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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 0-11321
---------------------------
UNIVERSAL AMERICAN FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2580136
(State of other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
SIX INTERNATIONAL DRIVE, SUITE 190 10573
RYE BROOK, NEW YORK (Zip code)
(Address of principal executive offices)
(914) 934-5200
(Registrant's telephone number, including area code)
---------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The number of shares of the registrant's common stock, par value $0.01 per
share, outstanding as of October 29, 2004 was 55,264,918.
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UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Operations - Three Months 4
Consolidated Statements of Operations - Nine Months 5
Consolidated Statements of Stockholders' Equity and Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24
Item 3. Quantitative and Qualitative Disclosure of Market Risk 53
Item 4. Controls and Procedures 55
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 55
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 56
Item 3. Defaults Upon Senior Securities 56
Item 4. Submission of Matters to a Vote of Security Holders 56
Item 5. Other Information 56
Item 6. Exhibits 56
Signatures 57
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- -----------
(In thousands)
ASSETS
Investments (Note 7):
Fixed maturities available for sale, at fair value
(amortized cost: 2004, $1,081,121; 2003, $1,081,954) $ 1,135,382 $ 1,141,392
Equity securities, at fair value (cost: 2004, $748; 2003, $1,481) 753 1,507
Policy loans 24,810 25,502
Other invested assets 1,167 1,583
------------- -----------
Total investments 1,162,112 1,169,984
Cash and cash equivalents 163,696 116,524
Accrued investment income 12,875 14,476
Deferred policy acquisition costs 193,915 143,711
Amounts due from reinsurers 211,728 219,182
Due and unpaid premiums 9,570 7,433
Deferred income tax asset - 15,757
Present value of future profits and other amortizing intangible assets 62,736 44,047
Goodwill and other indefinite lived intangible assets (Note 4) 76,711 13,117
Income taxes receivable 95 -
Receivable for securities sold 22,668 1,000
Other assets 44,396 35,717
------------- -----------
Total assets $ 1,960,502 $ 1,780,948
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances $ 461,207 $ 419,685
Reserves for future policy benefits 737,603 722,466
Policy and contract claims - life 9,164 8,672
Policy and contract claims - health 110,393 100,232
Loan payable (Note 10) 102,375 38,172
Other long term debt (Note 11) 75,000 75,000
Amounts due to reinsurers 5,727 6,779
Income taxes payable - 12,489
Deferred income tax liability 639 -
Other liabilities 62,724 51,715
------------- -----------
Total liabilities 1,564,832 1,435,210
------------- -----------
STOCKHOLDERS' EQUITY (Note 9)
Common stock (Authorized: 100 million shares, issued:
2004, 55.1 million shares; 2003, 54.1 million shares) 551 541
Additional paid-in capital 168,805 164,355
Accumulated other comprehensive income 38,351 39,774
Retained earnings 188,926 142,458
Less: Treasury stock (2004, 0.1 million shares; 2003, 0.2 million shares) (963) (1,390)
------------- -----------
Total stockholders' equity 395,670 345,738
------------- -----------
Total liabilities and stockholders' equity $ 1,960,502 $ 1,780,948
============= ===========
See notes to unaudited consolidated financial statements.
3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 2004 2003
- --------------------------------------------------------- ---------------- ---------------
(IN THOUSANDS, PER SHARE AMOUNTS IN DOLLARS)
Revenues:
Direct premiums and policyholder fees earned $ 231,971 $ 182,016
Reinsurance premiums assumed 8,851 6,190
Reinsurance premiums ceded (62,746) (66,686)
---------------- ---------------
Net premiums and policyholder fees earned 178,076 121,520
Net investment income 16,475 15,078
Realized gains on investments 5,485 582
Fee and other income 3,685 2,623
---------------- ---------------
Total revenues 203,721 139,803
---------------- ---------------
Benefits, claims and expenses:
Net change in future policy benefits 2,537 8,045
Net claims and other benefits 119,281 74,210
Interest credited to policyholders 4,737 4,264
Net increase in deferred acquisition costs (16,304) (15,097)
Amortization of present value of future profits 1,816 1,051
Commissions 35,413 35,736
Commission and expense allowances on reinsurance ceded (12,952) (15,755)
Interest expense 2,234 1,327
Other operating costs and expenses 37,641 28,325
---------------- ---------------
Total benefits, claims and expenses 174,403 122,106
---------------- ---------------
Income before taxes 29,318 17,697
Income tax expense 9,776 6,281
---------------- ---------------
Net income $ 19,542 $ 11,416
================ ================
Earnings per common share:
Basic $ 0.36 $ 0.21
================ ================
Diluted $ 0.34 $ 0.21
================ ================
See notes to unaudited consolidated financial statements.
4
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003
- --------------------------------------------------------- ---------------- ---------------
(IN THOUSANDS, PER SHARE AMOUNTS IN DOLLARS)
Revenues:
Direct premiums and policyholder fees earned $ 624,276 $ 516,542
Reinsurance premiums assumed 27,170 18,928
Reinsurance premiums ceded (190,682) (216,112)
---------------- ---------------
Net premiums and policyholder fees earned 460,764 319,358
Net investment income 48,636 44,888
Realized gains on investments 9,286 1,878
Fee and other income 10,080 9,701
---------------- ---------------
Total revenues 528,766 375,825
---------------- ---------------
Benefits, claims and expenses:
Net change in future policy benefits 10,400 14,738
Net claims and other benefits 305,573 206,534
Interest credited to policyholders 13,215 11,120
Net increase in deferred acquisition costs (47,527) (34,405)
Amortization of present value of future profits 3,687 2,246
Commissions 103,626 100,847
Commission and expense allowances on reinsurance ceded (36,215) (56,176)
Interest expense 5,519 3,400
Early extinguishment of debt (Note 10) - 1,766
Other operating costs and expenses 100,060 79,762
---------------- ---------------
Total benefits, claims and expenses 458,338 329,832
---------------- ---------------
Income before taxes 70,428 45,993
Income tax expense 23,960 16,029
---------------- ---------------
Net income $ 46,468 $ 29,964
================ ===============
Earnings per common share:
Basic $ 0.85 $ 0.56
================ ===============
Diluted $ 0.82 $ 0.55
================ ===============
See notes to unaudited consolidated financial statements.
5
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(UNAUDITED)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN COMPREHENSIVE RETAINED TREASURY
NINE MONTHS ENDED SEPTEMBER 30, STOCK CAPITAL INCOME (LOSS) EARNINGS STOCK TOTAL
- -------------------------------- ------ ---------- ------------- -------- -------- ----------
(In thousands)
2003
Balance, January 1, 2003 $ 532 $ 158,264 $ 29,887 $ 99,406 $ (1,320) $ 286,769
Net income - - - 29,964 - 29,964
Other comprehensive income
(Note 8) - - 13,084 - - 13,084
----------
Comprehensive income 43,048
----------
Issuance of common stock (Note 9) 9 4,190 - - - 4,199
Stock-based compensation - 900 - - - 900
Loans to officers 653 - - - 653
Treasury shares purchased, at
cost (Note 9) - - - - (477) (477)
Treasury shares reissued (Note 9) - 17 - - 1,043 1,060
------ ---------- ------------- -------- -------- ----------
Balance, September 30, 2003 $ 541 $ 164,024 $ 42,971 $129,370 $ (754) $ 336,152
====== ========== ============= ======== ======== ==========
2004
Balance, January 1, 2004 $ 541 $ 164,355 $ 39,774 $142,458 $ (1,390) $ 345,738
Net income - - - 46,468 - 46,468
Other comprehensive income
(Note 8) - - (1,423) - - (1,423)
----------
Comprehensive income 45,045
----------
Issuance of common stock (Note 9) 10 3,705 - - - 3,715
Stock-based compensation - 415 - - - 415
Loans to officers 76 - - - 76
Treasury shares purchased, at
cost (Note 9) - - - - (319) (319)
Treasury shares reissued (Note 9) - 254 - - 746 1,000
------ ---------- ------------- -------- -------- ----------
Balance, September 30, 2004 $ 551 $ 168,805 $ 38,351 $188,926 $ (963) $ 395,670
====== ========== ============= ======== ======== ==========
See notes to unaudited consolidated financial statements.
6
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003
- --------------------------------------------------------------------------------- --------- ---------
(In thousands)
Cash flows from operating activities:
Net income $ 46,468 $ 29,964
Adjustments to reconcile net income to net cash provided by operating activities,
net of balances acquired (see Note 3 - Business Combinations):
Deferred income taxes 18,595 13,081
Change in reserves for future policy benefits 10,005 11,746
Change in policy and contract claims (4,795) (682)
Change in deferred policy acquisition costs (47,527) (34,405)
Amortization of present value of future profits and other intangibles 3,687 2,246
Net accretion of bond discount (2,612) (2,613)
Amortization of capitalized loan origination fees 507 2,119
Change in policy loans 693 (34)
Change in accrued investment income 1,601 (615)
Change in reinsurance balances 6,302 12,640
Realized gains on investments (9,286) (1,878)
Change in income taxes payable (12,584) (1,493)
Other, net 97 2,474
--------- ---------
Net cash provided by operating activities 11,151 32,550
--------- ---------
Cash flows from investing activities:
Proceeds from sale or redemption of fixed maturities 265,531 221,808
Cost of fixed maturities purchased (247,243) (286,771)
Proceeds from sale of equity securities 733 2,104
Cost of equity securities purchased - (697)
Change in other invested assets 551 6
Change in due from / to broker (21,666) (1,404)
Purchase of business, net of cash acquired (Note 3) (65,961) (58,940)
Other investing activities (3,011) (861)
--------- ---------
Net cash used by investing activities (71,066) (124,755)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 3,790 4,852
Cost of treasury stock purchases (319) (477)
Change in policyholder account balances 41,522 87,680
Change in reinsurance on policyholder account balances (34) 827
Principal repayment on loan payable (4,391) (6,887)
Early extinguishment of debt (Note 10) - (62,950)
Issuance of new debt (Note 10) 66,519 65,000
Issuance of trust preferred securities (Note 11) - 40,000
--------- ---------
Net cash provided by financing activities 107,087 128,045
--------- ---------
Net increase in cash and cash equivalents 47,172 35,840
Cash and cash equivalents at beginning of period 116,524 36,754
--------- ---------
Cash and cash equivalents at end of period $ 163,696 $ 72,594
========= =========
Supplemental cash flow information:
Cash paid during the period for interest $ 5,449 $ 3,497
========= =========
Cash paid during the period for income taxes $ 17,207 $ 4,061
========= =========
See notes to unaudited consolidated financial statements.
7
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim financial information herein is unaudited, but in the opinion
of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results of operations for the three months and
nine months ended September 30, 2004 and 2003 are not necessarily indicative of
the results to be expected for the full year. The accompanying consolidated
financial statements and notes should be read in conjunction with the Company's
Annual Report on Form 10-K for the year ended December 31, 2003. Certain
reclassifications have been made to prior year's financial statements to conform
to current period classifications.
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP") and
consolidate the accounts of Universal American Financial Corp. ("Universal
American") and its subsidiaries (collectively the "Company"), 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"), 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"), Penncorp Life Insurance Company, a Canadian company
("Penncorp Life (Canada)"), The Pyramid Life Insurance Company ("Pyramid Life"),
Heritage Health Systems, Inc., including SelectCare of Texas, L.L.C.
(collectively "Heritage") and CHCS Services, Inc. ("CHCS").
Pyramid Life was acquired on March 31, 2003 and Heritage was acquired on
May 28, 2004. Operating results for these entities prior to the date of their
respective acquisitions are not included in Universal American's consolidated
results of operations.
Collectively, the insurance company subsidiaries are licensed to sell life
and accident & health insurance and annuities in all fifty states, the District
of Columbia, Puerto Rico and all the provinces of Canada. The principal
insurance products currently sold by the Company are Medicare Supplement and
Select, fixed benefit accident and sickness disability insurance, senior life
insurance and fixed annuities. The Company distributes these products through an
independent general agency system and a career agency system. The career agents
focus on sales for Pennsylvania Life, Pyramid Life and Penncorp Life (Canada)
while the independent general agents sell for American Pioneer, American
Progressive, Constitution and Union Bankers. Heritage operates Medicare
Advantage plans in Houston and Beaumont Texas, and our Medicare Advantage
private fee-for-service plan in the northeastern portion of the United States.
CHCS, the Company's administrative services company, acts as a service provider
for both affiliated and unaffiliated insurance companies for senior market
insurance and non-insurance programs.
2. RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities", an interpretation of Accounting Research Bulletin No. 51, which
requires an entity to assess its interests in a variable interest entity to
determine whether to consolidate that entity. A variable interest entity is an
entity in which the equity investment at risk is not sufficient to permit the
entity to finance its activities without additional subordinated support from
other parties or the equity investors do not have the characteristics of a
controlling financial interest. FIN 46 requires that a variable interest entity
be consolidated by its primary beneficiary, which is the party that will absorb
a majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both.
8
The provisions of FIN 46 were effective immediately for variable interest
entities created after January 31, 2003 and for variable interest entities for
which the Company obtains an interest after that date. For any variable interest
entities acquired prior to February 1, 2003, the provisions of the
interpretation of FIN 46, as amended by FASB Staff Position No. 46-6, are
effective for the quarter ending December 31, 2003. An interpretation of FIN 46
was issued in December 2003, which allows the Company to defer the effective
date for consolidation of variable interest entities to the first reporting
period that ends after March 15, 2004. Adoption of the provisions of the
interpretation FIN 46 did not have a material impact on the consolidated
financial condition or results of operations.
In December 2003, the FASB issued a revised version of FIN 46 ("FIN 46R"),
which incorporates a number of modifications and changes made to the original
version. FIN 46R replaces the previously issued FIN 46 and, subject to certain
special provisions, is effective no later than the end of the first reporting
period that ends after December 15, 2003 for entities considered to be
special-purpose entities and no later than the end of the first reporting period
that ends after March 15, 2004 for all other variable interest entities
("VIEs"). Although early adoption was permitted, the Company adopted FIN 46R in
the first quarter of 2004. The adoption of FIN 46R resulted in the
deconsolidation of the VIEs that issued mandatorily redeemable preferred
securities of a subsidiary trust ("trust preferred securities"). The sole assets
of the VIEs are junior subordinated debentures issued by the Company with
repayment terms identical to the trust preferred securities. Previously, the
trust preferred securities were reported as a separate liability on the
Company's balance sheet as "company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior subordinated debentures".
The dividends on the trust preferred securities were reported as interest
expense. As a result of the deconsolidation, the liability for the junior
subordinated debentures issued by the Company to the subsidiary trusts are
reported as a separate liability in the Company's balance sheet as "other long
term debt". See Note 11 - Other Long Term Debt for a description of the trust
preferred securities.
In July 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued a final Statement of Position
03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1").
SOP 03-1 addresses a wide variety of topics, however, the primary provision that
applies to the Company relates to capitalizing sales inducements that meet
specified criteria and amortizing such amounts over the life of the contracts
using the same methodology as used for amortizing deferred acquisition costs.
The Company adopted SOP 03-1 effective January 1, 2004.
The Company currently offers enhanced or bonus crediting rates to
contract-holders on certain of its individual annuity products. The Company's
policy in this regard was to defer only the portion of the bonus interest amount
that was offset by a corresponding reduction in the sales commission to the
agent. Effective January 1, 2004, all bonus interest was deferred and amortized.
The adoption of SOP 03-1 did not have a material impact on the consolidated
financial position or results of operations of the Company.
The Company has various stock-based compensation plans for its employees,
directors and agents, which are more fully described in Note 9 to the
Consolidated Financial Statements included in the Company's 2003 Annual Report
on Form 10-K. The Company uses the fair value method of accounting for
stock-based awards granted to agents, however, as permitted by Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", ("SFAS 123"), the Company measures its stock-based compensation
for employees and directors using the intrinsic value approach under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees".
Accordingly, the Company does not recognize compensation expense upon the
issuance of its stock options when the option terms are fixed and the exercise
price equals the market price of the underlying common stock on the grant date.
The Company has not yet adopted the fair value method of accounting for
stock-based compensation provisions of SFAS 123 for its employees or directors.
9
On December 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure" ("SFAS 148"). This
standard amends SFAS 123 to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. This standard also requires prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company has applied the disclosure provisions of SFAS 148 as of
December 31, 2003, as required and presented below. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting period. The following table illustrates the pro forma
net income and pro forma earnings per share as if the Company had applied the
fair value based method of accounting to all stock-based awards during each
period presented (using the Black-Scholes option-pricing model for stock
options).
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2004 2003 2004 2003
-------- ------- ------- -------
(In thousands, except per share amounts)
Reported net income $ 19,542 $11,416 $46,468 $29,964
Add back: Stock-based
compensation expense included in
reported net income, net of tax 271 409 333 1,101
Less: Stock based compensation
expense determined under fair
value based method for all
awards, net of tax (754) (797) (1,412) (2,104)
-------- ------- ------- -------
Pro forma net income $ 19,059 $11,028 $45,389 $28,961
======== ======= ======= =======
Net income per share:
Basic, as reported $ 0.36 $ 0.21 $ 0.85 $ 0.56
Basic, pro forma $ 0.35 $ 0.21 $ 0.83 $ 0.54
Diluted, as reported $ 0.34 $ 0.21 $ 0.82 $ 0.55
Diluted, pro forma $ 0.34 $ 0.20 $ 0.80 $ 0.53
Pro forma compensation expense reflected for prior periods is not
indicative of future compensation expense that would be recorded by the Company
if it were to adopt the fair value based recognition provisions of SFAS 123 for
stock-based compensation for its employees and directors. Future expense may
vary based upon factors such as the number of awards granted by the Company, the
then-current fair market value of such awards.
Pending Accounting Standards
In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" ("EITF 03-1"). EITF 03-1 adopts a three-step
impairment model for securities within its scope. The three-step model must be
applied on a security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is
impaired if the fair value of the investment is less than its
amortized cost basis.
Step 2: Evaluate whether an impairment is other-than-temporary. For debt
securities that cannot be contractually prepaid or otherwise
settled in such a way that the investor would not recover
substantially all of its cost, an impairment is deemed
other-than-temporary if the investor does not have the ability and
intent to hold the investment until a forecasted market price
recovery or it is probable that the investor will be unable to
collect all amounts due according to the contractual terms of the
debt security.
Step 3: If the impairment is other-than-temporary, recognize an
impairment loss equal to the difference between the investment's
cost basis and its fair value.
10
Subsequent to an other-than-temporary impairment loss, a debt security
should be accounted for in accordance with Statement of Position ("SOP") 03-3,
"Accounting for Loans and Certain Debt Securities Acquired in a Transfer". EITF
03-1 does not replace the impairment guidance for investments accounted for
under EITF Issue 99-20, "Recognition of Interest Income and Impairments on
Purchased and Retained Beneficial Interests in Securitized Financial Assets"
("EITF 99-20"), however, investors will be required to determine if a security
is other-than-temporarily impaired under EITF 03-1 if the security is determined
not to be impaired under EITF 99-20. The disclosure provisions of EITF 03-1
adopted by the Company effective December 31, 2003 and included in Note 6 -
Investments of the consolidated financial statements included in the Company's
2003 Annual Report on Form 10-K will prospectively include securities subject to
EITF 99-20.
