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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
COMMISSION FILE #0-11321
UNIVERSAL AMERICAN FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2580136
------------------ --------------------------
(State of Incorporation) (I.R.S. Employer I.D. Number)
Six International Drive, Suite 190, Rye Brook, NY 10573
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (914) 934-5200
Securities registered pursuant to Section 12 (b) of the Act:
Name of Each Exchange
Title of Class on which Registered
-------------- -------------------
Common Stock, par value $.01 per share NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--------------- -------------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 1, 2002 was approximately $134,000,000.
The number of shares outstanding of the Registrant's Common Stock as of
March 1, 2002 was 52,925,027.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated:
(1) Proxy Statement for the 2002 Annual Meeting incorporated by reference into
Part III.
(2) Exhibits listed in Part IV, Item 14 (a) incorporated by reference to Proxy
Statement dated July 12, 1999, Forms 8-K dated August 13, 1999 and March
16, 2001, Form 8-K/A dated March 16, 2001.
PART I
ITEM 1 - BUSINESS
GENERAL
We are the holding company for a group of life insurance companies that
sell life and supplemental health insurance products designed for the senior
market and the self-employed market, and administrative services companies that
specialize in providing outsourcing capabilities for senior market insurance and
non-insurance programs. We have been able to achieve rapid, and profitable,
growth as a result of our focus on our core markets, enhanced by several
acquisitions that have been additive financially and strategically. During the
three years ended December 31, 2001, our net income has increased from $9.6
million to $28.9 million, our gross premium has increased from $252.6 million to
$513.6 million, our total assets have grown from $272.6 million to $1.3 billion
and our stockholder's equity has grown from$28.3 million to $230.8 million.
SENIOR MARKET OPPORTUNITY
We believe that attractive growth opportunities exist in serving the
senior market. The population of persons over age 65 in the United States is
projected to grow from the current level of approximately 35 million to
approximately 70 million by 2030, according to the U.S. Census Bureau. The shift
in population toward individuals over age 65 presents significant opportunities
for us to sell our insurance products, especially supplemental health insurance.
Further, as health and medical technologies increase life expectancy, we believe
that seniors and their adult children will increasingly focus on elder care
needs and the services required, including insurance, to address those needs.
OUR OPERATING SEGMENTS
We manage our business through the following operating segments:
SENIOR MARKET BROKERAGE
Our senior market brokerage segment focuses on selling insurance products
designed for the senior market, including Medicare supplement, Medicare select,
long term care, senior life insurance and annuities through independent
marketing organizations and general agencies. This segment's operations are
conducted primarily by the following subsidiaries:
- American Pioneer Life Insurance Company
- American Progressive Life & Health Insurance Company of New York
- Constitution Life Insurance Company
CAREER AGENCY
Our career agency segment traditionally concentrated on selling fixed
benefit accident and sickness disability insurance and individual life insurance
products to the middle-income self-employed market. This segment has recently
expanded its focus to include senior market products as well. The producers in
our career agency segment are contracted to sell products only with our
companies; however, they may sell products of other companies through programs
sponsored by us. This segment's operations are conducted by the following
subsidiaries:
- Pennsylvania Life Insurance Company
- PennCorp Life Insurance Company (Canada)
2
ADMINISTRATIVE SERVICES
Our administrative companies, primarily CHCS Services, Inc., provide
outsourcing services that support insurance and non-insurance products,
primarily for the senior market. CHCS Services, Inc. has emerged as a leading,
full-service administrator of senior insurance products and an innovator in
geriatric care management. We utilize state of the art technology and a national
network of highly trained health care professionals to provide the
administrative platform for these insurance and insurance-related products and
services. Currently, we provide services to more than 45 insurers and generated
fee income of $32.8 million in 2001 from both unaffiliated ($16.9 million) and
affiliated companies ($15.9 million).
SPECIAL MARKETS
We maintain a special markets segment to manage blocks of business that
are no longer within our core focus. The products in this segment include
traditional, interest-sensitive and group life insurance, individual major
medical and other accident and health insurance. In the fourth quarter of 2000,
we decided to exit our individual major medical business to the extent permitted
by the policy form. Approximately $3.3 million of annualized major medical
premium in force is not cancelable by us and will continue to be managed in our
special markets segment.
CORPORATE
The results of operations of our corporate segment include the expenses of
our holding company, including the costs associated with being a public company,
and the interest payable on our debt.
OUR BUSINESS STRATEGY
The principal components of our business strategy are to:
- Develop and market competitive and innovative insurance products,
with an emphasis on the senior market;
- Expand our brokerage and career distribution channels through
additional recruiting and geographic expansion;
- Build our fee-based administrative business in order to complement
our risk-based insurance business;
- Sharpen our focus on core business by exiting lines of business that
do not fit within our strategy or core competencies;
- Employ conservative risk management techniques, including
maintaining a high quality investment portfolio, disciplined pricing
and prudent use of reinsurance;
- Pursue selective acquisitions that fit our strategic and financial
criteria in order to supplement our internal growth;
- Execute efficiently, especially in regard to integrating the
operations of companies and blocks of business that we acquire.
3
RECENT ACQUISITIONS, DIVESTITURES AND CAPITAL MARKET ACTIVITY
Equity Offering
In the third quarter of 2001, we completed a secondary equity offering in
which we sold 5.7 million shares of our common stock and raised $26.0 million,
net of expenses. In addition, 2.2 million shares were sold by some of our
shareholders as part of the offering. The primary reason for the offering was to
enhance the capital of our insurance subsidiaries to support our growth and to
improve our risk based capital ratios used by regulators and rating agencies to
evaluate the adequacy of capital of insurance companies. Out of the proceeds of
the offering, $9.3 million was contributed to the capital and surplus of our
insurance subsidiaries, $5.5 million was used to reduce the intercompany
debenture between our parent holding company and American Progressive and the
balance was held for general corporate purposes.
Acquisition of Administrative Service Companies
In November 2001, we acquired assets from Living Strategies, Inc., a
privately held company based in Bala Cynwyd, Pennsylvania, including certain
contracts, trademarks and proprietary web-based technology. Living Strategies is
a recognized provider of employer-sponsored elder care programs, providing
assistance and support to those dealing with the aging of their parents and
family members. As a result of the acquisition of the Living Strategies assets,
we have enhanced our technology infrastructure and expanded the audience for our
elder care management services.
In August 2000, we acquired Capitated HealthCare Services, Inc. ("CHCS") a
privately held administrator of long term care products located in Weston,
Florida. At the time of the acquisition, CHCS performed outsourcing services for
more than 30 insurance companies. This acquisition enhanced our expertise in the
long term care business.
In January 2000, we acquired American Insurance Administration Group,
Inc., a privately-held third party administrator of senior health products
located in Clearwater, Florida. At the time of the acquisition, American
Insurance Administration Group administered $125 million of senior market
premium. This acquisition strengthened our expertise and capacity to administer
senior market products.
1999 Acquisition
In July 1999, we acquired six insurance companies, including the insurance
subsidiaries that comprise our Career Agency segment, and other assets from
PennCorp Financial Group. This acquisition enhanced our prospects for internal
growth by increasing our scale, expanding our geographic reach and adding the
career agency marketing channel to supplement our senior market brokerage
marketing channel.
In January 2000, we began to integrate the operations of the acquired
companies from Raleigh, North Carolina into our existing locations in Toronto,
Pensacola and Orlando. We completed this integration in February 2001.
Cancellation of Major Medical Insurance
In the fourth quarter of 2000, we decided to exit our individual major
medical business to the extent permitted by the policy form. Out of the $31.3
million of cancelable premium that was in force on December 31, 2000,
approximately $2.4 million of annualized major medical premium in force remained
in force on December 31, 2001, and we anticipate the balance will be cancelled
by the end of 2002. We will not be able to cancel approximately $3.3 million of
major medical premium.
4
ADMINISTRATIVE SERVICES
We have built our administrative services capabilities through internal
development and acquisition. Through our wholly owned subsidiary, CHCS
Services, Inc., we provide outsourcing services that support insurance and
non-insurance products, primarily for the senior market. Our administrative
services operations are located in Pensacola, Clearwater and Weston, Florida. We
are in the process of closing the Clearwater office and consolidating the
operations to Pensacola and Weston.
We perform a full range of administrative services for senior market
insurance products, primarily Medicare supplement and long term care, for both
affiliated and unaffiliated companies. The services include policy underwriting
and issuance, policy billing and collecting, telephone verification,
policyholder services, claims adjudication, clinical case management, care
assessment and referral to health care facilities.
We are also increasingly performing similar services, particularly in the
long term care area, for non-insurance products offered both by insurance and
non-insurance companies. For example, we have begun to market our Nurse
Navigator(TM) product, a non-insurance elder care service product that includes
health related information and referrals and access to nationwide networks of
geriatric care nurses and long term care providers available on a discounted
basis.
We utilize state of the art technology and a national network of highly
trained health care professionals to provide the administrative platform for
these insurance and insurance-related products and services. The information
technology includes imaging and workflow processes to ensure maximum efficiency
in policy issue, policy administration and claims processing. Our propriety
network of over 3,500 registered nurses and social workers provides personalized
support and care for our senior programs nationwide. In addition, our propriety
network of approximately 5,500 discount providers is an integral part of our
geriatric care management services. We have established a customer contact
center that provides around the clock access to our nurses on staff and can
handle calls in 11 different languages.
The following table shows the sources of our service fee revenue by type
of product:
2001 2000 1999
------- ------- -------
(in thousands)
Affiliated Revenue
Medicare supplement $13,268 $ 8,467 $ 5,949
Long term care 1,607 981 572
Nurse Navigator(TM) 272 -- --
Other health insurance 358 930 1,031
Life insurance 388 135 50
------- ------- -------
Total Affiliated Revenue 15,893 10,513 7,602
------- ------- -------
Unaffiliated Revenue
Medicare supplement 9,564 9,410 --
Long term care 5,577 2,725 16
Other health insurance 554 758 1,160
Non-insurance assistance 1,242 724 512
------- ------- -------
Total Unaffiliated Revenue 16,937 13,617 1,688
------- ------- -------
Total Administrative Service Revenue $32,830 $24,130 $ 9,290
======= ======= =======
5
Included in unaffiliated revenue are fees received from a reinsurer of
100% of certain business of one of our insurance subsidiaries, which amounted to
$7.8 million and $7.6 million in 2001 and 2000. These fees, together with the
affiliated revenue, were eliminated in consolidation.
INSURANCE MARKETING AND DISTRIBUTION
Prior to 1999, we had marketed our products only through a traditional
general brokerage agency system. As a result of the acquisition of Pennsylvania
Life Insurance Company and PennCorp Life Insurance Company (Canada) in 1999, we
now distribute products through a career agency channel as well. The following
table shows our new sales (issued annualized premiums) by distribution channel
and by major product line for the three years ended December 31, 2001:
Product 2001 2000 1999
-------- -------- --------
(In thousands)
Senior Market Brokerage
Accident and Health
Medicare Supplement/Select $103,044 $ 78,213 $ 30,771
Long Term Care 3,196 4,580 4,058
Other Senior Health 262 244 241
-------- -------- --------
Total Senior Health 106,502 83,037 35,070
-------- -------- --------
Senior Life Insurance 3,240 2,106 1,495
-------- -------- --------
Total Senior Market Brokerage 109,742 85,143 36,565
-------- -------- --------
Career Agency
Accident and Health 20,154 20,750 20,000
Life Insurance 2,043 1,500 2,000
-------- -------- --------
Total Career Agency 22,197 22,250 22,000
-------- -------- --------
Special Markets
Accident and Health 1,838 6,988 8,175
Life Insurance 294 546 555
-------- -------- --------
Total Special Markets 2,132 7,534 8,730
-------- -------- --------
TOTAL ISSUED PREMIUM $134,071 $114,927 $ 67,295
======== ======== ========
The following table shows our annuity deposits by distribution channel for
the three years ended December 31, 2001:
2001 2000 1999
------- ------- -------
(In thousands)
Senior Market Brokerage $ 6,186 $ 5,188 $ 6,299
Career Agency 8,407 3,000 --
Special Markets -- -- --
------- ------- -------
TOTAL ANNUITY DEPOSITS $14,593 $ 8,188 $ 6,299
======= ======= =======
6
SENIOR MARKET BROKERAGE
This segment focuses on the sale of products designed for the senior
market such as Medicare supplement, Medicare select, long term care, senior life
insurance and annuities. We distribute these products through independent
marketing organizations and general agencies. These marketing organizations and
general agencies typically recruit and train their own agents, bearing all of
the costs incurred in connection with developing their organization. We now sell
our products through approximately 18,000 independent licensed agents in 26
states and have plans to recruit more agents and expand into additional states.
In 2001, this segment accounted for $340.7 million, or 66.0%, of our
consolidated gross premiums and $77.9 million, or 34.0%, of our consolidated net
premiums earned. New sales for this segment amounted to $109.7 million in 2001
and $85.1 million in 2000.
CAREER AGENCY
As part of the 1999 acquisition, we acquired a career agency sales force
that historically distributed fixed benefit accident and sickness disability
insurance and individual life insurance products to the self-employed market in
the United States and Canada. In contrast to independent agents, career agents
have an exclusive arrangement with us, and only sell products that we provide or
authorize. In order to maximize this distribution channel, we introduced our
senior market insured and non-insured products. As of December 31, 2001, the
career field force had 97 branch offices throughout the United States and 14
branch offices in Canada, with approximately 750 agents in the United States and
350 agents in Canada. In 2001, this segment accounted for $126.1 million, or
55.0%, of our net premiums earned. Approximately 37% of net premiums earned for
this segment were generated by our Canadian operations. The career agency
segment issued $22.2 million of new insurance premium in 2001, which was
comparable to the amount of new business issued by this segment in 2000. In
addition, the career sales force generated $1.7 million in sales of products for
our other subsidiaries, which includes $1.4 million of non insured products.
SPECIAL MARKETS
Our special market segment manages various lines of insurance that are no
longer part of our core focus, such as traditional and interest-sensitive life
insurance, group life insurance, individual major medical and other accident and
health insurance. Although we generally do not market these products to new
customers, we do continue to sell these products in limited amounts through
general agency relationships and we continue to receive premiums from existing
customers. We believe that these lines of business should be actively managed
for profit or disposed of through sale or cancellation. In December 2000, we
decided to exit the individual major medical business, which has accounted for
the majority of the production of new business in this segment. This segment had
net premiums earned of $25.2 million, or 11.0% of our consolidated total, in
2001, compared to $38.3 million, or 17.4% of our consolidated total, in 2000.
INSURANCE PRODUCTS
Our senior market brokerage segment focuses on our senior market products
(Medicare supplement, Medicare select, long term care, senior life insurance and
annuities), while our career agency segment focuses on fixed benefit disability
income, with an increasing focus on senior market products. We currently market
the following products:
SENIOR MARKET PRODUCTS -- SUPPLEMENTAL HEALTH AND LONG TERM CARE
Our core supplemental health insurance products include various Medicare
supplement and Medicare select plans. We also offer various long term care plans
consisting of fully integrated plans, nursing home only plans and stand alone
home health care plans. These products typically are guaranteed renewable for
the lifetime of the policyholder, which means that we cannot cancel the policy,
but can seek to increase premium rates on existing and future policies issued
based upon our actual claims experience. These rate increases are applied on a
uniform, nondiscriminatory state by state basis and are subject to state
regulatory approval and Federal and state loss-ratio requirements.
7
Medicare Supplement/Select
Under Federal and NAIC model regulations, adopted in substantially all
states, there are 11 standard Medicare supplement plans (Plans A through J and a
High Deductible Plan F). These policies provide supplemental coverage for many
of the medical expenses that the Medicare program does not cover, such as
deductibles, coinsurance and specified losses that exceed the Federal program's
maximum benefits. Plan A provides the least extensive coverage, while Plan J
provides the most extensive coverage. Under NAIC regulations, Medicare insurers
must offer Plan A, but may offer any of the other plans at their option. Our
insurance company subsidiaries offer Medicare supplement policies primarily on
plans A, B, C, D and F. In some areas, we also sell Medicare select policies in
conjunction with hospitals that contract with us to waive the Medicare Part A
deductible. We monitor the claim experience on our Medicare supplement and
Medicare select products and, when necessary, apply for rate increases in the
states in which we sell the products. Medicare supplement and Medicare select
issued gross premium amounted to $103.0 million in 2001 and $78.2 million in
2000, and were produced through our general agency system. We will be
introducing our High Deductible Plan F product in 2002, which provides seniors
with a lower cost plan for those who can afford a higher annual deductible. The
career agency segment began to sell Medicare supplement and Medicare select
products in 2001 and produced $0.3 million in premiums.
Long Term Care
Our long term care insurance products provide coverage, with limits
selected by the policyholders, for nursing home and assisted living care only
coverage, home health care only coverage, or an integrated combination of such
coverage. The nursing home and assisted living care products are subject to
daily fixed dollar maximum limits, have various elimination periods which must
be satisfied by the insureds and have maximum lifetime benefits or benefit
periods. The home health care products cover care needed in the insured's home,
are subject to daily or weekly maximum dollar benefits and an overall lifetime
maximum benefit or maximum benefit period. A new integrated long term care
product, combining nursing home, assisted living and home health care benefits
was introduced in late 1999 in several states and we have developed a new
nursing home-assisted living product with optional home health care riders which
we introduced in 2001. Issued premium for these long term care products
amounting to $3.2 million in 2001 and $4.6 million in 2000, were produced
through our general agency system. In addition, our career agents began to sell
these long term care products in 2000 and produced $4.0 million of issued
premium in 2001 and $3.9 million of issued premium in 2000.
SENIOR MARKET PRODUCTS -- SENIOR LIFE INSURANCE AND ANNUITIES
Senior Life
This series of low-face amount, simplified issue whole life products is
sold by both our senior market brokerage segment and our career agency segment.
Issued premium for these products was $3.2 million in 2001 and $2.1 million in
2000, and was produced primarily through the general agency system. In late
2000, our career agency segment began to sell senior life insurance and produced
$1.2 million of issued premium in 2001 and $0.6 million of issued premium in
2000
Annuities
We market single and flexible premium deferred annuities primarily
focusing on the senior and retirement markets. Our currently marketed annuity
products have a minimum guaranteed interest rate ranging from 3.0% to 4.0%
annually and current credited interest rates that range from 3.0% to 7.3%. We
have the right to change the crediting rates at any time. In exercising our
right to change the interest rate, we take into account the current interest
rate environment, the profitability of our annuity business and our relative
competitive position. Our general agency system produced $6.2 million of annuity
deposits in 2001 and $5.2 million of annuity deposits in 2000. Additionally, our
career agency system produced $8.4 million of annuity deposits in 2001 and $3.0
million of annuity deposits in 2000.
8
CAREER AGENCY PRODUCTS
Fixed Benefit Accident and Health
Fixed benefit accident and health products provide three principal types
of benefits:
- disability -- fixed periodic payments to an insured who becomes
disabled and unable to work due to an accident or sickness,
- hospital -- fixed periodic payments to an insured who becomes
hospitalized, and
- surgical -- fixed single payments that vary in amount for specified
surgical or diagnostic procedures.
Because the benefits we provide are fixed in amount at the time of policy
issuance and are not intended to provide full reimbursement for medical and
hospital expenses, payment amounts are not affected by inflation or the rising
cost of health care services. The disability income product is typically sold to
individuals in amounts which, when combined with other similar coverages, do not
provide monthly benefits in excess of $2,000, or 50% of the insured's monthly
income, if less. The hospital income product is typically sold to individuals to
provide the insured with a means of paying supplemental expenses during a
hospitalization stay and provides benefits of not more than $250 per day ($1,000
if the insured is in intensive care). The surgical product is typically sold as
a rider to an accident policy and our practice is to provide benefits of not
more than $5,000 ($2,500 if the procedure is performed on an out-patient basis).
Life Insurance
In late 2000, our career agency segment began to sell term life insurance
that provides a minimum coverage of $50,000 for a ten-year period (offered to
individuals ages 18 through 60) or a twenty-year period (offered to individuals
ages 18 through 50) as specified in the policy. Premium rates vary according to
age and sex and these policies are fully underwritten. No cash values are
accumulated in this policy and the policy can be renewed for a new term at an
increased premium on any expiration date, except for the final expiration date,
without evidence of insurability. Issued premium amounted to $0.3 million for
2001 and $0.5 million for 2000.
BUSINESS IN FORCE
As of December 31, 2001, the Company had $556.0 million of annualized
premium in force and $236.7 million in account values.
9
Our growth in direct, acquired and assumed annualized premium in force,
including only the portion of premiums on interest-sensitive products that is
applied to the cost of insurance, is shown in the following tables as of
December 31, 2001, 2000 and 1999.
ANNUALIZED PREMIUM IN FORCE
As of December 31,
----------------------------------------
2001 2000 1999
-------- -------- --------
(In thousands)
SENIOR MARKET BROKERAGE
Accident & Health
Medicare Supplement and Select Written $206,186 $115,217 $ 49,962
Medicare Supplement Acquired 157,284 149,200 154,617
Long Term Care 21,594 20,395 16,167
Hospital Indemnity 1,347 1,304 1,456
-------- -------- --------
TOTAL ACCIDENT & HEALTH 386,411 286,116 222,202
-------- -------- --------
Life
Asset Enhancer (1) 5,169 6,357 7,248
Final Expense Life 6,194 3,984 2,479
-------- -------- --------
TOTAL LIFE 11,363 10,341 9,727
-------- -------- --------
TOTAL SENIOR MARKET BROKERAGE 397,774 296,457 231,929
-------- -------- --------
CAREER AGENCY
Accident & Health
Accident & Sickness Disability 84,629 89,718 91,120
Hospital 16,229 16,635 21,614
Long Term Care Written 4,191 3,900 --
Long Term Care Acquired 10,930 9,680 12,011
-------- -------- --------
TOTAL ACCIDENT & HEALTH 115,979 119,933 124,745
LIFE (1) 13,233 13,234 15,800
-------- -------- --------
TOTAL CAREER AGENCY 129,212 133,167 140,545
-------- -------- --------
SPECIAL MARKETS
Accident & Health
Individual Medical (2) 5,675 31,422 45,442
Other Accident & Health 8,872 8,640 9,518
-------- -------- --------
TOTAL ACCIDENT & HEALTH 14,547 40,062 54,960
-------- -------- --------
Life
Group Life 3,139 3,444 3,542
Individual Life (1) 11,297 12,487 7,311
-------- -------- --------
TOTAL LIFE 14,436 15,931 10,853
-------- -------- --------
TOTAL SPECIAL MARKETS 28,983 55,993 65,813
-------- -------- --------
CONSOLIDATED
ACCIDENT & HEALTH 516,937 446,111 401,907
LIFE 39,032 39,506 36,380
-------- -------- --------
TOTAL CONSOLIDATED $555,969 $485,617 $438,287
======== ======== ========
(1) Included in the amounts shown are premiums for interest-sensitive
products. These amounts represent the portion of premium applied to
the cost of insurance (deposit premiums have been excluded).
(2) In the fourth quarter of 2000, we decided to exit our
under-performing individual major medical business to the extent
possible. We believe we will be able to cancel, by the end of 2002,
approximately $2.4 million of the $5.7 million in annualized premium
in force on December 31, 2001.
10
ACCOUNT VALUES ON INTEREST-SENSITIVE PRODUCTS
The following table shows all outstanding account values for
interest-sensitive products as of December 31, 2001, 2000 and 1999. For these
products, we earn income on the difference between investment income that we
earn on our invested assets and interest credited to these account balances.
As of December 31,
----------------------------------------
2001 2000 1999
-------- -------- --------
(In thousands)
Annuities $ 99,632 $ 98,053 $107,169
Interest-sensitive Life 137,110 135,362 131,496
-------- -------- --------
Grand Total $236,742 $233,415 $238,665
======== ======== ========
GEOGRAPHICAL DISTRIBUTION OF PREMIUM
Through our nine insurance subsidiaries, we are licensed to market our
products in all fifty states, the District of Columbia and in all the provinces
of Canada. The following table shows (by direct cash premium collected as
reported to the regulatory authorities for the full year of 2001) the
geographical distribution of premiums collected:
State/Region Collected % Total
------------ Premium -------
-------
(In thousands)
Florida $105,049 19.7%
Texas 60,953 11.5%
Canada 47,234 8.9%
New York 37,191 7.0%
Wisconsin 30,802 5.8%
Pennsylvania 25,855 4.9%
Indiana 25,521 4.8%
Ohio 23,146 4.3%
Georgia 11,986 2.3%
Mississippi 10,404 2.0%
Missouri 10,885 2.0%
North Carolina 10,861 2.0%
Oklahoma 8,928 1.6%
-------- -----
Subtotal 408,815 76.8%
All other 123,342 23.2%
-------- -----
Total $532,157 100.0%
======== =====
In 2001, no agent produced as much as 5% of our total premiums collected.
11
REINSURANCE
We enter into reinsurance arrangements with unaffiliated reinsurance
companies to limit our exposure on individual claims, to support the increased
volume of new business generated by the Senior Market brokerage segment and to
limit or eliminate risk on our non-core or under-performing blocks of business.
The table below details our gross annualized premium in force, the portion that
we ceded to reinsurers and the net amount that we retained as of December 31,
2001.
ANNUALIZED PREMIUM IN FORCE
As of December 31, 2001
----------------------------------------------------------
Gross Ceded Net % Retained
-------- -------- -------- ----------
(In thousands)
SENIOR MARKET BROKERAGE
Accident & Health
Medicare Supplement and Select Written $206,186 $142,973 $ 63,213 31%
Medicare Supplement Acquired 157,284 149,001 8,283 5%
Long Term Care 21,594 8,694 12,900 60%
Hospital Indemnity 1,347 303 1,044 78%
-------- -------- --------
TOTAL ACCIDENT & HEALTH 386,411 300,971 85,440 22%
-------- -------- --------
Life
Asset Enhancer 5,169 1,097 4,072 79%
Final Expense Life 6,194 3,008 3,186 51%
-------- -------- --------
TOTAL LIFE 11,363 4,105 7,258 64%
-------- -------- --------
TOTAL SENIOR MARKET BROKERAGE 397,774 305,076 92,698 23%
-------- -------- --------
CAREER AGENCY
Accident & Health
Accident & Sickness Disability 84,629 -- 84,629 100%
Hospital 16,229 -- 16,229 100%
Long Term Care Written 4,191 2,095 2,096 50%
Long Term Care Acquired 10,930 -- 10,930 100%
-------- -------- --------
TOTAL ACCIDENT & HEALTH 115,979 2,095 113,884 98%
-------- -------- --------
LIFE 13,233 -- 13,233 100%
-------- -------- --------
TOTAL CAREER AGENCY 129,212 2,095 127,117 98%
-------- -------- --------
SPECIAL MARKETS
Accident & Health
Individual Medical 5,675 446 5,229 92%
Other Accident & Health 8,872 6,728 2,144 24%
-------- -------- --------
TOTAL ACCIDENT & HEALTH 14,547 7,174 7,373 51%
-------- -------- --------
Life
Group Life 3,139 -- 3,139 100%
Individual Life 11,297 1,169 10,128 90%
-------- -------- --------
TOTAL LIFE 14,436 1,169 13,267 92%
-------- -------- --------
TOTAL SPECIAL MARKETS 28,983 8,343 20,640 71%
-------- -------- --------
CONSOLIDATED
ACCIDENT & HEALTH 516,937 310,240 206,697 40%
LIFE 39,032 5,274 33,758 86%
-------- -------- --------
TOTAL CONSOLIDATED $555,969 $315,514 $240,455 43%
======== ======== ========
12
We are obligated to pay claims in the event that any reinsurer to whom we
have ceded an insured claim fails to meet its obligations under the reinsurance
agreement. As of December 31, 2001, our primary reinsurers were rated "A" or
better by A.M. Best. We do not know of any instances where any of our reinsurers
has been unable to pay any policy claims on any reinsured business.
In addition to the reinsurance agreements discussed below by segment, we
reinsure portions of the coverage of our life insurance products to unaffiliated
reinsurance companies under various reinsurance agreements, which allows us to
write policies in amounts larger than the risk we are willing to retain on any
one life. Our mortality risk retention limit on each policy varies between
$25,000 and $250,000.
Our reinsurance agreements are generally subject to cancellation on 90
days notice as to future business, but policies reinsured prior to such
cancellation remain reinsured as long as they remain in force. We believe that
if any of our reinsurance agreements were canceled we would be able to obtain
other reinsurance arrangements on satisfactory terms to enable us to continue
writing new business.
SENIOR MARKET BROKERAGE
We reinsure most of our senior market brokerage products to unaffiliated
reinsurers under various quota share agreements. Under these reinsurance
agreements, we reinsure a portion of the premiums earned, claims incurred and
commissions on a pro rata basis and receive additional expense allowances for
policy issue administration and premium taxes. Medicare supplement premium
currently being issued is reinsured under quota share reinsurance agreements
ranging between 50% and 75% based upon the geographic distribution. We have also
acquired various blocks of Medicare supplement premium, which we reinsure under
quota share reinsurance agreements ranging from 50% to 100%. Our long term care
products currently produced are reinsured at percentages averaging 50%, while
the long term care business acquired in 1999 is 100% retained. We reinsure
senior life insurance products currently being issued on a 50% quota share
basis.
CAREER AGENCY
Currently, we retain 100% of all life and health business issued in our
career agency segment other than the long term care and Medicare supplement
products, which we reinsure on a 50% quota share basis.
SPECIAL MARKETS
We have 50% quota share and excess of loss reinsurance agreements with
unaffiliated reinsurance companies on our medical insurance policies to reduce
the liability on individual risks to amounts ranging between $50,000 and
$250,000 per year. Under these treaties, we perform all the policy
administration and receive various allowances for commission and expenses on the
ceded portion of the premium. Excess of loss reinsurance passes the risk of
losses over a specified amount to the reinsurer, effectively capping our
exposure on any single claim to the specified amount. The major medical business
acquired in 1999 is 100% retained but has an excess of loss reinsurance
agreement limiting the liability on an individual risk to $250,000 per year.
Most of this business is in the process of being canceled.
ADMINISTRATION OF REINSURED BLOCKS OF BUSINESS
We generally retain the administration for reinsured blocks of business,
including underwriting, issue, policy maintenance, rate management and claims
adjudication and payment. In addition to reimbursement for commissions and
premium taxes on the reinsured business, we also receive allowances from the
reinsurers as compensation for our administration.
13
UNDERWRITING PROCEDURES
Premiums charged on insurance products are based, in part, on assumptions
about expected mortality and morbidity experience. We have adopted and follow
detailed uniform underwriting procedures designed to assess and quantify various
insurance risks before issuing individual life insurance, health insurance
policies and annuity policies to individuals. These procedures are generally
based on industry practices, reinsurer underwriting manuals and our prior
underwriting experience. To implement these procedures, our insurance company
subsidiaries employ an experienced professional underwriting staff.
