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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO __________
COMMISSION FILE NUMBER 0-23637
GLOBAL PREFERRED HOLDINGS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 58-2179041
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
6455 EAST JOHNS CROSSING, SUITE 402
DULUTH, GEORGIA 30097
(770) 248-3311
(Address, Including Zip Code and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
----------------------------
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.
[X] Yes [ ] No
As of November 12, 2002, there were 4,141,684 shares of common stock
outstanding.
1
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION........................................................................... 3
ITEM 1. FINANCIAL STATEMENTS............................................................................ 3
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS....................................................................... 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................................... 19
ITEM 4. CONTROLS AND PROCEDURES......................................................................... 19
PART II - OTHER INFORMATION.............................................................................. 20
ITEM 1. LEGAL PROCEEDINGS............................................................................... 20
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS....................................................... 20
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................................................. 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................. 20
ITEM 5. OTHER INFORMATION............................................................................... 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................................ 20
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GLOBAL PREFERRED HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
(Unaudited)
Assets
Fixed maturity securities - available for sale (amortized cost of
$11,840,749 and $11,105,323 for 2001 and 2002, respectively) $ 12,214,279 $ 11,731,349
Cash and cash equivalents 8,062,110 4,640,917
Investment income due and accrued 172,055 136,809
Reinsurance balances receivable 2,842,908 2,742,475
Reinsured policy loans 1,013,629 1,119,521
Deferred acquisition costs 42,800,269 51,617,276
Prepaid expenses 659,538 941,321
Current income tax recoverable -- 174,375
Fixed assets (net of accumulated depreciation of $147,750 and
$216,628 for 2001 and 2002, respectively) 88,114 241,573
------------ ------------
Total assets $ 67,852,902 $ 73,345,616
============ ============
Liabilities and Stockholders' Equity
Liabilities:
Future policy benefits $ 11,911,532 $ 16,180,243
Reinsurance balances payable 188,818 363,846
Accrued expenses and accounts payable 544,683 477,281
Accrued interest payable 158,219 63,699
Current income tax payable 413,299 --
Long term debt 5,000,000 5,000,000
Deferred tax liability 7,667,767 8,213,325
------------ ------------
Total liabilities 25,884,318 30,298,394
------------ ------------
Stockholders' equity:
Preferred stock, par value $2.00, 10,000,000 shares authorized;
Series A Preferred Stock, 1,000,000 shares authorized; 266,047
shares issued for 2001 and no shares issued for 2002 532,094 --
Common stock, par value $.001, 50,000,000 shares authorized;
3,750,000 shares and 4,149,074 shares issued for 2001
and 2002, respectively 3,750 4,149
Additional paid-in capital 22,794,331 23,326,026
Accumulated other comprehensive income 246,531 413,178
Retained earnings 18,441,145 19,353,136
Treasury stock, at cost (7,390 shares for 2001 and 2002,
respectively) (49,267) (49,267)
------------ ------------
Total stockholders' equity 41,968,584 43,047,222
------------ ------------
Total liabilities and stockholders' equity $ 67,852,902 $ 73,345,616
============ ============
See accompanying notes to consolidated financial statements.
3
GLOBAL PREFERRED HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- -----------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Revenues:
Premiums $ 4,908,499 $ 4,484,848 $ 14,360,578 $ 13,574,548
Reinsured policy revenues 2,728,000 3,441,907 8,474,901 10,596,850
Net investment income 220,681 168,074 587,712 570,455
Net realized gain (loss) on investments (1,658) -- 3,976 7,338
----------- ----------- ------------ ------------
Total revenue 7,855,522 8,094,829 23,427,167 24,749,191
----------- ----------- ------------ ------------
Benefits and expenses:
Benefits, claims and settlement expenses 1,406,931 2,134,758 4,492,408 6,806,589
Change in future policy benefits 742,345 353,099 1,933,841 1,210,776
Reinsurance expense allowances, net 2,094,355 2,100,972 6,344,766 6,435,428
Amortization of deferred acquisition
costs 740,840 2,483,943 2,619,938 4,674,447
Operating expenses 515,248 814,119 1,354,602 2,235,574
Costs of withdrawn offering -- 1,712,000 -- 1,712,000
Interest expense 94,521 94,521 283,625 285,596
----------- ----------- ------------ ------------
Total benefits and expenses 5,594,240 9,693,412 17,029,180 23,360,410
----------- ----------- ------------ ------------
Income (Loss) before income tax 2,261,282 (1,598,583) 6,397,987 1,388,781
Income tax benefit (expense) (653,529) 535,347 (2,050,749) (476,790)
----------- ----------- ------------ ------------
Net income (loss) 1,607,753 (1,063,236) 4,347,238 911,991
Preferred dividends 71,177 -- 208,938 --
----------- ----------- ------------ ------------
Net income (loss) available to common
shareholders $ 1,536,576 $(1,063,236) $ 4,138,300 $ 911,991
=========== =========== ============ ============
Basic earnings (loss) per share $ 0.41 $ (0.26) $ 1.11 $ 0.22
=========== =========== ============ ============
Diluted earnings (loss) per share $ 0.39 $ (0.26) $ 1.05 $ 0.22
=========== =========== ============ ============
Weighted-average common shares outstanding . 3,742,610 4,141,684 3,742,610 4,141,684
=========== =========== ============ ============
Total weighted-average common and common
equivalent shares outstanding 4,141,684 4,141,684 4,141,684 4,141,684
=========== =========== ============ ============
See accompanying notes to consolidated financial statements.