In September 2004, the FASB staff issued clarifying guidance for comment
in FSP EITF Issue 03-1-a, "Implementation Guidance for the Application of
Paragraph 16 of EITF Issue No. 03-1, 'The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments'", (FSP 03-1-a) and
subsequently voted to delay the implementation of the impairment measurement and
recognition guidance contained in paragraphs 10-20 of EITF 03-1 in order to
reconsider certain aspects of the consensus as well as the implementation
guidance included in FSP 03-1-a. The disclosure guidance in paragraphs 21 and
22 of the standard remains effective.
The ultimate impact the adoption of EITF 03-1 will have on the Company's
consolidated financial condition and results of operations is still unknown.
Depending on the nature of the ultimate guidance, adoption of the standard could
potentially result in the recognition of unrealized losses, including those
declines in value that are attributable to interest rate movements, as
other-than-temporary impairments, except those deemed to be minor in nature. As
of September 30, 2004, the Company had $3.9 million of total gross unrealized
losses. The amount of impairments to be recognized, if any, will depend on the
final standard, market conditions and management's intent and ability to hold
securities with unrealized losses at the time of the impairment evaluation.
3. BUSINESS COMBINATIONS
Acquisition of Pyramid Life
On March 31, 2003, the Company completed the acquisition of all of the
outstanding common stock of Pyramid Life. As part of this transaction, the
Company acquired a block of in-force business as well as a career sales force
that is skilled in selling senior market insurance products. The purchase price
of $57.5 million and transaction costs of $2.4 million were financed with $20.1
million of net proceeds generated from the refinancing of the Company's credit
facility and $39.8 million of cash on hand (See Note 10 - Loan Payable and Note
11 - Other Long Term Debt). Operating results generated by Pyramid Life prior to
March 31, 2003, the date of acquisition, are not included in the Company's
consolidated financial statements.
At the time of closing, the fair value of net tangible assets of the
acquired company amounted to $27.6 million. The excess of the purchase price
over the fair value of net tangible assets acquired was $32.3 million. At March
31, 2003, the Company performed the initial allocation of the excess to
identifiable intangible assets. Based on this initial allocation, approximately
$13.1 million, net of deferred income taxes of $7.1 million, was assigned to the
present value of future profits acquired, which has a weighted average life of 7
years. Approximately $14.3 million, net of deferred income taxes of $7.7
million, was assigned to the distribution channel acquired, which has a weighted
average life of 30 years. The value of the distribution channel represents the
projected new sales production from the career distribution established by
Pyramid Life. Pyramid Life distributes its products on an exclusive basis
through Senior Sales Solution Centers. The remaining $4.9 million was assigned
to the value of the trademarks and licenses acquired, which are deemed to have
an indefinite life.
11
Acquisition of Heritage Health Systems, Inc.
On May 28, 2004, the Company acquired 100% of the outstanding common stock
of Heritage, a privately owned managed care company that operates Medicare
Advantage plans in Houston and Beaumont Texas, for $98 million in cash plus
transaction costs of $1.6 million. Founded in 1995, Heritage generates its
revenues and profits from three sources. First, Heritage owns an interest in
SelectCare of Texas, L.L.C. ("SelectCare") a health plan that offers coverage to
Medicare beneficiaries under a contract with the federal government's Centers
for Medicare & Medicaid Services, ("CMS"). Next, Heritage operates three
separate Management Service Organizations ("MSO's") that manage the business of
SelectCare and two affiliated Independent Physician Associations ("IPA's").
Last, Heritage participates in the net results derived from these IPA's. The
acquisition was financed with $66.5 million of net proceeds derived from the
amendment of the Company's credit facility (See Note 10 - Loan Payable) and
$33.1 million of cash on hand. As of the date of acquisition, Heritage had
approximately 16,000 Medicare members and annualized revenues of approximately
$140 million. Operating results generated by Heritage prior to May 28, 2004, the
date of acquisition, are not included in the Company's consolidated financial
statements.
On the acquisition date, the fair value of net tangible assets of Heritage
amounted to $21.2 million. The excess of the purchase price over the fair value
of net tangible assets acquired was $78.4 million. As of May 28, 2004, the
Company performed the initial allocation of the excess to identifiable
intangible assets. Based on this initial allocation, approximately $14.6 million
was assigned to amortizing intangible assets, including $12.1 million, net of
deferred income taxes of $6.5 million, which was assigned to the value of the
membership in force, and was determined to have a weighted average life of 6
years and $2.5 million, net of deferred taxes of $1.3 million which was assigned
to the IPA's, which were determined to have a weighted average lives of between
6 and 13 years. Approximately $5.8 million was allocated to non-amortizing
intangible assets, including $5.1 million assigned to the value of trademarks
and $0.7 million assigned to the value of Heritage's licenses. Each of these
items was determined to have indefinite lives. The balance of $57.8 million was
assigned to goodwill.
The consolidated pro forma results of operations, assuming that Pyramid
Life and Heritage were purchased on January 1, 2004 and 2003 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2004 2003 2004 2003
----------- ------------ ------------ ------------
(In thousands, except per share amounts)
Total revenue $ 203,721 $ 171,956 $ 586,354 $ 501,667
Income before taxes (1) $ 29,318 $ 18,671 $ 75,116 $ 49,616
Net income (1) $ 19,542 $ 11,764 $ 49,515 $ 32,024
Earnings per common share:
Basic $ 0.36 $ 0.22 $ 0.91 $ 0.60
Diluted (1) $ 0.34 $ 0.21 $ 0.88 $ 0.58
(1) The above pro forma results of operations includes excess
amortization of capitalized loan fees of $1.9 million in 2003
as a result of the assumed refinancing of the existing debt at
January 1, 2003. This additional expense reduced net income by
$1.2 million or $0.02 per diluted share in 2003. The actual
amount of excess amortization reported in 2003 was $1.8
million.
The pro forma results of operations reflect management's best estimate
based upon currently available information. The pro forma adjustments are
applied to the historical financial statements of Universal American, Pyramid
Life and Heritage to account for Pyramid Life and Heritage under the purchase
method of accounting. In accordance with SFAS No. 141, "Business Combinations",
the total purchase cost was allocated to the assets and liabilities of Pyramid
Life and Heritage based on their relative fair values. These allocations are
subject to valuations as of the date of the acquisition based upon appraisals
and other information at that time. Management has provided its best estimate of
the fair values of assets and liabilities for the purpose of this pro forma
information. The pro forma information presented above is for disclosure
purposes only and is not necessarily indicative of the results of operations
that would have occurred if the acquisition had been consummated on the dates
assumed, nor is the pro forma information intended to be indicative of Universal
American's future results of operations.
12
4. INTANGIBLE ASSETS
The following table shows the Company's acquired intangible assets that
continue to be subject to amortization and accumulated amortization expense.
SEPTEMBER 30, 2004 DECEMBER 31, 2003
----------------------------- -----------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------------- ------------ -------------- ------------
(In thousands)
Present value of future profits:
Career Agency $20,208 $ 3,212 $20,208 $ 1,784
Senior Market Brokerage 2,391 1,182 2,391 974
Medicare Advantage 18,554 1,031 - -
Administrative Services 7,671 6,969 7,672 6,770
Value of future override fees 1,797 134 1,820 20
Value of IPAs 3,846 155 - -
Distribution Channel - Career Agency 22,055 1,103 22,055 551
------- ------- ------- -------
Total $76,522 $13,786 $54,146 $10,099
======= ======= ======= =======
The following table shows the changes in the present value of future
profits and other amortizing intangible assets.
Nine months ended September 30, 2004 2003
- ------------------------------- -------- --------
(In thousands)
Balance, beginning of year $ 44,047 $ 2,986
Additions and adjustments 22,376 44,061
Amortization, net of interest (3,687) (2,246)
-------- --------
Balance, end of period $ 62,736 $ 44,801
======== ========
Estimated future net amortization expense (in thousands) for the
succeeding five years is as follows:
2004 (Remainder of year) $ 1,784
2005 6,868
2006 6,776
2007 6,616
2008 6,246
Thereafter 34,446
-------
Total $62,736
=======
The carrying amounts of goodwill and intangible assets with indefinite
lives are shown below.
September 30, December 31,
2004 2003
------------- ------------
(In thousands)
Career Agency $ 4,867 $ 4,867
Senior Market Brokerage 3,893 3,893
Medicare Advantage 63,594 -
Administrative Services 4,357 4,357
------------- ------------
Total $ 76,711 $ 13,117
============= ============
13
5. REINSURANCE TRANSACTIONS
Recapture of Reinsurance Ceded
Effective April 1, 2003, American Pioneer entered into agreements to
recapture approximately $48 million of Medicare Supplement business that had
previously been reinsured to Transamerica Occidental Life Insurance Company,
Reinsurance Division ("Transamerica") under two quota share contracts. In 1996,
American Pioneer entered into two reinsurance treaties with Transamerica.
Pursuant to the first of these contracts, American Pioneer ceded to Transamerica
90% of approximately $50 million of annualized premium that it had acquired from
First National Life Insurance Company in 1996. Under the second contract, as
subsequently amended, American Pioneer agreed to cede to Transamerica 75% of
certain new business from October 1996 through December 31, 1999. As of April 1,
2003, approximately $27 million remained ceded under the First National treaty
and approximately $16 million remained ceded under the new business treaty.
As part of an effort to exit certain non-core lines of business,
Transamerica approached the Company in 2002 to determine our interest in
recapturing the two treaties. Under the terms of the recapture agreements,
Transamerica transferred approximately $18 million in cash to American Pioneer
to cover the statutory reserves recaptured by American Pioneer. No ceding
allowance was paid by American Pioneer in the recapture. American Pioneer
currently retains 100% of the risks on the current in force amount remaining of
the block of $48 million of Medicare Supplement business. There was no gain or
loss incurred on these recapture agreements.
Acquisition of Guarantee Reserve Marketing Organization
Effective July 1, 2003, Universal American entered into an agreement with
Swiss Re and its newly acquired subsidiary, Guarantee Reserve Life Insurance
Company ("Guarantee Reserve"), to acquire Guarantee Reserve's marketing
organization, including all rights to do business with its field force. The
primary product sold by this marketing organization is low face amount whole
life insurance.
Beginning July 1, 2003, the Guarantee Reserve field force continued to
write this business in Guarantee Reserve, with Universal American administering
all new business and assuming 50% of the risk through a quota share reinsurance
arrangement. Beginning in the second quarter of 2004, as the products were
approved for sale in each state, the new business was written by a Universal
American subsidiary, with 50% of the risk ceded to Swiss Re.
6. EARNINGS PER SHARE
The reconciliation of the numerators and the denominators of the basic and
diluted earnings per share is as follows:
INCOME SHARES PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, 2004 (NUMERATOR) (DENOMINATOR) AMOUNT
- ------------------------------------------ ---------- ------------ ---------
(In thousands, other than per share amounts)
Weighted average common stock outstanding 54,960
Less: Weighted average treasury shares (133)
------------
Basic earnings per share $ 19,542 54,827 $ 0.36
========== =========
Effect of Dilutive Securities 1,897
------------
Diluted earnings per share $ 19,542 56,724 $ 0.34
========== ============ =========
INCOME SHARES PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, 2003 (NUMERATOR) (DENOMINATOR) AMOUNT
- ------------------------------------------ ---------- ------------ ---------
(In thousands, other than per share amounts)
Weighted average common stock outstanding 53,837
Less: weighted average treasury shares (103)
------------
Basic earnings per share $ 11,416 53,734 $ 0.21
========== =========
Effect of Dilutive Securities 1,598
------------
Diluted earnings per share $ 11,416 55,332 $ 0.21
========== ============ =========
14
INCOME SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, 2004 (NUMERATOR) (DENOMINATOR) AMOUNT
- ------------------------------------------ ---------- ------------ ---------
(In thousands, other than per share amounts)
Weighted average common stock outstanding 54,619
Less: weighted average treasury shares (162)
------------
Basic earnings per share $ 46,468 54,457 $ 0.85
========== =========
Effect of Dilutive Securities 1,968
------------
Diluted earnings per share $ 46,468 56,425 $ 0.82
========== ============ =========
INCOME SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, 2003 (NUMERATOR) (DENOMINATOR) AMOUNT
- ------------------------------------------ ---------- ------------ ---------
(In thousands, other than per share amounts)
Weighted average common stock outstanding 53,521
Less: weighted average treasury shares (150)
------------
Basic earnings per share $ 29,964 53,371 $ 0.56
========== =========
Effect of Dilutive Securities 1,386
------------
Diluted earnings per share $ 29,964 54,757 $ 0.55
========== ============ =========
7. INVESTMENTS
Fixed maturity securities are classified as investments available for sale
and are 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.
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
CLASSIFICATION COST GAINS LOSSES VALUE
- ------------------------------------- ---------- ---------- ---------- ----------
(In thousands)
SEPTEMBER 30, 2004
US Treasury securities
and obligations of US government $ 75,075 $ 716 $ (177) $ 75,614
Corporate debt securities 487,642 30,969 (2,751) 515,860
Foreign debt securities (1) 213,467 19,274 (300) 232,441
Mortgage- and asset-backed securities 304,937 7,180 (650) 311,467
---------- ---------- ---------- ----------
$1,081,121 $ 58,139 $ (3,878) $1,135,382
========== ========== ========== ==========
DECEMBER 31, 2003
US Treasury securities
and obligations of US government $ 74,187 $ 695 $ (219) $ 74,663
Corporate debt securities 544,744 36,892 (4,988) 576,648
Foreign debt securities (1) 218,011 19,041 (118) 236,934
Mortgage- and asset-backed securities 245,012 8,711 (576) 253,147
---------- ---------- ---------- ----------
$1,081,954 $ 65,339 $ (5,901) $1,141,392
========== ========== ========== ==========
(1) Primarily Canadian dollar denominated bonds owned by our Canadian insurance
subsidiary.
The amortized cost and fair value of fixed maturities by contractual
maturity are shown below. Expected maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
SEPTEMBER 30, 2004
------------------
AMORTIZED FAIR
COST VALUE
----------- ----------
(In thousands)
Due in 1 year or less $ 26,718 $ 26,920
Due after 1 year through 5 years 182,178 194,435
Due after 5 years through 10 years 322,536 343,431
Due after 10 years 244,752 259,128
Mortgage - and asset-backed securities 304,937 311,468
----------- ----------
$ 1,081,121 $1,135,382
=========== ==========
15
During the nine months ended September 30, 2004, the Company did not write
down the value of any fixed maturity securities. During the nine months ended
September 30, 2003, the Company wrote down the value of certain fixed maturity
securities by $0.5 million. These write downs represent management's estimate of
other than temporary declines in value and were included in net realized gains
on investments in our consolidated statement of operations.
8. COMPREHENSIVE INCOME
The components of other comprehensive income and the related tax effects
for each component are as follows:
2004 2003
-------------------------------- --------------------------------
GROSS OF NET OF GROSS OF NET OF
THREE MONTHS ENDED SEPTEMBER 30, TAX TAX EFFECT TAX TAX TAX EFFECT TAX
- ----------------------------------- -------- ---------- -------- -------- ---------- -------
(In thousands)
Net unrealized gain (loss)arising
during the year (net of deferred
acquisition cost adjustment) $ 31,216 $ 10,926 $ 20,290 $(12,635) $ (4,421) $(8,214)
Less: Reclassification adjustment
for gains included in net income (5,485) (1,920) (3,565) (582) (204) (378)
-------- ---------- -------- -------- ---------- -------
Net unrealized gains (losses) 25,731 9,006 16,725 (13,217) (4,625) (8,592)
Cash flow hedge (594) (208) (386) - - -
Currency translation adjustments 2,360 826 1,534 (459) (161) (298)
-------- ---------- -------- -------- ---------- -------
Other comprehensive income (loss) $ 27,497 $ 9,624 $ 17,873 $(13,676) $ (4,786) $(8,890)
======== ========== ======== ======== ========== =======
2004 2003
--------------------------------- ---------------------------------
GROSS OF NET OF GROSS OF NET OF
NINE MONTHS ENDED SEPTEMBER 30, TAX TAX EFFECT TAX TAX TAX EFFECT TAX
- ------------------------------------ ------- ---------- ------- -------- ---------- --------
(In thousands)
Net unrealized gain (loss) arising
during the year (net of deferred
acquisition cost adjustment) $ 5,999 $ 2,100 $ 3,899 $ 14,888 $ 5,207 $ 9,681
Less: Reclassification adjustment
for gains included in net income (9,286) (3,250) (6,036) (1,878) (657) (1,221)
-------- ---------- ------- -------- ---------- --------
Net unrealized gains (losses) (3,287) (1,150) (2,137) 13,010 4,550 8,460
Cash flow hedge 351 123 228 - - -
Currency translation adjustments 747 261 486 7,114 2,490 4,624
-------- ---------- ------- -------- ---------- --------
Other comprehensive income (loss) $ (2,189) $ (766) $(1,423) $ 20,124 $ 7,040 $ 13,084
======== ========== ======= ======== ========== ========
9. STOCKHOLDERS' EQUITY
Common Stock
The par value of common stock is $.01 per share with 100 million shares
authorized for issuance. The shareholders approved a proposal to amend the
Company's Restated Certificate of Incorporation to increase the number of
authorized shares of common stock, par value $0.01 per share, from 80 million
shares to 100 million shares at the Annual Meeting on May 26, 2004. The Board of
Directors of the Company (the "Board") has concluded that increasing the number
of authorized shares of common stock will give the Company the ability to react
quickly to future growth opportunities for the Company. Although the Board has
no specific plans or commitments for the issuance of any of the additional
shares that would be authorized by the amendment, the Board believes that the
increase in the number of authorized shares will provide flexibility for actions
the Company might wish to take, such as paying for acquisitions with stock of
the Company, equity offerings to raise capital, distributing stock splits or
stock dividends and granting new awards under employee benefit plans.
16
Changes in the number of shares of common stock issued were as follows:
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003
- -------------------------------------------------------- ---------- ----------
Common stock issued, beginning of year 54,111,923 53,184,381
Stock options exercised 1,001,074 368,867
Stock issued in connection with acquisition - 147,711
Agent stock award - 31,770
Stock purchases pursuant to agents' stock purchase plans 11,977 352,039
---------- ----------
Common stock issued, end of period 55,124,974 54,084,768
========== ==========
Treasury Stock
The Board approved a plan to repurchase up to 1.5 million shares of
Company stock in the open market. The primary purpose of the plan is to fund
employee stock bonuses.