Applications for insurance are reviewed on the basis of the answers that
the customer provides to the application questions. Where appropriate to the
type and amount of insurance applied for and the applicant's age and medical
history, additional information is required, such as medical examinations,
statements from doctors who have treated the applicant in the past and, where
indicated, special medical tests. If deemed necessary, we use investigative
services to supplement and substantiate information. For certain coverages, we
may verify information with the applicant by telephone. After reviewing the
information collected, we either issue the policy as applied for on a standard
basis, issue the policy with an extra premium charge due to unfavorable factors,
issue the policy excluding benefits for certain conditions, either permanently
or for a period of time, or reject the application. For some of our coverages,
we have adopted simplified policy issue procedures in which the applicant
submits an application for coverage typically containing only a few
health-related questions instead of a complete medical history. Under
regulations promulgated by the NAIC and adopted as a result of the Omnibus
Budget Reconciliation Act of 1990, we are prohibited from underwriting our
Medicare supplement policies for certain first-time purchasers and for
dis-enrollees from Health Maintenance Organizations (HMO's). If a person applies
for insurance within six months after becoming eligible by reason of age, or
disability in some circumstances, the application may not be rejected due to
medical conditions. For other prospective Medicare supplement policyholders,
such as senior citizens who are purchasing our products, the underwriting
procedures are limited based upon standard industry practices. In New York and
some other states, some of our products, including Medicare supplement, are
subject to guaranteed issue "Community Rating" laws that severely limit or
prevent underwriting of individual applications. See "Regulation" section of
this document.
RESERVES
In accordance with applicable insurance regulations, we have established,
and carry as liabilities in our statutory financial statements, actuarially
determined reserves that are calculated to satisfy our policy and contract
obligations. Reserves, together with premiums to be received on outstanding
policies and contracts and interest at assumed rates on such amounts, are
calculated to be sufficient to satisfy policy and contract obligations. The
actuarial factors used in determining reserves for life insurance policies are
based on statutorily prescribed mortality tables and interest rates. In
addition, reserves for accident and health insurance policies use prescribed or
permitted morbidity tables. Reserves are also maintained for unearned premiums,
for premium deposits, for claims that have been reported and are in the process
of being paid or contested and for our estimate for claims that have been
incurred but have not yet been reported.
The reserves reflected in our consolidated financial statements are
calculated in accordance with GAAP. These reserves are determined based on our
best estimates of mortality and morbidity, persistency, expenses and investment
income. We use the net level premium method for all non-interest-sensitive
products and the retrospective deposit method for interest-sensitive products.
GAAP reserves differ from statutory reserves due to the use of different
assumptions regarding mortality and morbidity, interest rates and the
introduction of lapse assumptions into the GAAP reserve calculation. See Note 2
to our consolidated financial statements.
When we acquire blocks of insurance policies or insurers owning blocks of
policies, our assessment of the adequacy of the transferred policy liabilities
is subject to risks and uncertainties. With acquired and existing businesses, we
may from time to time need to increase our claims reserves significantly in
excess of those estimated. An inadequate estimate in reserves could have a
material adverse impact on our results of operations or financial condition.
14
COMPETITION
The life and accident and health insurance industry in North America is
highly competitive. We compete with other insurance and financial services
companies, including large multi-line organizations, both in connection with the
sale of insurance and asset accumulation products and in acquiring blocks of
business. Many of these organizations have been in business for a longer period
of time and have substantially greater capital and surplus, larger and more
diversified portfolios of life and health insurance policies, larger agency
sales operations and higher ratings than we do. In addition, it has become
increasingly difficult for mid-size companies to compete effectively with their
larger competitors for insurance product sales in part as a result of heightened
consumer and agent awareness of the financial size of companies.
We believe we can meet these competitive pressures by offering a high
level of service and accessibility to our field force and by developing
specialized products and marketing approaches. We also believe that our policies
and premium rates are generally competitive with those offered by other
companies selling similar types of products in the same jurisdictions.
RATINGS
Increased public and regulatory concerns regarding the financial stability
of insurance companies have resulted in policyholders placing greater emphasis
upon company ratings and have created some measure of competitive advantage for
insurance carriers with higher ratings. A.M. Best is considered to be a leading
insurance company rating agency. In evaluating a company's financial and
operating performance, A.M. Best reviews profitability, leverage and liquidity
as well as the quality of the book of business, the adequacy and soundness of
reinsurance programs, the quality and estimated market value of assets, reserve
adequacy and the experience and competence of management. A.M. Best's ratings
are based upon factors relevant to policyholders, agents, insurance brokers and
intermediaries and are not directed to the protection of investors. In November
2001, A.M. Best upgraded the ratings for our American Pioneer, American
Progressive, Constitution Life, Pennsylvania Life and PennCorp Life Insurance
Company (Canada) subsidiaries to "B++" from "B+". In addition, A.M. Best
reaffirmed the rating for our Union Bankers subsidiary at "B+". These ratings
mean that, in A.M. Best's opinion, these companies have demonstrated "very good"
overall performance when compared to standards it has established and have a
"good" ability to meet their obligations to policyholders and are in the
"Secure" category of all companies rated by A.M. Best. A.M. Best has also
reaffirmed the rating for our Peninsular Life subsidiary at "FPR5," which means
the company has a "good" ability to meet its obligations to policyholders, based
primarily on a quantitative evaluation of Peninsular Life's financial strength
and operating performance. Currently, Peninsular has no business in force and is
available for sale. A.M. Best does not rate our other insurance company
subsidiaries.
In March 2002, Standard & Poor's assigned its "BBB+" counterparty credit
and financial strength ratings to our American Pioneer, American Progressive,
Pennsylvania Life and PennCorp Life Insurance Company (Canada) subsidiaries.
This rating means that in Standard & Poor's opinion, these companies have good
financial security characteristics, but are more likely to be affected by
adverse business conditions than are insurers that are rated higher by Standard
& Poor's. A plus (+) or minus (-) shows Standard & Poor's opinion of the
relative standing of the insurer within a rating category.
Our insurance company subsidiaries are not currently rated by Moody's
Investors Service or Duff and Phelps rating organizations. Although a higher
rating by A.M. Best, Standard & Poor's or another insurance rating organization
could have a favorable effect on our business, we believe that our marketing has
enabled, and will continue to enable, our insurance company subsidiaries to
compete effectively.
15
INVESTMENTS
Our investment policy is to balance the portfolio duration to achieve
investment returns consistent with the preservation of capital and maintenance
of liquidity adequate to meet payment of policy benefits and claims. We invest
in assets permitted under the insurance laws of the various jurisdictions in
which we operate. Such laws generally prescribe the nature, quality of and
limitations on various types of investments that may be made. We currently
engage the services of two investment advisors under the direction of the
management of our insurance company subsidiaries and in accordance with
guidelines adopted by the Investment Committees of their respective boards of
directors. Conning Asset Management Company manages our fixed maturity portfolio
in the United States, and Elliot & Page, Limited manages our Canadian fixed
maturity portfolio.
The following table summarizes the composition of our investment portfolio
by carrying value (which is an estimate of fair value) as of December 31, 2001
and 2000:
INVESTMENT PORTFOLIO
December 31, 2001 December 31, 2000
------------------------------------ --------------------------------------
Percent of Percent of
Carrying Value Total Carrying Value Total
(Fair Value) Carrying Value (Fair Value) Carrying Value
-------- ----- -------- -----
(In thousands)
Fixed Maturity Securities:
U.S. Government and
Government agencies (1) $ 36,970 4.1% $ 34,734 4.2%
Mortgage-backed (1) 150,993 17.1% 172,857 21.0%
Asset-backed 88,977 10.1% 85,547 10.4%
Foreign securities (2) 157,752 17.8% 145,403 17.6%
Investment grade corporates 357,292 40.4% 291,274 35.3%
Non-investment grade corporates 7,234 0.8% 21,923 2.7%
-------- ----- -------- -----
Total fixed maturity securities 799,218 90.3% 751,738 91.2%
Cash and cash equivalents 53,690 6.1% 40,250 4.9%
Other Investments:
Policy loans 24,043 2.7% 25,077 3%
Equity securities 4,199 0.5% 3,547 .4%
Other invested assets 3,773 0.4% 4,318 .5%
-------- ----- -------- -----
Total cash and invested assets $884,923 100.0% $824,930 100.0%
======== ===== ======== =====
(1) US Government and government agencies include GNMA and FMNA
mortgage-backed securities.
(2) Primarily Canadian dollar denominated bonds supporting our Canadian
insurance reserves.
16
The following table shows the distribution of the contractual maturities
of our portfolio of fixed maturity securities by carrying value as of December
31, 2001. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties:
CONTRACTUAL MATURITIES OF FIXED MATURITY SECURITIES
Percent of
Carrying Total Fixed
Available for Sale Value Maturities
------------------ ----- ----------
(In thousands)
Due in 1 year or less $ 29,535 3.7%
Due after 1 year through 5 years 113,043 14.1%
Due after 5 years through 10 years 254,435 31.8%
Due after 10 years 162,235 20.3%
Asset-backed securities 88,977 11.2%
Mortgage-backed securities 150,993 18.9%
-------- -----
$799,218 100.0%
======== =====
The following table shows the distribution of the ratings assigned by
Standard & Poors Corporation to the securities in our portfolio of fixed
maturity securities as of December 31, 2001 and 2000:
DISTRIBUTION OF FIXED MATURITY SECURITIES BY RATING
December 31, 2001 December 31, 2000
-------------------------------- ----------------------------------
(In thousands)
Carrying % of Carrying % of
Standard & Value Total Value Total
Poor's (Estimated Fixed (Estimated Fixed
Rating Fair Value) Investment Fair Value) Investment
------ ----------- ---------- ----------- ----------
AAA $259,847 32.5% $285,274 37.9%
AA 99,222 12.4% 105,749 14.1%
A 318,899 39.9% 239,420 31.9%
BBB 113,500 14.2% 99,372 13.2%
BB 5,008 0.7% 7,965 1.1%
B 2,603 0.3% 12,766 1.7%
CCC and below 139 -- 1,192 0.1%
----- -------- -----
Total $799,218 100.0% $751,738 100.0%
======== ===== ======== =====
At December 31, 2001 99.0% of our fixed maturity investments were
"investment grade". As of December 31, 2000, 97.1% of our fixed maturity
investments were "investment grade". "Investment grade" securities are those
rated "BBB-" or higher by Standard & Poor's Corporation or "Baa3" or higher by
Moody's Investors Service. This included approximately $239.9 million, as of
December 31, 2001 and $258.4 million, as of December 31, 2000, of collateralized
mortgage obligations secured by residential mortgages and asset-backed
securities, representing approximately 30% of our fixed maturity portfolio as of
December 31, 2001 and 34% of our fixed maturity portfolio as of December 31,
2000. Some classes of mortgage backed securities are subject to significant
prepayment risk, because in periods of declining interest rates, mortgages may
be repaid more rapidly than scheduled, as individuals refinance higher rate
mortgages to take advantage of the lower rates. As a result, holders of mortgage
backed securities may receive higher prepayments on their investments, which
they may not be able to reinvest at an interest rate comparable to the rate paid
on such mortgage backed securities.
17
Fixed maturity securities with a less than investment grade rating had
aggregate carrying values of $7.8 million as of December 31, 2001 and $21.9
million as of December 31, 2000, amounting to 1.0% of total investments as of
December 31, 2001 and 2.9% of total investments as of December 31, 2000. These
securities represented 0.6% of total assets as of December 31, 2001 and 1.8% of
total assets as of December 31, 2000. Our holdings of less than investment grade
fixed maturity securities are diversified and the largest investment in any one
such security as of December 31, 2001 was $2.0 million, which was less than 0.2%
of total assets. We wrote down the value of some of our fixed maturity
portfolio's securities, considered to have been subject to an
other-than-temporary decline in value, by $4.2 million in the year ended
December 31, 2001 and $0.5 million in the year ended December 31, 2000, which
were included in net realized gains (losses) on investments in our consolidated
statements of operations.
INVESTMENT INCOME
Investment income is an important part of our total revenues and
profitability. We cannot predict the impact that changes in future interest
rates will have on our financial statements.
The following table shows the investment results of our total invested
asset portfolio, for the three years ended December 31, 2001:
Years Ended December 31,
-----------------------------------------------------------
2001 2000 1999
----------- ----------- ---------
(In thousands)
Total cash and invested assets, end of period $ 884,923 $ 824,930 $ 812,297
=========== =========== =========
Net investment income $ 57,812 $ 56,945 $ 29,313
=========== =========== =========
Yield on average cash and investments 6.76% 6.88% 6.79%
=========== =========== =========
Net realized investment gains (losses) on the
sale of securities (including other than
temporary declines in market value) $ 3,078 $ 146 $ (241)
=========== =========== =========
REGULATION
General
Our insurance company subsidiaries, like other insurance companies, are
subject to the laws, regulations and supervision of the jurisdictions in which
they are domiciled. The purpose of those laws and regulations is primarily to
provide safeguards for policyholders rather than to protect the interest of
shareholders.
18
The following table sets forth the domiciles of our insurance company
subsidiaries.
NEW YORK TEXAS
American Progressive Life & American Exchange Life
Health Insurance Company of Insurance Company
New York Constitution Life Insurance
Company
FLORIDA Marquette National Life
American Pioneer Life Insurance Company
Insurance Company Union Bankers Insurance
Peninsular Life Insurance Company
Company
CANADA
PENNSYLVANIA PennCorp Life Insurance
Pennsylvania Life Insurance Company
Company
Pennsylvania Life, Constitution Life and Union Bankers are subsidiaries of
American Exchange. Marquette is a subsidiary of Constitution Life. Peninsular
Life is a subsidiary of American Pioneer Life Insurance Company. As part of its
change in ownership from American Exchange to American Pioneer, Peninsular Life
re-domesticated to Florida from North Carolina effective December 31, 2000.
Each of our insurance company subsidiaries is also subject to regulation
and supervision by the insurance department in each of the jurisdictions in
which they are admitted and authorized to transact business. Such regulation and
supervision by the insurance departments covers, among other things, the
declaration and payment of dividends by our insurance company subsidiaries, the
setting of rates to be charged for some types of insurance, the granting and
revocation of licenses to transact business, the licensing of agents, the
regulation and monitoring of market conduct and claims practices, the approval
of forms, the establishment of reserve and minimum surplus requirements, the
regulation of maximum commissions payable, the mandating of some insurance
benefits, and the form and content of financial statements required by statute.
A failure to comply with legal or regulatory restrictions may subject us to a
loss of a right to engage in some businesses or an obligation to pay fines or
make restitution, which may affect our profitability.
Most jurisdictions mandate minimum benefit standards and loss ratios for
accident and health insurance policies. Generally we are required to maintain,
with respect to our individual long term care policies, minimum anticipated loss
ratios over the entire period of coverage. With respect to our Medicare
supplement policies, generally we are required to attain and maintain an actual
loss ratio, after three years, of not less than 65 percent of premium. We
provide, to the insurance departments of all states in which we conduct
business, annual calculations that demonstrate compliance with required loss
ratio standards for both long term care and Medicare supplement insurance. We
prepared these calculations utilizing statutory lapse and interest rate
assumptions. In the event we have failed to maintain minimum mandated loss
ratios, our insurance company subsidiaries could be required to provide
retrospective refunds or prospective rate reductions. We believe that our
insurance company subsidiaries currently comply with all applicable mandated
minimum loss ratios. In addition, we actively review the loss ratio experience
of our products and make an application with the respective insurance
departments for rate increases when we determine one is needed. We cannot
guarantee that we will receive the rate increases we request.
Under Federal and NAIC model regulations, adopted in substantially all
states, there are 11 standard Medicare supplement plans (Plans A through J and a
High Deductible Plan F). Plan A provides the least extensive coverage, while
Plan J provides the most extensive coverage. Under NAIC regulations, Medicare
insurers must offer Plan A, but may offer any of the other plans at their
option.
19
Every insurance company that is a member of an "insurance holding company
system" generally is required to register with the insurance regulatory
authorities in each state in which it is authorized to do business and file
periodic reports concerning its relationships with its insurance holding
company. Material transactions between registered insurance companies and
members of the holding company system are required to be "fair and reasonable"
and in some cases are subject to administrative approval, and the books,
accounts and records of each party are required to be maintained so as to
clearly and accurately disclose the precise nature and details of any such
transactions.
Each of our insurance company subsidiaries is required to file detailed
reports with the insurance department of each jurisdiction in which it is
licensed to conduct business and its books and records are subject to
examination by each such insurance department. In accordance with the insurance
codes of their domiciliary states and the rules and practices of the NAIC, our
insurance company subsidiaries are examined periodically by examiners of each
company's domiciliary state and by representatives (on an "association" or
"zone" basis) of the other states in which they are licensed to do business.
Examinations are currently pending by Florida, New York, Pennsylvania and Texas.
We do not believe that there are any material issues with respect to the
examinations in progress that would have a material adverse impact on the
financial position or results of operations of the companies under examination.
Many states require deposits of assets by insurance companies for the
protection of policyholders either in those states or for all policyholders.
Nonetheless, these deposited assets remain part of the total assets of the
company. As of December 31, 2001, securities totaling $32.4 million,
representing approximately 3.9% of the carrying value of our total investments,
were on deposit with various state treasurers or custodians. As of December 31,
2000, securities totaling $33.1 million, representing approximately 4.2% of
total assets, were on deposit. These deposits must consist of securities that
comply with the standards established by the particular state.
PennCorp Life, our Canadian domiciled subsidiary, and the Canadian branch
of Pennsylvania Life are subject to provincial regulation and supervision in
each of the provinces of Canada in which they carry on business. Provincial
insurance regulation is concerned primarily with the form of insurance contracts
and the sale and marketing of insurance and annuity products, including the
licensing and supervision of insurance marketing personnel. Individual annuity
products and the underlying segregated funds to which they relate are subject to
guidelines adopted by the Canadian Council of Insurance Regulators and
incorporated by reference into provincial insurance regulations. These
guidelines govern a number of matters relating to the sale of these products and
the administration of the underlying segregated funds. During the first quarter
of 2002, the Canadian Branch of Pennsylvania Life was merged into PennCorp Life,
consolidating our Canadian operations into a single entity. This transaction was
approved by the Office of the Superintendent of Financial Institutions, in
Canada, and the Pennsylvania Department of Insurance.
Codification of Statutory Accounting Practices
In 1998, the NAIC approved a codification of statutory accounting
principles, which became effective January 1, 2001 and will serve as a
comprehensive and standardized guide to statutory accounting principles. The
adoption of the codification increased the capital and surplus of our U.S.
insurance subsidiaries by approximately $11.0 million at January 1, 2001, due
primarily to the recognition of certain loss carryforwards as deferred tax
assets.
20
Other Insurance Regulatory Changes
The NAIC and state insurance regulators have recently become involved in a
process of re-examining existing laws and regulations and their application to
insurance companies. This re-examination has focused on insurance company
investment and solvency issues, risk-based capital guidelines, assumption
reinsurance, interpretations of existing laws, the development of new laws, the
interpretation of nonstatutory guidelines, and the circumstances under which
dividends may be paid. The NAIC has encouraged states to adopt model NAIC laws
on specific topics as follows:
- investment reserve requirements;
- risk-based capital standards;
- codification of insurance accounting principles;
- additional investment restrictions;
- restrictions on an insurance company's ability to pay dividends; and
- product illustrations.
The NAIC is currently developing new model laws or regulations, including
product design standards and reserve requirements. While the Federal government
currently does not regulate the insurance business directly, Federal legislation
and administrative policies in a number of areas, such as Medicare, employee
benefits regulation, age, sex and disability-based discrimination, financial
services regulation and Federal taxation, can significantly affect the insurance
business. It is not possible to predict the future impact of changing regulation
on our operations or the operations of our insurance company subsidiaries.
Since 1993, New York State has required that all health insurance sold to
individuals and groups with less than 50 employees be offered on an open
enrollment and community rated basis. The community rating aspect of the law
prohibits the use of age, sex, health or occupational factors in rating and
requires that the same average rate be used for all persons with the same policy
residing in the same location. Such insurance may continue to be sold to groups
with more than 50 employees on an underwritten basis, with premium set to
reflect expected or actual results. The Medicare supplement policies actively
marketed by American Progressive in New York State and some of its in force
business are subject to the community rating rules. Similar legislation is in
effect for certain products in other states. The extension of such legislation
to Florida, Texas and other states where we offer significant medically
underwritten health insurance could cause us to reconsider our health care
coverage offerings in any such state.
Dividend and Distribution Restrictions
Under the insurance law of Pennsylvania, in the case of Pennsylvania Life,
and Texas, in the case of American Exchange, Constitution Life, Marquette
National Life and Union Bankers, a life insurer may pay dividends or make
distributions from accumulated earnings without the prior approval of the
insurance department, provided they do not exceed the greater of 10% of the
insurer's surplus as to policyholders as of the preceding December 31 or the
insurer's net gain from operations for the immediately preceding calendar year.
21
Under current Florida State insurance law, American Pioneer and Peninsular
Life may pay a dividend or make a distribution without the prior written
approval of the insurance department when:
- the dividend is paid from that portion of the insurer's accumulated
and available surplus as is derived from the net operating profits
of its business and its net realized capital gains;
- the dividend is no more than the greater of:
- 10% of the insurer's surplus as to policyholders derived from
net operating profits on its business and net realized capital
gains; and
- the insurer's entire net operating profits and realized net
capital gains derived during the immediately preceding
calendar year;
- the insurer will have surplus as to policyholders equal to or
exceeding 115% of the minimum required statutory surplus as to
policyholders after the dividend or distribution is made; and
- the insurer has filed notice with the department at least 10
business days prior to the dividend payment or distribution.
Under the New York State Insurance Law, the declaration or payment of a
dividend by American Progressive requires the approval of the New York
Superintendent of Insurance, who, as a matter of present policy, would not
approve such payment until American Progressive had generated sufficient
statutory profits to offset its entire negative unassigned surplus, which was
approximately $7.7 million at December 31, 2001.
Under current Canadian law, a life insurer may pay a dividend after such
dividend declaration has been approved by its board of directors and upon at
least 10 days prior notification to the Superintendent of Financial
Institutions. In considering approval of a dividend, the board of directors must
consider whether the payment of such dividend would be in contravention of the
Insurance Companies Act of Canada.
In 2001, Union Bankers paid an ordinary dividend to American Exchange of
$1.7 million. Union Bankers also distributed its investment in the common stock
of Marquette to American Exchange in the form of an extraordinary dividend.
American Exchange, in turn, contributed Marquette to Constitution Life.
Additionally, Peninsular paid an extraordinary dividend of $1.9 million to
American Pioneer in 2001.
In 2000, Pennsylvania Life paid ordinary dividends to American Exchange of
$2.9 million and Union Bankers paid ordinary dividends to American Exchange of
$2.0 million. Additionally, Peninsular Life paid an extraordinary dividend of
$1.5 million to our holding company in 2000.
Based on the current dividend regulations of the respective states, it is
estimated that in 2002, Pennsylvania Life would be able to pay ordinary
dividends of up to approximately $8.4 million and Constitution would be able to
pay ordinary dividends of up to approximately $1.7 million to American Exchange
without prior approval from the respective insurance departments. Additionally,
in 2002 Peninsular Life would be able to pay ordinary dividends of up to
approximately $0.7 million to American Pioneer without prior approval from the
Florida Insurance Department. We do not anticipate that our remaining insurance
subsidiaries will be able to pay ordinary dividends in 2002.
22
Risk-Based Capital Requirements
The NAIC's risk-based capital requirements for insurance companies adopted
by state regulators take into account asset risks, interest rate risks,
mortality and morbidity risks and other relevant risks with respect to the
insurer's business and specify varying degrees of regulatory action to occur to
the extent that an insurer does not meet the specified risk-based capital
thresholds, with increasing degrees of regulatory scrutiny or intervention
provided for companies in categories of lesser risk-based capital compliance.
Our Canadian domiciled subsidiary, PennCorp Life, and the Canadian branch of
Pennsylvania Life are subject to minimum continuing capital and surplus
requirements which Canadian regulators use to assess financial strength and to
determine when regulatory intervention is needed. As of December 31, 2001 all of
our U.S. insurance company subsidiaries maintained ratios of total adjusted
capital to risk-based capital in excess of the authorized control level and
PennCorp Life and the Canadian branch of Pennsylvania Life maintained minimum
continuing capital and surplus requirement ratios in excess of minimum
requirements. However, should our insurance company subsidiaries' capital
position decline in the future, their continued ability to pay dividends and the
degree of regulatory supervision or control to which they are subjected might be
affected.
Guaranty Association Assessments
Our insurance company subsidiaries can be required, under solvency or
guaranty laws of most jurisdictions in which they do business, to pay
assessments to fund policyholder losses or liabilities of unaffiliated insurance
companies that become insolvent. These assessments may be deferred or forgiven
under most solvency or guaranty laws if they would threaten an insurer's
financial strength and, in most instances, may be offset against future premium
taxes. None of our insurance company subsidiaries has ever incurred any
significant costs of this nature. The likelihood and amount of any future
assessments are now unknown and are beyond our control.
Health Care Financing Reform
From time to time, numerous proposals have been considered, and in some
cases enacted, in Congress and the state legislatures to reform aspects of the
health care financing system.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"),
a significant federal health care financing reform, restricted the ability of
insurers to utilize medical underwriting and pre-existing condition provisions
in health insurance policies issued to persons who were previously insured under
qualifying policies. These changes affect only a small part of the coverages we
write, but may have an adverse effect on them. HIPAA also mandates the adoption
of standars for the exchange of electronic health information and contains
privacy requirements that will govern the handling, use and security of
protected customer information, which will become effective in stages in 2002
through 2003. We have implemented some of the changes in our business procedures
needed to comply with these requirements, and are in the process of implementing
others. We anticipate that we will meet all the requirements which become
effective in 2002 and 2003, but the cost of doing so is not yet fully
determined.
On the state level in 2000, the NAIC amended its Model Long Term Care
Insurance Regulation to include provisions intended to assure that rates on long
term care insurance policies, under which the insurer reserves the right to
increase premiums, are initially set high enough to make such increases
unlikely. This amendment has thus far been adopted only in some states where we
sell, or intend to sell, such policies, and may become more widely adopted.
Where it is adopted, these rules could increase the cost of policies sold by us
and by our competitors. We have not determined the impact this model regulation
could have on our long term care insurance business.
Some states have enacted, and others states are considering, small group
insurance and rating reforms, which generally limit the ability of insurers and
health plans to use risk selection as a method of controlling costs for small
group businesses. These laws may generally limit or eliminate use of
pre-existing condition exclusions, experience rating, and industry class rating
and limit the amount of rate increases from year to year.
23
Congress and various states are considering some form of the "Patients'
Bill of Rights." This legislation, if enacted, is designed to provide consumers
more freedom of choice in the selection of doctors, facilities, and treatments.
Although the bill was originally conceived to regulate health maintenance
organizations, it will affect all facets of the nation's health care delivery
system, including insurers. The pending federal legislation, known as the
Bipartisan Patient Protection Act of 2001:
- requires a more stringent timeframe for claims review and
processing, utilization review and internal and external appeals
processes;
- provides that insureds have greater access to non-formulary drugs,
clinical trials, physicians, specialists and emergency care; and
- allows insureds to bring suit after exhaustion of the administrative
appeals process.
These changes, if enacted, are expected to result in higher total medical costs,
which could encourage more partnerships and associations between medical
providers and insurers to control costs, more community-based health
organizations, and greater use of higher deductibles to lower insurance costs
and reduce administrative expenses of smaller claims.
Proposals for further federal reforms have included, among other things,
restricting coverage of deductible and co-payments on Medicare supplement
policies, expansion of Medicare to provide prescription drug benefits, provide
coverage to persons under age 65 and employer-based insurance systems, subsidize
premiums for lower income people and programs, regulate policy availability,
affordability of public and private programs standardization of major medical or
long term care coverages, impose mandated or target loss ratios or rate
regulation, and require the use of community rating or other means that further
limit the ability of insurers to differentiate among risks, or mandate
utilization review or other managed care concepts to determine what benefits
would be paid by insurers.
In addition to federal regulation, many states have enacted, or are
considering, various health care reform statutes. These proposed reforms relate
to, among other things, managed care practices, such as waiting period
restrictions on pre-existing conditions, credit for certain prior coverage, and
limitations on rate increases and guaranteed renewability for small business
plans and policies for individuals. Most states have also enacted patient
confidentiality laws that prohibit the disclosure of confidential medical
information, some of which, as permitted by HIPAA, are more restrictive than
HIPAA's rules protecting health information privacy.
These or other reform proposals could necessitate revisions in our
Medicare supplement products, and could increase or decrease the level of
competition among health care insurers and could significantly affect our health
insurance business, although it is not possible to predict which proposals will
be adopted and what their effect will be.
Other potential initiatives, designed to tax insurance premiums or shift
medical care costs from government to private insurers, could affect our
business, perhaps adversely.
Other Possible Changes in Legislation
Since insurance is a regulated business, with a high public profile, it is
always possible that legislation may be enacted which would have an adverse
effect on our business.
A portion of our insurance business is the sale of deferred annuities and
life insurance products, which are attractive to purchasers in part because
policyholders generally are not subject to Federal income tax on increases in
the value of an annuity or life and health insurance contract until some form of
distribution is made from the contract. From time to time, Congress has
considered proposals to reduce or eliminate the tax advantages of annuities and
life insurance, which, if enacted, might have an adverse effect on our ability
to sell the affected products in the future. We are not aware that Congress is
actively considering any legislation that would reduce or eliminate the tax
advantages of annuities or life or health insurance. However, it is possible
that the tax treatment of annuities or life or health insurance products could
change by legislation or other means, such as Internal Revenue Service
regulations or judicial decisions.
24
Other potential changes in insurance and tax laws and regulations could
also have a material adverse effect on the operations of insurance companies.
Examples of regulatory developments that could have a material adverse effect on
the operation of the insurance industry include, but are not limited to, the
potential repeal of the McCarran-Ferguson Act, which exempts insurance companies
from a variety of Federal regulatory requirements). In addition, the
administration of insurance regulations is typically vested in state agencies
that have broad powers and are concerned primarily with the protection of
policyholders.
EMPLOYEES
As of March 1, 2002, we employed approximately 860 employees, none of whom
is represented by a labor union in such employment. We consider our relations
with our employees to be good.
ITEM 2 - PROPERTIES
The Company currently leases the following office space, representing
primarily the operating offices of American Progressive, American Pioneer,
Pennsylvania Life, CHCS Services, Inc., PennCorp Life (Canada) and CHCS:
Type of Square Annual
Location Space Footage Rent Lease Expiration
-------- ----- ------- ---- ----------------
Rye Brook, New York Office 9,000 $174,000 October 2004
Orlando, Florida Office 2,500 41,000 August 2003
Office 24,000 395,000 February 2005
Office 5,300 88,000 June 2005
Pensacola, Florida Warehouse 5,100 18,000 June 2005
Office 21,600 161,000 November 2007(1)
Office/
Warehouse 18,800 51,000 November 2007
Warehouse 6,000 28,000 November 2007
Rental housing
1,200 15,000 August 2002
McKinney, Texas Office 240 2,850 March 2002
Mississauga, Ontario, Office 42,000 299,000 July 2011
Canada Warehouse 2,600 10,500 November 2004
Clearwater, Florida Office 14,300 252,000 December 2002
Weston, Florida Office 16,200 216,000 June 2008
Andalusia, Alabama Office 1,200 17,000 August 2002
(1) This lease includes one renewal, at our option, for an additional
five years.