4
GLOBAL PREFERRED HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------ ------------
2001 2002
------------ ------------
Cash flows from operating activities:
Net income $ 4,347,238 $ 911,991
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Amortization and depreciation 2,656,733 4,743,326
Costs of withdrawn offering -- 1,712,000
Deferred tax expense 2,100,604 459,709
Net realized gain on investments (3,976) (7,338)
Change in:
Investment income due and accrued (68,062) 35,246
Reinsurance balances receivable (376,460) 100,433
Reinsured policy loans (128,212) (105,892)
Deferred acquisition costs (3,178,465) (13,491,454)
Prepaid expenses (225,945) (858,895)
Current income tax recoverable (173,962) (174,375)
Future policy benefits 2,802,334 4,268,711
Reinsurance balances payable (182,564) 175,028
Accrued expenses and accounts payable 44,787 (67,402)
Accrued interest payable (87,997) (94,520)
Current income tax payable (410,530) (413,299)
----------- ------------
Net cash provided by (used in) operating activities 7,115,523 (2,806,731)
----------- ------------
Cash flows from investing activities:
Proceeds from sale and maturity of available for sale securities 722,703 1,572,284
Proceeds from maturities and principal payments on
mortgage-backed securities of available for sale securities -- 628,942
Purchase of available-for-sale securities (8,127,240) (1,458,463)
Purchase of fixed assets -- (222,337)
----------- ------------
Net cash provided by (used in) investing activities (7,404,537) 520,426
----------- ------------
Cash flows from financing activities:
Repayment of long term debt (277,285) --
Prepaid expenses - costs of withdrawn offering -- 577,112
Costs of withdrawn offering -- (1,712,000)
----------- ------------
Net cash used in financing activities (277,285) (1,134,888)
----------- ------------
Net decrease in cash and cash equivalents (566,299) (3,421,193)
Cash and cash equivalents at beginning of period 4,259,153 8,062,110
----------- ------------
Cash and cash equivalents at end of period $ 3,692,854 $ 4,640,917
=========== ============
Supplemental disclosure of cash flow information:
Interest paid $ 371,622 $ 380,116
=========== ============
Income taxes paid $ 534,637 $ 604,755
=========== ============
Change in preferred dividend accrual $ 208,938 $ --
=========== ============
See accompanying notes to consolidated financial statements.
5
GLOBAL PREFERRED HOLDINGS, INC.
Notes to Consolidated Financial Statements
September 30, 2002
(Unaudited)
(1) Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP") for interim financial information and with the
instructions for Form 10-Q of Regulation S-K. Accordingly, they do not include
all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002. The unaudited financial statements should be read in
conjunction with Global Preferred's audited financial statements included in
Global Preferred's 2001 Annual Report on Form 10-K, as amended, as filed with
the Securities and Exchange Commission.
(2) Deferred Tax
Global Preferred uses the asset and liability method to record deferred
income taxes. Accordingly, 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 using an effective federal income tax rate of 34%.
Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for
Income Taxes specifically excludes recognition of the "small life insurance
company deduction" available under Section 806 of the Internal Revenue Code for
qualifying life insurance companies. This special deduction can reduce the
effective federal income tax rate from 34% to less than 20% depending upon the
amount of taxable income. Consequently, the effective tax rate on Global
Preferred's earnings may ultimately prove to be less than the deferred income
tax liabilities and related expenses determined under SFAS No. 109, at September
30, 2002.
(3) Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, establishes standards for
reporting and displaying comprehensive income and its components in a full set
of general-purpose financial statements. The primary component of other
comprehensive income is the unrealized gain on securities as shown under the
equity section of the consolidated balance sheet. Total other comprehensive loss
for the three months ended September 30, 2002 was $933,093 compared to total
other comprehensive income of $1,850,794 for the three months ended September
30, 2001. Total other comprehensive income for the nine months ended September
30, 2002 was $1,078,638 compared to $4,641,954 for the nine months ended
September 30, 2001.
(4) Earnings Per Share
Basic earnings per share is computed based on the weighted-average
number of common shares outstanding during the period, in accordance with SFAS
No. 128, Earnings Per Share. Shares of convertible preferred stock issued in
June and July 2000 are included in the calculations of total weighted-average
common and common equivalent shares outstanding for the three months and nine
months ended September 30, 2001. The dilution effect on earnings per share from
the issuance of convertible preferred stock is shown on the consolidated
statements of income. The preferred stock converted to common stock on January
1, 2002.
(5) Common Stock
On July 12, 2001, the board of directors declared a three-for-two stock
split in the form of a stock dividend, consisting of 1.25 million shares,
payable to stockholders of record at the close of business on August 24, 2001.
The stock dividend was distributed on September 7, 2001. Fractional shares were
adjusted up to the next whole share using shares of treasury stock. Ninety-five
treasury shares were issued as a result of such rounding. Share and per-share
amounts have been retroactively adjusted to reflect the stock split on the
consolidated statements of income.
6
(6) Accounting Pronouncements
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended and interpreted, establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. It requires that an
entity recognize all derivatives as either assets or liabilities on the balance
sheet and measure those instruments at fair value. The accounting for changes in
the fair value of a derivative will be included in either earnings or other
comprehensive income depending on the intended use of the derivative instrument.
The provisions of SFAS No. 133 do not have a material impact on Global
Preferred's financial statements.
In September 2000, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities--a replacement of FASB Statement No. 125.
This statement revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, not previously required under SFAS No. 125. The provisions of SFAS
No. 140 do not have a material impact on Global Preferred's financial
statements.
The FASB issued four accounting standards in 2001. SFAS No. 141, SFAS
No. 142, SFAS No. 143 and SFAS No. 144 primarily address the accounting for
goodwill, business combinations, and the impairment and disposition of
long-lived assets. Additionally, in 2002, the FASB issued SFAS No. 145, SFAS No.
146 and SFAS No. 147 dealing with extinguishment of debt, intangible assets,
exit and disposal activities and acquisitions of financial institutions. The
provisions of these standards do not have a material impact on Global
Preferred's financial statements.
(7) Segment Reporting
Global Preferred defines reportable segments based on the nature of its
reinsurance agreements and the accounting treatment used for the various
reinsurance agreements. Based on this definition, two reportable segments have
been identified: non-universal life-type agreements and universal life-type
agreements (as each is referenced in 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, paragraphs 44 and 45). Global Preferred
reinsures certain variable universal life policies on a renewable term basis,
which are reported below as Non-Universal Life-Type Agreements and, as such,
these revenues are classified as premiums revenue. Renewable term reinsurance
involves the reinsurance of mortality risk whereby premiums are not directly
related to the premium rates on the original plan of insurance. Global
Preferred's renewable term agreements are accounted for under SFAS No. 60
accounting principles. Global Preferred reinsures variable annuity contracts and
certain other variable universal life policies on a coinsurance and modified
coinsurance basis, which are reported below as Universal Life-Type Agreements
and, as such, these revenues are classified as reinsured policy revenues.
Coinsurance involves the reinsurance of mortality and investment risks on the
same basis as that of the underlying policies. The ceding life companies and
Global Preferred share in these risks on a pro rata basis. Global Preferred's
existing coinsurance and modified coinsurance agreements are accounted for under
SFAS No. 97 accounting principles.