2004 2003
----------------------------- -----------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
COST PER COST PER
NINE MONTHS ENDED SEPTEMBER 30, SHARES AMOUNT SHARE SHARES AMOUNT SHARE
- ------------------------------- ------ ------ -------- ------ ------ --------
(In thousands) (In thousands)
Treasury stock beginning of year 192,863 $1,390 $ 7.21 241,076 $1,320 $ 5.48
Shares repurchased 30,448 319 10.49 72,978 477 6.54
Shares distributed in the form of
employee bonuses (98,851) (746) 10.12 (189,931) (1,043) 5.58
------- ------ -------- ------
Treasury stock, end of period 124,460 963 $ 7.74 124,123 $ 754 $ 6.08
======= ====== ======== ======
Through September 30, 2004, the Company had repurchased 790,638 shares at
an aggregate cost of $4.4 million. As of September 30, 2004, 709,362 shares
remained available for repurchase under the program. Additional repurchases may
be made from time to time at prevailing prices, subject to restrictions on
volume and timing.
Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income are as follows:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ ------------
(in thousands)
Net unrealized appreciation on investments $ 54,266 $ 59,464
Deferred acquisition cost adjustment (3,074) (4,985)
Foreign currency translation gains (losses) 7,263 6,516
Fair value of cash flow swap 547 196
Deferred income taxes on the above (20,651) (21,417)
------------ ------------
Accumulated other comprehensive income $ 38,351 $ 39,774
============ ============
10. LOAN PAYABLE
Credit Facility, as Amended in May 2004
In connection with the acquisition of Pyramid Life (see Note 3 - Business
Combinations), the Company obtained an $80 million credit facility (the "Credit
Agreement") on March 31, 2003 to repay the then existing loan and provide funds
for the acquisition of Pyramid Life. The Credit Agreement consisted of a $65
million term loan which was drawn to fund the acquisition and a $15 million
revolving loan facility. The Credit Agreement initially called for interest at
the London Interbank Offering Rate ("LIBOR") for one, two or three months, at
the option of the Company, plus 300 basis points. Effective March 31, 2004, the
spread over LIBOR was reduced to 275 basis points in accordance with the terms
of the Credit Agreement. Principal repayments were scheduled over a five-year
period with a final maturity date of March 31, 2008. The Company incurred loan
origination fees of approximately $2.1 million, which were capitalized and are
being amortized on a straight-line basis over the life of the Credit Agreement.
As of the end of the March 31, 2004, the outstanding balance of the term loan
was $36.4 million.
17
In connection with the acquisition of Heritage on May 28, 2004 (see Note 3
- - Business Combinations), the Company amended the Credit Agreement by increasing
the facility to $120 million from $80 million (the "Amended Credit Agreement"),
including an increase in the term loan portion to $105 million from $36.4
million (the balance outstanding at May 28, 2004) and maintaining the $15
million revolving loan facility. None of the revolving loan facility has been
drawn as of September 30, 2004. Under the Amended Credit Agreement, the spread
over LIBOR was reduced to 225 basis points. Effective November 1, 2004, the
interest rate on the term loan is 4.3%. Principal repayments are scheduled at
$5.3 million per year over a five-year period with a final payment of $80.1
million due upon maturity on March 31, 2009. The Company incurred additional
loan origination fees of approximately $2.1 million, which were capitalized and
are being amortized on a straight-line basis over the life of the Amended Credit
Agreement along with the continued amortization of the origination fees incurred
in connection with the Credit Agreement. The Company pays an annual commitment
fee of 50 basis points on the unutilized revolving loan facility. The
obligations of the Company under the Amended Credit Facility are guaranteed by
WorldNet Services Corp., CHCS Services Inc., CHCS Inc., Quincy Coverage
Corporation, Universal American Financial Services, Inc., Heritage, HHS-HPN
Network, Inc., Heritage Health Systems of Texas, Inc., PSO Management of Texas,
LLC, HHS Texas Management, Inc. and HHS Texas Management LP (collectively the
"Guarantors") and secured by substantially all of the assets of each of the
Guarantors. In addition, as security for the performance by the Company of its
obligations under the Amended Credit Facility, the Company, WorldNet Services
Corp., CHCS Services Inc., Heritage and HHS Texas Management, Inc. have each
pledged and assigned substantially all of their respective securities (but not
more than 65% of the issued and outstanding shares of voting stock of any
foreign subsidiary), all of their respective limited liability company and
partnership interests, all of their respective rights, title and interest under
any service or management contract entered into between or among any of their
respective subsidiaries and all proceeds of any and all of the foregoing.
The Amended Credit Facility requires the Company and its subsidiaries to
meet certain financial tests, including a minimum fixed charge coverage ratio, a
minimum risk based capital test and a minimum consolidated net worth test. The
Amended Credit Facility also contains covenants, which among other things, limit
the incurrence of additional indebtedness, dividends, capital expenditures,
transactions with affiliates, asset sales, acquisitions, mergers, prepayments of
other indebtedness, liens and encumbrances and other matters customarily
restricted in such agreements.
The Amended Credit Facility contains customary events of default,
including, among other things, payment defaults, breach of representations and
warranties, covenant defaults, cross-acceleration, cross-defaults to certain
other indebtedness, certain events of bankruptcy and insolvency and judgment
defaults.
The Company made regularly scheduled principal payments of $4.4 million
and paid $2.0 million in interest and fees in connection with its credit
facilities during the nine months ended September 30, 2004. During the nine
months ended September 30, 2003, the Company made regularly scheduled principal
payments of $6.9 million and paid $2.3 million in interest and fees in
connection with its credit facilities.
The following table shows the schedule of principal payments (in
thousands) remaining on the Amended Credit Agreement, as of September 30, 2004,
with the final payment in May 2009:
2004 (Remainder of year) $ 1,312
2005 5,250
2006 5,250
2007 5,250
2008 5,250
2009 80,063
---------
$ 102,375
=========
2003 Refinancing of Debt
On March 31, 2003, the Credit Facility issued in 1999 was repaid from the
proceeds of the Credit Agreement obtained in connection with the acquisition of
Pyramid Life. The early extinguishment of this debt resulted in the immediate
amortization of the related capitalized loan origination fees, resulting in a
pre-tax expense of approximately $1.8 million.
18
11. OTHER LONG TERM DEBT
The Company has formed statutory business trusts, which exist for the
exclusive purpose of issuing trust preferred securities representing undivided
beneficial interests in the assets of the trust, investing the gross proceeds of
the trust preferred securities in junior subordinated deferrable interest
debentures of the Company (the "Junior Subordinated Debt") and engaging in only
those activities necessary or incidental thereto. In accordance with the
adoption of FIN 46R, the Company has deconsolidated the trusts. For further
discussion of the adoption of FIN 46R, see Note 2 - Recent and Pending
Accounting Pronouncements.
Separate subsidiary trusts of the Company (the "Trusts") have issued a
combined $75.0 million in thirty year trust preferred securities (the "Capital
Securities") as of September 30, 2004, as detailed in the following table:
Amount Spread Rate as of
Maturity Date Issued Term Over LIBOR September 30, 2004
- ------------- -------------- -------------- -------------- ------------------
(In thousands) (Basis points)
December 2032 $ 15,000 Fixed/Floating 400(1) 6.7%
March 2033 10,000 Floating 400 5.6%
May 2033 15,000 Floating 420 6.0%
May 2033 15,000 Fixed/Floating 410(2) 7.4%
October 2033 20,000 Fixed/Floating 395(3) 7.0%
--------
$ 75,000
========
(1) Effective September 2003, the Company entered into a swap agreement
whereby it will pay a fixed rate of 6.7% in exchange for a floating rate
of LIBOR plus 400 basis points. The swap contract expires in December
2007.
(2) The rate on this issue is fixed at 7.4% for the first five years, after
which it is converted to a floating rate equal to LIBOR plus 410 basis
points.
(3) Effective April 29, 2004, the Company entered into a swap agreement
whereby it will pay a fixed rate of 6.98% in exchange for a floating rate
of LIBOR plus 395 basis points. The swap contract expires in October 2008.
The Trusts have the right to call the Capital Securities at par after five
years from the date of issuance. The proceeds from the sale of the Capital
Securities, together with proceeds from the sale by the Trusts of their common
securities to the Company, were invested in thirty-year floating rate Junior
Subordinated Debt of the Company. From the proceeds of the trust preferred
securities, $26.0 million was used to pay down debt during 2003. The balance of
the proceeds has been used, in part to fund acquisitions, to provide capital to
the Company's insurance subsidiaries to support growth and to be held for
general corporate purposes.
The Capital Securities represent an undivided beneficial interest in the
Trusts' assets, which consist solely of the Junior Subordinated Debt. Holders of
the Capital Securities have no voting rights. The Company owns all of the common
securities of the Trusts. Holders of both the Capital Securities and the Junior
Subordinated Debt are entitled to receive cumulative cash distributions accruing
from the date of issuance, and payable quarterly in arrears at a floating rate
equal to the three-month LIBOR plus a spread. The floating rate resets quarterly
and is limited to a maximum of 12.5% during the first sixty months. Due to the
variable interest rate for these securities, the Company would be subject to
higher interest costs if short-term interest rates rise. The Capital Securities
are subject to mandatory redemption upon repayment of the Junior Subordinated
Debt at maturity or upon earlier redemption. The Junior Subordinated Debt is
unsecured and ranks junior and subordinate in right of payment to all present
and future senior debt of the Company and is effectively subordinated to all
existing and future obligations of the Company's subsidiaries. The Company has
the right to redeem the Junior Subordinated Debt after five years from the date
of issuance.
19
The Company has the right at any time, and from time to time, to defer
payments of interest on the Junior Subordinated Debt for a period not exceeding
20 consecutive quarters up to each debenture's maturity date. During any such
period, interest will continue to accrue and the Company may not declare or pay
any cash dividends or distributions on, or purchase, the Company's common stock
nor make any principal, interest or premium payments on or repurchase any debt
securities that rank equally with or junior to the Junior Subordinated Debt. The
Company has the right at any time to dissolve the Trusts and cause the Junior
Subordinated Debt to be distributed to the holders of the Capital Securities.
The Company has guaranteed, on a subordinated basis, all of the Trusts'
obligations under the Capital Securities including payment of the redemption
price and any accumulated and unpaid distributions to the extent of available
funds and upon dissolution, winding up or liquidation but only to the extent the
Trusts have funds available to make such payments.
The Company paid $3.5 million in interest in connection with the Junior
Subordinated Debt during the nine months ended September 30, 2004, and paid $1.3
million during the nine months ended September 30, 2003.
12. DERIVATIVE INSTRUMENTS - CASH FLOW HEDGE
Effective September 4, 2003, the Company entered into a swap agreement
whereby it pays a fixed rate of 6.7% on a $15.0 million notional amount relating
to the December 2002 trust preferred securities issuance, in exchange for a
floating rate of LIBOR plus 400 basis points, capped at 12.5%. The swap contract
expires in December 2007. Effective April 29, 2004, the Company entered into a
second swap agreement whereby it pays a fixed rate of 6.98% on a $20.0 million
notional amount relating to the October 2003 trust preferred securities
issuance, in exchange for a floating rate of LIBOR plus 395 basis points, capped
at 12.45%. The swap contract expires in October 2008. The swaps are designated
and qualify as cash flow hedges, and changes in their fair value are recorded in
accumulated other comprehensive income. As of September 30, 2004, the fair value
of the swaps was $0.5 million and is included in other assets. As of September
30, 2003, the fair value of the swap was $(40) thousand and is included in other
liabilities.
13. STATUTORY FINANCIAL DATA
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 our insurance subsidiaries' operations.
Additionally, the National Association of Insurance Commissioners ("NAIC")
imposes regulatory risk-based capital ("RBC") requirements on life insurance
enterprises. At September 30, 2004, all of our insurance subsidiaries maintained
ratios of total adjusted capital to RBC in excess of the "authorized control
level". The combined statutory capital and surplus, including asset valuation
reserve, of the U.S. insurance subsidiaries totaled $123.8 million at September
30, 2004 and $111.5 million at September 30, 2003. Statutory net income for the
nine months ended September 30, 2004 was $3.6 million, which included net
realized gains of $0.4 million, and for the nine months ended September 30, 2003
was $6.5 million, which included net realized gains of $0.3 million.
Penncorp Life (Canada) reports to Canadian regulatory authorities based
upon Canadian statutory accounting principles that vary in some respects from
U.S. statutory accounting principles. Penncorp Life (Canada)'s net assets based
upon Canadian statutory accounting principles were C$59.0 million (US$46.8
million) as of September 30, 2004 and were C$60.3 million (US$44.5 million) as
of September 30, 2003. Net income based on Canadian generally accepted
accounting principles was C$7.1 million (US$5.3 million) for the nine months
ended September 30, 2004 and was C$7.8 million (US$5.4 million) for the nine
months ended September 30, 2003. Penncorp Life (Canada) maintained a Minimum
Continuing Capital and Surplus Requirement Ratio ("MCCSR") in excess of the
minimum requirement at September 30, 2004.
20
14. BUSINESS SEGMENT INFORMATION
The Company's principal business segments are: Career Agency, Senior
Market Brokerage, Medicare Advantage and Administrative Services. The Company
also reports the corporate activities of our holding company in a separate
segment. A description of these segments follows:
CAREER AGENCY -- The Career Agency segment is comprised of the operations of
Pennsylvania Life, Penncorp Life (Canada), and, beginning March 31, 2003,
Pyramid Life. Pennsylvania Life and Pyramid Life operate in the United States,
while Penncorp Life (Canada) operates exclusively in Canada. This segment's
products include Medicare Supplement/Select, other supplemental senior health
insurance, fixed benefit accident and sickness disability insurance, life
insurance, and fixed annuities. These products are distributed by career agents
who are under contract with Pennsylvania Life, Pyramid Life or Penncorp Life
(Canada).
SENIOR MARKET BROKERAGE -- This segment includes the operations of American
Pioneer, American Progressive, Constitution and Union Bankers, which distribute
senior market products through non-exclusive general agency and brokerage
distribution systems. The products sold include Medicare Supplement/Select, long
term care, senior life insurance and fixed annuities.
MEDICARE ADVANTAGE - The Medicare Advantage segment includes the operations of
Heritage and our other initiatives in Medicare managed care. Heritage operates
Medicare Advantage plans in Houston and Beaumont Texas, and our Medicare
Advantage private fee-for-service plan in the northeastern portion of the United
States. Founded in 1995, Heritage generates its revenues and profits from three
sources. First, Heritage owns an interest in SelectCare, a health plan that
offers coverage to Medicare beneficiaries under a contract with the federal
government's Centers for Medicare & Medicaid Services, ("CMS"). Next, Heritage
operates three separate Management Service Organizations ("MSO's") that manage
the business of SelectCare and two affiliated Independent Physician Associations
("IPA's"). Last, Heritage participates in the net results derived from these
IPA's. Our Medicare Advantage private fee-for-service plans were introduced
during the second quarter of 2004.
ADMINISTRATIVE SERVICES -- CHCS acts as a third-party administrator and service
provider for both affiliated and unaffiliated insurance companies, primarily
with respect to senior market insurance products and non-insurance products. The
services provided include policy underwriting and issuance, telephone and
face-to-face verification, policyholder services, claims adjudication, case
management, care assessment and referral to health care facilities.
CORPORATE -- This segment reflects the activities of Universal American,
including the payment of interest on our debt, certain senior executive
compensation, and the expense of being a public company.
Intersegment revenues and expenses are reported on a gross basis in each of the
operating segments but are eliminated in the consolidated results. These
intersegment revenues and expenses affect the amounts reported on the individual
financial statement line items, but are eliminated in consolidation and 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 and Senior Market
Brokerage segments and interest on notes payable by the Corporate segment to the
other operating segments.
21
Financial results by segment are as follows:
2004 2003
--------------------------- ----------------------------
Income (Loss) Income (Loss)
Before Before
THREE MONTHS ENDED SEPTEMBER 30, Revenue Income Taxes Revenue Income Taxes
- -------------------------------- ----------- ------------ ----------- -------------
(In thousands)
Career Agency $ 77,256 $ 15,839 $ 71,889 $ 13,294
Senior Market Brokerage 78,292 3,487 64,957 3,498
Medicare Advantage 39,533 4,942 - -
Administrative Services 14,075 3,096 12,044 2,888
Corporate 16 (3,531) 65 (2,565)
Intersegment revenues (10,936) - (9,734) -
----------- ------------ ----------- -------------
Segment total (1) 198,236 23,833 139,221 17,115
Adjustments to segment total:
Net realized gains (1) 5,485 5,485 582 582
----------- ------------ ----------- -------------
Total $ 203,721 $ 29,318 $ 139,803 $ 17,697
=========== ============ =========== =============
2004 2003
--------------------------- ----------------------------
Income (Loss) Income (Loss)
Before Before
NINE MONTHS ENDED SEPTEMBER 30, Revenue Income Taxes Revenue Income Taxes
- -------------------------------- ----------- ------------ ----------- -------------
(In thousands)
Career Agency $ 229,037 $ 42,128 $ 184,073 $ 32,484
Senior Market Brokerage 229,913 12,441 180,869 11,906
Medicare Advantage 51,491 5,780 - -
Administrative Services 42,000 9,583 36,352 8,085
Corporate 86 (8,790) 135 (8,360)
Intersegment revenues (33,047) - (27,482) -
----------- ------------ ----------- -------------
Segment total (1) 519,480 61,142 373,947 44,115
Adjustments to segment total:
Net realized gains (1) 9,286 9,286 1,878 1,878
----------- ------------ ----------- -------------
Total $ 528,766 $ 70,428 $ 375,825 $ 45,993
=========== ============ =========== =============
(1) We evaluate the results of operations of our segments based on income
before realized gains and losses and income taxes. Management believes
that realized gains and losses are not indicative of overall operating
trends. The schedule above reconciles our segment revenue to total revenue
and segment income to net income in accordance with generally accepted
accounting principles.
Identifiable assets by segment are as follows:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ ------------
(In thousands)
Career Agency $ 985,285 $ 945,911
Senior Market Brokerage 811,473 785,054
Medicare Advantage 133,729 -
Administrative Services 23,027 19,321
Corporate 586,507 475,377
Intersegment assets (1) (579,519) (444,715)
------------ ------------
Total Assets $ 1,960,502 $ 1,780,948
============ ============
(1) Intersegment assets include the elimination of the parent holding
company's investment in its subsidiaries as well as the elimination of
other intercompany balances.
22
15. FOREIGN OPERATIONS
A portion of the operations of the Company's Career Agency segment is
conducted in Canada through Penncorp Life (Canada). These assets and liabilities
are located in Canada where the insurance risks are written. Revenues, excluding
capital gains, of the Career Agency segment by geographic area are as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(In thousands, in US$'s) (In thousands, in US$'s)
Revenues
United States $ 60,750 $ 55,934 $ 178,793 $ 137,051
Canada 16,506 15,955 50,244 47,022
--------- --------- --------- ---------
Total $ 77,256 $ 71,889 $ 229,037 $ 184,073
========= ========= ========= =========
Total assets and liabilities of Penncorp Life (Canada), which are located
entirely in Canada, are as follows:
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ -----------
(In thousands)
Assets $ 217,884 $ 236,185
============ ===========
Liabilities $ 175,441 $ 175,253
============ ===========
23
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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," "estimate," "plan," "intend" 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.