25
ITEM 3 - LEGAL PROCEEDINGS
No reportable litigation was pending at December 31, 2001. We are party to
various lawsuits arising out of the ordinary conduct of the business of our
subsidiary corporations, none of which, we believe, would have a material
adverse effect upon our business if it were to be adversely determined.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted by us to a vote of stockholders, through
the solicitation of proxies or otherwise, during the fourth quarter of the
fiscal year for which this report is filed.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF PUBLICLY TRADED SECURITIES
Our common stock has been traded in the over-the-counter market and quoted
on the Nasdaq National Market under the symbol UHCO since May 12, 1983. The
following table sets forth the high and low sales prices per share of our common
stock as reported on the Nasdaq National Market for the periods indicated.
Common Stock
------------------
High Low
------ --------
2000
-----------------------------
First Quarter $4.625 $3.500
Second Quarter 4.156 3.250
Third Quarter 5.250 3.688
Fourth Quarter 4.375 3.813
2001
-----------------------------
First Quarter $5.563 $3.438
Second Quarter 7.000 4.625
Third Quarter 6.310 4.510
Fourth Quarter 7.650 5.270
2002
-----------------------------
First Quarter (through March 1) $6.990 $5.610
As of March 1, 2002, there were approximately 1,793 holders of record of
our common stock. On March 1, 2002, the closing bid and ask sales prices for our
common stock were $6.490 and $6.500.
DIVIDENDS
We have neither declared nor paid dividends on our common stock. Any
future decision to pay dividends will be made by our board of directors in light
of conditions then existing, including our results of operations, financial
condition and requirements, loan covenants, insurance regulatory restrictions,
business conditions and other factors. In addition, our ability to pay cash
dividends, if and when we should wish to do so, may depend on the ability of our
subsidiaries to pay dividends to our holding company and on compliance with the
covenants in our credit facility. See "Regulation - Dividend and Distribution
Restrictions".
26
ITEM 6 - SELECTED FINANCIAL DATA
As of or for the year ended December 31,
---------------------------------------------------------------------------
2001 2000 (4) 1999 (2) 1998 1997 (3)
--------- --------- --------- --------- ---------
INCOME STATEMENT DATA: (in thousands, except per share data)
Direct premium and policyholder fees $ 513,575 $ 451,323 $ 252,553 $ 131,044 $ 99,339
Reinsurance premium assumed 2,549 3,055 1,751 998 998
Reinsurance premium ceded (286,918) (234,625) (138,827) (89,546) (62,623)
---------- ---------- ---------- --------- ---------
Net premium and other policyholder fees 229,206 219,753 115,477 42,496 37,714
Net investment income 57,812 56,945 29,313 10,721 10,023
Realized gains (losses) 3,078 146 (241) 256 1,133
Fee and other income 10,847 7,247 3,587 2,616 2,460
---------- ---------- ---------- --------- ---------
Total revenues 300,943 284,091 148,136 56,089 51,330
Total benefits, claims and other deductions 257,580 251,025 132,080 52,157 48,119
---------- ---------- ---------- --------- ---------
Income before taxes 43,363 33,066 16,056 3,932 3,211
Net income after taxes 28,925 22,885 9,813 2,608 2,119
Net income applicable to common
shareholders (1) 28,925 22,885 9,633 2,174 1,870
OTHER DATA:
Net operating income (5) $ 26,924 $ 22,790 $ 9,790 $ 2,008 $ 1,134
Return on average equity 13.3% 14.9% 11.9% 8.0% 7.8%
Ratio of intangibles to equity (6) 33.8% 35.2% 30.1% 106.7% 103.6%
PER SHARE DATA:
Earnings per share:
Basic $ 0.58 $ 0.49 $ 0.42 $ 0.29 $ 0.26
Diluted $ 0.57 $ 0.49 $ 0.34 $ 0.20 $ 0.18
Net operating income per share (5):
Basic $ 0.54 $ 0.49 $ 0.42 $ 0.27 $ 0.16
Diluted $ 0.53 $ 0.48 $ 0.35 $ 0.19 $ 0.11
Book value per share:
Basic $ 4.38 $ 3.72 $ 2.92 $ 3.18 $ 2.96
Tangible book value per share (7):
Basic $ 2.90 $ 2.41 $ 2.04 $ (0.77) $ (0.67)
27
As of December 31,
------------------------------------------------------------------------------
BALANCE SHEET DATA: 2001 2000 1999 1998 1997
---------- ---------- ---------- -------- --------
(In thousands, except for per share data)
Total cash and investments $ 884,923 $ 824,930 $ 812,297 $164,674 $159,429
Total assets 1,275,916 1,189,864 1,153,421 283,302 272,575
Policyholder related liabilities 914,073 884,011 877,347 228,958 207,173
Loan payable 61,475 69,650 70,000 4,750 3,500
Series B Preferred Stock -- -- -- 4,000 4,000
Series C Preferred Stock -- -- -- 5,168 5,168
Series D Preferred Stock -- -- -- 2,250 --
Stockholders' equity 230,770 173,949 133,965 28,318 25,706
STATUTORY DATA (8):
Statutory capital and surplus $ 123,785 $ 101,367 $105,281 $21,076 $19,835
Asset valuation reserve 3,985 5,384 5,585 1,205 766
Adjusted capital and surplus $ 127,270 $ 106,751 $110,866 $22,281 $20,601
- --------------------------------------------
(1) After provision for Series C Preferred Stock dividends of $180, $434 and
$289 for the years ended December 31, 1999, 1998 and 1997, respectively.
(2) Includes the results of the companies acquired in the 1999 Acquisition,
since their acquisition on July 30, 1999.
(3) Includes the results of American Exchange since its acquisition on
December 1, 1997.
(4) Includes the results of AIAG since its acquisition on January 6, 2000, and
CHCS since its acquisition on August 10, 2000.
(5) Represents net income applicable to common shareholders, excluding
realized gains, net of tax.
(6) Represents the ratio of intangible assets (the sum of deferred acquisition
costs, goodwill and present value of future profits) to shareholders'
equity.
(7) Represents the amount of total assets less intangible assets (the sum of
deferred acquisition costs, goodwill and present value of future profits),
less total liabilities, divided by total shares outstanding.
(8) Includes capital and surplus of PennCorp Life (Canada) of C$32,314 as of
December 31, 2001, C$30,421 as of December 31, 2000, and C$31,531 as of
December 31, 1999 as reported to the Office of the Superintendent of
Financial Institutions Canada, converted at the related exchange rates of
C$0.6261 per U.S. $1.00 as of December 31, 2001, C$0.6671 per U.S. $1.00
as of December 31, 2000 and C$0.6900 per U.S. $1.00 as of December 31,
1999.
28
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following together with our financial statements and
the notes to financial statements included elsewhere herein.
FORWARD-LOOKING STATEMENTS
Certain statements in this report or incorporated by reference into this
report and oral statements made from time to time by our representatives
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
statements not based on historical information. They relate to future
operations, strategies, financial results or other developments. In particular,
statements using verbs such as "expect," "anticipate," "believe" or similar
words generally involve forward-looking statements. Forward-looking statements
include statements about development and distribution of our products,
investment spreads or yields, the impact of proposed or completed acquisitions,
the adequacy of reserves or the earnings or profitability of our activities.
Forward-looking statements are based upon estimates and assumptions that are
subject to significant business, economic and competitive uncertainties, many of
which are beyond our control and are subject to change. These uncertainties can
affect actual results and could cause actual results to differ materially from
those expressed in any forward-looking statements. Whether or not actual results
differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable risks and uncertainties, some of which relate
particularly to our business, such as our ability to set adequate premium rates
and maintain adequate reserves, our ability to compete effectively and our
ability to grow our business through internal growth as well as through
acquisitions. Other risks and uncertainties may be related to the insurance
industry generally or the overall economy, such as regulatory developments,
industry consolidation and general economic conditions and interest rates. We
disclaim any obligation to update forward-looking statements.
OVERVIEW
We offer life and health insurance designed for the senior market and the
self-employed market in all fifty states, the District of Columbia and all of
the provinces of Canada. We also provide administrative services to other
issuers by servicing their senior market products. Our principal insurance
products are Medicare supplemental health insurance, fixed benefit accident and
sickness disability insurance, long term care insurance, senior life insurance,
annuities and other individual life insurance. Our principal business segments
are: career agency, senior market brokerage, special markets and administrative
services. We also report the corporate activities of our holding company in a
separate segment. A description of these segments follows:
CAREER AGENCY -- Our career agency segment is comprised of the operations
of Pennsylvania Life Insurance Company and PennCorp Life Insurance Company of
Canada, both of which we acquired in 1999. PennCorp Life (Canada) operates
exclusively in Canada, while Pennsylvania Life operates in both the United
States and Canada. The career agency segment includes the operations of a career
agency field force, which distributes fixed benefit accident and sickness
disability insurance, life insurance and supplemental senior health insurance in
the United States and Canada. The career agents are under exclusive contract
with either Pennsylvania Life or PennCorp Life (Canada) and sell only products
that we provide. During the first quarter of 2002, the Canadian Branch of
Pennsylvania Life was merged into PennCorp Life (Canada), consolidating our
Canadian operations into a single entity. This transaction was approved by the
Office of the Superintendent of Financial Institutions and the Pennsylvania
Department of Insurance.
SENIOR MARKET BROKERAGE -- Our senior market brokerage segment focuses on
selling insurance products designed for the senior market, such as Medicare
supplement, long term care, senior life insurance and annuities. We distribute
these products through independent marketing organizations and general agencies.
29
SPECIAL MARKETS -- We have accumulated various blocks of business,
primarily as a result of acquisitions, that are not part of our core business
focus. We manage the run off of these blocks of business in our special markets
segment. The products in this segment include traditional, interest-sensitive
and group life insurance, individual major medical and other accident and health
insurance.
ADMINISTRATIVE SERVICES -- We act as a third party administrator and
service provider for both affiliated and unaffiliated insurance companies,
primarily with respect to various senior market products and a growing portion
of non-insurance products. The services that we perform include policy
underwriting, telephone verification, policyholder services, claims
adjudication, clinical case management, care assessment and referral to health
care facilities.
CORPORATE -- This segment reflects the activities of our holding company,
including the payment of interest on our debt and our public company
administrative expenses.
Intersegment revenues and expenses are reported on a gross basis in each
of the operating segments but are eliminated in our consolidated results. These
eliminations affect the amounts reported on the individual financial statement
line items, but do not change operating income before taxes. The significant
items eliminated include intersegment revenue and expense relating to services
performed by the administrative services segment for the career agency, senior
market brokerage and special market segments and interest on notes issued by the
corporate segment to the other operating segments.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP"). The
preparation of our financial statements in conformity with GAAP requires us to
make estimates and assumptions that affect the amounts of assets and liabilities
and disclosures of assets and liabilities reported by us at the date of the
financial statements and the revenues and expenses reported during the reporting
period. As additional information becomes available or actual amounts become
determinable, the recorded estimates may be revised and reflected in operating
results. Actual results could differ from those estimates. Accounts that, in our
judgment, are most critical to the preparation of our financial statements
include policy liabilities and accruals, deferred policy acquisition costs,
valuation of certain investments and deferred taxes.
Policy liabilities and accruals
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders using the same actuarial assumptions that we use in
the pricing of our products. For our accident and health insurance business, we
establish an active life reserve plus a liability for due and unpaid claims,
claims in the course of settlement and incurred but not reported claims, as well
as a reserve for the present value of amounts not yet due on claims. Many
factors can affect these reserves and liabilities, such as economic and social
conditions, inflation, hospital and pharmaceutical costs, changes in doctrines
of legal liability and extracontractual damage awards. Therefore, the reserves
and liabilities we establish are based on extensive estimates, assumptions and
prior years' statistics. When we acquire other insurance companies or blocks of
insurance, our assessment of the adequacy of transferred policy liabilities is
subject to similar estimates and assumptions. Establishing reserves is an
uncertain process, and it is possible that actual claims will materially exceed
our reserves and have a material adverse effect on our results of operations and
financial condition. Our net income depends significantly upon the extent to
which our actual claims experience is consistent with the assumptions we used in
setting our reserves and pricing our policies. If our assumptions with respect
to future claims are incorrect, and our reserves are insufficient to cover our
actual losses and expenses, we would be required to increase our liabilities
resulting in reduced net income and shareholders' equity.
30
Deferred policy acquisition costs
The cost of acquiring new business, principally commissions and certain
expenses of the agency, policy issuance and underwriting departments, all of
which vary with, and are primarily related to the production of new and renewal
business, have been deferred. These costs are being amortized in relation to the
present value of expected gross profits on the policies arising principally from
investment, mortality and expense margins in accordance with Statement of
Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments", for interest sensitive life and annuity
products and in proportion to premium revenue using the same assumptions used in
estimating the liabilities for future policy benefits in accordance with
Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by
Insurance Enterprises", for non-interest sensitive life and all accident &
health products.
The determination of gross profits is an inherently uncertain process, and
relies on assumptions including the persistency of the policies issued as well
as anticipated losses, commissions and expenses. It is possible that the actual
profits from the business will vary materially from the assumptions used in the
determination and amortization of deferred acquisition costs. Deferred policy
acquisition costs are written off to the extent that it is determined that
future policy premiums and investment income or gross profits would not be
adequate to cover related losses and expenses.
Investment valuation
Fair value of investments is based upon quoted market prices, where
available, or on values obtained from independent pricing services. For certain
mortgage and asset-backed securities, the determination of fair value is based
primarily upon the amount and timing of expected future cash flows of the
security. Estimates of these cash flows are based upon current economic
conditions, past credit loss experience and other circumstances.
We regularly evaluate the amortized cost of our investments compared to
the fair value of those investments. Impairments of securities generally are
recognized when a decline in fair value below the amortized cost basis is
considered to be other-than-temporary. We consider a decline in fair value to be
other than temporary when the fair value of an individual security is below
amortized cost for an extended period and we do not believe that recovery in
fair value is probable. Impairment losses for certain mortgage and asset-backed
securities are recognized when an adverse change in the amount or timing of
estimated cash flows occurs, unless the adverse change is solely a result of
changes in estimated market interest rates. The cost basis for securities
determined to be impaired are reduced to their fair value, with the excess of
the cost basis over the fair value recognized as a realized investment loss.
Deferred taxes
We have adopted the asset and liability method. Under the asset and
liability method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date of a change in tax rates.
We establish valuation allowances on our deferred tax assets for amounts
that we determine will not be recoverable based upon our analysis of projected
taxable income and our ability to implement prudent and feasible tax planning
strategies. Increases in these valuation allowances are recognized as deferred
tax expense. Subsequent determinations that portions of the valuation allowances
are no longer necessary are reflected as deferred tax benefits. To the extent
that valuation allowances were established in conjunction with acquisitions,
changes in those allowances are first applied to increasing or decreasing the
goodwill (but not below zero) or other intangibles related to the acquisition
and then applied as an increase or decrease in income tax expense.
31
RECENT TRENDS
EQUITY OFFERING
In the third quarter of 2001, we completed a secondary equity offering in
which we sold 5.7 million shares of our common stock and raised $26.0 million,
net of expenses. In addition, 2.2 million shares were sold by some of our
shareholders as part of the offering. The primary reason for the offering was to
enhance the capital of our insurance subsidiaries to support our growth and to
improve our risk based capital ratios. Out of the proceeds of the offering, $9.3
million was contributed to the capital and surplus of our insurance
subsidiaries, $5.5 million was used to reduce intercompany obligations and the
balance was held for general corporate purposes.
ACQUISITIONS AND DISPOSITIONS
Acquisition of Administrative Service Companies
In November 2001, we acquired the assets of Living Strategies, Inc., a
privately held company based in Bala Cynwyd, Pennsylvania, including certain
contracts, trademarks and proprietary web-based technology. Living Strategies is
a recognized provider of employer-sponsored elder care programs, providing
assistance and support to those dealing with the aging of their parents and
family members. As a result of the acquisition of the Living Strategies assets,
we have enhanced our technology infrastructure and expanded the audience for our
elder care management services.
In August 2000, we acquired CHCS a privately held administrator of long
term care products located in Weston, Florida. CHCS administers long term care
and home health care insurance and non-insurance products. This acquisition
enhanced our expertise in the long term care business.
In January 2000, we acquired American Insurance Administration Group,
Inc., a privately-held third party administrator located in Clearwater, Florida.
American Insurance Administration Group is a third party administrator of senior
health insurance. This acquisition strengthened our expertise and capacity to
administer senior market products.
1999 Acquisition
In July 1999, we acquired six insurance companies, including the
subsidiaries that comprise our career agency segment, and other assets from
PennCorp Financial Group. This acquisition enhanced our prospects for future
growth by expanding our geographic reach and through the addition of a career
agency marketing channel to supplement our senior market brokerage agency
marketing channel. We have included in the comparison of our 2000 and 1999
results of operations a simple extrapolation to annualize the five months of
activity during 1999 for the acquired business to a twelve-month amount in order
to provide a meaningful basis of comparison with the full twelve-month period
ended December 31, 2000.
Cancellation of Major Medical Insurance
In the fourth quarter of 2000, we decided to exit our under-performing
individual major medical business to the extent possible. We believe that we
will be able to cancel, by the end of 2002, all but $3.3 million of the
annualized major medical premium that was in force on December 31, 2001.
32
HEALTH MAINTENANCE ORGANIZATION ("HMO'S") DISENROLLMENT
Beginning in 1998, many HMO's realized that their Medicare programs were
unprofitable and therefore decided to terminate these programs. As a result,
millions of seniors were involuntarily disenrolled from these programs. This
development contributed to our increased new sales of Medicare supplement
products in 2001, 2000 and 1999. Under applicable legislation, such disenrollees
may have the right to acquire Medicare supplement insurance without underwriting
or pre-existing condition limitations. We expect that, over time, the effect of
disenrollment on new Medicare supplement sales will abate.
RESULTS OF OPERATIONS - CONSOLIDATED OVERVIEW
The following table reflects each of our segment's operating income
contribution and contains a reconciliation to net income for these items.
For the year ended December 31,
2001 2000 1999
-------- -------- --------
(in thousands)
Operating Income:
Career Agency $ 28,427 $ 28,814 $ 11,759
Senior Market Brokerage 8,292 5,491 3,871
Special Markets 5,424 4,790 4,618
Administrative Services 6,625 3,844 2,036
-------- -------- --------
Segment operating income 48,768 42,939 22,284
Corporate & Eliminations (8,483) (10,019) (5,987)
-------- -------- --------
Operating income before realized gains and Federal income taxes (1) 40,285 32,920 16,297
Federal income taxes on operating items (13,361) (10,130) (6,327)
Redemption accrual on Series C and Series D Preferred Stock -- -- (180)
-------- -------- --------
Net operating Income (1) $ 26,924 $ 22,790 $ 9,790
Realized gains (losses), net of tax 2,001 95 (157)
-------- -------- --------
Net income applicable to common shareholders $ 28,925 $ 22,885 $ 9,633
======== ======== ========
Per share data (diluted):
Net operating income (1) $ 0.53 $ 0.48 $ 0.35
Realized gains (losses), net of tax 0.04 0.01 (0.01)
-------- -------- --------
Net Income $ 0.57 $ 0.49 $ 0.34
======== ======== ========
(1) We evaluate the results of operations of our segments based on operating
income by segment. Operating income excludes realized gains. This differs from
generally accepted accounting principles, which includes the effect of realized
gains in the determination of net income. The schedule above reconciles our
operating income to net income in accordance with generally accepted accounting
principles.
YEARS ENDED DECEMBER 31, 2001 AND 2000
Consolidated net income after realized gains and Federal income taxes
increased by $6.0 million to $28.9 million ($0.57 per share) in 2001, compared
to $22.9 million ($0.49 per share) in 2000. Net operating income increased by
$4.1 million to $26.9 million in 2001 compared to $22.8 million in 2000.
Operating income from our Career Agency segment decreased by $0.4 million
or 1%, compared to 2000. This decrease was due primarily to a reduction in the
underwriting profit of the U.S. Operations, offset by a reduction in general
expenses.
Our senior market brokerage segment improved results by more than 51%,
increasing operating income by $2.8 million. This improvement is the result of
continued internally generated growth of business in this segment, primarily in
the Medicare supplement and long term care lines.
33
The operating income for our special markets segment for 2001 improved by
$0.6 million compared to 2000. In the fourth quarter of 2000, we wrote off $1.4
million of deferred acquisition costs related to our decision to exit the major
medical line of business. Adjusted for this item, operating income for the
segment decreased by $0.8 million. This decrease is due primarily to a reduction
in the overall business of the segment, resulting primarily from our decision to
exit the major medical line of business.
Operating income from our administrative services segment improved by $2.8
million or 72% in 2001 compared to 2000. The increase is due primarily to the
growth in the Medicare supplement business administered by this segment.
The decrease in the operating loss from our corporate segment is due
primarily to the reduction in interest cost. This reduction was due to a
combination of a declining balance of debt outstanding as a result of principal
repayments and reductions in the weighted average interest rates for the year,
compared to 2000.
Our effective tax rate was 33.2% for 2001 as compared to 30.8% in 2000. As
a result of the increased profitability of the administrative services segment,
valuation allowances on certain of the tax loss carryforwards were no longer
considered necessary during both 2001 and 2000. The amount of the valuation
allowance released through deferred income tax expense during 2001 was $0.7
million compared to $1.3 million during 2000.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Consolidated net income after realized gains and Federal income taxes
increased by $13.3 million to $22.9 million ($0.49 per share) in 2000, compared
to $9.6 million ($0.34 per share) in 1999. Net operating income increased by
$13.0 million to $22.8 million in 2000 compared to $9.8 million in 1999.
Operating income from our career agency segment increased by $17.1
million, reflecting the inclusion of a full year of operating results in 2000
compared to the inclusion of five months of operating results in 1999. The
results for 2000 were consistent with 1999 on an annualized basis.
Our senior market brokerage segment improved results by more than 40%,
increasing operating income by $1.6 million. This improvement is the result of
continued internally generated growth of business in this segment, primarily in
the Medicare supplement and long term care lines, offset in part by a
deterioration in overall loss ratios for the segment from 73% to 78%.
The operating income for our special markets segment for 2000 improved by
approximately 4% over 1999. This reflects the inclusion of a full year of
operating income in 2000 from the business acquired in 1999 compared to only
five months in 1999. However, underwriting results for the segment were
negatively impacted by a deterioration of the loss ratios in the major medical
line of business. Based in part on the poor performance of this block of
business, and in an effort to focus more on strategic core business lines, we
decided to exit the major medical business during 2000. As a result, we wrote
off $1.4 million of deferred acquisition costs relating to that line of
business.
Operating income from our administrative services segment nearly doubled
in 2000 compared to 1999, primarily as a result of the acquisitions of American
Insurance Administration Group, Inc. in January 2000 and CHCS in August 2000.
The increase in the operating loss from our corporate segment reflected
the inclusion in 2000 of a full year of interest expense and other costs related
to the debt incurred in connection with the business we acquired in 1999
compared to the inclusion of only five months of interest expense and other
costs for 1999.
Our effective tax rate was 30.8% for 2000 as compared to 38.9% in 1999. As
a result of the increased profitability of the administrative services segment,
valuation allowances on certain of the non-life tax loss carryforwards were no
longer considered necessary as of December 31, 2000. The amount of the valuation
allowance released was $1.3 million and was recorded as a benefit in the
deferred income tax expense.
34
SEGMENT RESULTS - CAREER AGENCY
For the year ended December 31,
2001 2000 1999
---- ---- ----
(in thousands)
Net premiums and policyholder fees:
Life and annuity $ 14,116 $ 17,258 $ 7,198
Accident & Health 112,028 112,100 48,365
--------- --------- --------
Net premiums 126,144 129,358 55,563
Net investment income 32,768 31,714 12,133
Other income 1,383 647 228
--------- --------- --------
Total revenue 160,295 161,719 67,924
--------- --------- --------
Policyholder benefits 83,947 81,432 30,396
Interest credited to policyholders 1,981 1,657 437
Change in deferred acquisition costs (12,178) (12,476) (2,919)
Amortization of present value of future profits and goodwill 7 28 12
Commissions and general expenses, net of allowances 58,111 62,264 28,239
--------- --------- --------
Total benefits, claims and other deductions 131,868 132,905 56,165
--------- --------- --------
Segment operating income $ 28,427 $ 28,814 $ 11,759
========= ========= ========
YEARS ENDED DECEMBER 31, 2001 AND 2000
Operating income from our Career Agency segment decreased by $0.4 million
or 1%, compared to 2000. This decrease was due primarily to a reduction in the
underwriting profit of the U.S. Operations, offset by a reduction in general
expenses.
REVENUES. Net premiums for the 2001 fell by approximately 2.5% compared to
2000. In the U.S. the decrease is due to a greater amount of annuities, which
are not reported as premiums for GAAP purposes. The decrease in Canadian net
premium is due to the run-off of the older block of Canadian business. Canadian
operations accounted for approximately 37% of the net premiums for the segment
for both 2001 and 2000.
Net investment income increased by approximately 3% over 2000. The increase
is due to an increase in the segment's invested assets, offset by a decrease in
the overall yield.
Other income increased by approximately $0.7 million in 2001 compared to
2000. This increase is due primarily to fees associated with the sale by Career
Agents of a recently introduced product designed to provide access to nursing
home and home healthcare services. This increase in other income is largely
offset by an increase in commissions related to this non-insurance product.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including a
change in reserves, increased by approximately 3% compared to 2000 on an
annualized basis. This was due to higher overall loss ratios, primarily in the
accident & health lines of business, for the segment in 2001 compared to 2000 on
lower premium, as noted above.
The increase in deferred acquisition costs was approximately $0.3 million
less in 2001, compared to the increase in 2000. This reflects a decrease in the
underwriting and issue costs and a higher level of amortization as the post
acquisition block of business increases.
Commissions and general expenses decreased by approximately $4.2 million,
or 7%, in 2001 compared to 2000 on an annualized basis. The decrease is
primarily due to the consolidation of the operations from the Raleigh location
into the existing operations in Toronto, Canada and Pensacola, Florida.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Operating income from our Career Agency segment increased by $17.1 million,
reflecting the inclusion of a full year net of operating results for this
segment in 2000 compared to the inclusion of five months of operating results in
five months in 1999.
35
REVENUES. Net premiums for the year fell by approximately 3% for the
segment compared to 1999 on an annualized basis. Canadian operations accounted
for approximately 37% of the net premiums for both 2000 and 1999. During 2000,
we began to develop new products for the Career Agency sales force which are
based on the Senior Market Brokerage products. Additionally, we were focused on
the recruiting and training of new agents during the year.
Net investment income increased by approximately 9% over 1999 on an
annualized basis. The increase resulted from the increase in the average
invested assets for the comparable periods. Average invested assets increased as
a result of earnings for the year, as well as the movement of the proceeds from
certain acquisition related transactions from short-term investments in 1999 to
long-term investments in 2000.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including a
change in reserves, increased by approximately 12% compared to 1999 on an
annualized basis. This was due to higher overall loss ratios.
The increase in deferred acquisition costs was approximately $5.5 million
more in 2000, compared to the increase in 1999 on an annualized basis and is
directly related to the new business sold in 2000. The deferred acquisition
costs in this segment relates solely to business sold subsequent to our
acquisition of PennCorp Life (Canada) and Pennsylvania Life.
Commissions and general expenses decreased by approximately $5.5 million or
8% in 2000 compared to 1999 on an annualized basis. Approximately $2.8 million
of the decrease related to a reduction in the overall commission rate for our
Career Agents, as well as a reduction in stock-based compensation related to
agent production. The remaining decrease related to the decrease in production
as compared to 1999 on an annualized basis.
SEGMENT RESULTS - SENIOR MARKET BROKERAGE
For the year ended December 31,
2001 2000 1999
---- ---- ----
(in thousands)
Net premiums and policyholder fees:
Life and annuity $ 5,252 $ 3,669 $ 1,068
Accident & Health 72,636 48,451 31,574
-------- -------- --------
Net premiums 77,888 52,120 32,642
Net investment income 11,740 11,391 9,422
Other income 2 3 41
-------- -------- --------
Total revenue 89,630 63,514 42,105
-------- -------- --------
Policyholder benefits 61,639 40,656 23,643
Interest credited to policyholders 4,524 4,996 5,550
Change in deferred acquisition costs (7,751) (5,015) (3,722)
Amortization of present value of future profits and goodwill 200 183 183
Commissions and general expenses, net of allowances 22,726 17,203 12,580
-------- -------- --------
Total benefits, claims and other deductions 81,338 58,023 38,234
-------- -------- --------
Segment operating income $ 8,292 $ 5,491 $ 3,871
======== ======== ========
The table below details the gross premiums and policyholder fees before
reinsurance for the major product lines in the Senior Market Brokerage segment
and the corresponding average amount of premium retained. We reinsure a
substantial portion of all of our senior market brokerage products with
unaffiliated third party reinsurers under various quota share agreements.
Medicare supplement written premium is reinsured under quota share reinsurance
agreements ranging between 50% and 75% based upon the geographic distribution.
We also acquired various blocks of Medicare supplement premium, which we
reinsure under quota share reinsurance agreements ranging from 50% to 100%.
Under our reinsurance agreements, we reinsure the claims incurred and
commissions on a pro rata basis and receive additional expense allowances for
policy issue, administration and premium taxes.
36
2001 2000 1999
---- ---- ----
Gross Net Gross Net Gross Net
Premiums Retained Premiums Retained Premiums Retained
-------- -------- -------- -------- -------- --------
(in thousands)
Medicare Supplement acquired $149,287 7% $145,972 8% $ 95,062 13%
Medicare Supplement written 161,121 31% 82,013 31% 34,810 34%
Other supplemental health 22,553 61% 20,701 56% 12,812 60%
Senior life insurance 8,328 69% 6,625 50% 3,560 50%
-------- -------- --------
Total gross premiums written $341,289 23% $255,311 20% $146,244 22%
======== ======== ========
YEAR ENDED DECEMBER 31, 2001 AND 2000
Operating income from our Senior Market Brokerage segment increased by $2.8
million, or 51%, in 2001 compared to 2000. This improvement is the result of
continued internally generated growth of business in the segment, primarily in
the Medicare Supplement/Select and long term care lines.
REVENUES. Total gross premium written increased $86.0 million, or 34%, over
2000. This increase consisted of an increase of $79.1 million, or 96%, on
Medicare supplement business written by our insurance companies, an increase of
$3.3 million in Medicare supplement premium acquired through acquisition, an
increase of $1.9 million in other senior supplemental health premium and an
increase of $1.7 million in senior life insurance premium.
This increase in gross premium for the Senior Market portfolio products by
our insurance company subsidiaries was the result of strong sales in the prior
year together with continued increase in new sales in the current year. New
production of our Senior Market products amounted to $109.7 million for 2001
compared to $85.1 million for 2000.
The increase in Medicare supplement acquired gross premium is due to new
sales by our insurance subsidiary, Constitution Life Insurance Company, which
are substantially ceded, and the effect of rate increases, offset by expected
lapses.
