. The
majority of the bond portfolio was classified as available for sale. The Company
had no investment in mortgage loans, non-publicly traded securities, real estate
held for investment or financial derivatives. The net unrealized gain on the
Company's available for sale securities decreased during the second quarter of
2004 due to rising interest rates.
The Company's operating cash flow fluctuates significantly from quarter to
quarter due to variations in the timing of claims, litigation and other
operating payments or recoveries. Cash used in operations for the second quarter
of 2004 was $3.6 million compared to cash provided by operations of $2.0 million
in the second quarter of the prior year. Cash used in operations for the second
quarter of 2004 reflects a reduction in claims inventories, an extra federal tax
payment, and the payment of litigation expenses. For the six months ended June
30, 2004, cash provided by operations was $6.8 million, compared to cash used in
operations of $1.6 million for the corresponding period in the prior year. The
majority of the improvement in cash flow for the six month period resulted from
the receipt of a cash payment of $5.9 million in the first quarter of 2004
resulting from the PBM settlement described above.
The Company maintains a revolving bank line of credit agreement with a maximum
available facility of $50.0 million. At June 30, 2004, 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
June 30, 2004. 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 ("UWLIC"), the Company's principal insurance subsidiary,
domiciled in Wisconsin.
During the first six months of 2004, the Company continued its investment 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 resources to support most of the Company's major
business processes. Management believes this software investment will help
support business growth, operational efficiency, service improvements and future
administrative cost savings. The design and development of certain
administrative software applications began during the first quarter of 2003 and
modules were implemented during 2003 and the first six months of 2004, and the
remaining implementation is scheduled to be phased in over the next few years.
Capital expenditures during the first six months of 2004 were $4.1 million. In
June 2004, the Company amended an agreement with a software vendor resulting in
a commitment to purchase software applications and other services to support the
Company's core insurance systems. The future minimum purchase obligations
related to this agreement representing software license fees and incurred
consulting fees and expenses are listed below under the section entitled
"Contractual Obligations." 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 the modernization 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. No share repurchases were
made by the Company during the first six months of 2004. The share repurchase
program will continue to be supported through existing funds and future cash
flow.
Dividends paid by UWLIC to the corporate parent may be limited by Wisconsin
insurance regulations. The insurance regulator may disapprove any dividend
which, together with other dividends paid by UWLIC 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. In June 2004, a $6.0 million dividend was paid by
UWLIC to the corporate parent. Based upon the financial statements of the
Company's
13
insurance subsidiaries as of December 31, 2003, as filed with the
insurance regulators, the remaining amount available for dividend without
regulatory approval is $0.3 million until December 2004, when a dividend of
$11.3 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.
CONTRACTUAL OBLIGATIONS
Significant changes in the Company's contractual obligations since December 31,
2003 include the following minimum purchase obligations arising from an
amendment to an agreement with a software vendor:
Payments Due by Period
-----------------------------------------------------------
Less than More than
(MILLIONS) Total 1 year 1 - 3 years 3 - 5 years 5 years
- --------------------------------------------------------------------------------
Purchase obligations $4.7 $3.9 $0.8 - -
================================================================================
In addition to the minimum purchase obligations outlined above, the Company
anticipates future expenditures to the software vendor for support fees,
upgrades, enhancements, consulting, training and other services when such
services are needed and requested by the Company.
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 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
14
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 insurance regulations 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 insurance regulations that would impair the
Company's ability to market its products profitably.
Federal and state legislatures also are considering regulatory measures that 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.
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 Company believes a trial to determine
damages could not be held before the fourth 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 II, Item 1, "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
15
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. As
competitors seek to increase market share, they may lower prices and/or enter
the markets in which the Company competes.
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. Consolidations within the
industry may also contribute to the competitive environment. 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.
The Company's challenge is to increase the number of individuals and small
employer groups purchasing its products and services and to retain existing
members. Also impacting the Company's growth prospects is the affordability of
health insurance premiums as health care costs continue to rise, as well as the
downsizing or restrained hiring among small employers as a result of economic
uncertainty. If the Company's initiatives are not successful and the Company
does not meet its growth goals, the Company's future operating performance may
be adversely affected.
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 9.6% of the Company's premium revenue for the
six months ended June 30, 2004. The loss of this relationship could hamper the
Company's growth plans and, as a result, adversely affect the Company's future
operating performance.
16
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.