As a result of our acquisition of Heritage, the Company is exposed to additional
risks and uncertainties. The risks and uncertainties described below are those
that we currently believe may materially affect our company. Additional risks
and uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations.
NEW RISK FACTORS
RISKS RELATED TO OUR MEDICARE ADVANTAGE BUSINESS
IF OUR GOVERNMENT CONTRACTS ARE NOT RENEWED OR ARE TERMINATED, OUR BUSINESS
COULD BE SUBSTANTIALLY IMPAIRED.
We provide our Medicare and other services through a limited number of contracts
with federal government agencies. These contracts generally have terms of one or
two years and are subject to nonrenewal by the applicable agency. All of our
government contracts are terminable for cause if we breach a material provision
of the contract or violate relevant laws or regulations. In addition, our right
to add new members may be suspended by a government agency if it finds
deficiencies in our provider network or operations.
If we are unable to renew, or to successfully rebid or compete for any of our
government contracts, or if any of our contracts are terminated, our business
could be substantially impaired. If any of those circumstances were to occur, we
would likely pursue one or more alternatives, including seeking to enter into
contracts in other geographic markets, seeking to enter into contracts for other
services in our existing markets, or seeking to acquire other businesses with
existing government contracts. If we were unable to do so, we could be forced to
cease conducting business. In any such event, our revenues and profits would
decrease materially.
24
IF WE ARE UNABLE TO MANAGE MEDICAL BENEFITS EXPENSE EFFECTIVELY, OUR
PROFITABILITY WILL LIKELY BE REDUCED OR WE COULD CEASE TO BE PROFITABLE.
The profitability of our Medicare Advantage business depends, to a significant
degree, on our ability to predict and effectively manage our costs related to
the provision of healthcare services. Relatively small changes in the ratio of
our expenses related to healthcare services to the premiums we receive, or
medical loss ratio, can create significant changes in our financial results.
Factors that may cause medical benefits expense to exceed our estimates include:
- an increase in the cost of healthcare services and supplies,
including pharmaceuticals, whether as a result of inflation or
otherwise;
- higher than expected utilization of healthcare services;
- periodic renegotiation of hospital, physician and other provider
contracts;
- the occurrence of catastrophes, major epidemics, terrorism or
bio-terrorism;
- changes in the demographics of our members and medical trends
affecting them; and
- new mandated benefits or other changes in healthcare laws,
regulations and/or practices.
Because of the relatively high average age of the Medicare population, medical
benefits expense for our Medicare plans may be particularly difficult to
control. According to the Centers for Medicare & Medicaid Services ("CMS"), from
1967 to 2002, Medicare healthcare expenses nationwide increased on average by
13.2% annually.
Although we have been able to manage our medical benefits expense through a
variety of techniques, including various payment methods to primary care
physicians and other providers, advance approval for hospital services and
referral requirements, medical management and quality management programs,
upgraded information systems, and reinsurance arrangements, we may not be able
to continue to manage these expenses effectively in the future. If our medical
benefits expense increases, our profits could be reduced or we may not remain
profitable.
We maintain reinsurance to protect us against severe or catastrophic medical
claims, but we cannot assure you that such reinsurance coverage currently is or
will be adequate or available to us in the future or that the cost of such
reinsurance will not limit our ability to obtain it.
BECAUSE OUR MEDICARE ADVANTAGE PREMIUMS, WHICH GENERATE MOST OF OUR MEDICARE
ADVANTAGE REVENUES, ARE FIXED BY CONTRACT, WE ARE UNABLE TO INCREASE OUR
MEDICARE ADVANTAGE PREMIUMS DURING THE CONTRACT TERM IF OUR CORRESPONDING
MEDICAL BENEFITS EXPENSE EXCEEDS OUR ESTIMATES.
Most of our Medicare Advantage revenues are generated by premiums consisting of
fixed monthly payments per member. These payments are fixed by contract, and we
are obligated during the contract period, which is generally one or two years,
to provide or arrange for the provision of healthcare services as established by
state and federal governments. We have less control over costs related to the
provision of healthcare services than we do over our selling, general and
administrative expense. Medical benefits expense as a percentage of premium
revenue tends to fluctuate. If our medical benefits expense exceeds our
estimates, we will be unable to adjust the premiums we receive under our current
contracts, and our profits may decline.
REDUCTIONS IN FUNDING FOR GOVERNMENT HEALTHCARE PROGRAMS COULD SUBSTANTIALLY
REDUCE OUR PROFITABILITY.
All of our Medicare Advantage programs we offer are through government-sponsored
programs, such as Medicare. As a result, our profitability is dependent, in
large part, on continued funding for government healthcare programs at or above
current levels. For example, the premium rates paid to health plans like ours by
state and federal governments differ depending on a combination of factors such
as upper payment limits established by the state and federal governments, a
member's health status, age, gender, county or region, benefit mix and member
eligibility categories. In addition, CMS has adopted a payment program, whereby,
in 2004, 30% of the premium rates paid to health plans relate to specific
disease classification of members. In 2007, 100% of premium rates will be based
upon the specific disease classification of members. Reductions in payments
under Medicare or the other programs under which we offer health plans could
likewise reduce our profitability.
25
Federal budgetary constraints also may limit premiums payable under our Medicare
plans. For example, as a result of the Balanced Budget Act of 1997, annual
increases on premiums paid to many Medicare+Choice plans (renamed "Medicare
Advantage" plans) through 2003 were subject to a 2% cap, even though overall
Medicare healthcare expenses were increasing at a higher rate.
WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION, AND ANY VIOLATION OF THE LAWS
AND REGULATIONS APPLICABLE TO US COULD REDUCE OUR REVENUES AND PROFITABILITY AND
OTHERWISE ADVERSELY AFFECT OUR OPERATING RESULTS.
Our Medicare Advantage business is extensively regulated by the federal
government and the states in which we operate. The laws and regulations
governing our Medicare Advantage operations are generally intended to benefit
and protect health plan members and providers rather than stockholders. The
government agencies administering these laws and regulations have broad latitude
to enforce them. These laws and regulations, along with the terms of our
government contracts, regulate how we do business, what services we offer, and
how we interact with our members, providers and the public. We are subject, on
an ongoing basis, to various governmental reviews, audits and investigations to
verify our compliance with our contracts and applicable laws and regulations.
Any adverse review, audit or investigation could result in:
- forfeiture of amounts we have been paid pursuant to our government
contracts;
- imposition of civil or criminal penalties, fines or other sanctions
on us;
- loss of our right to participate in government-sponsored programs,
including Medicare;
- damage to our reputation in various markets;
- increased difficulty in marketing our products and services; and
- loss of one or more of our licenses to act as an insurer or health
maintenance organization or to otherwise provide a service.
Any of these events could reduce our revenues and profitability and otherwise
adversely affect our operating results.
WE DERIVE A SUBSTANTIAL PORTION OF OUR MEDICARE ADVANTAGE REVENUES AND PROFITS
FROM MEDICARE ADVANTAGE OPERATIONS IN TEXAS, AND LEGISLATIVE ACTIONS, ECONOMIC
CONDITIONS OR OTHER FACTORS THAT ADVERSELY AFFECT THOSE OPERATIONS COULD
MATERIALLY REDUCE OUR REVENUES AND PROFITS.
If we are unable to continue to operate in Texas, or if our current operations
in any portion of Texas are significantly curtailed, our revenues will decrease
materially. Our reliance on our operations in Texas could cause our revenues and
profitability to change suddenly and unexpectedly, depending on legislative
actions, economic conditions and similar factors. In addition, our significant
market share in Texas may make it more difficult for us to expand our membership
in existing markets in Texas. Our inability to continue to operate in Texas, or
a decrease in the revenues of our Texas operations, would harm our overall
operating results.
WE MAY NOT BE ABLE TO REALIZE THE BENEFITS WE ANTICIPATE FROM THE ACQUISITION OF
HERITAGE.
As a result of our recent acquisition of Heritage, we will face significant
challenges in integrating organizations, operations, technology and services in
a timely and efficient manner and in retaining key personnel. Cost savings,
revenue growth and other anticipated benefits of the acquisition may not
materialize. The acquisition may result in a diversion of our management's
attention, loss of management-level and other key employees of Heritage, and an
inability to integrate management, systems and operations. The failure to
integrate Heritage successfully and to manage the challenges presented by the
integration process may result in our not achieving the anticipated benefits of
the acquisition.
26
WE MAY BE UNABLE TO EXPAND INTO SOME GEOGRAPHIC AREAS WITHOUT INCURRING
SIGNIFICANT ADDITIONAL COSTS.
We are likely to incur additional costs if we enter states or counties where we
do not currently operate. Our rate of expansion into other geographic areas may
also be inhibited by:
- the time and costs associated with obtaining a health maintenance
organization license to operate in the new area or the expansion of
our licensed service area, if necessary;
- our inability to develop a network of physicians, hospitals and
other healthcare providers that meets our requirements and those of
government regulators;
- competition, which increases the costs of recruiting members;
- the cost of providing healthcare services in those areas; and
- demographics and population density.
Accordingly, we may be unsuccessful in entering other metropolitan areas,
counties or states.
A FAILURE TO ESTIMATE INCURRED BUT NOT REPORTED MEDICAL BENEFITS EXPENSE
ACCURATELY WILL AFFECT OUR PROFITABILITY.
Our medical benefits expense includes estimates of medical claims incurred but
not reported, or IBNR. We, together with our internal and consulting actuaries,
estimate our medical cost liabilities using actuarial methods based on
historical data adjusted for payment patterns, cost trends, product mix,
seasonality, utilization of healthcare services and other relevant factors.
Actual conditions, however, could differ from those assumed in the estimation
process. Due to the uncertainties associated with the factors used in these
assumptions, materially different amounts could be reported in our financial
statements for a particular period under different conditions or using different
assumptions. Adjustments, if necessary, are made to medical benefits expense
when the criteria used to determine IBNR change and when actual claim costs are
ultimately determined. Although our estimates of IBNR have historically been
adequate, they may be inadequate in the future, which would adversely affect our
results of operations. Further, our inability to estimate IBNR accurately may
also affect our ability to take timely corrective actions, further exacerbating
the extent of any adverse effect on our results.
THE NEW MEDICARE LEGISLATION MAKES CHANGES TO THE MEDICARE PROGRAM THAT COULD
REDUCE OUR PROFITABILITY AND INCREASE COMPETITION FOR OUR EXISTING AND
PROSPECTIVE MEMBERS.
On December 8, 2003, President Bush signed the Medicare Modernization Act of
2003. This legislation makes significant changes to the Medicare program. We
believe that many of these changes will benefit the managed care sector.
However, the new rate methodologies, expanded benefits and shifts in certain
coverage responsibilities pursuant to the Act may increase competition and
create uncertainties, including the following:
- The Act increases reimbursement for Medicare+Choice plans, which was
renamed "Medicare Advantage". Higher reimbursement rates may
increase the number of plans that participate in the program,
creating new competition that could adversely affect our
profitability.
- Beginning in 2006, a new regional Medicare Preferred Provider
Organization, or Medicare PPO, program will be implemented pursuant
to the Act. Medicare PPOs would allow their members more flexibility
to select physicians than the current plans, which are HMOs that
require members to coordinate with a primary care physician. The Act
requires the Secretary of the Department of Health and Human
Services to create between 10 and 50 regions for the Medicare PPO
program, with each region covering at least one state and some
possibly crossing state lines. The regional Medicare PPO program
will compete with local Medicare Advantage HMO programs and may
affect our Medicare Advantage HMO business. We do not know whether
the regions will be constructed in a way that will create obstacles
or opportunities for us to participate in the program. We also do
not know how the creation of the regional Medicare PPO program,
which is intended to provide further choice to beneficiaries, will
affect our Medicare Advantage HMO business.
- In order to participate in the regional Medicare Advantage PPO
program under the Act, a plan must meet certain requirements,
including having an adequate provider network throughout the region.
The Act provides some incentives for certain hospitals to join the
network. However, we
27
do not know whether we will be able to contract with a sufficient
number of providers throughout our regions to satisfy the network
adequacy requirements under the Act that would enable us to
participate in the regional product.
- Beginning in 2006, the payments for the local Medicare Advantage HMO
and regional Medicare Advantage PPO programs will be based on a
competitive bidding process that may decrease the amount of premiums
paid to us or cause us to increase the benefits we offer.
- Beginning in 2006, organizations that offer Medicare Advantage plans
of the type we currently offer will be required to offer a level
prescription drug benefit, as defined by Medicare. It is not known
at this time whether the governmental payments will be adequate to
cover the costs for this benefit. In addition, Medicare Advantage
enrollees will be required to obtain their drug benefit from their
Medicare Advantage plan. Enrollees may prefer a stand-alone drug
plan and may disenroll from the Medicare Advantage plan altogether
in order to participate in another drug plan. Accordingly, the new
prescription drug benefit could reduce our profitability and
membership enrollment following its implementation in 2006.
- Some enrollees may have chosen our Medicare+Choice plan in the past
rather than a Medicare fee-for-service program because of the added
drug benefit that we offer with our Medicare+Choice plan. Following
the implementation of the new prescription drug benefit, Medicare
beneficiaries will have the opportunity to obtain a drug benefit
without joining a managed care plan. As a result, our membership
enrollment may decline.
- Beginning in 2006, individuals eligible for both Medicare and
Medicaid, or dual-eligibles, will generally receive their drug
coverage from Medicare rather than from Medicaid. Because Medicaid
will no longer be directly responsible for most drug coverage for
dual-eligibles, Medicaid payments to plans will be reduced. We
cannot predict whether this change in Medicaid payments will have an
adverse effect on our operating results.
FUTURE CHANGES IN HEALTHCARE LAW MAY REDUCE OUR PROFITABILITY OR LIQUIDITY.
Healthcare laws and regulations, and their interpretations, are subject to
frequent change. Changes in existing laws or regulations, or their
interpretations, or the enactment of new laws or regulations could reduce our
profitability by:
- imposing additional capital requirements;
- increasing our administrative and other costs;
- increasing mandated benefits;
- forcing us to restructure our relationships with providers; or
- requiring us to implement additional or different programs and
systems.
Changes in state law also may adversely affect our profitability. Laws relating
to managed care consumer protection standards, including increased plan
information disclosure, limits to premium increases, expedited appeals and
grievance procedures, third party review of certain medical decisions, health
plan liability, access to specialists, clean claim payment timing, physician
collective bargaining rights and confidentiality of medical records either have
been enacted or continue to be under discussion. New healthcare reform
legislation may require us to change the way we operate our business, which may
be costly. Further, although we have exercised care in structuring our
operations to attempt to comply in all material respects with the laws and
regulations applicable to us, government officials charged with responsibility
for enforcing such laws may assert that we or certain transactions in which we
are involved are in violation of these laws, or courts may ultimately interpret
such laws in a manner inconsistent with our interpretation. Therefore, it is
possible that future legislation and regulation and the interpretation of laws
and regulations could have a material adverse effect on our ability to operate
under the Medicare program and to continue to serve our members and attract new
members.
28
RESTRICTIONS ON OUR ABILITY TO MARKET WOULD ADVERSELY AFFECT OUR REVENUE.
We rely on our marketing and sales efforts for a significant portion of our
membership growth. The federal and state governments in which we currently
operate permit marketing but impose strict requirements and limitations as to
the types of marketing activities that are permitted. If our marketing efforts
were to be prohibited or curtailed, our ability to increase or sustain
membership would be significantly harmed, which would adversely affect our
revenue.
IF WE ARE UNABLE TO MAINTAIN SATISFACTORY RELATIONSHIPS WITH OUR PROVIDERS, OUR
PROFITABILITY COULD DECLINE AND WE MAY BE PRECLUDED FROM OPERATING IN SOME
MARKETS.
Our profitability depends, in large part, upon our ability to enter into
cost-effective contracts with hospitals, physicians and other healthcare
providers in appropriate numbers in our geographic markets and at convenient
locations for our members. In any particular market, however, providers could
refuse to contract, demand higher payments or take other actions that could
result in higher medical benefits expense. In some markets, certain providers,
particularly hospitals, physician/hospital organizations or multi-specialty
physician groups, may have significant market positions or near monopolies. If
such a provider or any of our other providers refuse to contract with us, use
their market position to negotiate contracts that might not be cost-effective or
otherwise place us at a competitive disadvantage, those activities could
adversely affect our operating results in that market area. In the long term,
our ability to contract successfully with a sufficiently large number of
providers in a particular geographic market will affect the relative
attractiveness of our managed care products in that market and could preclude us
from renewing our Medicaid or Medicare contracts in those markets or from
entering into new markets.
Our provider contracts with network primary care physicians and specialists
generally have terms of one year, with automatic renewal for successive one-year
terms. We may terminate these contracts for cause, based on provider conduct or
other appropriate reasons, subject to laws giving providers due process rights.
The contracts generally may be cancelled by either party without cause upon 60
or 90 days prior written notice. Our contracts with hospitals generally have
terms of one to two years, with automatic renewal for successive one-year terms.
We may terminate these contracts for cause, based on provider misconduct or
other appropriate reasons. Our hospital contracts generally may be cancelled by
either party without cause upon 120 days prior written notice. We may be unable
to continue to renew such contracts or enter into new contracts enabling us to
serve our members profitably. We will be required to establish acceptable
provider networks prior to entering new markets. Although we have established
long-term relationships with many of our network providers, we may be unable to
maintain those relationships or enter into agreements with providers in new
markets on a timely basis or under favorable terms. If we are unable to retain
our current provider contracts or enter into new provider contracts timely or on
favorable terms, our profitability could decline.
WE MAY NOT HAVE ADEQUATE INTELLECTUAL PROPERTY RIGHTS IN OUR BRAND NAMES FOR OUR
HEALTH PLANS, AND WE MAY BE UNABLE TO ADEQUATELY ENFORCE SUCH RIGHTS.
Our success depends, in part, upon our ability to market our health plans under
our brand names, including "Texan Plus". While we hold federal trademark
registrations for the "Texan Plus" trademark, we have not taken enforcement
action to prevent infringement of our federal trademark and have not secured
registrations of our other marks. Other businesses may have prior rights in the
brand names that we market under or in similar names, which could limit or
prevent our ability to use these marks, or to prevent others from using similar
marks. If we are unable to prevent others from using our brand names, or if
others prohibit us from using them, our revenues could be adversely affected.
Even if we are able to protect our intellectual property rights in such brands,
we could incur significant costs in doing so.
29
INEFFECTIVE MANAGEMENT OF OUR GROWTH MAY ADVERSELY AFFECT OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND BUSINESS.