The increase of $1.9 million in other supplemental senior health gross
premiums was the result of new sales of long term care products offset by the
run off of premium associated with the acquired block of long term care
products.
Net premiums for 2001 increased by approximately $25.8 million, or 49%,
compared to 2000. Net premiums did not increase in line with the gross premiums
due to a change in the mix of annualized premium in force. The amount of premium
retained increased from 20% in 2000 to 23% in 2001 due to the increase in
Medicare Supplement/Select premiums written, which we retain 30% on average.
Net investment income increased by 3% compared to 2000, as a result of the
increasing asset base, offset by a decrease in the overall yield.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including the
change in reserves, increased by approximately $21.0 million, or 52%, compared
to 2000, due primarily to the increase in the annualized premium in force.
Interest credited to policyholders decreased by approximately $0.5 million
as a result of the decrease in the effective interest rate credited to the
policies in 2001 compared to 2000 and the expected lapses of policies in force.
The increase in deferred acquisition costs was approximately $2.7 million
more in 2001, compared to the increase in 2000. The increase in deferred
acquisition costs related to the increase in premiums issued during 2001,
primarily Medicare supplement, compared to 2000.
37
Commissions and general expenses increased by approximately $5.5 million or
32% in 2001 compared to 2000. The following table details the components of
commission and other general expenses:
2001 2000
---- ----
Commissions $ 59,997 $ 43,131
Other operating costs 41,426 33,345
Reinsurance allowances (78,697) (59,273)
------- --------
Commissions and general expenses, net of allowances $ 22,726 $ 17,203
======== ========
The ratio of commissions to gross premiums increased to 17.6% in 2001 from
16.9% in 2000. Other operating costs as a percentage of gross premiums decreased
to 12.1% in 2001 from 13.1% in 2000. Commission and expense allowances received
from reinsurers as a percentage of the premiums ceded were relatively flat at
29.9% in 2001 compared to 29.2% in 2000.
YEAR ENDED DECEMBER 31, 2000 AND 1999
Operating income from our Senior Market Brokerage segment increased by $1.6
million, or 42%, in 2000 compared to 1999.
REVENUES. Total gross premium written increased $109.1 million, or 75%,
over 1999. This increase consisted of an increase of $47.2 million, or 136%, on
Medicare supplement business written by our insurance companies, an increase of
$50.9 million in Medicare supplement premium acquired through acquisition, an
increase of $7.9 million in other senior supplemental health premium and an
increase of $3.1 million in senior life insurance premium.
This increase in gross premium written by our insurance company
subsidiaries was the result of an increase in sales of $48.5 million, or 133%,
of the senior market products from $36.6 million in 1999 to $85.1 million in
2000. Medicare supplement written premium grew as a result of the increase in
the number of general agents under contract and by the disenrollment of
policyholders by HMO's. In addition, premiums increased as a result of rate
increases that we implemented in 2000. This increase was partially offset by
lapses attributable to the rate increases.
The 1999 amount of gross premium for Medicare supplement acquired included
approximately $36.7 million of gross premiums received on policies from the
business acquired in 1999 for the five months ended December 31, 1999. On a
annualized basis, the gross premium on this acquired business would have been
$88.1 million. Gross premiums for this acquired business were $89.7 million in
2000, a $1.6 million increase compared to annualized 1999.
The increase of $7.9 million in other supplemental health gross premiums
was the result of increased new sales of long term care products and an increase
of $2.8 million due to the inclusion in 2000 of twelve months of long term care
premiums from the business acquired in 1999 compared to the inclusion of only
five months of such premiums in 1999. Senior life insurance premium increased in
2000 as a result of increased sales resulting from more general agents under
contract.
Net premiums for 2000 increased by approximately $19.5 million, or 60%,
compared to 1999. Net premiums did not increase in line with the gross premiums
due to a decrease in the amount of retained Medicare supplement written premium
from 34% in 1999 to 31% in 2000. This reduction in retained premium was a result
of increased premiums written by our American Pioneer Life Insurance Company
subsidiary for which 75% quota share reinsurance agreements are in force. The
Retained Medicare supplement acquired premium decreased from 13% in 1999 to 8%
in 2000 as a result of the inclusion of a full year of the Medicare supplement
premium from the business acquired in 1999, which premium was 100% reinsured
under agreements that predated the acquisition. The other supplemental senior
health insurance retained decreased from 60% in 1999 to 56% in 2000 as result of
the increased writing of long term care insurance that is reinsured pursuant to
50% quota share reinsurance agreements.
38
Net investment income increased by approximately 21% over 1999, as a result
of the increase in the average invested assets for the comparable periods.
Average invested assets increased primarily as a result of increased cash flow
from operations.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including the
change in reserves, increased by approximately $17.0 million, or 72%, compared
to 1999. Net policyholder benefits increased more than net premium primarily due
to an increase in loss ratios on our Medicare supplement written policies from
approximately 70% in 1999 to 75% in 2000. In response to this increase in the
loss ratio, we have implemented rate increases, which will be effective during
2001. The loss ratios on the Medicare supplement acquired policies increased
slightly from 82% in 1999 to 84% in 2000. In addition, the net benefits incurred
from the business acquired in 1999 increased $2.0 million as a result of
including twelve months of operations in 2000 compared to only five months of
operations in 1999.
Interest credited to policyholders decreased by approximately $0.6 million,
or 10%, as a result of the decrease in the effective interest rate credited to
the policies in 2000 compared to 1999 and the expected lapses of policies in
force.
The increase in deferred acquisition costs was approximately $1.3 million
more in 2000, compared to the increase in 1999. The increase in deferred
acquisition costs related to the increase in premiums issued during 2000
compared to 1999.
Commissions and general expenses increased by approximately $4.6 million or
37% in 2000 compared to 1999. The following table details the components of
commission and other general expenses:
2000 1999
---- ----
Commissions $ 43,131 $ 24,181
Other operating costs 33,345 21,262
Reinsurance allowances (59,273) (32,863)
-------- --------
Commissions and general expenses, net of allowances $ 17,203 $ 12,580
======== ========
The ratio of commissions to gross premiums remained relatively flat at
16.9% in 2000 and 16.5% in 1999. Other operating costs as a percentage of gross
premiums decreased to 13.1% in 2000 from 14.5% in 1999. Commission and expense
allowances received from reinsurers as a percentage of the premiums ceded were
relatively flat at 29.2% in 2000 compared to 28.9% in 1999.
SEGMENT RESULTS - SPECIAL MARKETS
For the year ended December 31,
2001 2000 1999
---- ---- ----
(in thousands)
Net premiums and policyholder fees:
Life and annuity $11,239 $12,773 $ 9,325
Accident & Health 13,935 25,502 17,947
------- ------- -------
Net premiums 25,174 38,275 27,272
Net investment income 13,434 14,704 8,662
Other income 203 332 246
------- ------- -------
Total revenue 38,811 53,311 36,180
------- ------- -------
Policyholder benefits 19,433 31,831 19,216
Interest credited to policyholders 3,764 3,477 2,681
Change in deferred acquisition costs 713 1,566 412
Amortization of present value of future profits and goodwill 224 230 314
Commissions and general expenses, net of allowances 9,253 11,417 8,939
------- ------- -------
Total benefits, claims and other deductions 33,387 48,521 31,562
------- ------- -------
Segment operating income $ 5,424 $ 4,790 $ 4,618
======= ======= =======
YEARS ENDED DECEMBER 31, 2001 AND 2000
39
Operating results from our Special Markets segment for 2001 improved by
$0.6 million compared to 2000.
REVENUES. Net premiums for 2001 decreased by $13.1 million or 34% compared
to 2000. Major medical premiums decreased by approximately $10.7 million
compared to 2000, directly related to our decision, in the fourth quarter of
2000, to exit the major medical line of business. Life premiums decreased by
$1.5 million.
Net investment income decreased by $1.3 million compared to 2000. This
decrease is due to a combination of a lower invested asset base, combined with a
decrease in the overall yield.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits decreased by
$12.4 million in 2001 compared to 2000. This decrease is related to the decline
in premium for the segment, offset by an increase in the overall loss ratios for
the segment, compared to 2000.
Interest credited to policyholders was consistent with 2000.
The net amortization of deferred acquisition costs decreased by $0.9
million in 2001, compared to 2000. In the fourth quarter of 2000, we wrote off
approximately $1.4 million of deferred acquisition costs related to our decision
to exit the major medical line of business. Adjusting for this item, net
amortization of deferred acquisition costs increased by $0.5 million, reflecting
lower levels of production as the remaining lines of business run off.
Commissions and general expenses, net of allowances, decreased by $2.2
million, or 19%, during 2001, compared to 2000. This reflects the lower costs
associated with the reduction in premium.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Operating results from our Special Markets segment for 2000 improved
approximately 4% compared to 1999.
REVENUES. Net premiums for 2000 increased by $11.0 million or 40% compared
to 1999. Approximately $10.6 million of the increase, including $3.3 million of
life premium and $7.3 million of accident and health premium, related to the
inclusion of a full year of operating results in 2000 for the business acquired
in 1999, compared to the inclusion of only five months in 1999.
Net investment income increased by $6.0 million compared to 1999, primarily
due to the inclusion in 2000 of twelve months of investment income on assets
relating to the business acquired in 1999, compared to the inclusion of only
five months in 1999.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits increased by
$12.6 million in 2000 compared to 1999. Approximately $9.8 million of the
increase related to the inclusion in 2000 of a full year of operating results
the business acquired in 1999 compared to the inclusion of only five months of
operating results in 1999. Approximately $2.0 million resulted from
deterioration in the loss ratios from the major medical business of the segment.
The remaining increase related to adverse mortality for the life business in
2000 compared to 1999.
The increase in interest credited of $0.8 million was due primarily to the
inclusion of a full year of operating results for the business acquired in 1999.
The increase in the net amortization of deferred acquisition costs related
primarily to our decision to exit the major medical line of business. As a
result of this decision, we wrote off approximately $1.4 million of deferred
acquisition costs in 2000.
40
Commissions and general expenses, net of allowances, increased by $2.5
million, or 28%, during 2000. An increase of approximately $3.3 million was due
to the inclusion of a full year of operating results of the business acquired in
2000 compared to the inclusion of only five months of operating results in 1999.
Offsetting this increase was a decrease in operating expenses relating to
existing blocks of business.
SEGMENT RESULTS - ADMINISTRATIVE SERVICES
For the year ended December 31,
2001 2000 1999
---- ---- ----
(in thousands)
Service fee income $32,831 $24,130 $9,290
Net investment income 322 77 --
------- ------- ------
Total revenue 33,153 24,207 9,290
------- ------- ------
Amortization of present value of future profits and goodwill 2,206 2,920 --
General expenses 24,322 17,443 7,254
------- ------- ------
Total benefits, claims and other deductions 26,528 20,363 7,254
------- ------- ------
Segment operating income 6,625 3,844 2,036
Depreciation, amortization and interest 3,108 3,379 320
------- ------- ------
Earnings before interest, taxes, depreciation and amortization (1) $ 9,733 $ 7,223 $2,356
======= ======= ======
(1) For our Administrative Services segment, we evaluate its results based on
earnings before interest, taxes, depreciation and amortization, which is not in
accordance with generally accepted accounting principles.
YEARS ENDED DECEMBER 31, 2001 AND 2000
Operating income for the Administrative Services segment for 2001 improved
by more than 72% over the amount in 2000, primarily as the result of the
increase in Medicare premiums being serviced by our administrative services
company. Earnings before interest, taxes, depreciation and amortization
("EBITDA") increased by approximately 35% to $9.7 million in 2001.
Service fee income increased by $8.7 million, or 36%, in 2001 as compared
to 2000. Fees for our administration of Medicare supplemental business increased
by $4.6 million, or 46%, in 2001 compared to 2000, primarily as a result of the
increase in Medicare business issued by our Senior Market Brokerage segment.
Fees for our administration of long term care business increased $4.3 million in
2001 compared to 2000. This increase is due primarily to the inclusion of a full
year of operations of CHCS in 2001 compared to only five months in 2000.
Currently our Administrative Services segment generates 48% of its revenues from
the administration of business on behalf of affiliates, 27% from unaffiliated
third party clients and 25% from the reinsurer of 100% of a certain block of
business of one of our insurance subsidiaries. Fees for the affiliated business
are priced using terms similar to those charged for our unaffiliated business.
For the year ended December 31, 2000, our Administrative Services segment
generated $24.1 million in service fee income with 42% of its revenues from the
administration of business on behalf of affiliates, 25% from unaffiliated third
party clients and 33% from the reinsurer of 100% of a certain block of business
of one of our insurance subsidiaries.
The amortization of present value of future profits and goodwill in 2001
related primarily to the acquisition of American Insurance Administration Group.
Approximately $7.7 million of present value of future profits ("PVFP") was
established when we acquired that company. The PVFP is amortized in proportion
to the expected profits from the contracts in force on the date of acquisition.
A large portion of the contracts had a remaining term of three years and,
accordingly, the amortization is heavily weighted to that period. Approximately
$2.1 million of the PVFP was amortized during 2001 and $2.8 million of the PVFP
was amortized during 2000. Cumulatively, 64% of the PVFP has been amortized,
with 36% of the original balance remaining as of December 31, 2001. We expect to
amortize approximately $1.7 million of PVFP in 2002. The remaining amortization
related to the goodwill established in connection with the acquisition of CHCS,
which we expect will have no amortization expense in 2002 as a result of the
adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets."
41
General expenses for the segment increased by $6.9 million in 2001 compared
to 2000. Expenses relating to the administration of long term care business
increased by approximately $4.3 million. This increase is due primarily to the
inclusion of a full year of operations of CHCS operations in 2001 compared to
only five months in 2000. The remaining increase related to the costs associated
with the increase in Medicare business administered, primarily for our
affiliated insurance subsidiaries.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Operating income for the Administrative Services segment nearly doubled in
2000 compared to 1999, primarily as a result of the acquisition of American
Insurance Administration Group in January 2000 and the acquisition of CHCS in
August 2000.
Service fee income from the Administrative Services segment increased by
$14.9 million, or 161%, in 2000 as compared to 1999. Fees from American
Insurance Administration Group added $10.3 million in revenues and CHCS,
acquired in August 2000, added $2.2 million in revenues to the segment in 2000.
Affiliated revenues at WorldNet Services Corp. increased by $2.7 million as a
result of the increase in premiums serviced by WorldNet on behalf of affiliated
insurance subsidiaries.
As of December 31, 2000, the Administrative Services segment administered
more than $308.5 million of annualized in force premium. Approximately $276.7
million of annualized premium in force was administered on behalf of affiliates.
This, combined with fees for telephone support and managed care and claims
services on behalf of the affiliated insurance subsidiaries, generated $18.1
million of affiliated revenue for 2000. The remaining $6.0 million was generated
from services provided to unaffiliated companies.
The amortization of present value of future profits and goodwill in 2000
related primarily to the acquisition of American Insurance Administration Group.
During 2000, approximately $2.8 million, or 37% of the original balance, was
amortized. The remaining amortization related to the goodwill established in
connection with the acquisition of CHCS.
General expenses for the segment increased by $10.2 million in 2000
compared to 1999. Approximately $8.1 million of the increase related to the two
acquisitions. The remaining increase related to the costs associated with the
increase in business administered for our affiliated insurance subsidiaries.
SEGMENT RESULTS - CORPORATE
The following table presents the primary components comprising the
corporate segment's operating loss:
For the year ended December 31,
2001 2000 1999
---- ---- ----
(in thousands)
Interest cost of acquisition financing $5,152 $ 7,097 $2,859
Amortization of capitalized loan origination fees 530 528 220
Stock-based compensation expense 730 757 921
Other parent company expenses, net 2,071 1,987 1,987
Insurance settlement -- (350)
------ -------- ------
Segment operating loss $8,483 $ 10,019 $5,987
====== ======== ======
YEARS ENDED DECEMBER 31, 2001 AND 2000
The decrease in the operating loss from our corporate segment is due
primarily to the reduction in interest cost. This reduction was due to a
combination of the declining balance of debt outstanding as a result of
principal repayments and reductions in the weighted average interest rates for
the year, compared to 2000. During 2001, we repaid $8.2 million of our term loan
while at the same time the weighted average interest rate on our debt decreased
to 7.84% from 10.05% in 2000.
42
YEARS ENDED DECEMBER 31, 2000 AND 1999
The increase in the interest cost and the amortization of capitalized loan
fees reflected the inclusion of a full year's costs in 2000 compared to five
months in 1999. The stock-based compensation expense decreased due to
termination of options as the result of employees leaving the company prior to
vesting.
RESTRUCTURING COSTS
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired in the 1999 Acquisition into its
locations in Toronto (Canada), Pensacola (Florida) and Orlando (Florida) in
order to improve operating efficiencies and capabilities. The plan to
consolidate this location was being formed at the date of the acquisition and
was approved by the Board of Directors. Accordingly, the Company recorded an
$11.1 million restructuring liability in its accounting for the 1999
Acquisition. These restructuring costs were accounted for under EITF No 95-3,
"Recognition of Liabilities in Connection with a Purchase Business Combination"
("EITF 95-3"). During 2001, we paid $2.8 million of restructuring costs. As of
December 31, 2001, the remaining liability consisted of employee relocation
costs of $0.2 million.
ELIMINATIONS
The Corporate segment reflects the elimination of revenues and expenses
associated with services performed by our Administrative Services segment for
our insurance company subsidiaries. These eliminations amounted to $23.6 million
for 2001, $18.1 million for 2000 and $7.3 million for 1999. The Corporate
segment also reflects the elimination of interest income and expense on
debentures issued by our parent holding company to our American Progressive
subsidiary of $0.5 million for 2001, $0.7 million for 2000 and $0.7 million for
1999.
LIQUIDITY AND CAPITAL RESOURCES
We use capital primarily to maintain or increase the surplus of our
insurance company subsidiaries and to support our holding company as an
insurance holding company. In addition, we require capital to fund our
anticipated growth through acquisitions of other companies or blocks of
insurance business.
We require cash to meet our obligations under our credit facility and our
outstanding debentures held by our subsidiary, American Progressive. We also
require cash to pay the operating expenses necessary to function as an insurance
holding company (applicable insurance department regulations require us to bear
our own expenses), and to meet the costs involved in being a public company.
We believe that our current cash position, the availability of the
revolving credit facility, the expected cash flows of the administrative service
company and the surplus note interest payments from American Exchange can
support our parent holding company obligations for the foreseeable future.
However, there can be no assurance as to our actual future cash flows or to the
continued availability of dividends from our insurance company subsidiaries.
43
Contractual Obligations and Commercial Commitments
Our $80 million credit facility consists of a $70 million term loan and a
$10 million revolving loan facility. The loans call for interest at LIBOR for
one, two, three or six months plus 350 basis points (currently 5.37%). Principal
repayments are due on a quarterly basis over a seven-year period that commenced
on July 31, 2000. The final maturity date of the facility is July 31, 2006. We
pay a commitment fee of 50 basis points on the unutilized portion of the
revolving facility. The term loan is secured by a first priority security
interest in 100% of the outstanding common stock of American Exchange, American
Progressive, and WorldNet Services and 65% of the outstanding under common stock
of UAFC (Canada) Inc. (the parent of PennCorp Life (Canada)) and a subordinate
interest in 100% of the outstanding common stock of American Pioneer. As of
December 31, 2001, $58.5 million was outstanding under the term loan and $3.0
million was outstanding under the revolving loan facility. We incurred the
revolving indebtedness in connection with our acquisition of CHCS in August
2000. During January 2002, we made a regularly scheduled repayment that further
reduced the outstanding balance of the term loan to $55.9 million. During 2001,
we paid $5.2 million in interest and repaid $8.2 million in principal on the
term loan. For 2000, we paid $7.1 million in interest and repaid $3.4 million in
principal on the term loan.
The following table shows the schedule of remaining principal payments on the
Company's outstanding term loan, with the final payment in July 2006:
Principal
Repayment
---------
(In thousands)
2002 $ 10,700
2003 11,525
2004 12,400
2005 13,275
2006 10,575
----------
Total $ 58,475
==========
We are obligated under certain lease arrangements for its executive and
administrative offices in New York, Florida, Texas, and Ontario, Canada. Rent
expenses for the three years ended December 2001, 2000 and 1999 was $1.8
million, $2.9 million, and $1.5 million, respectively. The minimum rental
commitments, subject to escalation clauses, at December 31, 2001 under
non-cancelable operating leases are as follows:
(In thousands)
2002 $ 1,737
2003 1,516
2004 1,435
2005 947
2006 and thereafter 5,686
---------
Totals $ 11,321
=========
Other than the lease obligations noted above, we do not have any
contractual or other commitments involving off-balance sheet arrangements.
44
Equity Offering
On July 12, 2001, the Company entered into an Underwriting Agreement
with Banc of America Securities LLC and Raymond James & Associates, Inc., as
representatives of the underwriters named therein, and certain shareholders of
the Company, with respect to the sale of up to 7,950,000 shares of the Company's
common stock (including 750,000 shares of Common Stock subject to an
over-allotment option granted to the Underwriters by the Company and some of the
selling shareholders). As a result, on July 12, 2001, the Company issued five
million shares of common stock at a price of $5.00 per share, generating
proceeds of $25 million. Expenses for this transaction, including the
underwriters' discounts and commissions, amounted to $2.4 million, resulting in
net proceeds of $22.6 million to the Company. The proceeds from this offering
were used to enhance the capital and surplus of certain of our insurance
subsidiaries through capital contribution totaling $9.3 million ($5.0 million to
American Pioneer and $4.3 million to American Exchange), to reduce intercompany
obligations by $5.5 million and to hold the balance at the parent company for
general corporate purposes. In connection with this offering, certain
shareholders of the company, none of whom were management, sold 2.2 million
shares at $5.00 per share, less the underwriters' discounts and commissions of
$0.3187 per share.
On August 13, 2001, the over-allotment option was exercised and, as a
result, the Company issued an additional 720,000 shares of common stock at a
price of $5.00 per share, less the underwriters' discounts and commissions of
$0.3187 per share, generating additional net proceeds of $3.4 million. In
connection with the over-allotment option, certain shareholders sold an
additional 30,000 shares at $5.00 per share, less the underwriters' discounts
and commissions of $0.3187 per share.
The total offering, including the over-allotment raised $26.0 million,
net of total expenses of $2.6 million.
In connection with an agreement entered into in 1996 under which
American Pioneer became a direct subsidiary of our holding company rather than
an indirect subsidiary owned through American Progressive, our holding company
issued $7.9 million in debentures to American Progressive. A portion of the
proceeds from our equity offering in July 2001 was used to pay down $5.5 million
of the debentures. At December 31, 2001, $2.4 million of the debentures remained
outstanding and are due between December 2002 and May 2003. Our holding company
pays interest on the remaining debentures quarterly at a rate of 8.50%. During
2001 our parent holding company paid $0.5 million in interest on these
debentures to American Progressive and $0.7 million in 2000, which was
eliminated in consolidation.
ADMINISTRATIVE SERVICE COMPANY
Liquidity for our administrative service company is measured by its
ability to pay operating expenses. The primary source of liquidity is fees
collected from clients. We believe that the sources of cash for our
administrative service company exceed scheduled uses of cash and results in
amounts available to dividend to our parent holding company. We measure the
ability of the administrative service company to pay dividends based on its
earnings before interest, taxes, depreciation and amortization ("EBITDA"). For
the year ended December 31, 2001, EBITDA for our administrative services segment
was $9.7 million.
Insurance Subsidiary - Surplus Note
Cash generated by our insurance company subsidiaries will be made
available to our holding company, principally through periodic payments of
principal and interest on surplus notes. As of December 31, 2001, the principal
amount of surplus notes owed to our holding company from our American Exchange
subsidiary totaled $70 million. The notes pay interest to our parent holding
company at LIBOR plus 375 basis points. We anticipate that the surplus notes
will be primarily serviced by dividends from Pennsylvania Life, a wholly owned
subsidiary of American Exchange, and by tax-sharing payments among the insurance
companies that are wholly owned by American Exchange and file a consolidated
Federal income tax return. During 2001, American Exchange paid $5.7 million in
interest on the surplus notes to our parent holding company and paid $7.2
million in 2000. No principal payments were made during 2001 or 2000.
45
During 2001, Union Bankers paid cash dividends amounting to $1.7
million to American Exchange. In addition, the insurance companies included in
the tax allocation agreement with American Exchange paid $6.5 million in tax
sharing payments to American Exchange. In connection with the equity offering
discussed above, American Exchange received $4.3 million in capital
contributions from its parent. During 2001, American Exchange made cash capital
contributions of $7.0 million to Pennsylvania Life.
During 2000, Pennsylvania Life paid $2.9 million and Union Bankers paid
$2.0 million in dividends to American Exchange. In addition, the insurance
companies included in the tax allocation agreement with American Exchange paid
$4.8 million in tax sharing payments to American Exchange.
Insurance Subsidiaries
Our insurance subsidiaries are required to maintain minimum amounts of
capital and surplus as determined by statutory accounting practices. As of
December 31, 2001, each insurance company subsidiary's statutory capital and
surplus exceeded its respective minimum requirement. However, substantially more
than these minimum amounts are needed to meet statutory and administrative
requirements of adequate capital and surplus to support the current level of our
insurance subsidiaries' operations. As of December 31, 2001 the statutory
capital and surplus, including asset valuation reserves, of our U.S. domiciled
insurance subsidiaries totaled $107.0 million.
The National Association of Insurance Commissioners has developed, and
state insurance regulators have adopted, risk-based capital requirements on life
insurance enterprises. As of December 31, 2001 all of our insurance company
subsidiaries maintained ratios of total adjusted capital to risk-based capital
in excess of the minimum trigger point for regulatory action.
PennCorp Life (Canada) and Pennsylvania Life's Canadian branch are
subject to Canadian capital requirements and report results to Canadian
regulatory authorities based upon Canadian statutory accounting principles that
vary in some respects from U.S. statutory accounting principles. Canadian net
assets based upon Canadian statutory accounting principles were $58.6 million as
of December 31, 2001. PennCorp Life (Canada) maintained a minimum continuing
capital and surplus requirement ratio in excess of the minimum requirement and
Pennsylvania Life's Canadian branch maintained a test of adequacy of assets in
Canada and margin ratio in excess of the minimum requirement as of December 31,
2001.
Dividend payments by our insurance companies to our parent holding
company or to intermediate subsidiaries are limited by, or subject to the
approval of the insurance regulatory authorities of each insurance company's
state of domicile. Such dividend requirements and approval processes vary
significantly from state to state. The maximum amount of dividends which can be
paid to American Exchange from Pennsylvania Life (to assist in the service of
the surplus note held by American Exchange) without the prior approval of the
Pennsylvania Department of Insurance is restricted to the greater of 10% of the
Pennsylvania Life's surplus as regards policyholders as of the preceding
December 31 or the net gain from operations during the preceding year, but such
dividends can be paid only out of unassigned surplus. Thus, future earnings of
Pennsylvania Life would be available for dividends without prior approval,
subject to the restrictions noted above. Based upon the current dividend
regulations of the respective states, Pennsylvania Life would be able to pay
ordinary dividends of up to $8.4 million and Constitution Life would be able to
pay ordinary dividends of approximately $1.7 million to American Exchange (their
direct parent) without the prior approval from their respective insurance
departments in 2002. Additionally, in 2002, Peninsular Life would be able to pay
ordinary dividends of up to $0.7 million to American Pioneer without approval
from the Florida Department. We do not expect that our remaining subsidiaries
will be able to pay ordinary dividends in 2002.
Liquidity for our insurance company subsidiaries is measured by their
ability to pay scheduled contractual benefits, pay operating expenses, and fund
investment commitments. Sources of liquidity include scheduled and unscheduled
principal and interest payments on investments, premium payments and deposits
and the sale of liquid investments. We believe that these sources of cash for
our insurance company subsidiaries exceed scheduled uses of cash.
46
Liquidity is also affected by unscheduled benefit payments including
death benefits, benefits under accident and health insurance policies and
interest-sensitive policy surrenders and withdrawals. The amount of surrenders
and withdrawals is affected by a variety of factors such as credited interest
rates for similar products, general economic conditions and events in the
industry that affect policyholders' confidence. Although the contractual terms
of substantially all of our in force life insurance policies and annuities give
the holders the right to surrender the policies and annuities, we impose
penalties for early surrenders. As of December 31, 2001 we held reserves that
exceeded the underlying cash surrender values of our inforce life insurance and
annuities by $17.4 million. Our insurance company subsidiaries, in our view,
have not experienced any material changes in surrender and withdrawal activity
in recent years.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity, unanticipated
surrenders and withdrawals in a changed interest rate environment could
adversely affect earnings if we were required to sell investments at reduced
values in order to meet liquidity demands. We manage our asset and liability
portfolios in order to minimize the adverse earnings impact of changing market
rates. We seek to invest in assets that have duration and interest rate
characteristics similar to the liabilities that they support.
The net yields on our cash and invested assets decreased slightly from
6.88% in 2000 to 6.76% in 2001. A significant portion of these securities are
held to support the liabilities for policyholder account balances, which
liabilities are subject to periodic adjustments to their credited interest
rates. The credited interest rates of the interest-sensitive policyholder
account balances are determined by us based upon factors such as portfolio rates
of return and prevailing market rates and typically follow the pattern of yields
on the assets supporting these liabilities.
As of December 31, 2001, our insurance company subsidiaries held cash
and cash equivalents totaling $49.8 million, as well as fixed maturity
securities that could readily be converted to cash with carrying values (and
fair values) of $796.2 million. The fair values of these holdings totaled more
than $846.0 million as of December 31, 2001.
INVESTMENTS
Our investment policy is to balance the portfolio duration to achieve
investment returns consistent with the preservation of capital and maintenance
of liquidity adequate to meet payment of policy benefits and claims. We invest
in assets permitted under the insurance laws of the various states in which we
operate. However, we do not invest in partnerships, special purpose entities,
real estate, commodity contracts, or other derivative securities. Such laws
generally prescribe the nature, quality of and limitations on various types of
investments that may be made. We currently engage the services of two investment
advisors under the direction of the management of our insurance company
subsidiaries and in accordance with guidelines adopted by the Investment
Committees of their respective boards of directors. Conning Asset Management
Company manages our fixed maturity portfolio in the United States and Elliot &
Page, Limited manages our Canadian fixed maturity portfolio. Our policy is not
to invest in derivative programs or other hybrid securities, except for GNMA's,
FNMA's and investment grade corporate collateralized mortgage obligations. We
invest primarily in fixed maturity securities of the U.S. Government and its
agencies and in corporate fixed maturity securities with investment grade
ratings of "Baa3" (Moody's Investor Service), "BBB-" (Standard & Poor's
Corporation) or higher. As of December 31, 2001, 99.0% of our fixed maturity
investments had investment grade ratings from Moody's Investors Service or
Standard & Poor's Corporation. However, we do own some investments that are
rated "BB+" or below by Standard & Poor's (together 1.0% of total fixed
maturities as of December 31, 2001). Fixed maturities with a carrying value of
$0.1 million were non-income producing for the year ended December 31, 2001. We
wrote down the value of certain fixed maturity securities by $4.2 million during
the year ended December 31, 2001, and by $0.5 million during 2000. In each case,
these write-downs represent our estimate of other than temporary declines in
value and were included in net realized gains (losses) on investments in our
consolidated statements of operations.