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 could have a material
adverse effect on the Company. Some of the 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.
17
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 June 30, 2004 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.
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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk has not substantially changed from the year ended
December 31, 2003.
ITEM 4. 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 June 30, 2004. 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 June 30, 2004. There were no changes in the Company's internal
control over financial reporting during the second quarter of 2004 that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
18
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following report of recent developments in previously reported legal
proceedings should be read in conjunction with Item 3, Legal Proceedings, in the
Company's annual report on Form 10-K for the fiscal year ended December 31,
2003, and quarterly report on Form 10-Q for the quarter ended March 31, 2004.
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
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 Company believes
a trial could not be held before the fourth 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. The settlement has received preliminary approval of the Court. If the
settlement receives final approval, all claims of participating class members
would be dismissed in exchange for the settlement consideration. On June 14,
2004, the Superior Court of Cobb County, Georgia, in PARKER V. AMERICAN MEDICAL
SECURITY GROUP, INC., issued an order enjoining the Company from settling with
Georgia residents who are members of the Gadson class. The Company believes this
injunction violates general principles of comity and the Full Faith and Credit
clause of the United States Constitution and expects the injunction to be
overturned by the Georgia Supreme Court, where the Company's appeal of the order
is currently pending. 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 of the settlement by the Circuit Court in
September 2004.
The Company's subsidiaries, AMS and UWLIC, are defendants in a number of other
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.
19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders of the Company was held on May 18, 2004 for
the purpose of electing three directors for terms expiring at the 2007 annual
meeting of shareholders and re-approving the material terms of performance goals
in the Company's Equity Incentive Plan, as required by Section 162(m) of the
Internal Revenue Code. Shareholders elected all three of the Company's nominees
for director and approved the material terms of the performance goals in the
Company's Equity Incentive Plan. The voting results for the proposals were as
follows:
ELECTION OF DIRECTORS FOR TERMS EXPIRING IN 2007:
Mark A. Brodhagen: Samuel V. Miller:
For 12,527,326 shares For 12,411,204 shares
Withheld 149,225 shares Withheld 265,347 shares
Abstained 0 Abstained 0
Broker Non-Votes 0 Broker Non-Votes 0
Michael T. Riordan:
For 12,196,573 shares
Withheld 479,978 shares
Abstained 0
Broker Non-Votes 0
RE-APPROVAL OF MATERIAL TERMS OF PERFORMANCE GOALS IN EQUITY INCENTIVE PLAN:
For 11,967,444 shares
Against 667,589 shares
Abstained 41,517 shares
Broker Non-Votes 1 shares
Further information concerning these matters, including the names of the
directors whose terms continued after the meeting, is contained in the Company's
Proxy Statement dated April 5, 2004, with respect to the 2004 annual meeting of
shareholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
See the Exhibit Index following the signature page of this report, which is
incorporated herein by reference.
(b) REPORTS ON FORM 8-K
The Company submitted the following reports on Form 8-K during the second
quarter of 2004:
o A Form 8-K dated May 4, 2004, was submitted on May 5, 2004, to furnish
the Company's earnings release for the quarter ended March 31, 2004.
After the end of the quarter, the Company submitted the following reports on
Form 8-K:
o A Form 8-K dated August 4, 2004, was submitted on August 4, 2004, to
furnish the Company's earnings release for the quarter ended June 30,
2004.
20
SIGNATURES
Pursuant to the requirements 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.
DATE: August 5, 2004
AMERICAN MEDICAL SECURITY GROUP, INC.
/s/ John R. Lombardi
John R. Lombardi
Executive Vice President, Chief Financial Officer and Treasurer
(Principal Financial Officer and Chief Accounting Officer
and duly authorized to sign on behalf of the Registrant)
21
AMERICAN MEDICAL SECURITY GROUP, INC.
(the "Registrant")
(Commission File No. 1-13154)
EXHIBIT INDEX
TO
FORM 10-Q QUARTERLY REPORT
for quarter ended June 30, 2004
EXHIBIT DESCRIPTION INCORPORATED HEREIN FILED
NUMBER BY REFERENCE TO HEREWITH
10 Deferred Compensation Trust as Amended X
and Restated April 15, 2004
31.1 Certification of Chief Executive Officer X
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 Officer X
Pursuant to Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act
of 1934, as amended
32 Certification of Chief Executive Officer X
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
EX-1