Depending on acquisition and other opportunities, we expect to continue to
increase our membership and to expand into other markets. Continued rapid growth
could place a significant strain on our management and on other resources. Our
ability to manage our growth may depend on our ability to strengthen our
management team and attract, train and retain skilled associates, and our
ability to implement and improve operational, financial and management
information systems on a timely basis. If we are unable to manage our growth
effectively, our financial condition and results of operations could be
materially and adversely affected. In addition, due to the initial substantial
costs related to potential acquisitions, rapid growth could adversely affect our
short-term profitability and liquidity.
WE ARE SUBJECT TO COMPETITION THAT MAY LIMIT OUR ABILITY TO INCREASE OR MAINTAIN
MEMBERSHIP IN THE MARKETS WE SERVE.
We operate in a highly competitive environment and in an industry that is
currently subject to significant changes due to business consolidations, new
strategic alliances and aggressive marketing practices by other managed care
organizations. We compete for members principally on the basis of size, location
and quality of provider network, benefits provided, quality of service and
reputation. A number of these competitive elements are partially dependent upon
and can be positively affected by financial resources available to a health
plan.
Many other organizations with which we compete have substantially greater
financial and other resources than we do. In addition, changes resulting from
the new Medicare legislation may bring additional competitors into our market
area. As a result, we may be unable to increase or maintain our membership.
WE HAVE INCURRED ADDITIONAL DEBT OBLIGATIONS IN CONNECTION WITH OUR ACQUISITION
OF HERITAGE THAT COULD RESTRICT OUR OPERATIONS.
We have a significant amount of outstanding indebtedness, including $102 million
in borrowings under our amended credit agreement and $75 million in trust
preferred securities. We have available borrowing capacity under our new senior
secured revolving credit facility of approximately $15 million. We may also
incur additional indebtedness in the future. Our substantial indebtedness could
have adverse consequences, including:
- increasing our vulnerability to adverse economic, regulatory and
industry conditions, and placing us at a disadvantage compared to
our competitors that are less leveraged;
- limiting our ability to compete and our flexibility in planning for,
or reacting to, changes in our business and the industry in which we
operate;
- limiting our ability to borrow additional funds for working capital,
capital expenditures, acquisitions and general corporate or other
purposes; and
- exposing us to greater interest rate risk since the interest rate on
borrowings under our senior credit facilities is variable.
Our debt service obligations will require us to use a portion of our operating
cash flow to pay interest and principal on indebtedness instead of for other
corporate purposes, including funding future expansion of our business and
ongoing capital expenditures. If our operating cash flow and capital resources
are insufficient to service our debt obligations, we may be forced to sell
assets, seek additional equity or debt capital or restructure our debt. However,
these measures might be unsuccessful or inadequate in permitting us to meet
scheduled debt service obligations.
30
CLAIMS RELATING TO MEDICAL MALPRACTICE AND OTHER LITIGATION COULD CAUSE US TO
INCUR SIGNIFICANT EXPENSES.
Our providers involved in medical care decisions may be exposed to the risk of
medical malpractice claims. A small percentage of these providers do not have
malpractice insurance. Although our network providers are independent
contractors, claimants sometimes allege that a managed care organization such as
us should be held responsible for alleged provider malpractice, and some courts
have permitted that theory of liability. In addition, managed care organizations
may be sued directly for alleged negligence, such as in connection with the
credentialing of network providers or for improper denials or delay of care. In
addition, Congress and several states are considering legislation that would
expressly permit managed care organizations to be held liable for negligent
treatment decisions or benefits coverage determinations.
From time to time, we are party to various other litigation matters, some of
which seek monetary damages. We cannot predict with certainty the eventual
outcome of any pending litigation or potential future litigation, and we might
incur substantial expense in defending these or future lawsuits or indemnifying
third parties with respect to the results of such litigation.
We maintain errors and omissions insurance with a policy limit of $10 million
and other insurance coverage and, in some cases, indemnification rights that we
believe are adequate based on industry standards. However, potential liabilities
may not be covered by insurance or indemnity, our insurers or indemnifying
parties may dispute coverage or may be unable to meet their obligations or the
amount of our insurance or indemnification coverage may be inadequate. We cannot
assure you that we will be able to obtain insurance coverage in the future, or
that insurance will continue to be available on a cost-effective basis, if at
all. Moreover, even if claims brought against us are unsuccessful or without
merit, we would have to defend ourselves against such claims. The defense of any
such actions may be time-consuming and costly, and may distract our management's
attention. As a result, we may incur significant expenses and may be unable to
effectively operate our business.
NEGATIVE PUBLICITY REGARDING THE MANAGED CARE INDUSTRY MAY HARM OUR BUSINESS AND
OPERATING RESULTS.
In the past, the managed care industry has received negative publicity. This
publicity has led to increased legislation, regulation, review of industry
practices and private litigation in the commercial sector. These factors may
adversely affect our ability to market our services, require us to change our
services and increase the regulatory burdens under which we operate, further
increasing the costs of doing business and adversely affecting our operating
results.
RESULTS OF OPERATIONS
INTRODUCTION
The following discussion and analysis presents a review of the Company as
of September 30, 2004 and its results of operations for the three months and
nine months ended September 30, 2004. This Management's Discussion and Analysis
of Financial Condition and Results of Operation should be read in conjunction
with the consolidated financial statements as well as the Management's
Discussion and Analysis of Financial Condition and Results of Operation included
in the Company's 2003 Annual Report on Form 10-K.
OVERVIEW
Our principal business segments are: Career Agency, Senior Market
Brokerage, Medicare Advantage and Administrative Services. We also report the
activities of our holding company in a separate segment. See Note 14 - Business
Segment Information in our consolidated financial statements included in this
Form 10-Q for a description of our segments.
31
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,
intangible assets, valuation of certain investments and deferred income taxes.
There have been no changes in our critical accounting policies during the
current quarter.
Policy related liabilities
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 extra contractual 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.
During the third quarter of 2004, we performed an experience study on the
duration assumption used in determining the claim reserves for the Freedom Care
business. Based on this study, we concluded that our long duration claims were
persisting slightly longer than provided for previously. Therefore, we revised
the duration assumption to reflect this finding, which resulted in an increase
to our 50% retained portion of the claim reserves of $1.4 million, pre-tax.
In connection with a conversion of the actuarial system used to determine
reserves on our Canadian policies during the third quarter of 2004, we
identified a non-recurring reduction in reserve in the amount of CAD$1.8 million
pre-tax (U.S.$1.3 million).
Deferred policy acquisition costs
The cost of acquiring new business, principally non-level commissions and
agency production, underwriting, policy issuance, and associated costs, all of
which vary with, and are primarily related to the production of new and renewal
business, have been deferred. For interest-sensitive life and annuity products,
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 SFAS 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 other life and health products,
these costs are amortized in proportion to premium revenue using the same
assumptions used in estimating the liabilities for future policy benefits in
accordance with SFAS No. 60, "Accounting and Reporting by Insurance
Enterprises."
32
The determination of expected gross profits for interest-sensitive
products is an inherently uncertain process that relies on assumptions including
projected interest rates, the persistency of the policies issued as well as
anticipated benefits, 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.
Present value of future profits and other intangibles
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, including the present value of future profits
and other identified intangibles, 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. Other identified intangibles are amortized over
their estimated lives.
On a periodic basis, management reviews the unamortized balances of
present value of future profits, goodwill and other identified intangibles 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 believes that no impairments of present value of future
profits, goodwill or other identified intangibles existed as of September 30,
2004.
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. Generally, 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 and we intend to hold the
security until maturity. 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.
33
Income taxes
We use the liability method to account for deferred income taxes. Under
the 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.
ACQUISITIONS AND FINANCING ACTIVITY
Acquisition of Heritage Health Systems, Inc.
On May 28, 2004, the Company acquired Heritage Health Systems, Inc.
("Heritage"), a privately owned managed care company that operates Medicare
Advantage plans in Houston and Beaumont Texas, for $98 million in cash plus
transaction costs of $1.6 million. Founded in 1995, Heritage generates its
revenues and profits from three sources. First, Heritage owns an interest in
SelectCare, a health plan that offers coverage to Medicare beneficiaries under a
contract with the federal government's Centers for Medicare & Medicaid Services,
("CMS"). Next, Heritage operates three separate Management Service Organizations
("MSO's") that manage the business of SelectCare and two affiliated Independent
Physician Associations ("IPA's"). Last, Heritage participates in the profits
derived from these IPA's. The acquisition was financed with $66.5 million of net
proceeds derived from the amendment of the Company's credit facility (See Note
10 - Loan Payable) and $33.1 million of cash on hand. As of the date of
acquisition, Heritage had approximately 16,000 Medicare members and annualized
revenues of approximately $140 million. Operating results generated by Heritage
prior to May 28, 2004, the date of acquisition, are not included in the
Company's consolidated financial statements. Refer to Note 3 - Business
Combinations in our consolidated financial statements included in this Form 10-Q
for additional information on the acquisition.
2004 Amendment of Credit Agreement
In connection with the acquisition of Heritage (see Note 3 - Business
Combinations in our consolidated financial statements included in this Form
10-Q) on May 28, 2004, we amended our credit facility to increase the term loan
to $105 million from $36.4 million (the balance outstanding at May 28, 2004). We
used the proceeds to fund the purchase of Heritage. Under the amended credit
agreement, the interest rate was reduced to 225 basis points over the London
Inter Bank Offering Rate. (Refer to Note 10 - Loan Payable in our consolidated
financial statements included in this Form 10-Q).
Acquisition of Guarantee Reserve Marketing Organization
Effective July 1, 2003, we entered into an agreement with Swiss Re and its
newly acquired subsidiary, Guarantee Reserve Life Insurance Company ("Guarantee
Reserve"), to acquire Guarantee Reserve's marketing organization including all
rights to do business with its field force. The primary product sold by this
marketing organization is low face amount whole life insurance.
Beginning July 1, 2003, the Guarantee Reserve field force continued to
write this business in Guarantee Reserve, with us administering all new business
and assuming 50% of the risk through a quota share reinsurance arrangement.
Beginning in the second quarter of 2004, as the products were approved for sale
in each state, the new business was written by our subsidiaries, with 50% of the
risk ceded to Swiss Re.
34
Recapture of Reinsurance Ceded
Effective April 1, 2003, our subsidiary, American Pioneer entered into
agreements to recapture approximately $48 million of Medicare Supplement
business that had previously been reinsured to Transamerica Occidental Life
Insurance Company, Reinsurance Division ("Transamerica") under two quota share
contracts. In 1996, American Pioneer entered into two reinsurance treaties with
Transamerica. Pursuant to the first of these contracts, American Pioneer ceded
to Transamerica 90% of approximately $50 million of annualized premium that it
had acquired from First National Life Insurance Company in 1996. Under the
second contract, as subsequently amended, American Pioneer agreed to cede to
Transamerica 75% of certain new business from October 1996 through December 31,
1999. As of April 1, 2003, approximately $27 million remained ceded under the
First National treaty and approximately $16 million remained ceded under the new
business treaty.
As part of an effort to exit certain non-core lines of business,
Transamerica approached the Company in 2002 to determine our interest in
recapturing the two treaties. Under the terms of the recapture agreements,
Transamerica transferred approximately $18 million in cash to American Pioneer
to cover the statutory reserves recaptured by American Pioneer. No ceding
allowance was paid by American Pioneer in the recapture. American Pioneer
currently retains 100% of the risks on the current in force amount remaining of
the block of $48 million of Medicare Supplement business. There was no gain or
loss reported on these recapture agreements.
Acquisition of Pyramid Life
On March 31, 2003, we acquired all of the outstanding common stock of
Pyramid Life. Pyramid Life specializes in selling health and life insurance
products to the senior market, including Medicare Supplement and Select, long
term care, life insurance, and fixed annuities. With this acquisition, we
acquired a $120 million block of in-force business, as well as a career sales
force that is skilled in selling senior market insurance products. Pyramid Life
markets its products in 26 states through a career agency sales force operating
out of Senior Solutions Sales Centers. During the full year 2003, Pyramid Life
agents produced more than $27 million of annualized new sales. Following a
transition period that took approximately ten months, the Pyramid Life business
has been fully transitioned into our existing operations, where we have been
able to take advantage of increased scale and efficiencies. Operating results
generated by Pyramid Life prior to the date of acquisition are not included in
our consolidated financial statements. Refer to Note 3 - Business Combinations
in our consolidated financial statements included in this Form 10-Q for
additional information on the acquisition.
2003 Refinancing of Debt
Prior to March 31, 2003, we had $38 million outstanding on our then
existing term loan credit facility. In connection with the acquisition of
Pyramid Life (see Note 3 - Business Combinations in our consolidated financial
statements included in this Form 10-Q) on March 31, 2003, we entered into a new
$80 million credit facility consisting of a $65 million term loan and a $15
million revolving loan facility. We used the proceeds from the new term loan to
repay the balance outstanding on our then existing term loan and to fund the
purchase of Pyramid Life. The early extinguishment of the existing debt resulted
in the immediate amortization of the related capitalized loan origination fees,
resulting in a pre-tax expense of approximately $1.8 million. A portion of the
proceeds from Trust preferred issuances in May 2003 and October 2003 (see the
discussion below) were used to reduce the balance of the term loan by $21.0
million during 2003. (Refer to Note 10 - Loan Payable in our consolidated
financial statements included in this Form 10-Q).
Trust Preferred Securities Issuances
During 2003, we issued $60.0 million of fixed and floating rate trust
preferred securities through subsidiary trusts which, including the $15.0
million issued in December 2002, results in a total of $75 million of such
securities outstanding. A portion of the proceeds was used to repay our existing
debt and the balance was retained at the parent company for general corporate
purposes (for more detailed information, see Note 11 - Other Long Term Debt in
our consolidated financial statements included in this Form 10-Q).
35
RESULTS OF OPERATIONS - CONSOLIDATED OVERVIEW
The following table reflects income from each of our segments(1) and
contains a reconciliation to reported net income:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
(In thousands)
Career Agency (1) $ 15,839 $ 13,294 $ 42,128 $ 32,484
Senior Market Brokerage (1) 3,487 3,498 12,441 11,906
Medicare Advantage (1) 4,942 - 5,780 -
Administrative Services (1) 3,096 2,888 9,583 8,085
Corporate & Eliminations (3,531) (2,565) (8,790) (8,360)
Realized gains (losses) 5,485 582 9,286 1,878
-------- -------- -------- --------
Income before income taxes (1) 29,318 17,697 70,428 45,993
Income taxes, excluding capital gains (7,856) (6,078) (20,710) (15,990)
Income taxes on capital gains (1,920) (203) (3,250) (657)
Income taxes on early extinguishment of debt - - - 618
-------- -------- -------- --------
Total income taxes (9,776) (6,281) (23,960) (16,029)
-------- -------- -------- --------
Net income $ 19,542 $ 11,416 $ 46,468 $ 29,964
======== ======== ======== ========
Per Share Data (Diluted):
Net income $ 0.34 $ 0.21 $ 0.82 $ 0.55
======== ======== ======== ========
(1) We evaluate the results of operations of our segments based on income
before realized gains and income taxes. Management believes that realized
gains and losses are not indicative of overall operating trends. 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 segment income to net income in accordance with
generally accepted accounting principles.
Three months ended September 30, 2004 and 2003
Net income for the third quarter of 2004 increased 71% to $19.5 million,
or $0.34 per share, compared to $11.4 million, or $0.21 per share in 2003.
During the third quarter of 2004, we recognized realized gains, net of tax, of
$3.6 million, or $0.06 per share, compared to realized gains, net of tax, of
$0.4 million, or $0.01 per share in 2003. We took the opportunity to realize
investment gains as interest rates dropped during the year to make efficient use
of our tax capital loss carryforwards. Our overall effective tax rate was 33.3%
for the third quarter of 2004 as compared to 35.5% for the third quarter of
2003.
Our Career Agency segment results improved by $2.5 million, or 19%, to
$15.8 million in the third quarter of 2004 compared to the third quarter of
2003. Profits for the third quarter of 2004 included a non-recurring reduction
in reserves in the amount of U.S.$1.3 million (CAD$1.8 million) which was
identified during a review of reserves in connection with a conversion of the
actuarial system used to determine reserves on our Canadian policies. Absent
this non-recurring benefit, profits increased by 9%.
Senior Market Brokerage segment profits for the third quarter of 2004 of
$3.5 million were consistent with the results for the third quarter of 2003.
However, during the third quarter of 2004, we increased reserves on the runoff
block of Florida home healthcare business by $1.4 million as a result of an
actuarial study performed on this block. Absent this reserve increase, which we
believe is non-recurring, profits increased by 39% over the third quarter of
2003. The increase was due primarily to higher revenues.
Administrative Services segment income improved by $0.2 million, or 7%,
compared to the third quarter of 2003. This improvement is primarily a result of
the growth in premiums managed.
36
The loss from the Corporate segment increased by $1.0 million, or 38%,
compared to the third quarter of 2003. The increase was due to higher interest
cost as a result of an increase in the amount of the debt outstanding during the
quarter, relating to the amendment of our credit facility in connection with our
acquisition of Heritage, offset in part, by a reduction in the weighted average
interest rates, as compared to the same period of 2003.
Nine months ended September 30, 2004 and 2003
Net income for the first nine months of 2004 increased 55% to $46.5
million, or $0.82 per share, compared to $30.0 million, or $0.55 per share in
2003. During the nine months of 2004, we recognized realized gains, net of tax,
of $6.0 million, or $0.10 per share, compared to realized gains, net of tax, of
$1.3 million, or $0.02 per share in 2003. The realized gains in 2004 were
generated at Penncorp Life (Canada) as a result of the sale of investments to
fund the dividend of approximately $19.6 million paid to the parent company
during the first quarter of 2004 and the tax payments made during the first
quarter of 2004 relating to 2003 taxable income. See "Liquidity and Capital
Resources - Obligations of the Parent Company to Affiliates" for additional
information regarding the dividend. Additionally, during the third quarter of
2004, we took the opportunity to realize investment gains as interest rates
dropped during the year to make efficient use of our tax capital loss
carryforwards. Our overall effective tax rate was 34.0% for the first nine
months of both 2004 and 34.9% for the same period of 2003.
Our Career Agency segment results improved by $9.6 million, or 30%, to
$42.1 million in the first nine months of 2004 compared to the first nine months
of 2003, primarily as a result of the acquisition of Pyramid Life, as well as
the strengthening of the Canadian dollar. Profits for the third quarter of 2004
also included a non-recurring reduction in reserves in the amount of U.S.$1.3
million (C$1.8 million) which was identified during a review of reserves in
connection with a conversion of the actuarial system used to determine reserves
on our Canadian policies. Absent this non-recurring benefit, profits increased
by 26%.