47
FEDERAL INCOME TAXATION OF THE COMPANY
We file a consolidated return for Federal income tax purposes, in which
American Exchange and the companies acquired in 1999 are not currently permitted
to be included. As of December 31, 2001, we (exclusive of American Exchange and
the companies acquired in 1999) had net operating tax loss carryforwards of
approximately $6.3 million that expire in the years 2005 to 2019. As of December
31, 2001, we also had an Alternative Minimum Tax ("AMT") credit carryforward for
Federal income tax purposes of approximately $0.3 million that can be carried
forward indefinitely. As a result of the change in our ownership in July 1999,
use of most of our loss carryforwards is subject to annual limitations.
American Exchange and the other U. S. companies acquired in 1999 file a
separate consolidated Federal income tax return. As of December 31, 2001, these
companies had net operating loss carryforwards, most of which were incurred
prior to their acquisition by us, of approximately $40.4 million that expire in
the years 2007 to 2013. As a result of the change in the ownership of the
companies acquired in 1999, use of most of these loss carryforwards is subject
to annual limitations.
As of December 31, 2001 and 2000, we carried valuation allowances of
$6.8 million and $10.4 million, respectively, with respect to our tax loss
carryforwards (deferred tax assets). We determine a valuation allowance based
upon an analysis of projected taxable income and our ability to implement
prudent and feasible tax planning strategies. The tax planning strategies
include the expense reductions anticipated from our recent reorganization and
from the income generated by our administrative services companies. As a result
of the increased profitability of the insurance subsidiaries acquired in 1999,
valuation allowances on certain of the life tax loss carryforwards were
considered not necessary at December 31, 2001. The amount of the valuation
allowance released during 2001 was $3.6 million and was recorded as a reduction
of goodwill of $2.9 million and as a benefit in the deferred income tax expense
of $0.7 million. As a result of the increased profitability of the
Administrative Services segment, valuation allowances on certain of the non-life
tax loss carryforwards were considered not necessary as of December 31, 2000.
The amount of the valuation allowance released during 2000 was $1.3 million and
was recorded as a benefit in the deferred income tax expense. This decrease was
partially offset by the establishment of a valuation allowance for the purchased
net operating losses of CHCS, which are subject to limitation on their use. We
believe it is more likely than not that we will realize the recorded net
deferred tax assets.
Our U.S. insurance company subsidiaries are taxed as life insurance
companies as provided in the Internal Revenue Code. The Omnibus Budget
Reconciliation Act of 1990 amended the Internal Revenue Code to require a
portion of the expenses incurred in selling insurance products to be capitalized
and amortized over a period of years, as opposed to an immediate deduction in
the year incurred. Instead of measuring actual selling expenses, the amount
capitalized for tax purposes is based on a percentage of premiums. In general,
the capitalized amounts are subject to amortization over a ten-year period.
Since this change only affects the timing of the deductions, it does not,
assuming stability of rates, affect the provisions for taxes reflected in our
financial statements prepared in accordance with GAAP. However, by deferring
deductions, the change does have the effect of increasing the current tax
expense, thereby reducing statutory surplus. Because of our insurance company
subsidiaries' net operating loss carryforwards, there was no material increase
in our current income tax provision for any of the three years in the period
ended December 31, 2001 due to this provision.
EFFECTS OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board, or FASB,
issued Statement of Financial Accounting Standards, or SFAS, No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. This Statement supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, and the accounting and reporting provisions
of Accounting Principles Board Opinion, or APB Opinion No. 30, Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business. This Statement also
amends Accounting Research Bulletin No. 51, Consolidated Financial Statements.
48
This Statement requires that one accounting model be used for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and by broadening the presentation of discontinued operations to
include more disposal transactions. Additionally, this Statement resolves
significant implementation issues, which will improve compliance.
The effective date of this Statement is for fiscal years beginning
after December 15, 2001 and interim periods within those fiscal years, with
early application encouraged. The provisions of this Statement generally are to
be applied prospectively. We anticipate that the adoption of this standard will
not have a significant effect on our results of operations, financial position
or liquidity.
In the second quarter, 2001, we adopted the provisions of EITF No.
99-20, "Recognition of Interest Income and Impairment of Purchased and Retained
Beneficial Interests in Securitized Financial Assets." EITF No. 99-20 changed
the method of assessing other than temporary impairments for certain mortgage
and asset-backed securities classified as available for sale. The guidance
requires the recognition of impairment when a change in the amount or timing of
estimated cash flows results in a decline in fair value below the amortized cost
basis, unless the decrease is solely a result of changes in estimated market
interest rates. The new guidance also revised he method of recognizing interest
income for the investments within its scope, requiring a prospective approach to
account for changes in estimated future cash flows. The adoption of the new
Statement did not have a material effect on our earnings for 2001or our
financial position at December 31, 2001.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement is effective for financial
statements issued for fiscal years beginning after June 15, 2002. We anticipate
that the adoption of this standard will not have a significant effect on our
results of operations, financial position or liquidity.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other
Intangible Assets, which replaced APB Opinion No. 17, Intangible Assets. The
Statement, addresses how intangible assets that are acquired individually or
with a group of other assets (but not those acquired in a business combination)
should be accounted for in financial statements upon their acquisition. This
Statement also addresses how goodwill and other intangible assets should be
accounted for after they have been initially recognized in the financial
statements. This Statement:
- specifies that goodwill and intangible assets that have indefinite
useful lives will not be amortized but rather will be tested at least
annually for impairment;
- provides specific guidance for testing goodwill for impairment; and
- requires additional disclosures not previously required.
The effective date of this Statement is for fiscal years beginning
after December 15, 2001. Impairment losses are to be reported as resulting from
a change in accounting principle. We will apply the new rules on accounting for
goodwill and other intangible assets beginning in the first quarter of 2002.
Application of the non-amortization provisions of the Statement is expected to
result in an increase in net income of $0.4 million (less than $0.01 per diluted
share) per year. We performed the first of the required impairment tests of
goodwill and indefinite lived intangible assets as of January 1, 2002 and we
expect that the adoption of this statement will not have a material effect on
our earnings or our financial position.
In June 2001, the FASB issued SFAS No. 141, Business Combinations,
which addresses the accounting and reporting for business combinations and
broadens the criteria for recording intangible assets separate from goodwill. On
July 1, 2001, we adopted this Statement, which requires us to use the purchase
method of accounting for all business combinations initiated after June 30,
2001.
49
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation, an Interpretation of the
Accounting Principles Board Opinion No. 25, which clarifies the application of
APB Opinion No. 25 for some issues including:
- the definition of an employee for purposes of applying APB Opinion
No. 25;
- the criteria for determining whether a plan qualifies as a
noncompensatory plan;
- the accounting consequences of various modifications to the terms of
a previously fixed stock option or award; and
- the accounting for an exchange of stock compensation awards in a
business combination.
Interpretation No. 44 became effective July 1, 2000, but some of the
conclusions were retroactive. The adoption of this guidance on July 1, 2000 did
not have a material impact on our results of operations or financial position.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities as amended by SFAS No. 137, Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the Effective Date
of FASB Statement No. 133. We adopted the new statement effective January 1,
2001. If in the future we have derivative instruments, this Statement will
require us to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If a derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of the derivative will either be offset against the change in fair
value of the hedged asset, liability, or firm commitment through earnings, or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. The adoption of SFAS No. 133 did not have a
significant effect on our results of operations, financial position or
liquidity.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In general, market risk relates to changes in the value of financial
instruments that arise from adverse movements in interest rates, equity prices
and foreign exchange rates. We are exposed principally to changes in interest
rates that affect the market prices of our fixed income securities.
Interest Rate Sensitivity
Our profitability could be affected if we were required to liquidate
fixed income securities during periods of rising and/or volatile interest rates.
However, we attempt to mitigate our exposure to adverse interest rate movements
through a combination of active portfolio management and by staggering the
maturities of our fixed income investments to assure sufficient liquidity to
meet our obligations and to address reinvestment risk considerations. Our
insurance liabilities generally arise over relatively long periods of time,
which typically permits ample time to prepare for their settlement. To date, we
have not used various financial risk management tools on our investment
securities, such as interest rate swaps, forwards, futures and options to modify
our exposure to changes in interest rates. However, we may consider using risk
management tools in the future.
Certain classes of mortgage backed securities are subject to
significant prepayment risk due to the fact that in periods of declining
interest rates, individuals may refinance higher rate mortgages to take
advantage of the lower rates then available. We monitor and adjust our
investment portfolio mix to mitigate this risk.
We regularly conduct various analyses to gauge the financial impact of
changes in interest rate on our financial condition. The ranges selected in
these analyses reflect our assessment as being reasonably possible over the
succeeding twelve-month period. The magnitude of changes modeled in the
accompanying analyses should not be construed as a prediction of future economic
events, but rather, be treated as a simple illustration of the potential impact
of such events on our financial results.
50
The sensitivity analysis of interest rate risk assumes an instantaneous
shift in a parallel fashion across the yield curve, with scenarios of interest
rates increasing and decreasing 100 and 200 basis points from their levels as of
December 31, 2001, and with all other variables held constant. A 100 basis point
increase in market interest rates would result in a pre-tax decrease in the
market value of our fixed income investments of $49.4 million and a 200 basis
point increase in market interest rates would result in $94.9 million decrease.
Similarly, a 100 basis point decrease in market interest rates would result in a
pre-tax increase in the market value of our fixed income investments of $50.4
million and a 200 basis point decrease in market interest rates would result in
a $104.4 million increase.
Currency Exchange Rate Sensitivity
Portions of our operations are transacted using the Canadian dollar as
the functional currency. As of and for the year ended December 31, 2001,
approximately 13.6% of our assets, 18.4% of our revenues and 36.3% of our
operating income before taxes were derived from our Canadian operations. As of
and for the year ended December 31, 2000, approximately 14.1% of our assets,
20.0% of our revenues and 35.6% of our operating income before taxes were
derived from our Canadian operations. Accordingly, our earnings and
shareholder's equity are affected by fluctuations in the value of the U.S.
dollar as compared to the Canadian dollar. Although this risk is somewhat
mitigated by the fact that both the assets and liabilities for our foreign
operations are denominated in Canadian dollars, we are still subject to
translation losses.
We periodically conduct various analyses to gauge the financial impact
of changes in the foreign currency exchange rate on our financial condition. The
ranges selected in these analyses reflect our assessment of what is reasonably
possible over the succeeding twelve-month period.
As of December 31, 2001, a 10% strengthening of the U.S. dollar
relative to the Canadian dollar would result in a decrease in our operating
income before taxes of approximately $1.4 million and a decrease in
shareholders' equity of approximately $5.7 million. Our sensitivity analysis of
the effects of changes in foreign currency exchange rates does not factor in any
potential change in sales levels, local prices or any other variable.
The magnitude of changes reflected in the above analysis regarding
interest rates and foreign currency exchange rates should, in no manner, be
construed as a prediction of future economic events, but rather as a simple
illustration of the potential impact of such events on our financial results.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary schedules are listed in the
accompanying Index to Consolidated Financial Statements and Financial Statement
Schedules on Page F - 1.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
51
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding our executive
officers and directors:
NAME AGE POSITION
Richard A. Barasch (4) ........................ 48 Chairman of the Board of Directors, President and Chief
Executive Officer; Director and President of American
Progressive; and Chairman of the Board of all our other
subsidiaries.
Robert A. Waegelein, C.P.A (3)................. 41 Senior Vice President and Chief Financial Officer; Director
of all subsidiaries
Gary W. Bryant ................................ 52 Senior Vice President and Chief Operating Officer of the
Company; President, Chief Executive Officer and Director of
American Pioneer; Vice Chairman of American Progressive and
President and Director of American Exchange, Constitution
Life, Marquette National Life, Peninsular Life and Union
Bankers.
William E. Wehner, C.L.U....................... 58 President and Director of Pennsylvania Life; and Senior
Vice President and Chief Marketing Officer of American
Pioneer and other subsidiaries.
Bradley E. Cooper (3) (4) ..................... 35 Director
Susan S. Fleming (2)........................... 31 Director
Mark M. Harmeling (2).......................... 49 Director
Bertram Harnett (3) (4) ....................... 78 Director
Patrick J. McLaughlin (1) (3) (4) ............. 43 Director
Robert A. Spass (4) ........................... 46 Director
Francis S. Wilson (1) (2)...................... 53 Director
Robert F. Wright (1)........................... 76 Director
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
(3) Member of the Investment Committee.
(4) Member of the Executive Committee.
52
RICHARD A. BARASCH. Mr. Barasch has served as a Director since July
1988, as Chairman since December 1997, as President since April 1991 and as
Chief Executive Officer since June 1995. He has served as a Director and the
President of American Progressive since 1991, and he is Chairman of the Board of
all of our subsidiaries. Mr. Barasch has held positions with our subsidiaries
since their acquisition or organization.
ROBERT A. WAEGELEIN, C.P.A. Mr. Waegelein has served as our Senior Vice
President and Chief Financial Officer since October 1990 and has been Chief
Financial Officer of each of our subsidiaries since they were acquired or
organized. Prior to that, Mr. Waegelein, a certified public accountant, was
employed by KPMG Peat Marwick LLP, the company's then independent public
accountants, in positions of increasing responsibility, finally serving as
Senior Manager.
GARY W. BRYANT. Mr. Bryant has served as Senior Vice President since
June 1995 and Chief Operating Officer since June 2000. He has also been a
Director and President and Chief Executive Officer of American Pioneer since
April 1983, Vice Chairman of American Progressive since 2001 and a Director and
President of American Exchange since December 1997. In addition, Mr. Bryant has
served as a Director and President of Constitution Life, Marquette, Peninsular
Life and Union Bankers since March 2000. Mr. Bryant has also served as the
Chairman of the Board of AIAG since January 2000.
WILLIAM E. WEHNER, C.L.U. Mr. Wehner has served as a Director and as
President of Pennsylvania Life since April 2000. Mr. Wehner has also been Senior
Vice President and Chief Marketing Officer of American Pioneer and other
subsidiaries since November 1997. Mr. Wehner was employed for over twenty years
by Mutual Life Insurance Company of New York and its affiliates in positions of
increasing responsibility, finally serving as Vice President for Group
Insurance.
BRADLEY E. COOPER. Mr. Cooper has served as a Director since July 1999.
Mr. Cooper is a Partner and co-founder of Capital Z Financial Services Fund II
L.P. which owns 47.8% of our outstanding stock. Prior to joining Capital Z, Mr.
Cooper served in similar roles at Insurance Partners, L.P. and International
Insurance Investors, L.P. Prior to that, Mr. Cooper was an investment banker in
the Financial Institutions Group at Salomon Brothers, Inc. Mr. Cooper currently
serves on the board of directors of SNTL Group, Highlands Insurance Group and
CERES Group, Inc.
SUSAN S. FLEMING. Ms. Fleming has served as a Director since July 1999.
She is a Partner of Capital Z Financial Services Fund II L.P. Prior to joining
Capital Z, Ms. Fleming served as Vice President of Insurance Partners, L.P. and
was an investment banker in the Mergers and Acquisitions Financial Institutions
Group at Morgan Stanley & Co. Ms. Fleming currently serves on the Board of
Directors of CERES Group, Inc.
MARK M. HARMELING. Mr. Harmeling has served as a Director since July
1990. He has also served as Director of American Progressive from 1992 to 1999.
Mr. Harmeling is a Managing Director of TA Associates Realty, a pension fund
advisory firm. He was previously President of Bay State Realty Advisors, a real
estate management and development company. Mr. Harmeling is also a Director of
Rochester Shoetree Corporation (since 1988) and Applied Extrusion Technologies,
Inc. (since 1987).
BERTRAM HARNETT. Mr. Harnett has served as a Director since 1996. Mr.
Harnett has been a practicing lawyer since 1948 and has been President of the
law firm of Harnett Lesnick & Ripps P.A., Boca Raton, Florida and its
predecessors since 1988. He is the author of treatises on insurance law and is a
former Justice of New York State Supreme Court.
PATRICK J. MCLAUGHLIN. Mr. McLaughlin has served as a Director since
January 1995. Mr. McLaughlin has been a Managing Director of Emerald Capital
Group, Ltd., an asset management and consulting firm specializing in the
insurance industry, since April 1993. Prior to that he was an Executive Vice
President and Chief Investment Officer of Life Partners Group, Inc., Managing
Director of Conning & Company and Senior Vice President and Chief Investment
Officer of ICH Corporation.
53
ROBERT A. SPASS. Mr. Spass has served as a Director since July 1999.
Mr. Spass is a Partner and co-founder of Capital Z. Prior to founding Capital Z,
Mr. Spass was the Managing Partner and co-founder of Insurance Partners, L.P.
Prior to the formation of Insurance Partners, Mr. Spass was President and CEO of
International Insurance Advisors Inc. Prior to that, Mr. Spass was a Director of
Investment Banking at Salomon Brothers and a Senior Manager for Peat Marwick
Main & Co. Mr. Spass serves on the board of directors of Highlands Insurance
Group, Inc., SNLT Group, Inc., CERES Group, Inc., Kinexus Corporation, Aames
Financial Corp. and USI Insurance Services Corp.
FRANCIS S. WILSON. Mr. Wilson has served as a Director since October
2001. Mr. Wilson has been a managing partner of AAM Investment Banking Group,
Ltd. since October 1993. Prior to that, Mr. Wilson was the chairman of Highland
Development Corp. Prior to that, Mr. Wilson held various positions in the field
of investment banking with the firms Prescott Ball & Turben, Inc., Dean Witter
Reynolds, Inc. and Halsey, Stuary & Co., Inc. Mr. Wilson is a director of
INFOCUS Financial Group, Inc. and Wasatch Crest Group, Inc.
ROBERT F. WRIGHT. Mr. Wright has served as a Director since June 1998.
Mr. Wright has been President of Robert F. Wright Associates, Inc. since 1988.
Prior to that, Mr. Wright was a senior partner of the public accounting firm of
Arthur Andersen LLP. Mr. Wright is Director of Reliance Standard Life Insurance
Company (and its affiliates), GVA Williams, The Navigators Group, Inc., U.S.
Timberlands Company, L.P and CDG Technology.
All of the executive officers listed above devote their full business
time to the Company. All of our officers and directors are elected annually for
one-year terms. All officers and directors hold office until their successors
are duly elected and qualified.
Our by-laws provide that our Board of Directors shall set the number of
directors. Our Board of Directors currently consists of nine directors.
Our Board of Directors has an Audit Committee, which also acts as a
Transactions Committee, a Compensation Committee, an Investment Committee and an
Executive Committee. The Audit Committee has adopted a charter which, among
other things, empowers it to consult with our independent auditors with respect
to their audit plans and to review their audit report and the accompanying
management letters and, as the Transactions Committee, reviews and makes
recommendations to our Board on certain capital transactions entertained by us.
The Compensation Committee reviews and recommends compensation, including
incentive stock option grants, of our officers. The Investment Committee reviews
the Company's investment policy and guidelines, reviews portfolio performance
and reviews and approves all investment transactions. The Executive Committee
has the authority to act between Board meetings on behalf of our Board, on all
matters allowed by law.
Additional information regarding our directors and executive officers
is incorporated by reference to our definitive proxy statement to be filed
pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120
days after the end of our fiscal year ended December 31, 2001.
ITEM 11 - EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated by
reference to our definitive proxy statement to be filed pursuant to Regulation
14A under the Securities Exchange Act of 1934 within 120 days after the end of
our fiscal year ended December 31, 2001.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding beneficial ownership of our voting securities by
directors, officers and persons who, to the best knowledge of us, are known to
be the beneficial owners of more than 5% of our voting securities as of December
31, 2001, is incorporated by reference to our definitive proxy statement to be
filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
within 120 days after the end of our fiscal year ended December 31, 2001.
54
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
incorporated by reference to our definitive proxy statement to be filed pursuant
to Regulation 14A under the Securities Exchange Act of 1934 within 120 days
after the end of our fiscal year ended December 31, 2001.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) 1 AND 2 FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
See separate index to Financial Statements and Financial Statement
Schedules on Page F - 1.
3 EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS
3(a) Restated Certificate of Incorporation filed March 30, 2000,
incorporated by reference to Exhibit A of Form 8-K dated March 16,
2001.
3(b) By-Laws, as amended, incorporated by reference to Exhibit A to Form
8-K dated August 13, 1999.
4 Instruments defining rights of securityholders. See Exhibits 3(a)
and 10(e)
10(a) Amended and Restated Purchase Agreement among the Company, dated
December 31, 1999, as amended and restated on July 2, 1999, between
Universal American, PennCorp Financial Group, Inc. ("PFG") and
several of PFG's subsidiaries, incorporated by reference to Annex B
of Proxy Statement dated July 12, 1999.
10(b) Share Purchase Agreement, as of December 31, 1998, between the
Company and Capital Z Financial Services Fund II, L.P. as amended by
Amendment, dated as of July 2, 1999, incorporated by reference to
Annex A of Proxy Statement dated July 12, 1999.
10(c) Shareholders Agreement dated July 30, 1999, among the Company,
Capital Z Financial Services Fund II, L.P., UAFC, L.P., AAM Capital
Partners, L.P., Chase Equity Associates, L.P., Richard A. Barasch
and others, incorporated by reference to Exhibit A of Form 8-K dated
August 13, 1999.
10(d) Registration Rights Agreement, dated July 30, 1999, among the
Company, Capital Z Financial Services Fund II, L.P., Wand/Universal
American Investments L.P.I., Wand/Universal American Investments
L.P. II, Chase Equity Associates, L.P., Richard A. Barasch and
others, incorporated by reference to Exhibit A to Form 8-K dated
August 13, 1999.
10(e) Credit Agreement dated as of July 30, 1999, among the Registrant and
the Chase Manhattan Bank as agent, the lender and signatory thereto,
incorporated by reference to Exhibit C to Form 8-KA dated March 16,
2001.
55
10(f) Employment Contracts, between Registrant and the following officers:
Richard A. Barasch, dated July 30, 1999
Robert A. Waegelein, dated July 30, 1999
Gary W. Bryant, dated July 30, 1999
William E. Wehner, dated July 30, 1999
incorporated by reference to Exhibits D and E to Form 8-KA dated March 16, 2001.
11 Computation of basic and diluted earnings per share, incorporated by
reference to Note 18 of Notes to Consolidated Financial Statements
for 2001, included in this Form 10-K.
12 List of Subsidiaries:
State of Percentage
Name Incorporation Owned
American Exchange Life Insurance Company Texas 100%
American Pioneer Life Insurance Company Florida 100%
American Progressive Life & Health Insurance Company
of New York New York 100%
CHCS, Inc. Florida 100%
CHCS Services, Inc. Florida 100%
Constitution Life Insurance Company Texas 100%
Marquette National Life Insurance Company Texas 100%
Peninsular Life Insurance Company Florida 100%
PennCorp Life Insurance Company Ontario, Canada 100%
Pennsylvania Life Insurance Company Pennsylvania 100%
Security Health Providers, Inc. Delaware 100%
Union Bankers Insurance Company Texas 100%
Universal American Services, Inc. Delaware 100%
WorldNet Services Corp. Florida 100%
23(a) Consent of Ernst & Young LLP
(B) REPORTS ON FORM 8-K
None
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 28th day of
March 2002.
UNIVERSAL AMERICAN FINANCIAL CORP.
(Registrant)
By: /s/ Richard A. Barasch
------------------------
Richard A. Barasch
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on March 28, 2002 by the following persons in
the capacities indicated:
Signatures Title
/s/ Richard A. Barasch Chairman of the Board, President,
- ------------------------------ Chief Executive Officer and Director
Richard A. Barasch (Principal Executive Officer)
/s/ Robert A. Waegelein Senior Vice President and Chief
- ------------------------------ Financial Officer
Robert A. Waegelein (Principal Accounting Officer)
/s/ Bradley E. Cooper Director
- -----------------------------
Bradley E. Cooper
/s/ Susan S. Fleming Director
- -----------------------------
Susan S. Fleming
/s/ Mark M. Harmeling Director
- -----------------------------
Mark M. Harmeling
/s/ Bertram Harnett Director
- -----------------------------
Bertram Harnett
/s/ Patrick J. McLaughlin Director
- -----------------------------
Patrick J. McLaughlin
/s/ Robert A. Spass Director
- -----------------------------
Robert A. Spass
/s/ Francis S. Wilson Director
- -----------------------------
Francis S. Wilson
/s/ Robert F. Wright Director
- -----------------------------
Robert Wright
57
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULES OF THE REGISTRANT:
Independent Auditors' Reports F-2
Consolidated Balance Sheets as of December 31, 2001 and 2000 F-3
Consolidated Statements of Operations
for the Three Years Ended December 31, 2001 F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income
for the Three Years Ended December 31, 2001 F-5
Consolidated Statements of Cash Flows
for the Three Years Ended December 31, 2001 F-6
Notes to Consolidated Financial Statements F-7
Schedule I -- Summary of Investments - other than investments in related parties F-38
Schedule II -- Condensed Financial Information of Registrant F-39
Notes to Condensed Financial Information F-42
Schedule III -- Supplementary Insurance Information F-43
Schedule IV - Reinsurance
(incorporated in Note 13 to the Consolidated Financial Statements)
Schedule V - Valuation and Qualifying Accounts
(incorporated in Note 6 to the Consolidated Financial Statements)
Other schedules were omitted because they were not applicable
Independent Auditors' Report
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated balance sheets of Universal
American Financial Corp. and subsidiaries as of December 31, 2001 and 2000 and
the related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the three years in the period
ended December 31, 2001. Our audits also included the financial statement
schedules listed in the Index at Item 14(a). 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
Universal American Financial Corp. and subsidiaries at December 31, 2001 and
2000 and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001 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.
Ernst & Young LLP
New York, New York
February 19, 2002
F-2
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
(IN THOUSANDS)
ASSETS 2001 2000
----------- -----------
Investments (Notes 2 and 5):
Fixed maturities available for sale, at fair value
(amortized cost: 2001, $786,844; 2000, $746,060) $ 799,218 $ 751,738
Equity securities, at fair value (cost: 2001, $4,339; 2000, $3,819) 4,199 3,547
Policy loans 24,043 25,077
Other invested assets 3,773 4,318
----------- -----------
Total investments 831,233 784,680
Cash and cash equivalents 53,690 40,250
Accrued investment income 12,663 11,459
Deferred policy acquisition costs (Notes 2 and 11) 66,025 48,651
Amounts due from reinsurers (Note 13) 212,532 202,929
Due and unpaid premiums 3,385 3,680
Deferred income tax asset (Note 6) 59,952 65,014
Present value of future profits and goodwill (Note 2) 11,921 12,514
Other assets 24,515 20,687
----------- -----------
Total assets 1,275,916 1,189,864
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances (Note 2) 236,742 233,415
Reserves for future policy benefits 591,453 565,505
Policy and contract claims - life 6,282 7,207
Policy and contract claims - health (Note 12) 79,596 77,884
Loan payable (Note 14) 61,475 69,650
Amounts due to reinsurers 6,680 2,877
Restructuring liability 179 2,955
Other liabilities 62,739 56,422
----------- -----------
Total liabilities 1,045,146 1,015,915
----------- -----------
Commitments and contingencies (Note 15)
STOCKHOLDERS' EQUITY (Notes 7 and 8)
Common stock (Authorized: 80 million shares, issued and outstanding:
2001, 52.8 million shares; 2000, 46.8 million shares) 528 468
Additional paid-in capital 155,746 128,625
Accumulated other comprehensive income 5,603 4,875
Retained earnings 69,279 40,354
Less: Treasury stock (2001, 0.1 million shares; 2000, 0.1 million shares) (386) (373)
----------- -----------
Total stockholders' equity 230,770 173,949
----------- -----------
Total liabilities and stockholders' equity $ 1,275,916 $ 1,189,864
=========== ===========
See notes to consolidated financial statements.
F-3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 2001
(IN THOUSANDS, PER SHARE AMOUNTS IN DOLLARS)
REVENUE: 2001 2000 1999
--------- --------- ---------
Gross premiums and policyholder fees earned $ 513,575 $ 451,323 $ 252,553
Reinsurance premiums assumed 2,549 3,055 1,751
Reinsurance premiums ceded (286,918) (234,625) (138,827)
--------- --------- ---------
Net premiums and policyholder fees earned (Note 13) 229,206 219,753 115,477
Net investment income (Note 5) 57,812 56,945 29,313
Realized gains (losses) on investments (Note 5) 3,078 146 (241)
Fee and other income 10,847 7,247 3,587
--------- --------- ---------
Total revenues 300,943 284,091 148,136
--------- --------- ---------
BENEFITS, CLAIMS AND OTHER DEDUCTIONS:
Net increase in future policy benefits 10,450 6,968 357
Claims and other benefits 154,570 146,951 72,898
Interest credited to policyholders 10,271 10,130 8,668
Net increase in deferred acquisition costs (19,186) (15,925) (6,229)
Amortization of present value of future profits and goodwill 2,637 2,749 70
Commissions 99,026 82,903 46,624
Commission and expense allowances
on reinsurance ceded (87,122) (69,757) (38,966)
Interest expense 5,152 7,097 2,859
Other operating costs and expenses 81,782 79,909 45,799
--------- --------- ---------
Total benefits, claims and other deductions 257,580 251,025 132,080
--------- --------- ---------
Operating income before taxes 43,363 33,066 16,056
Federal income tax expense (Note 6) 14,438 10,181 6,243
--------- --------- ---------
Net income 28,925 22,885 9,813
Redemption accrual on Series C and Series D Preferred
Stock (Note 7) -- -- 180
--------- --------- ---------
Net Income applicable to common shareholders $ 28,925 $ 22,885 $ 9,633
========= ========= =========
Earnings per common share (Notes 2 and 18):
Basic $ 0.58 $ 0.49 $ 0.42
========= ========= =========
Diluted $ 0.57 $ 0.49 $ 0.34
========= ========= =========
See notes to consolidated financial statements
F-4
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE YEARS ENDED DECEMBER 31, 2001
(IN THOUSANDS)
Accumulated
Series B Additional Other
Preferred Common Paid-In Comprehensive Retained Treasury
Stock Stock Capital Income / (Loss) Earnings Stock Total
------------ --------- ---------- ---------------- ------------ ---------- -----------
Balance, January 1, 1999 $ 4,000 $ 76 $ 16,411 $ 858 $ 6,973 -- $ 28,318
Net income -- -- -- -- 9,813 -- 9,813
Redemption accrual on
Series C Preferred Stock -- -- -- -- (180) -- (180)
Other comprehensive income
(Note 19) -- -- -- (7,745) -- -- (7,745)
-----------
Comprehensive income 1,888
-----------
Issuance of common stock (Note 8) -- 383 89,927 -- -- -- 90,310
Preferred Stock Conversion (Note (4,000) -- 13,142 -- 863 -- 10,005
Stock-based compensation (Note 9) -- -- 4,411 -- -- -- 4,411
Loans to officers (Note 7) -- -- (967) -- -- -- (967)
------------ --------- ---------- ---------------- ------------ ---------- -----------
Balance, December 31,1999 -- 459 122,924 (6,887) 17,469 -- 133,965
Net income -- -- -- -- 22,885 -- 22,885
Other comprehensive income
(Note 19) -- -- -- 11,762 -- -- 11,762
-----------
Comprehensive income 34,647
-----------
Issuance of common stock (Note 8) -- 9 3,289 -- -- -- 3,298
Stock-based compensation (Note 9) -- -- 2,388 -- -- -- 2,388
Loans to officers (Note 7) -- -- 13 -- -- -- 13
Treasury shares purchased, at
cost (Note 8) -- -- -- -- -- (711) (711)
Treasury shares reissued (Note 8) -- -- 11 -- -- 338 349
Balance, December 31, 2000 -- 468 128,625 4,875 40,354 (373) 173,949
Net income -- -- -- -- 28,925 -- 28,925
Other comprehensive income
(Note 19) -- -- -- 728 -- -- 728
-----------
Comprehensive income 29,653
-----------
Issuance of common stock (Note 8) -- 60 26,168 -- -- -- 26,228
Stock-based compensation (Note 9) -- -- 863 -- -- -- 863
Loans to officers (Note 7) -- -- 68 -- -- -- 68
Treasury shares purchased, at
cost (Note 8) -- -- -- -- -- (764) (764)
Treasury shares reissued (Note 8) -- -- 22 -- -- 751 773
------------ --------- ---------- ---------------- ------------ ---------- -----------
Balance, December 31, 2001 $ -- $ 528 $ 155,746 $ 5,603 $ 69,279 $ (386) $ 230,770
============ ========= ========== ================ ============ ========== ===========
See notes to consolidated financial statements.