7
Items not directly related to the business segments and unallocated
corporate items (i.e., other income, interest expense on corporate debt and
unallocated operating expenses) are shown separately, consistent with Global
Preferred's internal measurement process. Segment assets reported include those
assets directly attributable to the reinsurance agreements such as reinsurance
balances receivable, deferred acquisition costs, policy loans, prepaid expenses,
invested assets and cash. Cash and invested assets are allocated to the
agreements based upon statutory reserves, the letters of credit posted in
support of the statutory reserves held, and allocated surplus, which is
consistent with Global Preferred's internal measurement process.
SEGMENT REPORTING
THREE MONTHS ENDED SEPTEMBER 30, 2001 2002
---------------------------------------- -----------------------------------------
Non- Non-
Universal Universal Universal Universal
(Dollars in thousands) Life-type Life-type Other Total Life-type Life-type Other Total
--------- --------- ------- -------- --------- --------- ------- --------
Premiums $ 4,909 $ -- $ -- $ 4,909 $4,485 $ -- $ -- 4,485
Reinsured policy revenues -- 2,728 -- 2,728 -- 3,442 -- 3,442
Benefits, claims and settlement expenses* 1,899 251 -- 2,150 2,086 402 -- 2,488
Reinsurance expense allowances, net 1,745 349 -- 2,094 1,574 527 -- 2,101
Amortization of deferred acquisition costs (78) 819 -- 741 117 2,367 -- 2,484
------- ------- ------- -------- ------ ------- ------- --------
Underwriting profit 1,343 1,309 -- 2,652 708 146 -- 854
Net investment income 52 58 111 221 37 97 34 168
Net realized gain on investments -- -- (2) (2) -- -- -- --
Costs of withdrawn offering -- -- -- -- -- -- 1,712 1,712
Other expenses 28 49 532 609 40 75 793 908
------- ------- ------- -------- ------ ------- ------- --------
Segment operating income (loss) before tax 1,367 1,318 (423) 2,262 705 168 (2,471) (1,598)
Income tax expense (benefit) 405 374 (125) 654 236 56 (827) (535)
------- ------- ------- -------- ------ ------- ------- --------
Segment net income (loss) $ 962 $ 944 $ (298) $ 1,608 $ 469 $ 112 $(1,644) $ (1,063)
Preferred dividends -- -- 71 71 -- -- -- --
------- ------- ------- -------- ------ ------- ------- --------
Segment net income (loss) available
to common stockholders $ 962 $ 944 $ (369) $ 1,537 $ 469 $ 112 $(1,644) $ (1,063)
======= ======= ======= ======== ====== ======= ======= ========
Segment assets $ 8,779 $47,368 $ 9,259 $ 65,406 $7,866 $61,251 $ 4,229 $ 73,346
======= ======= ======= ======== ====== ======= ======= ========
NINE MONTHS ENDED SEPTEMBER 30, 2001 2002
---------------------------------------- -----------------------------------------
Non- Non-
Universal Universal Universal Universal
(Dollars in thousands) Life-type Life-type Other Total Life-type Life-type Other Total
--------- --------- ------- -------- --------- --------- ------- --------
Premiums $14,361 $-- $ -- $ 14,361 $13,575 $ -- $ -- $ 13,575
Reinsured policy revenues -- 8,475 -- 8,475 -- 10,597 -- 10,597
Benefits, claims and settlement expenses* 5,947 480 -- 6,427 6,494 1,523 -- 8,017
Reinsurance expense allowances, net 5,091 1,254 -- 6,345 4,776 1,660 -- 6,436
Amortization of deferred acquisition costs 108 2,512 -- 2,620 190 4,485 -- 4,675
------- ------- ------- -------- ------ ------- ------- --------
Underwriting profit 3,215 4,229 -- 7,444 2,115 2,929 -- 5,044
Net investment income 165 161 262 588 111 230 230 571
Net realized gain on investments -- -- 4 4 -- -- 7 7
Costs of withdrawn offering -- -- -- -- -- -- 1,712 1,712
Other expenses 93 176 1,369 1,638 98 193 2,230 2,521
------- ------- ------- -------- ------ ------- ------- --------
Segment operating income (loss) before tax 3,287 4,214 (1,103) 6,398 2,128 2,966 (3,705) 1,389
Income tax expense (benefit) 1,054 1,351 (354) 2,051 731 1,018 (1,272) 477
------- ------- ------- -------- ------ ------- ------- --------
Segment net income (loss) $ 2,233 $ 2,863 $ (749) $ 4,347 $1,397 $ 1,948 $(2,433) $ 912
Preferred dividends -- -- 209 209 -- -- -- --
------- ------- ------- -------- ------ ------- ------- --------
Segment net income (loss) available
to common stockholders $ 2,233 $ 2,863 $ (958) $ 4,138 $1,397 $ 1,948 $(2,433) $ 912
======= ======= ======= ======== ====== ======= ======= ========
Segment assets $ 8,779 $47,368 $ 9,259 $ 65,406 $7,866 $61,251 $ 4,229 $ 73,346
======= ======= ======= ======== ====== ======= ======= ========
- ---------------------
* Benefits, claims and settlement expenses includes change in future
policy benefits.