Senior Market Brokerage segment profits for the first nine months of 2004
increased $0.5 million, or 5%, to $12.4 million, compared to 2003. However,
during the third quarter of 2004, we increased reserves on the runoff block of
Florida home healthcare business by $1.4 million as a result of an actuarial
study performed on this block. Absent this reserve increase, which we believe is
non-recurring, profits increased by 16% over the first nine months of 2003. The
increase was due primarily to higher revenues.
Administrative Services segment income improved by $1.5 million, or 19%,
compared to the first nine months of 2003. This improvement is primarily a
result of the growth in premiums managed.
The loss from the Corporate segment decreased by $0.4 million, or 5%,
compared to the first nine months of 2003. During the first nine months of 2003,
the segment reported a charge relating to the early extinguishment of debt that
was incurred during the first quarter of 2003 that did not recur in 2004.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
SEGMENT RESULTS - CAREER AGENCY 2004 2003 2004 2003
- ------------------------------- --------- --------- --------- ---------
(In thousands)
Net premiums and policyholder fees:
Life and annuity $ 5,898 $ 5,942 $ 17,675 $ 15,109
Accident & health 61,079 56,509 181,507 141,208
--------- --------- --------- ---------
Net premiums 66,977 62,451 199,182 156,317
Net investment income 9,980 9,304 29,370 27,420
Other income 299 134 485 336
--------- --------- --------- ---------
Total revenue 77,256 71,889 229,037 184,073
--------- --------- --------- ---------
Policyholder benefits 40,683 37,545 124,309 97,500
Interest credited to policyholders 2,187 1,879 5,967 4,758
Change in deferred acquisition costs (8,036) (6,287) (23,918) (17,021)
Amortization of present value of future profits 726 878 1,980 1,726
Commissions and general expenses, net of allowances 25,857 24,580 78,571 64,626
--------- --------- --------- ---------
Total benefits, claims and other deductions 61,417 58,595 186,909 151,589
--------- --------- --------- ---------
Segment income $ 15,839 $ 13,294 $ 42,128 $ 32,484
========= ========= ========= =========
37
Three Months ended September 30, 2004 and 2003
Our Career Agency segment results improved by $2.5 million, or 19%, to
$15.8 million in the third quarter of 2004 compared to the third quarter of
2003. Profits for the third quarter of 2004 included a non-recurring reduction
in reserves in the amount of U.S.$1.3 million (C$1.8 million) which was
identified during a review of reserve in connection with a conversion of the
actuarial system used to determine reserves on our Canadian policies. Absent
this non-recurring benefit, profits increased by 9%. The operations of Penncorp
Life (Canada), which are included in the Career Agency segment results, are
transacted using the Canadian dollar as the functional currency. The Canadian
dollar has strengthened relative to the U.S. dollar. The average conversion rate
increased 5%, to C$0.7648 per US$1.00 for the three months ended September 30,
2004, from C$0.7264 per US$1.00 for the same period of 2003. This strengthening
added approximately $0.3 million to the Career Agency segment results for 2004,
compared to 2003. See discussion below under the heading "Quantitative and
Qualitative Disclosures about Market Risk" for additional information.
REVENUES. Net premiums during the three months ended September 30, 2004
for the Career Agency segment increased by approximately $4.5 million, or 7%,
compared to 2003. Canadian premiums accounted for approximately 22% of the net
premiums of this segment in the third quarter of 2004 and 21% of the net
premiums for the third quarter of 2003.
Our Career agents also sold $12.6 million of fixed annuities during the
three months ended September 30, 2004, compared to $15.0 million in 2003.
Annuity deposits are not considered premiums for reporting in accordance with
generally accepted accounting principles.
Net investment income increased by $0.7 million, or 7%, compared to the
third quarter of 2003. The increase in the segment's invested assets was
partially offset by a decrease in overall investment yields.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including
the change in reserves, increased by $3.1 million, or 8%, during the third
quarter of 2004 compared to 2003, primarily as a result of the increase in
business in force. Overall loss ratios for the segment increased to 61% in 2004
from 60% in 2003, despite the reduction in reserves noted above. Interest
credited increased by $0.3 million, due to the increase in annuity balances,
offset by a reduction in credited rates.
The increase in deferred acquisition costs was approximately $1.7 million
more in the third quarter of 2004, compared to the increase in the third quarter
of 2003. This is directly related to the increase in the new business added by
Pyramid Life, as well as continued sales of annuities generated by the segment.
The amortization of the present value of future profits relates to the
intangibles acquired with Pyramid Life.
Commissions and general expenses increased by approximately $1.3 million,
or 5%, in the third quarter of 2004 compared to 2003.
Nine Months ended September 30, 2004 and 2003
Our Career Agency segment results improved by $9.6 million, or 30%, to
$42.1 million in the first nine months of 2004 compared to the first nine months
of 2003, primarily as a result of the acquisition of Pyramid Life, as well as
the strengthening of the Canadian dollar. Profits for the third quarter of 2004
also included a non-recurring reduction in reserves in the amount of U.S.$1.3
million (C$1.8 million) which was identified during a review of reserve in
connection with a conversion of the actuarial system used to determine reserves
on our Canadian policies. Absent this non-recurring benefit, profits increased
by 26%. The operations of Penncorp Life (Canada), which are included in the
Career Agency segment results, are transacted using the Canadian dollar as the
functional currency. The Canadian dollar has strengthened relative to the U.S.
dollar. The average conversion rate increased 8%, to C$0.7531 per US$1.00 for
the nine months ended September 30, 2004, from C$0.7003 per US$1.00 for the same
period of 2003. This strengthening added approximately $0.8 million to the
Career Agency segment results for 2004, compared to 2003. See discussion below
under the heading "Quantitative and Qualitative Disclosures about Market Risk"
for additional information.
38
REVENUES. Net premiums during the nine months ended September 30, 2004 for
the Career Agency segment increased by approximately $42.9 million, or 27%,
compared to 2003, primarily as a result of the $35.2 million increase in
premiums from the Pyramid Life business. Canadian premiums accounted for
approximately 22% of the net premiums of this segment in 2004 and 25% of the net
premiums in 2003.
Our Career agents also sold $39.5 million of fixed annuities during the
nine months ended September 30, 2004, compared to $47.2 million in 2003. Annuity
deposits are not considered premiums for reporting in accordance with generally
accepted accounting principles.
Net investment income increased by approximately $2.0 million, or 7%,
compared to the first nine months of 2003. The increase is due to an increase in
the segment's invested assets from the acquisition of Pyramid Life (net of the
assets used to fund a portion of the acquisition) and the sale of annuities,
offset by a decrease in overall investment yields.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including
the change in reserves, increased by $26.8 million, or 28%, during the first
nine months of 2004 compared to 2003, primarily as a result of the increase in
business in force. Approximately $23.6 million of the increase relates to the
Pyramid Life business added in 2003. Overall loss ratios for the segment of 62%
in 2004 were consistent with 2003, despite the reduction in reserves noted
above. Interest credited increased by $1.2 million, due to the increase in
annuity balances as a result of the continued sales and the Pyramid business
added in 2003, offset by a reduction in credited rates.
The increase in deferred acquisition costs was approximately $6.9 million
more in the first nine months of 2004, compared to the increase in the first
nine months of 2003. This is directly related to the increase in the new
business added by Pyramid Life, as well as continued sales of annuities
generated by the segment. The amortization of the present value of future
profits relates to the intangibles acquired with Pyramid Life.
Commissions and general expenses increased by approximately $13.9 million,
or 23%, in the first nine months of 2004 compared to 2003. Approximately $9.6
million of the increase relates to the Pyramid Life business, with the balance
relating primarily to the increase in the segment's new business.
THREE MONTHS ENDED NINE MONTHS ENDED
SEGMENT RESULTS - SENIOR MARKET BROKERAGE SEPTEMBER 30, SEPTEMBER 30,
- ----------------------------------------- ---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(In thousands)
Net premiums and policyholder fees:
Life and annuity $ 7,616 $ 4,967 $ 21,251 $ 14,216
Accident & health 64,159 54,101 189,069 148,826
--------- --------- --------- ---------
Net premiums 71,775 59,068 210,320 163,042
Net investment income 6,409 5,763 19,086 17,536
Other income 108 126 507 291
--------- --------- --------- ---------
Total revenue 78,292 64,957 229,913 180,869
--------- --------- --------- ---------
Policyholder benefits 53,462 44,709 155,349 123,772
Interest credited to policyholders 2,551 2,384 7,249 6,362
Change in deferred acquisition costs (8,268) (8,810) (23,608) (17,384)
Amortization of present value of future profits 65 78 208 249
Commissions and general expenses, net of allowances 26,995 23,098 78,274 55,964
--------- --------- --------- ---------
Total benefits, claims and other deductions 74,805 61,459 217,472 168,963
--------- --------- --------- ---------
Segment income $ 3,487 $ 3,498 $ 12,441 $ 11,906
========= ========= ========= =========
39
The table below details the gross premiums and policyholder fees collected
for the major product lines in the Senior Market Brokerage segment and the
corresponding average amount of net premium retained after reinsurance. We
reinsure a substantial portion of our Senior Market Brokerage products to
unaffiliated third party reinsurers under various quota share coinsurance
agreements. Medicare supplement/select written premium is reinsured under quota
share coinsurance agreements ranging between 50% and 75% based upon the
geographic distribution of the underlying policies. We have also acquired
various blocks of Medicare supplement premium, which are 100% reinsured under
quota share coinsurance agreements. 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. In 2002 and 2003, we increased our retention on new Medicare
supplement/select business, causing the percentage of net retained premium to
increase as seen below. Additionally, the recapture of the Transamerica
treaties, effective April 1, 2003, and the new life business for Guarantee
Reserve, effective July, 1, 2003, increased the net retained premium. Beginning
in 2004, all new Medicare supplement/select business is 100% retained.
THREE MONTHS ENDED SEPTEMBER 30, 2004 2003
- ------------------------------- ------------------- -------------------
GROSS NET GROSS NET
PREMIUMS RETAINED PREMIUMS RETAINED
-------- -------- -------- --------
(In thousands)
Medicare supplement/select $110,712 54% $106,923 46%
Other senior supplemental health 6,003 62% 6,061 61%
Other health 2,649 42% 3,747 31%
Senior life insurance 8,081 62% 3,484 67%
Other life 3,316 79% 3,317 79%
-------- --------
Total gross premiums $130,761 55% $123,532 48%
======== ========
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003
- ------------------------------- ------------------- -------------------
GROSS NET GROSS NET
PREMIUMS RETAINED PREMIUMS RETAINED
-------- -------- -------- --------
(In thousands)
Medicare supplement/select $335,832 51% $322,970 36%
Other senior supplemental health 19,048 62% 19,323 60%
Other health 7,891 38% 11,099 33%
Senior life insurance 19,327 69% 9,554 66%
Other life 9,979 79% 10,180 78%
-------- --------
Total gross premiums $392,077 54% $373,126 44%
======== ========
Three Months ended September 30, 2004 and 2003
Senior Market Brokerage segment profits for the third quarter of 2004 of
$3.5 million were consistent with the results for the third quarter of 2003.
However, during the third quarter of 2004, we increased reserves on the runoff
block of Florida home healthcare business by $1.4 million as a result of an
actuarial study performed on this block. Absent this reserve increase, which we
believe is non-recurring, profits increased by 39% over the third quarter of
2003. The increase was due primarily to higher revenues.
REVENUES. Gross direct and assumed premiums written increased $7.2
million, or 6%, over the third quarter of 2003. Medicare supplement/select
premiums increased $3.8 million, or 4%, as a result of continued new sales, rate
increases and better than assumed persistency. Senior life insurance premiums
increased by $4.6 million, or 132%, due to organic growth, as well as the
addition of the premiums written by the Guarantee Reserve marketing
organization. These increases were partially offset by a decrease of $1.1
million, or 29%, in other health premiums, primarily as a result of the normal
lapsation of the run-off block of major medical business.
40
Net premiums for the third quarter of 2004 increased by $12.7 million, or
22%, compared to the same period of 2003. Net premiums grew faster than gross
premiums primarily as a result of our decision to reinsure fewer premiums and
retain more risk on our new business. This is reflected in the increase in the
percentage of the net amount of premium retained to 55% in 2004 from 48% in
2003.
Approximately $3.4 million in annuity deposits were received during the
three months ended September, 30, 2004 compared to $27.6 million during 2003.
The decline in annuity deposits is as a result of a reduction in the current
interest rates that we credit and minimum interest rates that we guarantee on
our annuity products. Annuity deposits are not considered premiums for
reporting in accordance with generally accepted accounting principles.
Net investment income increased by $0.6 million compared to the third
quarter of 2003, due to an increase in the segment's average invested assets of
approximately $51 million, partially offset by an overall decline in investment
yields.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including
the change in reserves, increased by approximately $8.8 million, or 20%,
compared to the third quarter of 2003, including the $1.4 million increase noted
above. The remainder of the increase is due primarily to the increase in our net
retained business as a result of the increase in our net retained new business
premium. However, the overall loss ratios for the segment improved to 74% for
the third quarter of 2004 (including 200 basis points from the reserve increase
noted above) from 76% for the third quarter of 2003. The loss ratios for our
Medicare supplement/select business were 67.5% for the third quarter of 2004
compared to 62.2% for the third quarter of 2003.
Interest credited to policyholders increased by $0.2 million, or 7%,
compared to the three months ended September 30, 2003 due to the continued
increase in annuity balances.
The increase in deferred acquisition costs in the third quarter of 2004
was approximately $0.5 million less than in the third quarter of 2003. The
increase was driven by our higher retention on new business and the increase in
our life insurance sales.
Commissions and other operating expenses increased by $3.9 million, or
39%, in the third quarter of 2004 compared to 2003. The following table details
the components of commission and other operating expenses:
THREE MONTHS ENDED SEPTEMBER 30, 2004 2003
- -------------------------------- --------- --------
(In thousands)
Commissions $ 20,714 $ 21,149
Other operating costs 18,554 17,007
Reinsurance allowances (12,273) (15,058)
--------- --------
Commissions and general expenses, net of allowances $ 26,995 $ 23,098
========= ========
The ratio of commissions to gross premiums decreased to 15.8% during the
third quarter of 2004, from 17.1% in 2003, as a result of the growth of the in
force renewal premium from better persistency and rate increases. Other
operating costs as a percentage of gross premiums increased to 14.2% during the
third quarter of 2004 compared to 13.8% in 2003, primarily as a result of the
Guarantee Reserve business which generally has higher costs of acquisition
compared to the segment's other lines of business. Commission and expense
allowances received from reinsurers as a percentage of the premiums ceded
decreased to 20.8% during the third quarter of 2004 compared to 23.4% in 2003,
primarily due to the reduction in new business ceded and the affects of normal
lower commission allowances on a growing base of renewal ceded business.
Nine Months ended September 30, 2004 and 2003
Senior Market Brokerage segment profits for the first nine months of 2004
increased $0.5 million, or 5%, to $12.4 million, compared to 2003. However,
during the third quarter of 2004, we increased reserves on the runoff block of
Florida home healthcare business by $1.4 million as a result of an actuarial
study performed on this block. Absent this reserve increase, which we believe is
non-recurring, profits increased by 16% over the first nine months of 2003. The
increase was due primarily to higher revenues.
41
REVENUES. Gross direct and assumed premiums written increased $19.0
million, or 5.1%, over the first nine months of 2003. Medicare supplement/select
premiums increased $12.9 million, or 4.0 %, over the first nine months of 2003
as a result of continued new sales, rate increases and better than assumed
persistency. Senior life insurance premiums increased by $9.8 million, or 102%,
due to organic growth, as well as the addition of the premiums written by the
Guarantee Reserve marketing organization. These increases were partially offset
by a decrease of $3.2 million, or 29%, in other health premiums, primarily as a
result of the normal lapsation of the run-off block of major medical business.
Net premiums for the first nine months of 2004 increased by $47.3 million,
or 29%, compared to the same period of 2003. Net premiums grew faster than gross
premiums primarily as a result of the recapture of the Transamerica treaties and
our decision to reinsure fewer premiums and retain more risk on our new
business. This is reflected in the increase in the percentage of the net amount
of premium retained to 54% in 2004 from 44% in 2003.
Approximately $15.4 million in annuity deposits were received during the
nine months ended September 30, 2004 compared to $54.3 million during 2003. The
decline in annuity deposits is as a result of a reduction in the current
interest rates that we credit and minimum interest rates that we guarantee on
our annuity products. Annuity deposits are not considered premiums for
reporting in accordance with generally accepted accounting principles.
Net investment income increased by $1.6 million compared to the first nine
months of 2003, due to an increase in the segment's average invested assets of
approximately $51 million, partially offset by an overall decline in investment
yields.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Policyholder benefits, including
the change in reserves, increased by approximately $31.6 million, or 26%,
compared to the first nine months of 2003, including the $1.4 million increase
noted above. The remainder of the increase is due primarily to the increase in
our net retained business as a result of the recapture of the Transamerica
treaties and the increase in our net retained new business premium. However, the
overall loss ratios for the segment improved to 74% for the first nine months of
2004 (including 70 basis points from the reserve increase noted above) from 76%
for the first nine months of 2003. The loss ratios for our Medicare
supplement/select business were 69.0% for the first nine months of 2004 compared
to 67.6% in 2003.
Interest credited to policyholders increased by $0.9 million, or 14%,
compared to the nine months ended September 30, 2003 due to the continued
increase in annuity balances.
The increase in deferred acquisition costs in the first nine months of
2004 was approximately $6.2 million more than in the first nine months of 2003.
The increase was driven by the increase in new life business written, as well as
our higher retention on new business. Acquisition costs for life business are
incurred on annualized premium written, including the $19.7 million of
annualized premium written by the Guarantee Reserve marketing organization.
Acquisition costs for annuities are based on the amount deposited, which is not
considered premiums for reporting in accordance with generally accepted
accounting principles.