F-5
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 2001
(IN THOUSANDS)
2001 2000 1999
--------- --------- ---------
Cash flows from operating activities:
Net income $ 28,925 $ 22,885 $ 9,813
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes 8,695 7,011 996
Change in reserves for future policy benefits 22,885 3,142 5,136
Change in policy and contract claims 788 7,185 (2,229)
Change in deferred policy acquisition costs (19,186) (15,925) (6,253)
Amortization of present value of future profits and goodwill 2,637 2,749 70
Change in policy loans 1,035 563 264
Change in accrued investment income (1,203) (410) (336)
Change in reinsurance balances (4,844) 1,155 (5,571)
Realized loss (gain) on investments (3,078) (146) 241
Change in restructuring liability (2,776) (7,025) 9,980
Change in income taxes payable 1,452 1,711 11,565
Other, net 2,046 (3,312) (5,008)
--------- --------- ---------
Net cash provided by operating activities 37,376 19,583 18,668
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale or redemption of fixed maturities available for sale 323,608 113,177 53,444
Cost of fixed maturities purchased available for sale (364,699) (127,255) (182,843)
Change in amounts held in trust for reinsurer (1,687) (3,105) (2,403)
Proceeds from sale of equity securities 612 1,896 374
Cost of equity securities purchased (1,480) (534) (144)
Change in mortgage loans (131) 462 2,870
Change in other invested assets 291 696 2,079
Purchase of business, net of cash acquired (1,544) (6,365) (9,620)
--------- --------- ---------
Net cash used by investing activities (45,030) (21,028) (136,243)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 26,242 213 93,209
Cost of treasury stock purchases (764) (711) --
Proceeds from the issuance of Series D Preferred Stock -- -- 1,750
Change in policyholder account balances 3,791 (16,210) (974)
Increase in loan payable -- 3,000 70,000
Principal repayment on loan payable (8,175) (3,350) (4,750)
--------- --------- ---------
Net cash provided from financing activities 21,094 (17,058) 159,235
Net increase (decrease) in cash and cash equivalents 13,440 (18,503) 41,660
--------- --------- ---------
Cash and cash equivalents at beginning of year 40,250 58,753 17,093
--------- --------- ---------
Cash and cash equivalents at end of year $ 53,690 $ 40,250 $ 58,753
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid (received) during the year for:
Interest $ 5,195 $ 7,097 $ 2,859
========= ========= =========
Income taxes $ 1,818 $ (3,375) $ 2,335
========= ========= =========
See notes to consolidated financial statements.
F-6
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND COMPANY BACKGROUND:
Universal American Financial Corp. ("the Company" or "Universal American")
was incorporated in the State of New York in 1981 as a life and accident &
health insurance holding company. Until July 30, 1999, the Company had three
insurance company subsidiaries: American Progressive Life & Health Insurance
Company of New York ("American Progressive"), American Pioneer Life Insurance
Company ("American Pioneer"), American Exchange Life Insurance Company
("American Exchange"), in addition to an administrative service company,
WorldNet Services Corp. ("WorldNet"). On July 30, 1999, Universal American
acquired all of the outstanding shares of common stock of certain direct and
indirect subsidiaries of PennCorp Financial Group ("PFG"), including the
following six insurance companies (the "Acquired Companies"): Pennsylvania Life
Insurance Company ("Pennsylvania Life"), Peninsular Life Insurance Company
("Peninsular"), Union Bankers Insurance Company ("Union Bankers"), Constitution
Life Insurance Company ("Constitution"), Marquette National Life Insurance
Company ("Marquette") and PennCorp Life Insurance Company, a Canadian company
("PennCorp Life (Canada)"). On January 2, 2000, Universal American acquired
American Insurance Administration Group, Inc. ("AIAG") and on August 10, 2000,
Universal American acquired Capitated Healthcare Services, Inc. ("CHCS").
The Company offers life and accident and health insurance designed for the
senior market and self-employed market in all fifty states, the District of
Columbia and all the provinces of Canada. It also provides administrative
services to other insurers by servicing their senior market products. The
Company's principal insurance products are Medicare supplement, fixed benefit
accident and sickness disability insurance, long term care, home health care,
senior life insurance and annuities. The Company distributes these products
through an independent general agency system and a career agency system. The
independent general agency system includes approximately 18,000 independent
agents that distribute for American Pioneer, American Progressive and
Constitution. The Career Agency distribution system operates through a network
of regional managers that operate branch offices throughout the United States
and Canada. The nearly 1,000 licensed agents in this network are under exclusive
contract with Pennsylvania Life and PennCorp Life of Canada.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. BASIS OF PRESENTATION: The significant accounting policies followed
by Universal American and subsidiaries that materially affect
financial reporting are summarized below. The accompanying
consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States
("GAAP") which, as to the insurance subsidiaries, differ from
statutory accounting practices prescribed or permitted by regulatory
authorities.
b. USE OF ESTIMATES: The preparation of financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosures of assets and liabilities at the date of
the financial statements and the reported revenues and expenses
during the reporting period. Accounts that the Company deems to be
sensitive to changes in estimates include policy liabilities and
accruals, deferred policy acquisition costs, present value of future
profits, valuation of certain investments and deferred taxes. As
additional information becomes available or actual amounts become
determinable, the recorded estimates may be revised and reflected in
operating results. Actual results could differ from those estimates.
c. PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial
statements include the accounts of Universal American and its
wholly-owned subsidiaries, including the operations of acquired
companies from the date of their acquisition. All material
intercompany transactions and balances have been eliminated.
F-7
d. INVESTMENTS: The Company follows Financial Accounting Standards
Board ("FASB") Statement No. 115, "Accounting for Certain Debt and
Equity Securities" ("Statement No. 115"). Statement No. 115 requires
that debt and equity securities be classified into one of three
categories and accounted for as follows: Debt securities that the
Company has the positive intent and the ability to hold to maturity
are classified as "held to maturity" and reported at amortized cost.
Debt and equity securities that are held for current resale are
classified as "trading securities" and reported at fair value, with
unrealized gains and losses included in earnings. Debt and equity
securities not classified as held to maturity or as trading
securities are classified as "available for sale" and reported at
fair value. Unrealized gains and losses on available for sale
securities are excluded from earnings and reported as accumulated
other comprehensive income, net of tax and deferred policy
acquisition cost adjustments.
As of December 31, 2001 and 2000, all fixed maturity securities were
classified as available for sale and were carried at fair value,
with the unrealized gain or loss, net of tax and other adjustments
(deferred policy acquisition costs), included in accumulated other
comprehensive income. Equity securities are carried at current fair
value. Policy loans are stated at the unpaid principal balance.
Short-term investments are carried at cost, which approximates fair
value. Other invested assets include mortgage loans and collateral
loans. The collateral loans are carried at cost which is equal to
the fair value of their estimated future cash flows at the date of
acquisition. Mortgage loans are carried at the unpaid principal
balance.
Fair value of investments is based upon quoted market prices, where
available, or on values obtained from independent pricing services.
For certain mortgage and asset- backed securities, the determination
of fair value is based primarily upon the amount and timing of
expected future cash flows of the security. Estimates of these cash
flows are based current economic conditions, past credit loss
experience and other circumstances.
The Company regularly evaluates the amortized cost of its
investments compared to the fair value of those investments.
Impairments of securities are generally recognized when a decline in
fair value below the amortized cost basis is considered to be other
than temporary. Impairment losses for certain mortgage and
asset-backed securities are recognized when an adverse change in the
amount or timing of estimated cash flows occurrs, unless the adverse
change is solely a result of changes in estimated market interest
rates. The cost basis for securities determined to be impaired are
reduced to their fair value, with the excess of the cost basis over
the fair value recognized as a realized investment loss.
Realized investment gains and losses on the sale of securities are
based on the specific identification method.
Investment income is generally recorded when earned. Premiums and
discounts arising from the purchase of certain mortgage and
asset-backed securities are amortized into investment income over
the estimated remaining term of the securities, adjusted for
anticipated prepayments. The prospective method is used to account
for the impact on investment income of changes in the estimated
future cash for these securities. Premiums and discounts on other
fixed maturity securities are amortized using the interest method
over the remaining term of the security.
F-8
e. DEFERRED POLICY ACQUISITION COSTS: The cost of acquiring new
business, principally commissions and certain expenses of the
agency, policy issuance and underwriting departments, all of which
vary with, and are primarily related to the production of new and
renewal business, have been deferred. These costs are being
amortized in relation to the present value of expected gross profits
on the policies arising principally from investment, mortality and
expense margins in accordance with FASB Statement No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments", ("Statement No. 97") for interest sensitive
life and annuity products and in proportion to premium revenue using
the same assumptions used in estimating the liabilities for future
policy benefits in accordance with FASB Statement No. 60,
"Accounting and Reporting by Insurance Enterprises", ("Statement No.
60") for non-interest sensitive life and all accident & health
products. Deferred policy acquisition costs are written off to the
extent that it is determined that future policy premiums and
investment income or gross profits would not be adequate to cover
related losses and expenses.
The Company has several reinsurance arrangements in place on its
life and accident & health insurance risks (see Note 13). In the
accompanying statement of operations, the Company reports
commissions incurred on direct premium written and commission and
expense allowances on reinsurance ceded on separate lines to
correspond to the presentation of the premiums earned by the
Company. In determining the amounts capitalized for deferred
acquisition costs, the Company includes an amount for gross
commissions and direct issue expenses, net of the related allowances
received from the reinsurer on these costs.
f. PRESENT VALUE OF FUTURE PROFITS AND GOODWILL: Business combinations
accounted for as a purchase result in the allocation of the purchase
consideration to the fair values of the assets and liabilities
acquired, including the present value of future profits,
establishing such fair values as the new accounting basis. The
present value of future profits is based on an estimate of the cash
flows of the in-force business acquired, discounted to reflect the
present value of those cash flows. The discount rate selected
depends upon the general market conditions at the time of the
acquisition and the inherent risk in the transaction. Purchase
consideration in excess of the fair value of net assets acquired,
for a specific acquisition, is allocated to goodwill. Allocation of
purchase price is performed in the period in which the purchase is
consummated. Adjustments, if any, in subsequent periods relate to
resolution of pre-acquisition contingencies and refinements made to
estimates of fair value in connection with the preliminary
allocation.
Amortization of present value of future profits is based upon the
pattern of the projected cash flows of the in-force business
acquired, over periods ranging from ten to forty years. Goodwill is
amortized on a straight line basis over periods ranging from twenty
to thrity years. Subsequent to December 31, 2001, goodwill will no
longer be amortized; see "Pending Accounting Pronouncements" below.
On a periodic basis, management reviews the unamortized balances of
present value of future profits and goodwill to determine whether
events or circumstances indicate the carrying value of such assets
is not recoverable, in which case an impairment charge would be
recognized. Management believed that no impairments of present value
of future profits or goodwill existed as of December 31, 2001.
F-9
g. RECOGNITION OF REVENUES, CONTRACT BENEFITS AND EXPENSES FOR
INVESTMENT AND UNIVERSAL LIFE TYPE POLICIES: Revenues for universal
life-type policies and investment products consist of mortality
charges for the cost of insurance and surrender charges assessed
against policyholder account balances during the period. Amounts
received for investment and universal life type products are not
reflected as premium revenue; rather such amounts are accounted for
as deposits, with the related liability included in policyholder
account balances. Benefit claims incurred in excess of policyholder
account balances are expensed. The liability for policyholder
account balances for universal life-type policies and investment
products under Statement No. 97 are determined following a
"retrospective deposit" method. The retrospective deposit method
establishes a liability for policy benefits at an amount determined
by the account or contract balance that accrues to the benefit of
the policyholder, which consists principally of policy account
values before any applicable surrender charges. Current credited
interest rates for these products range from 3.0% to 7.3%.
h. RECOGNITION OF PREMIUM REVENUES AND POLICY BENEFITS FOR ACCIDENT &
HEALTH INSURANCE PRODUCTS: Premiums are recorded when due and
recognized as revenue over the period to which the premiums relate.
Benefits and expenses associated with earned premiums are recognized
as the related premiums are earned so as to result in recognition of
profits over the life of the policies. This association is
accomplished by recording a provision for future policy benefits and
amortizing deferred policy acquisition costs. The liability for
future policy benefits for accident & health policies consists of
active life reserves and the estimated present value of the
remaining ultimate net cost of incurred claims. Active life reserves
include unearned premiums and additional reserves. The additional
reserves are computed on the net level premium method using
assumptions for future investment yield, mortality and morbidity
experience. The assumptions are based on past experience. Claim
reserves are established for future payments not yet due on incurred
claims, primarily relating to individual disability and long term
care insurance and group long-term disability insurance products.
These reserves are established based on past experience and are
continuously reviewed and updated with any related adjustments
recorded to current operations. Claim liabilities represent policy
benefits due but unpaid at year-end and primarily relates to
individual health insurance products.
i. RECOGNITION OF PREMIUM REVENUES AND POLICY BENEFITS FOR TRADITIONAL
LIFE AND ANNUITY PRODUCTS: Premiums from traditional life and
annuity policies with life contingencies generally are recognized as
income when due. Benefits and expenses are matched with such income
so as to result in the recognition of profits over the life of the
contracts. This match is accomplished by means of the provision for
liabilities for future policy benefits and the deferral and
subsequent amortization of policy acquisition costs.
j. RECOGNITION OF ADMINISTRATIVE SERVICE REVENUE: Fees for
administrative services generally are recognized over the period for
which the Company is obligated to provide service.
k. INCOME TAXES: The Company's method of accounting for income taxes is
the asset and liability method. Under the asset and liability
method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date of a change in
tax rates.
F-10
The Company establishes valuation allowances on its deferred tax
assets for amounts that it determines will not be recoverable based
upon an analysis of projected taxable income and its ability to
implement prudent and feasible tax planning strategies. Increases in
the valuation allowances are recognized as deferred tax expense.
Subsequent determinations that portions of the valuation allowances
are no longer necessary are reflected as deferred tax benefits. To
the extent that valuation allowances were established in conjunction
with acquisitions, changes in those allowances are first applied to
increasing or decreasing the goodwill (but not below zero) or other
intangibles related to the acquisition and then applied as an
increase or decrease in income tax expense.
l. REINSURANCE: Recoverables under reinsurance contracts are included
in total assets as amounts due from reinsurers rather than net
against the related policy asset or liability. The cost of
reinsurance related to long-duration contracts is accounted for over
the life of the underlying reinsured policies using assumptions
consistent with those used to account for the underlying policies.
m. FOREIGN CURRENCY TRANSLATION: The financial statement accounts of
the Company's Canadian operations, which are denominated in Canadian
dollars, are translated into U.S. dollars as follows: (i) Canadian
currency assets and liabilities are translated at the rates of
exchange as of the balance sheet dates and the related unrealized
translation adjustments are included as a component of accumulated
other comprehensive income, and (ii) revenues, expenses and cash
flows, expressed in Canadian dollars, are translated using a
weighted average of exchange rates for each period presented.
n. EARNINGS PER COMMON SHARE: Basic EPS excludes dilution and is
computed by dividing income available to common shareholders, (after
deducting the redemption accrual on the Series C and Series D
Preferred Stock), by the weighted average number of shares
outstanding for the period. Diluted EPS gives the dilutive effect of
the stock options, warrants and Series B, C and D Preferred Stock
outstanding during the year. At December 31, 2001, there were no
stock options excluded from the computation of diluted EPS because
they were antidilutive. As of December 31, 2000, there were 2.5
million stock options, excluded from the computation of diluted EPS
because they were antidilutive.
o. STOCK BASED COMPENSATION: The Company has elected to follow APB 25
and related interpretations in accounting for its employee stock
options. Accordingly, no expense is recognized for those options
issued with an exercise price at or above market on the date of the
award. For options issued to agents and other, the Company follows
Statement of Financial Accounting Standards No. 123 "Accounting for
Stock Based Compensation," ("SFAS No. 123"). Under SFAS No. 123, the
fair value of or options awarded to agents and others are expensed
over the vesting period of each award.
p. CASH FLOW INFORMATION: Included in cash and cash equivalents are
cash on deposit, money market funds, and short term investments
which had an original maturity of three months or less from the time
of purchase.
q. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS: In the second quarter,
2001, we adopted the provisions of Emerging Issues Task Force No.
99-20, "Recognition of Interest Income and Impairment of Purchased
and Retained Beneficial Interests in Securitized Financial Assets,"
("EITF 99-20"). EITF No. 99-20 changed the method of assessing other
than temporary impairments for certain mortgage and asset-backed
securities classified as available for sale. The guidance requires
the recognition of impairment when a change in the amount or timing
of estimated cash flows results in a decline in fair value below the
amortized cost basis, unless the decrease is solely a result of
changes in estimated market interest rates. The new guidance also
revised the
F-11
method of recognizing interest income for the investments within its
scope, requiring a prospective approach to account for changes in
estimated future cash flows. The adoption of the new Statement did
not have a material effect on our earnings for 2001or our financial
position.
In June 1998, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities." Its amendments SFAS 137, "Accounting for
Derivative Instruments and Hedging Activities-Deferral of the
Effective Date of SFAS No. 133" and 138, "Accounting for Derivative
Instruments and Certain Hedging Activities", were issued in June,
1999 and June, 2000, respectively. Collectively these are referred
to as "SFAS 133". SFAS 133 establishes accounting and reporting
standards for derivative instruments and is effective for fiscal
years beginning after June 15, 2000. The adoption did not have a
significant effect on earnings or the financial position of the
Company.
r. PENDING ACCOUNTING PRONOUNCEMENTS: In June, 2001, The FASB issued
Statements of Financial Accounting Standards, No. 141, "Business
Combinations", and No. 142, "Goodwill and Other Intangible Assets",
effective for fiscal years beginning after December 15, 2001. Under
the new rules, goodwill and intangible assets deemed to have
indefinite lives, will no longer be amortized but will be subject to
annual impairment tests in accordance with the Statements. Other
intangible assets will continue to be amortized over their useful
lives.
We will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002.
Application of the non-amortization provisions of the Statement is
expected to result in an increase in net income of $0.4 million
(less than $0.01 per diluted share) per year. We performed the first
of the required impairment tests of goodwill and indefinite lived
intangible assets as of January 1, 2002 and we expect that the
adoption will not have a material effect on our earnings or our
financial position.
s. RECLASSIFICATIONS: Certain reclassifications have been made to prior
years' financial statements to conform to current period
classifications
3. BUSINESS COMBINATION:
1999 Acquisition
On July 30, 1999, Universal American acquired all of the outstanding
shares of common stock of certain direct and indirect subsidiaries of PennCorp
Financial Group ("PFG"), including six insurance companies (the "Acquired
Companies") and certain other assets as follows (the "1999 Acquisition"). The
Acquired Companies are:
Name of Insurance Company State or Province of Domicile
------------------------- -----------------------------
Pennsylvania Life Insurance Company Pennsylvania
Peninsular Life Insurance Company Florida
Union Bankers Insurance Company Texas
Constitution Life Insurance Company Texas
Marquette National Life Insurance Company Texas
PennCorp Life Insurance Company (Canada) Ontario, Canada
F-12
The 1999 Acquisition was accounted for using the purchase method and,
accordingly, the operating results generated by the Acquired Companies after
July 30, 1999 are included in Universal American's consolidated financial
statements. The consolidated pro forma results of operations, assuming that the
companies described above were purchased on January 1, 1999 is as follows:
Year Ended
December 31,1999
----------------
(In thousands)
Total revenue $ 274,805
Operating income before taxes $ 32,279
Net income $ 18,763
Earnings per common share:
Basic $ 0.44
Diluted $ 0.41
4. ACQUISITION OF ADMINISTRATIVE SERVICE COMPANIES:
Acquisition of American Insurance Administration Group, Inc. ("AIAG")
In January 2000, Universal American acquired all of the outstanding shares
of AIAG, a privately held third party administrator located in Clearwater,
Florida, for $5.8 million, including $2.9 million in cash and 809,860 shares of
Universal American common stock. AIAG is a third party administrator of senior
supplemental health insurance. Approximately 76.4% of AIAG's total revenues are
generated from services provided to the Company's insurance subsidiaries'
reinsurer. This acquisition has generated increased cash flow and strengthened
the Company's administrative capabilities while it expands its presence in the
senior market and initiates cross-selling opportunities between the Company's
Senior Market Brokerage and Career Agency Segments.
The fair value of the net assets acquired was $(0.9) million. The present
value of future profits ("PVFP") acquired was $7.7 million and was offset by
related deferred taxes of $1.0 million. The PVFP was determined using a discount
rate of 15%. It is being amortized in proportion to the expected profits from
the contracts in force on the date of acquisition. A large portion of the
contracts had a remaining term of three years at the date of acquisition;
accordingly, the amortization is heavily weighted to those periods.
Approximately $2.1 of the PVFP was amortized during 2001 and $2.8 million was
amortized during 2000. Approximately 36% of the original PVFP balance remained
as of December 31, 2001.
Acquisition of CHCS, Inc. ("CHCS")
In August 2000, Universal American acquired all of the outstanding shares
of CHCS, a privately held third party administrator located in Weston, Florida,
for $4.6 million, including $3.3 million in cash, 64,820 shares on Universal
American common stock and future cash payments totaling $1.0 million over 18
months. CHCS is a third party administrator of long term care and home health
care insurance products for over 35 unaffiliated insurance companies, as well as
the Company's insurance subsidiaries.
The fair value of the net assets acquired was $1.9 million. The excess of
the purchase price over the fair value of the net assets acquired was assigned
to goodwill (see Note 2).
F-13
5. INVESTMENTS:
The amortized cost and fair value of fixed maturities as of December 31,
2001 and 2000 are as follows:
December 31, 2001
-----------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- -------------- ---- ----- ------ -----
(In thousands)
US Treasury securities
and obligations of
US government $ 35,719 $ 1,262 $ (11) $ 36,970
Corporate debt securities 357,431 8,990 (1,805) 364,616
Foreign debt securities(1) 157,077 2,225 (1,640) 157,662
Mortgage and asset-
backed securities 236,617 5,700 (2,347) 239,970
--------- --------- --------- ---------
$ 786,844 $ 18,177 $ (5,803) $ 799,218
========= ========= ========= =========
December 31, 2000
-----------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- -------------- ---- ----- ------ -----
(In thousands)
US Treasury securities
and obligations of
US government $ 34,199 $ 589 $ (54) $ 34,734
Corporate debt securities 311,711 5,625 (4,139) 313,197
Foreign debt securities(1) 144,243 1,929 (769) 145,403
Mortgage and asset-
backed securities 255,907 4,404 (1,907) 258,404
--------- --------- --------- ---------
$ 746,060 $ 12,547 $ (6,869) $ 751,738
========= ========= ========= =========
(1) Primarily Canadian dollar denominated bonds supporting our Canadian
insurance reserves.
The amortized cost and fair value of fixed maturities at December 31, 2001
by contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
---- -----
(In thousands)
Due in 1 year or less $ 28,904 $ 29,535
Due after 1 year through 5 years 109,639 113,043
Due after 5 years through 10 years 249,718 254,435
Due after 10 years 161,966 162,235
Mortgage and asset-backed securities 236,617 239,970
-------- --------
$786,844 $799,218
======== ========
Included in fixed maturities at December 31, 2001 and 2000 were securities
with carrying values of $32.4 million and $33.1 million, respectively, held by
various states as security for the policyholders of the Company within such
states.
F-14
Gross unrealized gains and gross unrealized losses of equity securities as
of December 31, 2001 and 2000 are as follows:
2001 2000
---- ----
(In thousands)
Gross unrealized gains $ 199 $ --
Gross unrealized losses (339) (272)
------ ------
Net unrealized losses $ (140) $ (272)
====== ======
The components of the change in unrealized gains and losses included in
the consolidated statements of stockholders' equity for the three years ended
December 31, 2001 are as follows:
2001 2000 1999
---- ---- ----
(In thousands)
Change in net unrealized gains (losses):
Fixed maturities $ 6,695 $ 22,584 $(19,476)
Equity securities 132 10 (239)
Foreign currency (3,996) (1,434) 2,177
Adjustment relating to
Deferred policy acquisition costs (1,333) (2,209) 4,509
-------- -------- --------
Change in net unrealized gains
(losses) before income tax 1,498 18,951 (13,029)
Income tax (expense) benefit (770) (7,189) 5,284
-------- -------- --------
Change in net unrealized gains (losses) $ 728 $ 11,762 $ (7,745)
======== ======== ========
The details of net investment income for the three years ended December
31, 2001 are as follows:
2001 2000 1999
---- ---- ----
(In thousands)
Investment Income:
Fixed maturities $ 54,100 $ 52,478 $ 25,950
Cash and cash equivalents 1,749 1,939 2,454
Equity securities 238 330 157
Other 1,181 1,380 52
Policy loans 1,529 1,617 1,004
Mortgage loans 205 214 485
-------- -------- --------
Gross investment income 59,002 57,958 30,102
Investment expenses (1,190) (1,013) (789)
-------- -------- --------
Net investment income $ 57,812 $ 56,945 $ 29,313
======== ======== ========
Fixed maturities with a carrying value of $0.1 million and $0.7 million
were non-income producing for the years ended December 31, 2001 and 2000,
respectively.
Gross realized gains and gross realized losses included in the
consolidated statements of operations for the three years ended December 31,
2001 are as follows:
2001 2000 1999
---- ---- ----
(In thousands)
Realized gains:
Fixed maturities $ 9,301 $ 1,022 $ 534
Equity securities and other invested assets 14 192 2,661
-------- -------- --------
Total realized gains 9,315 1,214 3,195
-------- -------- --------
Realized losses:
Fixed maturities (6,237) (1,019) (819)
Equity securities -- (49) (2,617)
-------- -------- --------
Total realized losses (6,237) (1,068) (3,436)
-------- -------- --------
Net realized gains (losses) $ 3,078 $ 146 $ (241)
======== ======== ========
F-15
During the years ended December 31, 2001 and 2000, the Company wrote down
the value of certain fixed maturity securities by $4.2 million and $0.5 million,
respectively, which represents management's estimate of other than temporary
declines in value and was included in net realized gains (losses) on
investments.
For the years ended December 31, 2001 and 2000, the Company held unrated
or less-than-investment grade corporate debt securities with carrying and
estimated fair values as follows:
2001 2000
---- ----
(In thousands)
Carrying value $ 7,750 $ 21,923
========= =========
Estimated fair value $ 7,750 $ 21,923
========= =========
Percentage of total assets 0.6% 1.8%
========= =========
The holdings of less-than-investment grade securities are widely
diversified and the investment in any one such security is currently less than
$2.0 million, which is approximately 0.2% of total assets.
6. INCOME TAXES:
The parent holding company files a consolidated return for Federal income
tax purposes, which includes all of the non-insurance company subsidiaries as
well as American Pioneer and American Progressive. American Exchange and its
subsidiaries and PennCorp Life (Canada) are not currently permitted to be
included. American Exchange and its subsidiaries file a separate consolidated
Federal income tax return. PennCorp Life (Canada) files a separate return with
Revenue Canada.
The Company's Federal income tax expense (benefit) for the three years
ended December 31, 2001 is as follows:
2001 2000 1999
---- ---- ----
(In thousands)
Current - - US $ 449 $ (126) $ 127
Current - - Canadian 5,451 3,296 1,394
-------- -------- --------
Sub total current 5,900 3,170 1,521
Deferred - - US 8,409 7,281 4,078
Deferred - - Canadian 129 (270) 644
-------- -------- --------
Sub total deferred 8,538 7,011 4,722
-------- -------- --------
Total tax expense $ 14,438 $ 10,181 $ 6,243
======== ======== ========
A reconciliation of the "expected" tax expense at 35% with the Company's
actual tax expense applicable to operating income before taxes reported in the
Consolidated Statements of Operations is as follows:
2001 2000 1999
---- ---- ----
(In thousands)
Expected tax expense $ 15,177 $ 11,573 $ 5,619
Change in valuation allowance (737) (1,343) --
Canadian taxes (208) (390) 365
Other 206 341 259
-------- -------- --------
Actual tax expense $ 14,438 $ 10,181 $ 6,243
======== ======== ========
In addition to Federal income tax, the Company is subject to state premium
and income taxes, which taxes are included in other operating costs and expenses
in the accompanying statements of operations. Income taxes receivable for the
years ended December 31, 2001 and 2000 totaled $2.5 million and $0.2 million,
respectively.
F-16
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. The tax effects of
temporary differences that give rise to significant portions of the deferred tax
assets and deferred tax liabilities at December 31, 2001 and 2000 are as
follows:
2001 2000
---- ----
(In thousands)
Deferred tax assets:
Reserves for future policy benefits $ 23,140 $ 22,032
Deferred policy acquisition costs 16,786 19,418
Net operating loss carryforwards 16,659 19,615
Investment valuation differences 10,745 10,733
Deferred revenues 1,214 1,145
AMT credit carryforward 68 389
Other 1,394 4,652
-------- --------
Total gross deferred tax assets 70,006 77,984
Less valuation allowance (6,794) (10,385)
-------- --------
Net deferred tax assets 63,212 67,599
-------- --------
Present value of future profits (244) (339)
Unrealized gains on investments (3,016) (2,246)
-------- --------
Total gross deferred tax liabilities (3,260) (2,585)
-------- --------
Net deferred tax asset $ 59,952 $ 65,014
======== ========
At December 31, 2001, the Company (exclusive of American Exchange and its
subsidiaries and PennCorp Life) had tax loss carryforwards of approximately $6.3
million that expire in the years 2005 to 2019. At December 31, 2001, the Company
also had an Alternative Minimum Tax (AMT) credit carryforward for Federal income
tax purposes of approximately $0.1 million that can be carried forward
indefinitely. At December 31, 2001, American Exchange and its subsidiaries had
tax loss carryforwards, most of which relate to the companies acquired in the
1999 Acquisition (and were incurred prior to their acquisition), of
approximately $40.4 million that expire in the years 2007 to 2013. As a result
of changes in ownership of the Company in July 1999, the use of most of the loss
carryforwards of the Company are subject to annual limitations.