Of the total premiums and reinsured policy revenues above for each of
the quarters ended September 30, 2001 and 2002, 90% relates to business issued
by Western Reserve Life Assurance Co. of Ohio ("Western Reserve"). Of the total
premiums and reinsured policy revenues above for the nine months ended September
30, 2001 and 2002, 89% and 91%, respectively, relates to business issued by
Western Reserve. Of the total underwriting profit above (excluding losses) for
the quarters ended September 30, 2001 and 2002, 86% and 95%, respectively,
relates to business issued by Western Reserve. Of the total underwriting profit
above for the nine months ended September 30, 2001 and 2002, 84% and 91%,
respectively, relates to business issued by Western Reserve.
8
(8) Reclassification
Global Preferred has reclassified the presentation of certain 2001
information to conform to the 2002 presentation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of Global Preferred
Holdings, Inc. as of September 30, 2002 compared with December 31, 2001, and its
results of operations for the three months and nine months ended September 30,
2002, compared with the three months and nine months ended September 30, 2001.
This discussion should be read in conjunction with the MD&A and Global
Preferred's consolidated financial statements and notes thereto included in
Global Preferred's 2001 Annual Report on Form 10-K, as amended.
OVERVIEW
Global Preferred Holdings, Inc. was incorporated in Delaware in 1995 as
a holding company, owning all of the outstanding capital stock of Global
Preferred Re Limited, a Bermuda company registered as a long-term insurer under
the Bermuda Insurance Act 1978 ("Global Preferred Re"). Global Preferred Re,
formed during 1995, commenced its reinsurance operations during 1996. References
in this report to "Global Preferred," "we," "us," "our" and "our company" refer
to Global Preferred Holdings, Inc. and, unless the context otherwise requires or
otherwise as expressly stated, our Bermuda subsidiary, Global Preferred Re.
Global Preferred, through Global Preferred Re, provides reinsurance for
life insurance and annuity products. We were formed principally to provide an
opportunity for the independent agents associated with an independent marketing
organization to participate indirectly in the reinsurance of the policies they
sold. An independent marketing organization ("IMO") is an organization of
independent agents that contracts with one or more insurance companies to
distribute and market securities and insurance products. Many of the individual
agents that purchased equity in Global Preferred are currently associated with
World Financial Group, Inc., an affiliate of AEGON USA, Inc., and currently,
control a majority of the outstanding common stock of Global Preferred. The
strength of our reinsurance business is based on our historical relationship
with the independent agents of World Financial Group, which is an IMO that
markets the products we currently reinsure.
Although our reinsurance business is directed to us through our IMO
relationship, the variable universal life insurance and variable annuity
policies that we currently reinsure are underwritten and issued by various
ceding life companies. In the insurance industry, the term "ceding" refers to
the use of reinsurance to transfer from one insurance company to another some or
all of the risks associated with one or more insurance policies. We often refer
to the life insurance companies that reinsure life insurance and annuity
policies through us as the "ceding life companies." The ceding life companies
who issue the policies we reinsure are:
- Western Reserve Life Assurance Co. of Ohio ("Western
Reserve");
- American Skandia Life Assurance Corporation ("American
Skandia");
- Pacific Life Insurance Company ("Pacific Life"); and
- Kemper Investors Life Insurance Company, an affiliate of
Zurich Insurance Company ("Zurich Life").
Under a reinsurance agreement, the economic consequences of certain
insurance risks are transferred from the ceding life company to the reinsurer.
Depending upon the type of reinsurance agreement, these risks may include
mortality, persistency, investment and expense. Key considerations in evaluating
the risks include industry experience, the ceding life company's pricing and
assumptions, the type of product, the ceding life company's underwriting
practices and procedures, the type of distribution system, the ceding life
company's recent experience and the market for the product.