Commissions and other operating expenses increased by $22.3 million, or
40%, in the first nine months of 2004 compared to 2003. The following table
details the components of commission and other operating expenses:
NINE MONTHS ENDED SEPTEMBER 30, 2004 2003
- ------------------------------- --------- ---------
(In thousands)
Commissions $ 59,406 $ 62,695
Other operating costs 53,020 47,306
Reinsurance allowances (34,152) (54,037)
--------- ---------
Commissions and general expenses, net of allowances $ 78,274 $ 55,964
========= =========
42
The ratio of commissions to gross premiums decreased to 15.2% during the
first nine months of 2004, from 16.8% in 2003, as a result of the growth of the
in force renewal premium from better persistency and rate increases. Other
operating costs as a percentage of gross premiums increased to 13.5% during the
first nine months of 2004 compared to 12.7% in 2003, primarily as a result of
the Guarantee Reserve business which generally has higher costs of acquisition
compared to the segment's other lines of business. Commission and expense
allowances received from reinsurers as a percentage of the premiums ceded
decreased to 18.8% during the first nine months of 2004 compared to 25.7% in
2003, primarily due to the reduction in new business ceded, the recapture of the
Transamerica treaties, and the effects of normal lower commission allowances on
a growing base of renewal ceded business.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, (2)
----------------------- -----------------------
SEGMENT RESULTS - MEDICARE ADVANTAGE 2004 2003 2004 2003
- ------------------------------------ ---------- ---------- ---------- ----------
(In thousands)
Net premiums $ 39,426 $ - $ 51,363 $ -
Net investment income 107 - 128 -
---------- ---------- ---------- ----------
Total revenue 39,533 - 51,491 -
---------- ---------- ---------- ----------
Medical expenses 27,672 - 36,314 -
Amortization of intangible assets 920 - 1,186 -
Commissions and general expenses 5,999 - 8,211 -
---------- ---------- ---------- ----------
Total benefits, claims and other deductions 34,591 - 45,711 -
---------- ---------- ---------- ----------
Segment income 4,942 - 5,780 -
Depreciation, amortization and interest 1,040 - 1,346 -
---------- ---------- ---------- ----------
Earnings before interest, taxes, depreciation
and amortization(1) $ 5,982 $ - $ 7,126 $ -
========== ========== ========== ==========
(1) In addition to segment income, we also evaluate the results of our
Medicare Advantage segment based on earnings before interest, taxes,
depreciation and amortization ("EBITDA"). EBITDA is a common alternative
measure of performance used by investors, financial analysts and rating
agencies. It is also a measure that is included in the fixed charge ratio
required by the covenants for our outstanding bank debt. Accordingly,
these groups use EBITDA, along with other measures, to estimate the value
of a company and evaluate the Company's ability to meet its debt service
requirements. While we consider EBITDA to be an important measure of
comparative operating performance, it should not be construed as an
alternative to segment income or cash flows from operating activities (as
determined in accordance with generally accepted accounting principles).
(2) Includes results for the four months since acquisition or inception.
The Medicare Advantage segment includes the operations of Heritage and our
other initiatives in Medicare managed care, including our Medicare Advantage
private fee-for-service plans. Heritage generates its revenues and profits from
three sources. First, Heritage owns an interest in SelectCare, a health plan
that offers coverage to Medicare beneficiaries under a contract with the federal
government's Centers for Medicare & Medicaid Services, ("CMS"). Next, Heritage
operates three separate Management Service Organizations ("MSO's") that manage
the business of SelectCare and two affiliated Independent Physician Associations
("IPA's"). Last, Heritage participates in the profits derived from these IPA's.
The components of the revenues and results for the segment are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004 (3)
-------------------- ----------------------
SEGMENT SEGMENT
REVENUES INCOME REVENUES INCOME
-------- -------- -------- ----------
(In thousands)
Health Plan $ 38,531 $ 1,638 $ 50,360 $ 1,886
Affiliated IPA's 25,045 2,040 33,129 2,619
MSO's and Corporate 6,577 1,404 8,509 1,706
Private Fee-for Service 1,154 (140) 1,278 (431)
Eliminations (31,774) - (41,785) -
-------- -------- -------- ----------
Total $ 39,533 $ 4,942 $ 51,491 $ 5,780
======== ======== ======== ==========
(3) Includes results for the four months since acquisition or inception.
43
Intrasegment revenues are reported on a gross basis in each of the above
components of the Medicare Advantage segment. These intrasegment revenues are
eliminated in the consolidation for the segment totals. The eliminations include
premiums received by the IPA's from the Health Plan amounting to $25.3 million
for the third quarter of 2004 and $33.4 million for the four months since
acquisition and Management fees received by the MSO's from the Health Plan and
the IPA's amounting to $6.5 million for the third quarter of 2004 and $8.4
million for the four months since acquisition.
Heritage operates a health plan through SelectCare, a provider sponsored
organization ("PSO"). SelectCare is a Medicare Advantage coordinated care plan
operating in Beaumont and Houston, Texas, which had 16,100 members as of May 28,
2004 (the date of acquisition) and receives its premiums primarily from CMS.
SelectCare makes capitated risk payments to four IPA's in the Houston and
Beaumont regions, two of which are affiliated IPA's. In addition, SelectCare
retains the risk for certain other types of care, primarily out of area
emergency and transplants. As of September 30, 2004, SelectCare had
approximately 18,200 members enrolled. During the third quarter of 2004,
SelectCare had revenues of $38.5 million and had a medical loss ratio of 83.0%.
For the four months since acquisition, SelectCare had revenues of $50.4 million
and had a medical loss ratio of 83.6%.
Heritage participates in the profits from the two affiliated IPA's that
receive capitated payments from SelectCare. As of September 30, 2004, the
affiliated IPA's managed the care for approximately 14,000 SelectCare members.
During the third quarter of 2004, Heritage earned $2.0 million on $25.0 million
in fees received from SelectCare. For the four months since acquisition,
Heritage earned $2.6 million on $33.1 million in fees received from SelectCare.
Heritage owns three MSO's that provide comprehensive management services
to SelectCare and its' affiliated IPA's as part of long-term management
agreements. Services provided include strategic planning, provider network
services, marketing, finance and accounting, enrollment, claims processing,
information systems, utilization review, credentialing and quality management.
During the third quarter of 2004, these MSO's earned $1.4 million of income on
$6.6 million of fees collected. For the four months since acquisition, these
MSO's earned $1.7 million of income on $8.5 million of fees collected.
Starting in the month of June, American Progressive, an insurance
subsidiary of Universal American, began enrolling members in its private fee for
service product, a Medicare Advantage program that allows its member to have
more flexibility in the delivery of their health care services than other
Medicare Advantage plans. In addition to premium received from CMS, American
Progressive receives modest premium payments from the members as well. As of
September 30, 2004, American Progressive had 860 members enrolled. During the
third quarter of 2004, American Progressive collected $1.2 million of premium
from CMS and the members, and had a medical loss ratio of 81.4%. For the four
months since inception, American Progressive collected $1.3 million of premium
from CMS and the members, and had a medical loss ratio of 80.5%. In addition,
American Progressive expensed approximately $0.4 million in start-up expenses,
primarily during the second quarter of 2004.
44
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------- ----------------------
SEGMENT RESULTS - ADMINISTRATIVE SERVICES 2004 2003 2004 2003
- ----------------------------------------- --------- --------- --------- ---------
(In thousands)
Affiliated Fee Revenue
Medicare supplement $ 7,286 $ 5,365 $ 21,567 $ 17,002
Long term care 658 562 2,063 1,881
Life insurance 910 1,173 3,012 1,626
Other 774 402 2,156 1,300
--------- --------- --------- ---------
Total Affiliated Revenue 9,628 7,502 28,798 21,809
--------- --------- --------- ---------
Unaffiliated Fee Revenue
Medicare supplement 1,943 2,478 6,448 6,884
Long term care 1,699 1,405 4,620 5,771
Non-insurance products 372 426 1,150 1,153
Other 430 233 975 704
--------- --------- --------- ---------
Total Unaffiliated Revenue 4,444 4,542 13,193 14,512
--------- --------- --------- ---------
Service fee and other income 14,072 12,044 41,991 36,321
Net investment income 3 - 9 31
--------- --------- --------- ---------
Total revenue 14,075 12,044 42,000 36,352
--------- --------- --------- ---------
Amortization of present value of future profits 104 96 313 271
General expenses 10,875 9,060 32,104 27,996
--------- --------- --------- ---------
Total expenses 10,979 9,156 32,417 28,267
--------- --------- --------- ---------
Segment income 3,096 2,888 9,583 8,085
Depreciation, amortization and interest 536 541 1,605 1,499
--------- --------- --------- ---------
Earnings before interest, taxes, depreciation
and amortization $ 3,632 $ 3,429 $ 11,188 $ 9,584
========= ========= ========= =========
(1) In addition to segment income, we also evaluate the results of our
Administrative Services segment based on earnings before interest, taxes,
depreciation and amortization ("EBITDA"). EBITDA is a common alternative
measure of performance used by investors, financial analysts and rating
agencies. It is also a measure that is included in the fixed charge ratio
required by the covenants for our outstanding bank debt. Accordingly,
these groups use EBITDA, along with other measures, to estimate the value
of a company and evaluate the Company's ability to meet its debt service
requirements. While we consider EBITDA to be an important measure of
comparative operating performance, it should not be construed as an
alternative to segment income or cash flows from operating activities (as
determined in accordance with generally accepted accounting principles).
Included in unaffiliated revenue are fees received to administer certain
business of our insurance subsidiaries that is 100% reinsured to an unaffiliated
reinsurer, which amounted to $2.9 million in the nine months ended September 30,
2004 and $5.4 million in for the same period of 2003. These fees, together with
the affiliated revenue, were eliminated in consolidation.
Three months ended September 30, 2004 and 2003
Administrative Services segment income improved by $0.2 million, or 7%,
compared to the third quarter of 2003. This improvement is primarily a result of
the growth in premiums managed. Earnings before interest, taxes, depreciation
and amortization ("EBITDA") for this segment increased $0.2 million, or 7%,
compared to the third quarter of 2003.
Administrative Services fee revenue increased by $2.0 million, or 17%, as
compared to the third quarter of 2003. Affiliated service fee revenue increased
by $2.1 million compared to the third quarter of 2003 as a result of the
increase in Medicare Supplement/Select business in force at our insurance
subsidiaries, including Pyramid, for which CHCS began providing service
effective January 1, 2004. Unaffiliated service fee revenue was relatively
unchanged from the third quarter of 2003. General expenses for the segment
increased by $1.8 million, or 20%, due primarily to the increase in business.
Nine months ended September 30, 2004 and 2003
Administrative Services segment income improved by $1.5 million, or 19%,
compared to the first nine months of 2003. This improvement is primarily a
result of the growth in premiums managed. EBITDA for this segment increased $1.6
million, or 17%, compared to the first nine months of 2003.
45
Administrative Services fee revenue increased by $5.7 million, or 16%, as
compared to the first nine months of 2003. Affiliated service fee revenue
increased by $7.0 million compared to the nine months of 2003 as a result of the
increase in Medicare Supplement/Select business in force at our insurance
subsidiaries, including Pyramid, for which CHCS began providing service,
effective January 1, 2004, and fees from the administration of the life
insurance products sold by the Guarantee Reserve marketing organization that was
acquired in July 2003. Unaffiliated service fee revenue decreased by
approximately $1.3 million primarily due to the reduction in the fees from the
underwriting work we performed for the consortium that is offering long term
care to employees of the federal government and their families. The initial
enrollment period for this program, for which we performed underwriting, began
in the third quarter of 2002 and ended during the first quarter of 2003. General
expenses for the segment increased by $4.1 million, or 15%, due primarily to the
increase in business.
SEGMENT RESULTS - CORPORATE
The following table presents the primary components comprising the loss from the
segment:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(In thousands)
Interest cost of acquisition financing $ 2,234 $ 1,327 $ 5,519 $ 3,400
Early extinguishment of debt - - - 1,766
Amortization of capitalized loan origination
fees 220 124 507 367
Stock-based compensation expense 23 94 69 276
Other parent company expenses, net 1,054 1,020 2,695 2,551
--------- --------- --------- ---------
Segment loss $ 3,531 $ 2,565 $ 8,790 $ 8,360
========= ========= ========= =========
Three Months ended September 30, 2004 and 2003
The loss from the Corporate segment increased by $1.0 million, or 38%,
compared to the third quarter of 2003. The increase was due to higher interest
cost as a result of an increase in the amount of the debt outstanding during the
quarter, relating to the amendment of our credit facility in connection with our
acquisition of Heritage, offset in part, by a reduction in the weighted average
interest rates, as compared to the same period of 2003. Our combined outstanding
debt was $177.4 million at September 30, 2004 compared to $100.9 million at
September 30, 2003. The weighted average interest rate on our loan payable
decreased to 3.8% during the third quarter of 2004 from 4.1% in the third
quarter of 2003. The weighted average interest rate on our other long term debt
increased slightly to 6.6% for the quarter ended September 30, 2004 and 6.1% for
the same period of 2003. See "Liquidity and Capital Resources" for additional
information regarding our loan payable and other long term debt.
Nine Months ended September 30, 2004 and 2003
The loss from the Corporate segment decreased by $0.4 million, or 5%,
compared to the first nine months of 2003. During the first nine months of 2003,
the segment reported a charge relating to the early extinguishment of debt that
was incurred during the first quarter of 2003 that did not recur in 2004. In
connection with the acquisition of Pyramid Life, we refinanced our debt. The
early extinguishment of the existing debt resulted in the immediate amortization
of the related capitalized loan origination fees, resulting in a pre-tax expense
of approximately $1.8 million. Partially offsetting this was an increase in
interest costs, as noted above.
46
LIQUIDITY AND CAPITAL RESOURCES
Our capital is used primarily to support the retained risks and growth of
our insurance company subsidiaries and health plan and to support our parent
company as an insurance holding company. In addition, we use capital to fund our
growth through acquisitions of other companies, blocks of insurance or
administrative service business.
We require cash at our parent company to meet our obligations under our
credit facility and our outstanding debentures held by our subsidiary,
Pennsylvania Life. In January 2002, our parent company issued a debenture to
Pennsylvania Life in conjunction with the transfer of the business of
Pennsylvania Life's Canadian Branch to Penncorp Life (Canada). We anticipate
funding the repayment of the debenture from dividends of Penncorp Life (Canada).
We also require cash to pay the operating expenses necessary to function as a
holding company (applicable insurance department regulations require us to bear
our own expenses), and to meet the costs of being a public company.
We believe that our current cash position, the availability of our $15.0
million revolving credit facility, the expected cash flows of our administrative
service company and management service organizations (acquired in the
acquisition of Heritage) and the surplus note interest payments from American
Exchange (as explained below) can support our parent 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.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Credit Facility, as Amended in May 2004
In connection with the acquisition of Pyramid Life (see Note 3 - Business
Combinations), the Company obtained an $80 million credit facility (the "Credit
Agreement") on March 31, 2003 to repay the then existing loan and provide funds
for the acquisition of Pyramid Life. The Credit Agreement consisted of a $65
million term loan which was drawn to fund the acquisition and a $15 million
revolving loan facility. The Credit Agreement initially called for interest at
the London Interbank Offering Rate ("LIBOR") for one, two or three months, at
the option of the Company, plus 300 basis points. Effective March 31, 2004, the
spread over LIBOR was reduced to 275 basis points in accordance with the terms
of the Credit Agreement. Principal repayments were scheduled over a five-year
period with a final maturity date of March 31, 2008. The Company incurred loan
origination fees of approximately $2.1 million, which were capitalized and are
being amortized on a straight-line basis over the life of the Credit Agreement.
In accordance with the Credit Agreement, 50% of the net proceeds from the
$30 million Trust Preferred securities issued in May 2003 (see Note 11 - Other
Long Term Debt) were used to pay down the term loan. In October 2003, $6.0
million of the proceeds from an additional $20 million Trust Preferred offering
was used to further reduce the outstanding balance of the term loan. A waiver
was requested and received to limit the required repayment from the proceeds of
the Trust Preferred offering to $6.0 million. Future scheduled principal
payments were reduced as a result of these repayments, primarily in 2006 and
2007. As of the end of the March 31, 2004, the outstanding balance of the term
loan was $36.4 million.
In connection with the acquisition of Heritage on May 28, 2004 (see Note 3
- - Business Combinations), the Company amended the Credit Agreement by increasing
the facility to $120 million from $80 million (the "Amended Credit Agreement"),
including an increase in the term loan portion to $105 million from $36.4
million (the balance outstanding at May 28, 2004) and maintaining the $15
million revolving loan facility. None of the revolving loan facility has been
drawn as of September 30, 2004. Under the Amended Credit Agreement, the spread
over LIBOR was reduced to 225 basis points. Effective November 1, 2004, the
interest rate on the term loan is 4.3%. Principal repayments are scheduled at
$5.3 million per year over a five-year period with a final payment of $80.1
million due upon maturity on March 31, 2009. The Company incurred additional
loan origination fees of approximately $2.1 million, which were capitalized and
are being amortized on a straight-line basis over the life of the Amended Credit
Agreement along with the continued amortization of the origination fees incurred
in connection with the Credit Agreement. The Company pays an annual commitment
fee of 50 basis points on the unutilized revolving loan facility. The
obligations of the Company under the Amended Credit Facility are guaranteed by
WorldNet Services Corp., CHCS Services Inc., CHCS Inc., Quincy Coverage
47
Corporation, Universal American Financial Services, Inc., Heritage, HHS-HPN
Network, Inc., Heritage Health Systems of Texas, Inc., PSO Management of Texas,
LLC, HHS Texas Management, Inc. and HHS Texas Management LP (collectively the
"Guarantors") and secured by substantially all of the assets of each of the
Guarantors. In addition, as security for the performance by the Company of its
obligations under the Amended Credit Facility, the Company, WorldNet Services
Corp., CHCS Services Inc., Heritage and HHS Texas Management, Inc., have each
pledged and assigned substantially all of their respective securities (but not
more than 65% of the issued and outstanding shares of voting stock of any
foreign subsidiary), all of their respective limited liability company and
partnership interests, all of their respective rights, title and interest under
any service or management contract entered into between or among any of their
respective subsidiaries and all proceeds of any and all of the foregoing.
The Amended Credit Facility requires the Company and its subsidiaries to
meet certain financial tests, including a minimum fixed charge coverage ratio, a
minimum risk based capital test and a minimum consolidated net worth test. The
Amended Credit Facility also contains covenants, which among other things, limit
the incurrence of additional indebtedness, dividends, capital expenditures,
transactions with affiliates, asset sales, acquisitions, mergers, prepayments of
other indebtedness, liens and encumbrances and other matters customarily
restricted in such agreements.
The Amended Credit Facility contains customary events of default,
including, among other things, payment defaults, breach of representations and
warranties, covenant defaults, cross-acceleration, cross-defaults to certain
other indebtedness, certain events of bankruptcy and insolvency and judgment
defaults.
Due to the variable interest rate for this Credit Agreement, the Company
would be subject to higher interest costs if short-term interest rates rise.
The Company made regularly scheduled principal payments of $4.4 million
and paid $2.0 million in interest and fees in connection with its credit
facilities during the nine months ended September 30, 2004. During the nine
months ended September 30, 2003, the Company made regularly scheduled principal
payments of $6.9 million and paid $2.3 million in interest and fees in
connection with its credit facilities.
The following table shows the schedule of principal payments (in
thousands) remaining on the Amended Credit Agreement, as of September 30, 2004,
with the final payment in March 2009:
2004 (Remainder of year) $ 1,312
2005 5,250
2006 5,250
2007 5,250
2008 5,250
2009 80,063
---------
$ 102,375
=========
2003 Refinancing of Debt
In January 2003, the Company made a scheduled principal payment of $2.8
million on its then current credit facility, and in March, 2003 made an
additional principal payment of $5.0 million from a portion of the proceeds from
the issuance of Trust Preferred securities (see Note 11 - Other Long Term Debt).