At December 31, 2001 and 2000, the Company carried valuation allowances of
$6.8 million and $10.4 million, respectively, with respect to its deferred tax
assets. The Company establishes a valuation allowance based upon an analysis of
projected taxable income and its ability to implement prudent and feasible tax
planning strategies. As a result of the increased profitability of the insurance
subsidiaries acquired in 1999, valuation allowances on certain of the life tax
loss carryforwards no longer were considered necessary at December 31, 2001. The
amount of the valuation allowance released during 2001 was $3.6 million and was
recorded as a reduction of goodwill of $2.9 million and as a benefit in the
deferred income tax expense of $0.7 million. As a result of the increased
profitability of the Administrative Services segment, valuation allowances on
certain of the non-life tax loss carryforwards no longer were considered
necessary as of December 31, 2000. The amount of the valuation allowance
released during 2000 was $1.3 million and was recorded as a benefit in the
deferred income tax expense. This decrease was partially offset by the
establishment of a valuation allowance for the purchased net operating losses of
CHCS, which are subject to limitation on their use. Management believes it is
more likely than not that the Company will realize the recorded net deferred tax
assets.
F-17
7. EQUITY TRANSACTIONS
Share Purchase Agreement with Capital Z Financial Services Fund II, L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement ("UA
Purchase Agreement") with Capital Z Financial Services Fund II, L.P. ("Capital
Z"), which was amended on July 2, 1999. Under the amended agreement, Capital Z
agreed to purchase up to 28.9 million shares of Universal American common stock
for a purchase price of up to $91.0 million (the "Capital Z Transaction")
subject to adjustment as outlined in the UA Purchase Agreement. The UA Purchase
Agreement received the approvals of the Florida, New York and Texas Insurance
Departments (the states in which Universal American's insurance subsidiaries
prior to the 1999 Acquisition are domiciled). The stockholder approvals required
for the closing of the UA Purchase Agreement were given on July 27, 1999.
On July 30, 1999, the Capital Z Transaction closed with Capital Z
purchasing 25.7 million shares of common stock for $81.0 million ($3.15 per
share). As contemplated by the UA Purchase Agreement, certain members of
management and agents of Universal American and of the companies acquired on
July 30, 1999 and holders of Series C Preferred Stock preemptive rights
purchased 3.8 million shares of common stock for $11.8 million ($3.15 per
share). The total number of shares issued amounted to 29.5 million for total
proceeds of $92.8 million. The Company provided loans to certain members of
management to purchase the shares of common stock. The total amount of the loans
of $1.0 million was accounted for as a reduction in paid in capital in the
financial statements. The terms of these loans include a provision whereby they
will be forgiven should the closing price of the Company's common stock reach a
level of $9.50 for each and every day during any period of 60 consecutive
calendar days, prior to August 1, 2003. The transaction expenses incurred with
the UA Purchase Agreement amounted to $7.0 million and were charged to paid-in
capital. Included in these transaction expenses was a transaction fee and
expense reimbursement of $5.1 million paid to an affiliate of Capital Z, of
which $1.4 million was paid by issuing 0.4 million shares of common stock of the
Company ($3.15 per share). In addition, the Company recorded an expense of $1.7
million to record the difference between the purchase price of the stock
purchased by employees and agents of the Company and the fair value of the stock
on the closing date.
Shareholders' Agreement
Universal American, Capital Z, UAFC L.P. ("AAM") (an unaffiliated
investment firm), Richard Barasch (the Chairman and Chief Executive Officer of
the Company) and several other shareholders of Universal American entered into a
shareholders' agreement on July 30, 1999 (the "Shareholders' Agreement"). The
Shareholders' Agreement requires that all proposed sales/transfers by the other
shareholders who are party to the Shareholders' Agreement must first be offered
to Richard Barasch and Capital Z, including its affiliates. However, pledges and
some other transfers by any party to the Shareholders' Agreement of less than 1%
of Universal American's outstanding common stock at any one time, or 2.5% when
aggregated with the other transfers by the shareholder and his, her or its
permitted transferees of Universal American's outstanding common stock, are
permitted. In addition, Richard Barasch is not permitted to sell more than 3% of
his holdings for a three-year period beginning July 30, 1999. The Shareholders'
Agreement provides for tag-along and drag-along rights under some circumstances.
"Tag-along rights" allow the holder of stock to include his, her or its stock in
a sale of common stock initiated by another party to the Shareholders'
Agreement. "Drag-along rights" permit a selling party to the Shareholders'
Agreement to force the other parties to the Shareholders' Agreement to sell a
proportion of the other holder's shares in a sale arranged by the selling
shareholder.
Under the terms of the Shareholders' Agreement, of the nine members of
Universal American's board of directors, certain shareholders are permitted to
nominate directors as follows: Capital Z: four, Richard Barasch: two, AAM: one
and Universal American: two. Capital Z, Richard Barasch and AAM are each
required to vote for the director(s) nominated by the others. The right of
Richard Barasch to nominate directors is also conditioned upon his continued
employment with Universal American. In addition, the right to nominate directors
is not transferable, except that Capital Z may transfer its right to a
third-party buyer who acquires 10% or more of the outstanding common stock of
Universal American from Capital Z.
F-18
Conversion of Preferred Stock
Under the terms of the Series C Preferred Stock, the Company had the right
to require conversion if certain conditions were met, which conditions were
satisfied on March 5, 1999. All of the 51,680 outstanding shares of Series C
Preferred Stock were converted to 2.2 million shares of common stock on April 1,
1999. As a result of this conversion, the cumulative redemption accrual of $0.8
million was eliminated and credited to retained earnings.
The holders of the Series C Preferred Stock had preemptive rights, which
were triggered by the execution of the UA Purchase Agreement on December 31,
1998, subject to the closing of the sale pursuant to that agreement. On July 30,
1999, 1.2 million shares were purchased pursuant to these preemptive rights at a
price of $3.15 per share.
As a result of the closing of the Capital Z transaction on July 30, 1999,
all of the Series B, D-1 and D-2 Preferred Stock was converted into 1.8 million,
0.8 million and 0.6 million shares of common stock, respectively.
Exercise of Common Stock Warrants
At December 31, 1998, the Company had 0.7 million common stock warrants
issued and outstanding which were registered under the Securities Act of 1933
and 2.0 million warrants outstanding which were not registered under the
Securities Act of 1933. The warrants had an exercise price to purchase common
stock on a one to one basis at $1.00 and expired on December 31, 1999. During
the year ended December 31, 1999, 0.7 million of the registered common stock
warrants and all of the unregistered common stock warrants were exercised for
$2.7 million resulting in the issuance of 2.7 million shares of the Company's
common stock.
Equity Offering
On July 12, 2001, the Company entered into an Underwriting Agreement with
Banc of America Securities LLC and Raymond James & Associates, Inc., as
representatives of the underwriters named therein, and certain shareholders of
the Company, with respect to the sale of up to 7,950,000 shares of the Company's
common stock (including 750,000 shares of Common Stock subject to an
over-allotment option granted to the Underwriters by the Company and some of the
selling shareholders). As a result, on July 12, 2001, the Company issued five
million shares of common stock at a price of $5.00 per share, generating
proceeds of $25 million. Expenses for this transaction, including the
underwriters' discounts and commissions, amounted to $2.4 million, resulting in
net proceeds of $22.6 million to the Company. The proceeds from this offering
were used to enhance the capital and surplus of certain of our insurance
subsidiaries ($9.3 million), reduce intercompany obligations ($5.5 million) and
the balance to hold at the parent company for general corporate purposes. In
connection with this offering, certain shareholders of the company, none of whom
were management, sold 2.2 million shares at $5.00 per share, less the
underwriters' discounts and commissions of $0.3187 per share.
On August 13, 2001, the over-allotment option was exercised and, as a
result, the Company issued an additional 720,000 shares of common stock at a
price of $5.00 per share, less the underwriters' discounts and commissions of
$0.3187 per share, generating additional net proceeds of $3.4 million. In
connection with the over-allotment option, certain shareholders sold an
additional 30,000 shares at $5.00 per share, less the underwriters' discounts
and commissions of $0.3187 per share.
The total offering, including the over-allotment, raised $26.0 million,
net of total expenses of $2.6 million.
F-19
8. STOCKHOLDERS' EQUITY
Preferred Stock
The Company had 2.0 million authorized shares of preferred stock to be
issued in series with no such shares issued and outstanding at December 31, 2001
or 2000. During 1999 all of the outstanding preferred stock was converted into
common stock (see Note 7 for a discussion of the conversion of previously
outstanding Series B, C, D and D-1 Preferred Stock).
Common Stock
The par value of common stock is $.01 per share with 80.0 million shares
authorized for issuance. The shares issued and outstanding at December 31, 2001
and 2000 were 52.8 million and 46.8 million, respectively. During the years
ended December 31, 2001, 2000 and 1999, the Company issued 6.0 million shares
(primarily as a result of the equity offering noted above), 0.9 million shares
and 38.3 million shares, respectively, of its common stock.
Treasury Stock
During 2000, the Board of Directors approved a plan to re-purchase up to
0.5 million shares of Company stock in the open market. In March 2002, the Board
of Directors approved an amendment of the plan to increase the amount of shares
available for re-purchase from 0.5 million shares to 1.0 million shares. The
purpose of this plan is to fund employee stock bonuses. During the year ended
December 31, 2001, the Company acquired 0.2 million shares at a cost of $0.8
million during the year at market prices ranging from $3.75 to $6.87 per share.
The Company distributed 0.2 million shares in the form of officer and employee
bonuses at market prices ranging from $3.88 to $6.81 per share at the date of
distribution, amounting to of $0.8 million.
During the year ended December 31, 2000, the Company acquired 0.2 million
shares at a cost of $0.7 million during the year at market prices ranging from
$3.69 to $4.13 per share. The Company distributed 0.1 million shares in the form
of officer and employee bonuses at market prices ranging from $4.00 to $4.09 per
share at the date of distribution, amounting to $0.3 million.
9. STOCK BASED COMPENSATION
1998 Incentive Compensation Plan
On May 28, 1998, the Company's shareholders approved the 1998 Incentive
Compensation Plan (the "1998 ICP"). The 1998 ICP superceded the Company's 1993
Incentive Stock Option Plan. Options previously granted under the Company's
Incentive Stock Option Plan will remain outstanding in accordance with their
terms and the terms of the respective plans. The 1998 ICP provides for grants of
stock options, stock appreciation rights ("SARs"), restricted stock, deferred
stock, other stock-related awards, and performance or annual incentive awards
that may be settled in cash, stock, or other property ("Awards").
The total number of shares of the Company's Common Stock reserved and
available for delivery to participants in connection with Awards under the 1998
ICP is (i) 1.5 million, plus (ii) the number of shares of Common Stock subject
to awards under Preexisting Plans that become available (generally due to
cancellation or forfeiture) after the effective date of the 1998 ICP, plus (iii)
13% of the number of shares of Common Stock issued or delivered by the
Corporation during the term of the 1998 ICP (excluding any issuance or delivery
in connection with Awards, or any other compensation or benefit plan of the
Corporation), provided, however, that the total number of shares of Common Stock
with respect to which incentive stock options ("ISOs") may be granted shall not
exceed 1.5 million. As of December 31, 2001, a total of 7.3 million shares were
eligible for grant under the plan. There were 4.7 million shares reserved for
outstanding options awarded under the 1998 ICP, 1.1 million shares issued
pursuant to previous awards and 1.5 million shares reserved for issuance under
future Awards at December 31, 2001.
F-20
Executive officers, directors, and other officers and employees of the
Corporation or any subsidiary, as well as other persons who provide services to
the Company or any subsidiary, are eligible to be granted Awards under the 1998
ICP, which is administered by the Board or a Committee established pursuant to
the Plan.
The Committee, may, in its discretion, accelerate the exercisability, the
lapsing of restrictions, or the expiration of deferral or vesting periods of any
Award, and such accelerated exercisability, lapse, expiration and vesting shall
occur automatically in the case of a "change in control" of the Company, except
to the extent otherwise determined by the Committee at the date of grant or
thereafter. The Committee has not yet exercised any of its discretions noted
above.
Stock Awards
In accordance with the 1998 ICP, the Company grants restricted stock to
its officers and non-officer employees. These grants vest upon issue. The
non-officer grants are expensed and awarded in the same year. Officer grants are
accrued for during the year for which they are earned and awarded the following
year. During 2001, the Company awarded 11,386 shares to employees with a fair
value of $6.81 per share. Additionally, the Company anticipates issuing
approximately 92,600 shares to officers for 2001 performance based on a fair
value of $6.45 per share. During 2000, the Company awarded 32,290 shares to
employees with a fair value of $4.00 per share. The Company also issued 176,614
shares to officers for 2000 performance based on a weighted average fair value
of $3.94 per share. During 1999, the Company awarded 141,825 shares of
restricted stock at weighted average fair values of $4.19 to officers and
employees. The Company recognized compensation expense of $0.7 million, $0.8
million and $0.6 million, respectively relating to awards of restricted stock
for the years ended December 31, 2001, 2000 and 1999.
Agent's Stock Purchase Plan
The Company offers shares of its common stock for sale to qualifying
agents of the Insurance Subsidiaries pursuant to the Company's Agents Stock
Purchase Plan ("ASPP"). Shares are sold at market price, accordingly, no expense
is recognized. Pursuant to the ASPP, agents purchased 13,100 shares at a
weighted average price of $4.89 per share in 2001, 16,050 shares at a weighted
average price of $4.00 per share in 2000, and 13,800 shares at a weighted
average price of $3.30 per share in 1999.
Agent's Deferred Compensation Plan
The Company also offers shares of Common Stock for sale to its agents
pursuant to the Company's Deferred Compensation Plan for Agents ("DCP"). Under
the DCP, agents may elect to defer receipt between 5% and 100% of their first
year commission, which deferral will be matched by a contribution by the
Company, initially set at 25% of the amount of the deferral, up to a maximum of
5% of the agent's commissions. Both the agent's participation in the DCP and the
Company's obligation to match the agent's deferral are subject to the agent
satisfying and continuing to satisfy minimum earning, production and persistency
standards. Shares are sold under the plan at market price, accordingly, no
expense is recognized, except for the cost of the Company match. Agents deferred
commissions amounting to $0.1 million in 2001, $0.1 million in 2000 and $0.1
million in 1999.
F-21
Option Awards
A summary of the status of the Company's stock option plans during the
three years ended December 31, 2001 and changes during the years ending on those
dates is presented below:
2001 2000 1999
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Fixed Exercise Exercise Exercise
Options Options Price Options Price Options Price
- ------- ------- ----- ------- ----- ------- -----
(In thousands) (In thousands) (In thousands)
Outstanding-beginning of year 4,643 $ 3.22 4,388 $ 3.09 1,309 $ 2.57
Granted 485 4.14 682 4.30 3,121 3.31
Exercised (168) 2.95 (17) 2.60 (29) 2.33
Terminated (44) 3.60 (410) 3.18 (13) 2.18
-------- -------- --------
Outstanding-end of year 4,916 $ 3.31 4,643 $ 3.22 4,388 $ 3.09
======== ======== ========
Options exercisable at end of
Year 2,911 $ 3.16 2,157 $ 2.90 1,315 $ 2.69
======== ======== ========
A summary of the weighted average fair value of options granted during the
three years ended December 31, 2001 is presented below:
2001 2000 1999
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Options Fair Price Options Fair Price Options Fair Price
------- ---------- ------- ---------- ------- ----------
(In thousands) (In thousands) (In thousands)
Above market 93 $ 1.13 160 $ 1.34 140 $ 1.63
At market 382 2.60 286 1.72 125 2.01
Below market 10 2.16 236 1.86 2,856 3.02
-------- -------- --------
Total granted 485 $ 2.31 682 $ 1.68 3,121 $ 2.92
======== ======== ========
The following table summarizes information about stock options outstanding
at December 31, 2001:
Number Weighted- Number
Outstanding Average Weighted- Exercisable Weighted-
Range of at Remaining Average at Average
Exercise Prices December 31, 2001 Contractual Life Exercise Price December 31, 2001 Exercise Price
--------------- ----------------- ---------------- -------------- ----------------- --------------
(In thousands) (In thousands)
$1.88 -- 3.12 1,060 5.5 years $ 2.50 1,060 $ 2.50
3.15 2,471 6.9 years 3.15 1,262 3.15
3.25 -- 4.25 1,028 6.4 years 3.88 340 3.79
5.06 -- 6.00 357 4.4 years 5.25 249 5.18
------- -------
$1.88 -- 6.00 4,916 6.3 years $ 3.31 2,911 $ 3.16
======= =======
F-22
A summary of the activity relating to the options awarded by the Company
for employees, directors and agents for the three years ended December 31, 2001,
is as follows:
Agents &
Employees Directors Others Total Range of Exercise Prices
--------- --------- ------ ----- ------------------------
(In thousands)
Balance, January 1, 1999 963 109 237 1,309
Granted 2,349 36 736 3,121 $3.09 - $5.31
Exercised (13) (16) -- (29) $1.88 - $3.50
Terminated (13) -- -- (13) $2.00 - $2.25
--------- --------- ------ ------
Balance, December 31, 1999 3,286 129 973 4,388
Granted 471 51 160 682 $3.15 - $5.06
Exercised (12) (5) -- (17) $2.25 - $3.15
Terminated (375) -- (35) (410) $2.25 - $4.25
--------- --------- ------ ------
Balance, December 31, 2000 3,370 175 1,098 4,643
Granted 334 48 103 485 $3.15 - $6.00
Exercised (83) (10) (75) (168) $2.20 - $4.06
Terminated (23) (3) (18) (44) $3.15 - $4.25
--------- --------- ------ ------
Balance, December 31, 2001 3,598 210 1,108 4,916
========= ========= ====== ======
At December 31, 2001, approximately 1.9 million, 0.1 million and 0.9
million options were currently exercisable by employees, directors and agents,
respectively.
Options Granted to Employees
Options are generally granted to eligible employees at a price not less
than the market price of the Company's common stock on the date of the grant.
Option shares may be exercised subject to the terms prescribed by the individual
grant agreement, however, options generally vest 50% after the first year and
50% after the second year. The options must be exercised not later than ten
years after the date of the grant or following earlier termination of
employment. Because these awards are made at a price equal to or greater than
market, no compensation cost is recognized for such awards.
The Company issued 2.3 million stock options with an exercise price of
$3.15 per share to certain employees and members of management on August 1,
1999. During 2000, the Company issued an additional 0.2 million stock options
with an exercise price of $3.15 per share to certain relocated employees and
members of management on July 31, 2000. As of December 31, 2001, the number of
these options outstanding was reduced to 2.1 million, primarily through
terminations. These options generally vest 20% upon grant and 20% each
subsequent year. However, 0.6 million vest after seven years, subject to certain
criteria, which could accelerate vesting to five years. These options must be
exercised not later than ten years after the date of the grant or following
earlier termination of employment. In accordance with APB 25, the Company
recorded an expense for the difference between the exercise price of $3.15 per
share and the value of the options on the date of grant of $0.6 million, $0.8
million and $1.0 million for the years ended December 31, 2001, 2000 and 1999,
respectively.
Stock Options Issued to Directors
Directors of the Company are eligible for options under the 1998 ICP. The
1998 ICP provides that unless otherwise determined by the Board, each
non-employee director would be granted an option to purchase 4,500 shares of
Common Stock upon approval of the 1998 ICP by shareholders or, as to directors
thereafter elected, his or her initial election to the Board, and at each annual
meeting of shareholders starting in 1999 at which he or she qualifies as a
non-employee director. The 1998 ICP also provides that the non-employee
directors for American Progressive would be granted an option to purchase 1,500
shares of Common Stock at each annual meeting. Unless otherwise determined by
the Board, such options will have an exercise price equal to 100% of the fair
market value per share on the date of grant and will become exercisable in three
equal installments after each of the first, second and third anniversaries of
the date of grant based on continued service as a director. Because these are
made at a price equal to market, no compensation expense is recognized for such
awards.
F-23
Stock Option Plan for Agents and Others
In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock Based Compensation," ("SFAS 123"), the fair value of these
options are expensed over the vesting period of each award.
On December 15, 1995, the Board of Directors approved a plan under which
up to 200,000 options could be granted to agents of the Company's subsidiaries
(subject to insurance law restrictions) and to other persons as to whom the
board of directors believes the grant of such options will serve the best
interests of the Corporation, provided that no options may be granted under this
plan to officers, directors or employees of the Company or of any subsidiary,
while they are serving as such. Such options expire ten years from the date of
the grant. Options outstanding under this plan total 102,786, all of which are
exercisable. In 1998, agents and other persons became eligible for options under
the 1998 ICP. Agents were issued a total of 159,600 options with an exercise
price of $5.00 per share in 2000 and 152,000 options with an exercise price of
$5.31 per share in 1999. These options vest in equal installments over a three
year period and expire five years from the date of grant.
In addition, in connection with the acquisition of the Acquired Companies,
the Company adopted additional stock option plans for agents and regional
managers of the Acquired Companies. Agents are to be issued stock and stock
options based on new premium production at predetermined exercise prices. The
plan ended at December 31, 2001. Total options granted may not exceed $0.6
million of proceeds to be received upon exercise to a maximum of 175,778
options. Options issued under this plan cliff vest 24 months after the end of
the year of option grant and expire at the earliest of the termination date as
an agent or 30 days after the option becomes exercisable. A total of 74,000
options were issued with an exercise price of $4.17 related to 2000 sales
performance and 84,254 options with an exercise price of $3.62 were issued
related to 1999 sales performance. These agents were also eligible for stock
grants based on new premium production. The stock grants awarded were 66,102
shares for 2000 sales performance and 84,254 shares for 1999 sales performance.
Regional managers will receive options based on growth of new premium
earned. The plan ended at December 31, 2001. Total options to be granted cannot
exceed $4.05 million of proceeds to be received upon exercise of such options to
a maximum of 1,135,174 options. Options cliff vest on the January 1st following
the second calendar year after the year of option grant. Options issued to
regional managers expire at the earliest of termination as an agent for cause,
30 days after termination not for cause, or 5 years after the grant date. A
total of 19,904 options with an exercise price of $4.17 were issued in 2001
relating to 2000 sales performance, 37,762 options with an exercise price of
$3.62 were issued in 2000 related to 1999 sales performance and 179,980 options
with an exercise price of $3.15 were issued in 1999 related to 1998 sales
performance.
A total of $0.2 million was expensed during 2001, $0.5 million was
expensed during 2000 and $1.5 million was expensed during 1999 related to the
above plans.
F-24
Accounting for Stock-Based Compensation
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions:
2001 2000 1999
---- ---- ----
Risk free interest rates 4.92% -- 5.52% 5.11% 6.51% -- 6.68%
Dividend yields 0.0% 0.0% 0.0%
Expected volatility 40.81% -- 48.41% 21.75% -- 43.74% 43.63% -- 48.64%
Expected lives of options (in years) 2.0 -- 9.0 1.0 -- 4.5 2.0 -- 6.0
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
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:
2001 2000 1999
---- ---- ----
(In thousands)
Pro forma net income $ 28,165 $ 22,360 $ 8,918
========== ========== ==========
Pro forma earnings per common share:
Basic $ 0.57 $ 0.48 $ 0.39
Diluted $ 0.56 $ 0.47 $ 0.32
10. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS:
The Insurance Subsidiaries are required to maintain minimum amounts of
capital and surplus as required by regulatory authorities. Each of the Insurance
Subsidiaries' statutory capital and surplus exceeds its respective minimum
requirement. However, substantially more than such minimum amounts are needed to
meet statutory and administrative requirements of adequate capital and surplus
to support the current level of the Insurance Subsidiaries' operations. At
December 31, 2001 and 2000 the statutory capital and surplus, including asset
valuation reserve, of the U.S. insurance subsidiaries totaled $107.0 million and
$86.5 million, respectively. Total statutory net income for the years
ended December 31, 2001 and 2000 was $14.6 million and $12.2 million,
respectively.
The National Association of Insurance Commissioners ("NAIC") imposes
regulatory risk-based capital ("RBC") requirements on life insurance
enterprises. At December 31, 2001 all of the Insurance Subsidiaries maintained
ratios of total adjusted capital to RBC in excess of the Authorized Control
Level.
F-25
PennCorp Life (Canada) and Pennsylvania Life's Canadian Branch report to
Canadian regulatory authorities based upon Canadian statutory accounting
principles that vary in some respects from U.S. statutory accounting principles.
Canadian net assets based upon Canadian statutory accounting principles were
$58.6 million and $56.4 million as of December 31, 2001 and 2000, respectively.
PennCorp Life (Canada) maintained a Minimum Continuing Capital and Surplus
Requirement Ratio ("MCCSR") in excess of the minimum requirement and
Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in
Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at
December 31, 2001.
Under the New York State Insurance Law, the declaration or payment of a
dividend by American Progressive requires the approval of the New York
Superintendent of Insurance, who, as a matter of present policy, would not
approve such payment until American Progressive had generated sufficient
statutory profits to offset its entire negative unassigned surplus, which was
approximately $7.7 million at December 31, 2001.
Under Pennsylvania and Texas insurance law, a life insurer may pay
dividends or make distributions from accumulated earning without the prior
approval of the Insurance Department, provided they do not exceed the greater of
(i) 10% of the insurer's surplus as to policyholders as of the preceding
December 31st; or (ii) the insurer's net gain from operations for the
immediately preceding calendar year.
Under current Florida State insurance law, a life insurer may pay a
dividend or make a distribution without the prior written approval of the
department when: a) the dividend is paid from that portion of the accumulated
and available surplus of the Company as is derived from the net operating
profits of its business and its net realized capital gains; b) the dividend is
no more than the greater of (i) 10% of the insurer's surplus as to policyholders
derived from net operating profits on its business and net realized capital
gains; or (ii) the insurer's entire net operating profits and realized net
capital gains derived during the immediately preceding calendar year; c) the
insurer will have surplus as to policyholders equal to or exceeding 115% of the
minimum required statutory surplus as to policyholders after the dividend or
distribution is made; and d) the insurer has filed notice with the department at
least 10 business days prior to the dividend payment or distribution.
During the year ended December 31, 2001, Union Bankers paid an ordinary
dividend to American Exchange of $1.7 million. Union Bankers also distributed
its investment in the common stock of Marquette to American Exchange in the form
of an extraordinary dividend. Additionally, Peninsular paid an extraordinary
dividend of $1.9 million to American Pioneer in 2001.
During the year ended December 31, 2000, Pennsylvania Life and Union
Bankers paid ordinary dividends to American Exchange of $2.9 million and $2.0
million, respectively. Additionally, Peninsular Life paid an extraordinary
dividend of $1.5 million to Universal American in 2000.
Under current Canadian law, a life insurer may pay a dividend after such
dividend declaration has been approved by its board of directors and upon at
least 10 days prior notification to the Superintendent of Financial
Institutions. In considering approval of a dividend, the board of directors must
consider whether the payment of such dividend would be in contravention of the
Insurance Companies Act of Canada. PennCorp Life (Canada) did not pay any
dividends during the three years ended December 31, 2001.
Based upon the current dividend regulations of the respective states,
Pennsylvania Life would be able to pay ordinary dividends of up to $8.4 million
and Constitution Life would be able to pay ordinary dividends of approximately
$1.7 million to American Exchange (their direct parent) without the prior
approval from their respective insurance departments in 2002. Additionally, in
2002, Peninsular Life would be able to pay ordinary dividends of up to $0.7
million to American Pioneer without approval from the Florida Department. We do
not expect that our remaining subsidiaries will be able to pay ordinary
dividends in 2002.
F-26
The Insurance Subsidiaries' statutory basis financial statements are
prepared in accordance with accounting practices prescribed or permitted by
their respective domiciliary states. "Prescribed" statutory accounting practices
include state laws, regulations and general administrative rules, as well as
publications of the NAIC. "Permitted" statutory accounting practices encompass
all accounting practices that are not prescribed but are authorized by the
relevant insurance departments; such practices may differ from state to state,
may differ from company to company within a state and may change in the future.
In 1998, the NAIC approved a codification of statutory accounting
principles, effective January 1, 2001, which will serve as a comprehensive and
standardized guide to statutory accounting principles. The adoption of the
codification changed, to some extent, the accounting practices that the
Company's Insurance Subsidiaries use to prepare their statutory financial
statements. Adoption of the codification resulted in an increase in the
statutory capital and surplus of the U.S. insurance subsidiaries of
approximately $11.0 million at January 1, 2001, due primarily to the recognition
of certain tax loss carry forwards as deferred tax assets.
11. DEFERRED POLICY ACQUISITION COSTS:
Details with respect to deferred policy acquisition costs for the three
years ended December 31, 2001 are as follows:
(In thousands)
Balance at January 1, 1999 $ 24,283
Capitalized costs 11,441
Adjustment relating to unrealized gain (loss) on fixed maturities 4,509
Foreign currency adjustment 24
Amortization (5,314)
--------
Balance at December 31, 1999 34,943
Capitalized costs 24,200
Adjustment relating to unrealized gain (loss) on fixed maturities (2,209)
Foreign currency adjustment (8)
Amortization (6,866)
Adjustment relating to the decision to exit the major medical (1,409)
line of business
--------
Balance at December 31, 2000 48,651
Capitalized costs 29,550
Adjustment relating to unrealized gain (loss) on fixed maturities (1,334)
Foreign currency adjustment (478)
Amortization (10,364)
--------
Balance at December 31, 2001 $ 66,025
========
During the year ended December 31, 2000, the Company decided to exit the
major medical line of business. This resulted in a reduction in the projected
gross profits for that line of business and accordingly, deferred policy
acquisition costs of $1.4 million were written off as of December 31, 2000. No
deferred policy acquisition costs were written off for the years ended December
31, 2001 or 1999.
F-27
12. ACCIDENT AND HEALTH POLICY AND CONTRACT CLAIM LIABILITIES:
Activity in the accident & health policy and contract claim liability is as
follows:
2001 2000 1999
---- ---- ----
(In thousands)
Balance at beginning of year $ 77,884 $ 72,261 $ 24,332
Less reinsurance recoverables (43,502) (36,231) (19,076)
-------- -------- --------
Net balance at beginning of year 34,382 36,030 5,256
-------- -------- --------
Balances acquired -- -- 31,043
Incurred related to:
Current year 74,204 59,700 58,163
Prior years (613) 299 (395)
-------- -------- --------
Total incurred 73,591 59,999 57,768
-------- -------- --------
Paid related to:
Current year 51,627 43,843 28,782
Prior years 21,094 17,631 29,320
-------- -------- --------
Total paid 72,721 61,474 58,102
-------- -------- --------
Foreign currency adjustment (341) (173) 65
-------- -------- --------
Net balance at end of year 34,911 34,382 36,030
Plus reinsurance recoverables 44,685 43,502 36,231
-------- -------- --------
Balance at end of year $ 79,596 $ 77,884 $ 72,261
======== ======== ========
During each of the three years in the period ended December 31, 2001,
the favorable or unfavorable development on accident and health claim reserves
was less than two percent of the prior year net balance.