These payments reduced the outstanding balance on its then current credit
facility to $42.9 million, which was repaid on March 31, 2003 from the proceeds
of the Credit Agreement obtained in connection with the acquisition of Pyramid
Life. The early extinguishment of the then existing debt resulted in the
immediate amortization of the related capitalized loan origination fees,
resulting in a pre-tax expense of approximately $1.8 million.
48
Other Long Term Debt
The Company has formed statutory business trusts, which exist for the
exclusive purpose of issuing trust preferred securities representing undivided
beneficial interests in the assets of the trust, investing the gross proceeds of
the trust preferred securities in junior subordinated deferrable interest
debentures of the Company (the "Junior Subordinated Debt") and engaging in only
those activities necessary or incidental thereto. In accordance with the
adoption of FIN 46R, the Company has deconsolidated the trusts. For further
discussion of the adoption of FIN 46R, see Note 2 - Recent and Pending
Accounting Pronouncements.
Separate subsidiary trusts of the Company (the "Trusts") have issued a
combined $75.0 million in thirty year trust preferred securities (the "Capital
Securities") as of September 30, 2004, as detailed in the following table:
Maturity Amount Spread Rate as of
Date Issued Term Over LIBOR September 30, 2004
- ------------- -------- -------------- ---------- ------------------
(In thousands) (Basis points)
December 2032 $ 15,000 Fixed/Floating 400(1) 6.7%
March 2033 10,000 Floating 400 5.6%
May 2033 15,000 Floating 420 6.0%
May 2033 15,000 Fixed/Floating 410(2) 7.4%
October 2033 20,000 Fixed/Floating 395(3) 7.0%
--------
$ 75,000
========
(1) Effective September, 2003, the Company entered into a swap agreement
whereby it will pay a fixed rate of 6.7% in exchange for a floating rate
of LIBOR plus 400 basis points. The swap contract expires in December
2007.
(2) The rate on this issue is fixed at 7.4% for the first five years, after
which it is converted to a floating rate equal to LIBOR plus 410 basis
points.
(3) Effective April 29, 2004, the Company entered into a swap agreement
whereby it will pay a fixed rate of 6.98% in exchange for a floating rate
of LIBOR plus 395 basis points. The swap contract expires in October 2008.
The Trusts have the right to call the Capital Securities at par after five
years from the date of issuance. The proceeds from the sale of the Capital
Securities, together with proceeds from the sale by the Trusts of their common
securities to the Company, were invested in thirty-year floating rate Junior
Subordinated Debt of the Company. From the proceeds of the trust preferred
securities, $26.0 million was used to pay down debt during 2003. The balance of
the proceeds has been used, in part to fund acquisitions, to provide capital to
the Company's insurance subsidiaries to support growth and to be held for
general corporate purposes.
The Capital Securities represent an undivided beneficial interest in the
Trusts' assets, which consist solely of the Junior Subordinated Debt. Holders of
the Capital Securities have no voting rights. The Company owns all of the common
securities of the Trusts. Holders of both the Capital Securities and the Junior
Subordinated Debt are entitled to receive cumulative cash distributions accruing
from the date of issuance, and payable quarterly in arrears at a floating rate
equal to the three-month LIBOR plus a spread. The floating rate resets quarterly
and is limited to a maximum of 12.5% during the first sixty months. Due to the
variable interest rate for these securities, the Company would be subject to
higher interest costs if short-term interest rates rise. The Capital Securities
are subject to mandatory redemption upon repayment of the Junior Subordinated
Debt at maturity or upon earlier redemption. The Junior Subordinated Debt is
unsecured and ranks junior and subordinate in right of payment to all present
and future senior debt of the Company and is effectively subordinated to all
existing and future obligations of the Company's subsidiaries. The Company has
the right to redeem the Junior Subordinated Debt after five years from the date
of issuance.
The Company has the right at any time, and from time to time, to defer
payments of interest on the Junior Subordinated Debt for a period not exceeding
20 consecutive quarters up to each debenture's maturity date. During any such
period, interest will continue to accrue and the Company may not declare or pay
any cash dividends or distributions on, or purchase, the Company's common stock
nor make any principal, interest or premium payments on or repurchase any debt
securities that rank equally with or junior to the Junior Subordinated Debt. The
Company has the right at any time to dissolve the Trusts and cause the Junior
Subordinated Debt to be distributed to the holders of the Capital Securities.
The
49
Company has guaranteed, on a subordinated basis, all of the Trusts' obligations
under the Capital Securities including payment of the redemption price and any
accumulated and unpaid distributions to the extent of available funds and upon
dissolution, winding up or liquidation but only to the extent the Trusts have
funds available to make such payments. The Capital Securities have not been and
will not be registered under the Securities Act of 1933, as amended (the
"Securities Act"), and will only be offered and sold under an applicable
exemption from registration requirements under the Securities Act.
The Company paid $3.5 million in interest in connection with the Junior
Subordinated Debt during the nine months ended September 30, 2004, and paid $1.3
million during the nine months ended September 30, 2003.
Lease Obligations
We are obligated under certain lease arrangements for our executive and
administrative offices in New York, Florida, Texas, and Ontario, Canada. Annual
minimum rental commitments, subject to escalation, under non-cancelable
operating leases (in thousands) are as follows:
2004 (Remainder of year) $ 597
2005 2,426
2006 2,275
2007 2,293
2008 2,196
Thereafter 7,337
--------
Totals $ 17,124
========
In addition to the above, Pennsylvania Life and Penncorp Life (Canada) are
the named lessees on approximately 57 properties occupied by our career agents
for use as field offices. Our career agents reimburse Pennsylvania Life and
Penncorp Life (Canada) the actual rent for these field offices. The total annual
rent obligation for these field offices is approximately $905,000.
Obligations of the Parent Company to Affiliates
In January 2002, our parent company issued an $18.5 million 8.5% debenture
to Pennsylvania Life in connection with the transfer of the business of
Pennsylvania Life's Canadian Branch to Penncorp Life (Canada). The debenture is
scheduled to be repaid in full by the second quarter of 2005. Our parent company
repaid principal of $11.6 million through December 31, 2003. During the nine
months ended September 30, 2004, the parent holding company repaid principal of
$3.0 million, reducing the outstanding balance to $3.9 million. Our parent
holding company paid $0.4 million in interest on these debentures during the
nine months ended September 30, 2004 and $0.8 million in the same period of
2003. The interest on these debentures is eliminated in consolidation. Dividends
from Penncorp Life (Canada) funded the interest and principal paid on the
debenture to date and it is anticipated that they will fund all future payments
made on this debenture.
Penncorp Life (Canada) is a Canadian insurance company. Canadian law
provides that 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. Such a dividend is
limited to retained net income (based on Canadian GAAP) for the preceding two
years, plus net income earned for the current year. 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.
During the first quarter of 2004, Penncorp Life (Canada) paid dividends of
C$26.7 million (approximately US$20.0 million) to Universal American in 2004,
relating to 2003 net income. The amount of the dividend was larger than normal
due to a benefit received by Penncorp Life (Canada) from an actuarial experience
study that allowed Penncorp Life (Canada) to reduce its policy reserves at
December 31, 2003 on a Canadian GAAP basis. The actuarial experience study did
not have an impact on Penncorp Life (Canada)'s policy reserves on a U.S. GAAP
basis. During the second and third quarters of 2004, Penncorp Life (Canada) paid
dividends totalling C$4.3 million (US$3.2 million) relating to net income for
2004. We anticipate that Penncorp Life (Canada) will be able to pay dividends
equal to its net income earned during the remainder of 2004.
50
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").
EBITDA for our administrative services segment was $11.2 million for the nine
months ended September 30, 2004, and was $9.6 million for the nine months ended
September 30, 2003.
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 the surplus note owed to our holding company by our
subsidiary, American Exchange Life. As of September 30, 2004, the principal
amount of the surplus note was $48.5 million. The note bears interest to our
parent holding company at LIBOR plus 325 basis points. We anticipate that the
surplus note 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. American Exchange made principal
payments totaling $11.5 million during the nine months ended September 30, 2004.
Our parent holding company made capital contributions to American Exchange
amounting to $9.9 million during the nine months ended September 30, 2004. No
principal payments were made during the same period of 2003. American Exchange
paid $1.8 million in interest on the surplus notes to our holding company during
the nine months ended September 30, 2004 and, $2.2 million for the same period
of 2003. The interest on these debentures is eliminated in consolidation.
In March 2004, Pennsylvania Life declared and paid a dividend in the
amount of $10.6 million to American Exchange. American Exchange made capital
contributions of $4.0 million to American Progressive and $5.0 million to Union
Bankers during the nine months ended September 30, 2004.
During the nine months ended September 30, 2003, no dividends were
declared or paid by the U.S. insurance company subsidiaries to American
Exchange. On March 31, 2003, American Exchange received a capital contribution
from its parent in the amount of $26.0 million. American Exchange, in turn, made
capital a contribution of $26.0 million to Pennsylvania Life, primarily relating
to the acquisition of Pyramid Life.
Dividend payments by our U.S insurance companies to our 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. Pennsylvania Life was able to and did pay ordinary dividends of $10.6
million to American Exchange in March 2004. Pyramid Life is able to pay ordinary
dividends of up to $1.5 million to Pennsylvania Life (its direct parent) with
prior notice to the Kansas Insurance Department and Marquette would be able to
pay ordinary dividends of up to $0.2 million to Constitution (its direct parent)
without the prior approval from the Texas Insurance Department in 2004. American
Exchange, American Pioneer, American Progressive and Union Bankers had negative
earned surplus at September 30, 2004 and are not be able to pay dividends in
2004 without special approval. We do not expect that our other insurance
subsidiaries will be able to pay ordinary dividends in 2004.
Insurance Subsidiaries
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.
51
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 September 30, 2004 we held reserves that
exceeded the underlying cash surrender values of our net retained in force life
insurance and annuities by $33.1 million. Our insurance 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 to 4.9% for the
nine months ended September 30, 2004 from 5.3% in the same period of 2003. A
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.
Our insurance subsidiaries are required to maintain minimum amounts of
capital and surplus as required by regulatory authorities. Each of our 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 our insurance subsidiaries' operations.
Additionally, the National Association of Insurance Commissioners ("NAIC")
imposes regulatory risk-based capital ("RBC") requirements on life insurance
enterprises. At September 30, 2004, all of our insurance subsidiaries maintained
ratios of total adjusted capital to RBC in excess of the "authorized control
level". The combined statutory capital and surplus, including asset valuation
reserve, of our U.S. insurance subsidiaries totaled $123.8 million at September
30, 2004 and $111.5 million at September 30, 2003. Statutory net income for the
nine months ended September 30, 2004 was $3.6 million, which included net
realized gains of $0.4 million, and for the nine months ended September 30, 2003
was $6.5 million, which included net realized gains of $0.3 million.
Penncorp Life (Canada) reports to Canadian regulatory authorities based
upon Canadian statutory accounting principles that vary in some respects from
U.S. statutory accounting principles. Penncorp Life (Canada)'s net assets based
upon Canadian statutory accounting principles were C$59.0 million (US$46.8
million) as of September 30, 2004 and were C$60.3 million (US$44.5 million) as
of September 30, 2003. Net income based on Canadian generally accepted
accounting principles was C$7.1 million (US$5.3 million) for the nine months
ended September 30, 2004 and was C$7.8 million (US$5.4 million) for the nine
months ended September 30, 2003. Penncorp Life (Canada) maintained a Minimum
Continuing Capital and Surplus Requirement Ratio ("MCCSR") in excess of the
minimum requirement at September 30, 2004.
52
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. Such laws generally prescribe the nature, quality of and limitations on
various types of investments that may be made. We do not currently have
investments in partnerships, special purpose entities, real estate, commodity
contracts, or other derivative securities. We currently engage the services of
three 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 the portfolio of all of our United States subsidiaries, except
for the portfolio of Pyramid Life, which is managed by Hyperion Capital. MFC
Global Investment Management manages our Canadian portfolio. 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 "BBB-"
(Standard & Poor's Corporation), "Baa3" (Moody's Investor Service) or higher.
Our current 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.
As of September 30, 2004, 99.4% of our fixed maturity investments had
investment grade ratings from Standard & Poor's Corporation or Moody's Investor
Service. There were no non-income producing fixed maturities as of September 30,
2004. During the nine months ended September 30, 2004, we did not write down the
value of any fixed maturity securities. During the nine months ended September
30, 2003, we wrote down the value of certain fixed maturity securities by $0.5
million. 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.
As of September 30, 2004, our insurance company subsidiaries held cash and
cash equivalents totaling $159.7 million, as well as fixed maturity securities
that could readily be converted to cash with carrying values (and fair values)
of $1.1 billion.
RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS
Refer to Consolidated Financial Statements Note 2 - Recent and Pending
Accounting Pronouncements.
ITEM 3. 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 as well as
the cost of our variable rate debt. Additionally, we are exposed to changes in
the Canadian dollar that affects the translation of the financial position and
the results of operations of our Canadian subsidiary from Canadian dollars to
U.S. dollars.
Investment 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.
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.
53
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.
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
September 30, 2004, 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 $66.7 million and a 200
basis point increase in market interest rates would result in $130.8 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 $70.6 million and a 200 basis point decrease in market interest rates would
result in a $145.4 million increase.
Debt
We pay interest on our term loan and a portion of our trust preferred
securities based on the London Inter Bank Offering Rate ("LIBOR") for one, two
or three months. Due to the variable interest rate for this loan, the Company
would be subject to higher interest costs if short-term interest rates rise. We
have attempted to mitigate our exposure to adverse interest rate movements by
fixing the rate on $15.0 million of the trust preferred securities for a five
year period through the contractual terms of the security at inception and an
additional $35.0 million through the use of interest rate swaps.
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.
The sensitivity analysis of interest rate risk assumes scenarios increases
or decreases in LIBOR of 100 and 200 basis points from their levels as of
September 30, 2004, and with all other variables held constant. The following
table summarizes the impact of changes in LIBOR, based on the weighted average
balance outstanding and the weighted average interest rates for the nine months
ended September 30, 2004.
Effect of Change in LIBOR on Pre-tax Income
for the nine months ended September 30, 2004
Weighted Weighted ---------------------------------------------
Average Average 200 Basis 100 Basis 100 Basis 200 Basis
Description of Floating Interest Balance Point Point Point Point
Rate Debt Rate Outstanding Decrease Decrease Increase Increase
- ----------------------- -------- ----------- --------- --------- --------- --------
(in millions)
Loan Payable 3.87% $66.8 $ 1.0 $ 0.5 $ (0.5) $ (1.4)
Other long term debt 5.48% $25.0 0.4 0.2 (0.2) (0.4)
----- ----- ------ ------
Total $ 1.4 $ 0.7 $ (0.7) $ (1.4)
===== ===== ====== ======
We anticipate that the weighted average balance outstanding of our
floating rate loan payable will increase to $75.8 million for the year ending
December 31, 2004, as a result of the amendment of our credit agreement in
connection with the acquisition of Heritage.
As noted above, we have fixed the interest rate on $50.0 million of our
$177.4 million of total debt outstanding, leaving $127.4 million of the debt
exposed to rising interest rates. To mitigate the negative impact of rising
interest rates on our debt, as of September 30, 2004 we have approximately
$163.7 million of cash, $26.0 million in short duration floating rate investment
securities and $5.2 million of fixed income securities maturing by December 31,
2004 totaling $194.9 million, all of which will be positively impacted by rising
interest rates.
54
Currency Exchange Rate Sensitivity
Portions of our operations are transacted using the Canadian dollar as the
functional currency. As of and for the nine months ended September 30, 2004,
approximately 11% of our assets, 10% of our revenues, excluding realized gains,
and 17% of our income before realized gains and taxes were derived from our
Canadian operations. As of and for the nine months ended September 30, 2003,
approximately 13% of our assets, 12% of our revenues, excluding realized gains,
and 23% of our income before realized gains and 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 gains and 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.
A 10% strengthening of the U.S. dollar relative to the Canadian dollar, as
compared to the actual average exchange rate for the nine months ended September
30, 2004, would have resulted in a decrease in our income before realized gains
and taxes of approximately $1.0 million for the nine months ended September 30,
2004 and a decrease in our shareholders' equity of approximately $3.5 million at
September 30, 2004. A 10% weakening of the U.S. dollar relative to the Canadian
dollar would have resulted in an increase in our income before realized gains
and taxes of approximately $1.2 million for the nine months ended September 30,
2004 and an increase in shareholders' equity of approximately $4.3 million at
September 30, 2004. 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 variables.
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 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management evaluated, with the participation of our principal
executive and principal financial officers, the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of
September 30, 2004. Based on their evaluation, our principal executive and
principal financial officers concluded that our disclosure controls and
procedures were effective as of September 30, 2004.
Change in Internal Control Over Financial Reporting
There has been no material change in our internal control over financial
reporting (as defined in Rules 13a - 15(f) and 15d - 15(f) under the Exchange
Act) that occurred during the quarter ended September 30, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has litigation in the ordinary course of business, including
claims for medical, disability and life insurance benefits, and in some cases,
seeking punitive damages. Management and counsel believe that after reserves and
liability insurance recoveries, none of these will have a material adverse
effect on the Company.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Stock Repurchases
((d) Maximum Number of
(a) Total (c)Total Number of Shares (or Approximate
Number of Shares Purchased Dollar Value) of Shares
Shares (b) Average as Part of Publicly That May Yet Be
Repurchased Price Paid Announced Plans or Purchased Under the
Period (1) Per Share Programs Plans or Programs
- -------------- ----------- ----------- ------------------- -----------------------
July 2004 105 $ 10.84 105 713,613
August 2004 3,646 $ 11.32 3,646 709,917
September 2004 555 $ 11.68 555 709,367
(1) All shares were purchased in private transactions.
Sales of Securities not registered under the Securities Act
During the Company's fiscal quarter ended September 30, 2004 in connection
with the acquisition of Heritage Health Systems, Inc., an employee acquired
14,500 shares of the Company's Common Stock pursuant to the Company's 1998
Incentive Compensation Plan. These shares were reissued from the Company's
treasury stock on September 10, 2004. The Company received proceeds of $10.35
per share, or $150,000, equal to the market value for the ten days trailing the
date the award was approved, in connection with the issuance of such shares. The
issuance was exempt from registration under the Securities Act pursuant to
Section 4(2) thereof. The issuance did not involve any public offering and the
employee received shares which contained a legend to indicate that such shares
are not registered under the Securities Act and cannot be transferred in the
absence of such a registration or an exemption from registration. The employee
who acquired such shares is a member of the Company's management.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
11.1 Computation of Per Share Earnings
Data required by Statement of Financial Accounting Standards
No. 128, Earnings Per Share, is provided in Note 4 to the
Consolidated Financial Statements in this report
12.1 Computation of Ratio of Earnings to Fixed Charges and Earnings
to Combined Fixed Charges and Preferred Stock Dividends
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /s/ Robert A. Waegelein
---------------------------------
Robert A. Waegelein
Executive Vice President and
Chief Financial Officer
Date: November 9, 2004
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