13. REINSURANCE:
In the normal course of business, the Company reinsures portions of
certain policies that it underwrites. Accordingly, the Company is party to
several reinsurance agreements on its life and accident & health insurance
risks. The Company's senior market accident & health insurance products are
reinsured under coinsurance treaties with unaffiliated insurers, while the life
insurance risks are reinsured under either coinsurance or yearly-renewable term
treaties with unaffiliated insurers. Under coinsurance treaties, the reinsurer
receives an agreed upon percentage of all premiums and reimburses the Company
that same percentage of any losses. In addition, the Company receives certain
allowances from the reinsurers to cover commissions, expenses and premium taxes.
Under yearly-renewable term treaties, the reinsuring company receives premiums
at an agreed upon rate and holds the required reserves for its share of the risk
on a yearly-renewable term basis. The Company is also party to certain
reinsurance agreements whereby the Company limits its loss in excess of certain
thresholds. The Company evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk to minimize its exposure to significant
losses from reinsurer insolvencies. A contingent liability exists with respect
to reinsurance that may become a liability of the Company in the event that the
reinsurers should be unable to meet the obligations that they assumed.
F-28
The Company has several quota share reinsurance agreements in place
with Hannover Life Re of America ("Hannover"), General & Cologne Life Re of
America ("General & Cologne") and Transamerica Occidental Life ("Transamerica"),
(collectively, the "Reinsurers"), which Reinsurers are rated A or better by A.M.
Best. These agreements cover various accident & health insurance products
written or acquired by the Company and contain ceding percentages ranging
between 50% and 100%. At December 31, 2001 and 2000 amounts due from Reinsurers
were as follows:
2001 2000
---- ----
Reinsurer (In thousands)
General & Cologne $ 94,296 $ 89,469
Hannover 67,849 54,838
Transamerica 19,430 21,191
Other 30,957 37,431
-------- --------
Total $212,532 $202,929
======== ========
A summary of reinsurance activity for the three years ended December
31, 2001 is presented below:
As of December 31,
------------------
2001 2000 1999
---- ---- ----
(In thousands)
Life insurance in force
Gross amount $ 3,266,564 $ 3,651,778 $ 4,445,889
Ceded to other companies (687,615) (916,669) (1,571,284)
Assumed from other companies 48,747 51,175 50,699
----------- ----------- -----------
Net Amount $ 2,627,696 $ 2,786,284 $ 2,925,304
=========== =========== ===========
Percentage of assumed to net 2% 2% 2%
Year Ended December 31,
-----------------------
Premiums 2001 2000 1999
---- ---- ----
(In thousands)
Life insurance $ 36,411 $ 41,371 $ 25,704
Accident & health 477,164 409,952 226,849
----------- ----------- -----------
Total gross premiums 513,575 451,323 252,553
----------- ----------- -----------
Ceded to other companies
Life insurance (7,875) (10,210) (9,290)
Accident & health (279,043) (224,415) (129,537)
----------- ----------- -----------
Total ceded premiums (286,918) (234,625) (138,827)
----------- ----------- -----------
Assumed from other companies
Life insurance 2,071 2,538 1,177
Accident & health 478 517 574
----------- ----------- -----------
Total assumed premium 2,549 3,055 1,751
----------- ----------- -----------
Net amount
Life insurance 30,607 33,699 17,591
Accident & health 198,599 186,054 97,886
----------- ----------- -----------
Total net premium $ 229,206 $ 219,753 $ 115,477
=========== =========== ===========
Percentage of assumed to net
Life insurance 7% 8% 7%
Accident & health -% -% 1%
Total assumed to total net 1% 1% 2%
Claims recovered $ 201,121 $ 175,700 $ 104,900
----------- ----------- -----------
F-29
14. LOAN AGREEMENTS:
The Company entered into an $80 million credit facility consisting of a
$70 million term loan and a $10 million revolving loan facility in connection
with the 1999 Acquisition on July 30, 1999. The term loan calls for interest at
the London Interbank Offering Rate for one, two, three or six months ("LIBOR")
plus 350 basis points with principal repayment over a seven-year period and a
final maturity date of July 31, 2006. The Company incurred loan origination fees
of $3.5 million, which were capitalized and are amortized on a straight-line
basis over the life of the loan. The term loan is secured by a first priority
interest in 100% of the outstanding common stock of American Exchange, American
Progressive, WorldNet and other immaterial subsidiaries and 65% of the
outstanding common stock of UAFC Canada Inc. (the 100% parent of PennCorp Life
(Canada)) and a subordinate interest in 100% of the outstanding common stock of
American Pioneer. For the year ended December 31, 2001, 2000 and 1999, the
Company paid $5.2 million, $7.1 million and $2.9 ,respectively in interest and
fees in connection with the credit facility.
The following table shows the schedule of remaining principal payments
on the Company's outstanding term loan, with the final payment in July 2006:
Principal
Repayment
---------
(In thousands)
2002 $10,700
2003 11,525
2004 12,400
2005 13,275
2006 10,575
----------
Total $ 58,475
==========
In August 2000, to fund the CHCS acquisition (see Note 4), the Company
drew down $3.0 million of the revolving loan facility, which amount currently
incurs interest at a rate consistent with the term loan and is due to mature on
July 31, 2004. The Company pays an annual commitment fee of 50 basis points on
the unutilized facility, which is currently $7.0 million.
The following table sets forth certain summary information with respect
to total borrowings of the Company for the three years ended December 31, 2001:
As of December 31, Year Ended December 31,
------------------ -----------------------
Weighted
Maximum Average(a) Average
Amount Interest Amount Amount Interest
Outstanding Rate Outstanding Outstanding Rate (b)
----------- ---- ----------- ----------- --------
(In thousands) (In thousands) (In thousands)
2001 $ 61,475 5.43% $ 69,650 $ 65,490 7.84%
=========== ===== =========== =========== =====
2000 $ 69,650 10.22% $ 71,500 $ 70,056 10.05%
=========== ===== =========== =========== =====
1999 $ 70,000 9.01% $ 70,000 $ 31,833 8.98%
=========== ===== =========== =========== =====
(a) The average amounts of borrowings outstanding were computed by
determining the arithmetic average of the months' average outstanding
in borrowings.
(b) The weighted-average interest rates were determined by dividing
interest expense related to total borrowings by the average amounts
outstanding of such borrowings.
F-30
15. COMMITMENTS:
The Company is obligated under certain lease arrangements for its
executive and administrative offices in New York, Florida, Texas, and Ontario,
Canada. Rent expenses for the three years ended December 2001, 2000 and 1999 was
$1.8 million, $2.9 million, and $1.5 million, respectively. The minimum rental
commitments, subject to escalation clauses, at December 31, 2001 under
non-cancelable operating leases are as follows:
(In thousands)
2002 $ 1,737
2003 1,516
2004 1,435
2005 947
2006 and thereafter 5,686
-------
Totals $11,321
=======
16. UNIVERSAL AMERICAN FINANCIAL CORP. 401(K) SAVINGS PLAN:
Effective April 1, 1992, the Company adopted the Universal American
Financial Corp. 401(k) Savings Plan ("Savings Plan"). The Savings Plan is a
voluntary contributory plan under which employees may elect to defer
compensation for federal income tax purposes under Section 401(k) of the
Internal Revenue Code of 1986. The employee is entitled to participate in the
Savings Plan by contributing through payroll deductions up to 20% of the
employee's compensation. Currently, the Company matches the employee's
contribution up to 2% of the employee's compensation with Company common stock.
At December 31, 2001 and 2000, the Savings Plan held 468,943 and 426,000 shares,
respectively of the Company's common stock, which represents 34.4% of total plan
assets as of December 31, 2001 and 18.2% of total plan assets as of December 31,
2000.
The participating employee is not taxed on these contributions until
they are distributed. Moreover, the employer's contributions vest at the rate of
25% per plan year. Employees are required to hold the employer contribution in
Company common stock until vested, at which point the employee has the option to
transfer the amount to any of the other investments available under the Savings
Plan. Amounts credited to employee's accounts under the Savings Plan are
invested by the employer-appointed investment committee. Generally, a
participating employee is entitled to distributions from the Savings Plan upon
termination of employment, retirement, death or disability. Savings Plan
participants who qualify for distributions may receive a single lump sum, have
the assets transferred to another qualified plan or individual retirement
account, or receive a series of specified installment payments. The Company made
matching contributions under the Savings Plan of $0.3 million in 2001, $0.3
million in 2000 and, $0.2 million in 1999.
17. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
a. Fixed maturities available for sale: Fair value of fixed
maturities is based upon quoted market prices, where
available, or on values obtained from independent pricing
services. For certain mortgage and asset-backed securities,
the determination of fair value is based primarily upon the
amount and timing of expected future cash flows of the
security. Estimates of these cash flows are based current
economic conditions, past credit loss experience and other
circumstances.
b. Equity securities: For equity securities carried at fair
value, fair value equals quoted market price.
F-31
c. Cash and cash equivalents and policy loans: For cash and cash
equivalents and policy loans, the carrying amount is a
reasonable estimate of fair value.
d. Investment contract liabilities: For annuity and universal
life type contracts, the carrying amount is the policyholder
account value (see Note 2); estimated fair value equals the
policyholder account value less surrender charges.
e. Short term debt and loan payable: For short-term borrowings
and loan payable, the carrying value is a reasonable estimate
of fair value due to their short-term nature.
f. Accounts receivable and uncollected premiums: Accounts
receivable and uncollected premiums are primarily insurance
contract related receivables, which are determined based upon
the underlying insurance liabilities and added reinsurance
amounts.
The estimated fair values of the Company's financial instruments as of
December 31, 2001 and 2000 are as follows:
2001 2000
---- ----
Carrying Carrying
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(In thousands) (In thousands)
Financial assets:
Fixed maturities available for $799,218 $799,218 $751,738 $751,738
sale
Equity securities 4,199 4,199 3,547 3,547
Policy loans 24,043 24,043 25,077 24,043
Other invested assets (a) 1,362 2,037
Mortgage loans (a) 2,411 2,281
Cash and cash equivalents 53,690 53,690 40,250 40,250
Financial liabilities:
Investment contract 236,742 219,330 233,415 212,475
liabilities
Loan payable 61,475 61,475 69,650 69,650
(a) Mortgage loans are carried at the aggregate unpaid balances and the
fair market value was not determined as the amount involved was
considered to be immaterial. Other invested assets consists mainly of
collateralized loans which are carried at cost. The determination of
fair value for these invested assets is not practical because there is
no active trading market for such invested assets.
18. EARNINGS PER SHARE:
The reconciliation of the numerators and the denominators for the
computation of basic and diluted EPS for the years ended December 31,
2001, 2000 and 1999 is as follows:
For the Year Ended December 31, 2001
------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
Weighted average common stock outstanding 49,591
Less: Weighted average treasury shares (66)
---------
Basic EPS
Net income applicable to common $ 28,925 49,525 $ 0.58
======== ========= ========
shareholders
Effect of Dilutive Securities
Incentive stock options 3,956
Director stock option 157
Treasury stock purchased from proceeds of
exercise of options (3,181)
-------- ---------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 28,925 50,457 $ 0.57
======== ========= ========
F-32
For the Year Ended December 31, 2000
------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
Weighted average common stock outstanding 46,761
Less: Weighted average treasury shares (31)
---------
Basic EPS
Net income applicable to common
shareholders $ 22,885 46,730 $ 0.49
======== ========= ========
Effect of Dilutive Securities
Incentive stock options 1,766
Director stock option 115
Treasury stock purchased from proceeds of
exercise of options (1,496)
-------- ---------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 22,885 47,115 $ 0.49
======== ========= ========
For the Year Ended December 31, 1999
------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
Net income $ 9,813
Less: Redemption accrual on Series C
preferred Stock (180)
Basic EPS
Net income applicable to common
shareholders 9,633 23,212 $ 0.42
======== ========= ========
Effect of Dilutive Securities
Series B Preferred Stock 1,037
Series C Preferred Stock 180 544
Series D Preferred Stock 744
Non-registered warrants 1,993
Registered warrants 614
Incentive stock options 1,261
Director stock option 93
Treasury stock purchased from proceeds of
exercise of options and warrants (937)
-------- ---------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 9,813 28,561 $ 0.34
======== ========= ========
F-33
19. OTHER COMPREHENSIVE INCOME
The components of other comprehensive income, and the related tax
effects for each component, for the years ended December 31, 2001, 2000 and 1999
are as follows:
Before Tax Tax Expense Net of Tax
Amount (Benefit) Amount
------ --------- ------
(In thousands)
Year ended December 31, 2001
- ----------------------------
Net unrealized gain arising during
the year (net of deferred acquisition costs) $ 8,572 $ 3,001 $ 5,571
Reclassification adjustment for gains
included in net income (3,078) (1,078) (2,000)
-------- -------- --------
Net unrealized gains 5,494 1,923 3,571
Foreign currency translation adjustment (3,996) (1,153) (2,843)
-------- -------- --------
Other comprehensive income $ 1,498 $ 770 $ 728
======== ======== ========
Before Tax Tax Expense Net of Tax
Amount (Benefit) Amount
------ --------- ------
(In thousands)
Year ended December 31, 2000
- ----------------------------
Net unrealized gain arising during
the year (net of deferred acquisition costs) $ 20,531 $ 7,498 $ 13,033
Reclassification adjustment for gains
included in net income (146) (51) (95)
-------- -------- --------
Net unrealized gains 20,385 7,447 12,938
Foreign currency translation adjustment (1,434) (258) (1,176)
-------- -------- --------
Other comprehensive income $ 18,951 $ 7,189 $ 11,762
======== ======== ========
Before Tax Tax Expense Net of Tax
Amount (Benefit) Amount
------ --------- ------
(In thousands)
Year ended December 31, 1999
- ----------------------------
Net unrealized loss arising during
the year (net of deferred acquisition costs) $(15,293) $ (6,202) $ (9,091)
Reclassification adjustment for losses
included in net income 87 35 52
-------- -------- --------
Net unrealized gains (15,206) (6,167) (9,039)
Foreign currency translation adjustment 2,177 883 1,294
-------- -------- --------
Other comprehensive income (loss) $(13,029) $ (5,284) $ (7,745)
======== ======== ========
F-34
20. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The quarterly results of operations for the three years ended December
31, 2001 are presented below. Due to the use of weighted average shares
outstanding when determining the denominator for earnings per share, the sum of
the quarterly per common share amounts may not equal the per common share
amounts.
2001 Three Months Ended
---- ------------------
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------
(In thousands)
Total revenue $ 76,671 $ 74,764 $ 73,851 $ 75,657
Total benefits, claims & other expenses 65,750 65,298 63,132 63,401
--------- --------- --------- ---------
Operating income before income taxes 10,921 9,466 10,719 12,256
Federal income tax expense 3,885 3,392 3,797 3,364
--------- --------- --------- ---------
Net income applicable to common
Shareholders $ 7,036 $ 6,074 $ 6,922 $ 8,892
========= ========= ========= =========
Basic earnings per share $ 0.15 $ 0.13 $ 0.13 $ 0.17
========= ========= ========= =========
Diluted earnings per share $ 0.15 $ 0.13 $ 0.13 $ 0.16
========= ========= ========= =========
2000 Three Months Ended
---- ------------------
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------
(In thousands)
Total revenue $ 70,770 $ 71,826 $ 71,469 $ 70,026
Total benefits, claims & other expenses 61,956 62,990 63,203 62,876
--------- --------- --------- ---------
Operating income before income taxes 8,814 8,836 8,266 7,150
Federal income tax expense 3,155 3,207 2,853 966
--------- --------- --------- ---------
Net income applicable to common
Shareholders $ 5,659 $ 5,629 $ 5,413 $ 6,184
========= ========= ========= =========
Basic earnings per share $ 0.12 $ 0.12 $ 0.12 $ 0.13
========= ========= ========= =========
Diluted earnings per share $ 0.12 $ 0.12 $ 0.12 $ 0.13
========= ========= ========= =========
1999 Three Months Ended
---- ------------------
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------
(In thousands)
Total revenue $ 13,850 $ 14,713 $ 50,188 $ 69,385
Total benefits, claims & other expenses 12,783 13,640 45,002 60,655
--------- --------- --------- ---------
Operating income before income taxes 1,067 1,073 5,186 8,730
Federal income tax expense 356 371 1,953 3,563
--------- --------- --------- ---------
Net Income 711 702 3,233 5,167
Redemption accrual on Series C
Preferred Stock 180 -- -- --
--------- --------- --------- ---------
Net income applicable to common
Shareholders $ 531 $ 702 $ 3,233 $ 5,167
========= ========= ========= =========
Basic earnings per share $ 0.07 $ 0.07 $ 0.10 $ 0.12
========= ========= ========= =========
Diluted earnings per share $ 0.05 $ 0.05 $ 0.09 $ 0.11
========= ========= ========= =========
F-35
21. BUSINESS SEGMENT INFORMATION:
Currently, the Company manages its business, with primary emphasis on
its distribution channels, through four operating segments, Senior Market
Brokerage, Career Agency, Special Markets and Administrative Services and also
maintains a Corporate segment.
SENIOR MARKET BROKERAGE - This distribution channel consists of an
independent general agency system and insurance brokerage system that focus on
the sale of products in the senior market segment, including medicare
supplement, long-term care, final expense life insurance and annuities.
CAREER AGENCY - The Career Agency Segment was acquired as part of the
1999 Acquisition in July 1999 and comprises the operations of Pennsylvania Life
and PennCorp Life (Canada). PennCorp Life operates exclusively in Canada, while
Pennsylvania Life operates in both the U.S. ("Pennsylvania Life U.S.") and
Canada. The Career Agency segment includes a career agency field force, which
distributes fixed benefit accident and sickness, life insurance and senior
market insurance in the United States and Canada. The Career Agents are under
exclusive contract with Pennsylvania Life and PennCorp Life (Canada).
SPECIAL MARKETS - Through its own operating history and through prior
acquisitions, Universal American has accumulated various lines of business that
it manages in its Special Markets segments. These products include traditional,
interest-sensitive and group life insurance, individual medical and other
accident and health insurance.
ADMINISTRATIVE SERVICES - In connection with the acquisition of AIAG
and CHCS, Universal American has increased its efforts on the development of the
Administrative Services segment. The primary services are to act as a third
party administrator and service provider on various senior supplemental health
insurance products offered by both affiliated and unaffiliated insurance
companies. Services performed include policy underwriting, telephone
verification, policyholder services, claims adjudication, clinical case
management, care assessment and referral to health care facilities.
CORPORATE - This segment includes the activities of the holding
company, including payment of interest on debt.
This segment also includes the elimination of intersegment revenues and
expenses that are reported gross in each of the operating segments. These
eliminations affect the amounts reported on the individual financial statement
line items, but do not change operating income before taxes. The significant
items eliminated include intersegment revenue and expense relating to services
performed by the Administrative Services segment for the Career Agency, Senior
Market Brokerage and Special Market segments and interest on notes issued by the
Corporate segment to the other operating segments.
F-36
Financial data by segment for the three years ended December 31, 2001
is as follows:
December, 31, 2001 December 31, 2000 December 31, 1999
------------------ ----------------- -----------------
(in thousands)
Segment Segment Segment
Income Income Income
(Loss) (Loss) (Loss)
Before Before Before
Segment Income Segment Income Segment Income
Revenue Taxes Revenue Taxes Revenue Taxes
------- ----- ------- ----- ------- -----
Career Agency $ 160,295 $ 28,427 $ 161,719 $ 28,814 $ 67,924 $ 11,759
Senior Market Brokerage 89,630 8,292 63,514 5,491 42,105 3,871
Special Markets 38,811 5,424 53,311 4,790 36,180 4,618
Administrative Services 33,153 6,625 24,207 3,844 9,290 2,036
--------- --------- --------- --------- --------- ---------
Subtotal 321,889 48,768 302,751 42,939 155,499 22,284
Corporate 360 (8,483) 358 (10,019) 936 (5,987)
Intersegment revenues (24,384) -- (19,164) -- (8,058) --
--------- --------- --------- --------- --------- ---------
Segment total 297,865 40,285 283,945 32,920 148,377 16,297
Adjustments to segment total
Net realized gains 3,078 3,078 146 146 (241) (241)
--------- --------- --------- --------- --------- ---------
$ 300,943 $ 43,363 $ 284,091 $ 33,066 $ 148,136 $ 16,056
========= ========= ========= ========= ========= =========
Identifiable assets by segment as of December 31, 2001 and 2000 are as
follows:
December 31, 2001 December 31, 2000
----------------- -----------------
Career Agency 605,758 $ 549,723
Senior Market Brokerage 426,689 358,790
Special Markets 242,080 278,699
Administrative Services 29,753 21,356
----------- -----------
Subtotal 1,304,280 1,208,568
Corporate 313,709 268,256
Intersegment assets(1) (342,073) (286,960)
----------- -----------
$ 1,275,916 $ 1,189,864
=========== ===========
1 Intersegment assets includes the elimination of the parent holding
company's investment in its subsidiaries as well as the elimination of
other intercompany balances.
21. FOREIGN OPERATIONS:
A portion of the operations of the Company's Career Agency segment is
conducted in Canada through PennCorp Life (Canada) and a Canadian Branch of
Pennsylvania Life. These assets and liabilities are located in Canada where the
insurance risks are written. Revenues of the Career Agency segment by geographic
area are as follows:
2001 2000 1999
---- ---- ----
Revenues (In thousands)
United States $103,432 $104,848 $ 44,157
Canada 56,863 56,871 23,767
-------- -------- --------
Total $160,295 $161,719 $ 67,924
======== ======== ========
F-37
SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
UNIVERSAL AMERICAN FINANCIAL CORP.
DECEMBER 31, 2001 AND 2000
December 31, 2001
-----------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- -------------- ----- ---- ----- -----
(In thousands)
US Treasury securities and
obligations $ 35,263 $ 35,719 $ 36,970 $ 36,970
of US Government
Corporate bonds 357,336 357,431 364,616 364,616
Foreign bonds (1) 241,925 157,077 157,662 157,662
Asset and mortgage-backed 245,406 236,617 239,970 239,970
securities
Equity securities 4,339 4,199 4,199
-------- -------- --------
Sub-total 791,183 $803,417 803,417
========
Policy loans 24,043 24,043
Other invested assets 3,773 3,773
-------- --------
Total investments $818,999 $831,233
======== ========
December 31, 2000
-----------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- -------------- ----- ---- ----- -----
(In thousands)
US Treasury securities and
obligations $ 33,741 $ 34,199 $ 34,734 $34,734
of US Government
Corporate bonds 310,806 311,711 313,197 313,197
Foreign bonds (1) 228,091 144,243 145,403 145,403
Asset and mortgage-backed 269,925 255,907 258,404 258,404
securities
Equity Securities 3,819 3,547 3,547
-------- -------- --------
Sub-total 749,879 $755,285 755,285
========
Policy loans 25,077 25,077
Other invested assets 4,318 4,318
-------- --------
Total investments $779,274 $784,680
======== ========
(1) Primarily Canadian dollar denominated bonds supporting our Canadian
insurance reserves.
See accompanying independent auditor's report
F-38
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
---- ----
ASSETS (In thousands)
Cash and cash equivalents $ 2,660 $ 3,212
Fixed maturities, available for sale 3,028 --
Investments in subsidiaries at equity 229,694 190,540
Note receivable from affiliate 70,000 70,000
Due from subsidiary -- 209
Capitalized loan origination fees 2,428 2,958
Deferred tax asset 781 875
Other assets 5,118 462
-------- --------
Total assets 313,709 268,256
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Loan payable 61,475 69,650
Note payable to American Progressive 2,400 7,900
Due to subsidiary 15,744 9,889
Amounts payable and other liabilities 3,320 6,868
-------- --------
Total liabilities 82,939 94,307
-------- --------
Total stockholders' equity 230,770 173,949
-------- --------
Total liabilities and stockholders' equity $313,709 $268,256
======== ========
See notes to condensed financial statements.
F-39
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 2001
2001 2000 1999
---- ---- ----
(In thousands)
REVENUES:
Net investment income $ 6,060 $ 7,258 $ 2,762
Other income 100 107 10
-------- -------- --------
Total revenues 6,160 7,365 2,772
-------- -------- --------
EXPENSES:
Selling, general and administrative expenses 3,990 3,833 3,620
Interest expense 5,152 7,097 2,859
-------- -------- --------
Total expenses 9,142 10,930 6,479
-------- -------- --------
Operating loss before provision for Federal
income taxes and equity income (2,982) (3,565) (3,707)
Federal income tax expense 166 1,659 1,250
-------- -------- --------
Net loss before equity income of subsidiaries (3,148) (5,224) (4,957)
Equity in undistributed income 32,073 28,109 14,770
-------- -------- --------
Net income 28,925 22,885 9,813
Redemption accrual on Series C Preferred Stock -- -- 180
-------- -------- --------
Net income applicable to common shareholders $ 28,925 $ 22,885 $ 9,633
======== ======== ========
See notes to condensed financial statements.
F-40
Schedule II - continued
2001 2000 1999
---- ---- ----
(In thousands)
Cash flows from operating activities:
Net income $ 28,925 $ 22,885 $ 9,813
Adjustments to reconcile net income to
net cash used by operating activities:
Stock based compensation 863 830 --
Equity earnings of subsidiaries (32,073) (28,109) (91,818)
Change in surplus note interest receivable -- 2,721 (2,721)
Change in amounts due to/from subsidiaries 6,064 5,917 268
Change in loan origination fees 530 558 (3,515)
Change in deferred income taxes 94 (817) 1,269
Change in other assets and liabilities (1,718) (2,158) 1,113
--------- --------- ---------
Net cash provided (used) by operating activities 2,685 1,827 (85,591)
--------- --------- ---------
Cash flows from investing activities:
Purchase of fixed maturities (3,028) -- --
Issuance of surplus note receivable to American Exchange -- -- (70,000)
Redemption of surplus note due from American Pioneer -- -- 1,000
Capital contribution to American Pioneer (7,000) -- (1,000)
Capital contribution to Pennsylvania Life (4,362) -- --
Capital contribution to PennCorp Life of Canada -- (1,400) --
Purchase of business (650) (6,189) --
--------- --------- ---------
Net cash used by investing activities (15,040) (7,589) (70,000)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 26,242 213 93,209
Purchase of Treasury Stock (764) (711) --
Proceeds from the issuance of Series C Preferred Stock -- -- --
Proceeds from the issuance of Series D Preferred Stock -- -- 1,750
Change in note payable to American Progressive (5,500) -- --
Increase in loan payable -- 3,000 70,000
Principal repayment on debt (8,175) (3,350) (4,750)
Dividends received -- 3,409 --
--------- --------- ---------
Net cash provided from financing activities 11,803 2,561 160,209
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents (552) (3,201) 4,618
Cash and cash equivalents:
At beginning of year 3,212 6,413 1,795
--------- --------- ---------
At end of year $ 2,660 $ 3,212 $ 6,413
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 5,195 $ 7,097 $ 2,859
========= ========= =========
Income taxes $ 209 $ 39 $ 18
========= ========= =========
See notes to condensed financial statements
F-41
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
In the parent-company-only financial statements, the parent company's
investment in subsidiaries is stated at cost plus equity in undistributed
earnings of subsidiaries since date of acquisition. The parent company's share
of net income of its wholly owned unconsolidated subsidiaries is included in its
net income using the equity method. Parent-company-only financial statements
should be read in conjunction with the Company's consolidated financial
statements.
F-42
SCHEDULE III - SUPPLEMENTAL INSURANCE INFORMATION
UNIVERSAL AMERICAN FINANCIAL CORP.
(In thousands)
Reserves Policy
Deferred for Future and Net Net Other
Acquisition Policy Unearned Contract Premium Investment Policyholder Net Change Operating
2001 Costs Benefits Premiums Claims Earned Income Benefits in DAC Expense
---- ----- -------- -------- ------ ------ ------ -------- ------ -------
Career Agency $ 27,043 $ 387,860 $ -- $ 22,013 $ 126,144 $ 32,768 $ 85,928 $ (12,178) $ 58,111
Senior Market
Brokerage 32,736 274,040 -- 54,093 77,888 11,740 66,166 (7,721) 22,726
Special Markets 6,246 166,295 -- 9,772 25,174 13,434 23,197 713 9,253
Administrative
Services -- -- -- -- -- 322 -- -- 24,322
--------- --------- -------- --------- --------- --------- --------- --------- ---------
Subtotal 66,025 828,195 -- 85,878 229,206 58,264 175,291 (19,186) 114,412
Corporate -- -- -- -- -- 331 -- -- 8,814
Intersegement -- -- -- -- -- (783) -- -- (24,388)
--------- --------- -------- --------- --------- --------- --------- --------- ---------
Segment Total $ 66,025 $ 828,195 $ -- $ 85,878 $ 229,206 $ 57,812 $ 175,291 $ (19,186) $ 98,838
========= ========= ======== ========= ========= ========= ========= ========= =========
2000
Career Agency $ 15,335 $ 361,415 $ -- $ 21,235 $ 129,358 $ 31,714 $ 83,089 $ (12,476) $ 62,264
Senior Market
Brokerage 25,507 249,204 -- 50,769 52,120 11,391 45,652 (5,015) 17,203
Special Markets 7,809 188,301 -- 13,087 38,275 14,704 35,308 1,566 11,417
Administrative
Services -- -- -- -- -- 77 -- -- 17,443
--------- --------- -------- --------- --------- --------- --------- --------- ---------
Subtotal 48,651 798,920 -- 85,091 219,753 57,886 164,049 (15,925) 108,327
Corporate -- -- -- -- -- 116 -- -- 11,033
Intersegement -- -- -- -- -- (1,057) -- -- (19,208)
--------- --------- -------- --------- --------- --------- --------- --------- ---------
Segment Total $ 48,651 $ 798,920 $ -- $ 85,091 $ 219,753 $ 56,945 $ 154,049 $ (15,925) $ 100,152
========= ========= ======== ========= ========= ========= ========= ========= =========
1999
Career Agency $ 2,944 $ 340,866 $ -- $ 20,333 $ 55,563 $ 12,130 $ 30,833 $ (2,919) $ 28,239
Senior Market
Brokerage 21,879 245,838 -- 42,946 32,642 9,422 29,193 (3,722) 12,580
Special Markets 10,120 212,738 -- 14,627 27,762 8,662 21,897 412 8,939
Administrative
Services -- -- -- -- -- 104 -- -- 7,254
--------- --------- -------- --------- --------- --------- --------- --------- ---------
Subtotal 34,943 799,441 -- 77,905 115,477 30,321 81,923 (6,229) 57,012
Corporate -- -- -- -- -- 89 -- -- 7,462
Intersegement -- -- -- -- -- (919) -- -- (8,108)
--------- --------- -------- --------- --------- --------- --------- --------- ---------
Segment Total $ 34,943 $ 799,441 $ -- $ 77,905 $ 115,477 $ 29,313 $ 81,923 $ (6,229) $ 56,316
========= ========= ======== ========= ========= ========= ========= ========= =========
See accompanying independent auditor's report
F-43