9
The ceding life companies retain responsibility for the payment of all
claims, surrender values, commissions and expenses involved in issuing and
maintaining the policies we reinsure. In addition, the ceding life companies
administer the reinsurance contracts and, on a monthly and quarterly basis,
provide us with information regarding premiums, reserves and benefits and the
amounts we owe to the ceding life company for claims and settlement expenses on
the policies we reinsure.
TYPES OF REINSURANCE
We currently write three types of reinsurance: renewable term
(consisting of yearly renewable term and monthly renewable term), coinsurance
and modified coinsurance.
Renewable Term. Renewable term, also referred to as risk premium
reinsurance, which includes monthly renewable term and yearly renewable term, is
a plan of reinsurance in which the premium rates are not directly related to the
premium rates on the original plan of insurance. Under renewable term
reinsurance, the ceding life company reinsures a portion of the mortality risk
with us. The amount reinsured in any one period is not based on the face amount
of the policy, but rather on the portion of the net amount of risk we reinsure.
The net amount of risk is typically defined as the difference between the death
benefit and the cash value of a policy.
Coinsurance. Under a coinsurance arrangement, the insured risks are
ceded to us on essentially the same basis as underwritten by the ceding life
company. The ceded risks include mortality, persistency, investment and expense.
We share the risks pro rata with the ceding life company. We receive a
proportionate share of gross premiums from the ceding life company and provide
expense allowances to the ceding life company to pay for the expenses associated
with the reinsured policies. We also pay our proportionate share of death
benefits and other policy benefits. The reserves on the ceded portion of the
policy are held by us and are our obligations. Correspondingly, we invest the
assets related to the reserves and receive investment income from those assets.
Modified Coinsurance. Modified coinsurance is similar to coinsurance
except the ceding life company retains the reserves and the assets related to
the reserves. Modified coinsurance is used primarily for products that develop
cash values and allows the ceding life company to retain the associated assets
for investment purposes.
FINANCIAL STATEMENT IMPACT OF REINSURANCE
The Securities and Exchange Commission's Financial Reporting Release
No. 60 requires all companies to include a discussion of critical accounting
policies used in the preparation of financial statements. Additional information
in the notes to consolidated financial statements is shown above and in Note 2
to the consolidated financial statements in our Annual Report on Form 10-K, as
amended for the year ended December 31, 2001, which includes a summary of the
policies used in the preparation of our consolidated financial statements.
Income Statement Impact
Reinsurance Revenues. For renewable term reinsurance, we record as
"premiums" the amount of reinsurance premiums we receive over the payment
periods of the reinsured policies. For policies reinsured on a coinsurance or
modified coinsurance basis, we record as "reinsured policy revenues" our
proportionate share of gross revenues received by the ceding life company over
the payment periods of the reinsured policies. These revenues represent the
policy mortality and expense charges, asset-based allowances and deferred sales
charges that have been assessed against the reinsured policy account balances.
If we elect to convert coverage on certain policies that we currently
reinsure on a renewable term basis to a coinsurance or modified coinsurance
basis, the associated premium revenues for those policies will discontinue, and
our proportionate share of the associated mortality and expense charges, asset
based allowances and deferred sales charges will be recorded as reinsured policy
revenues.
10
Reinsurance Expenses. Regardless of the type of reinsurance, our
related expenses may include: (1) benefits, claims and settlement expenses,
which represent our share of the payments made under the reinsured policies
during the period, (2) expense allowances paid to the ceding life company for
expenses associated with the reinsured policies, including commissions and costs
associated with underwriting, marketing, policy issue and maintenance, and (3)
amortization of deferred acquisition costs, which are discussed in more detail
below.
Net Income. Global Preferred's profitability, in part, depends on the
volume of policies written and experience of the business reinsured. Factors
that affect the experience of the business include reinsured policy persistency,
death claims, and investment performance of the separate account balances. While
death claims are reasonably predictable over a period of years, claims become
less predictable over shorter periods, and are subject to fluctuation from
quarter to quarter and year to year. Similarly, separate account investment
returns, upon which a significant portion of our revenues depend, have
relatively stable returns over a period of years but can be volatile over
shorter periods. A considerable amount of separate account balances is invested
in equities; therefore prolonged deterioration in the equity markets will result
in a decrease in our current and future income.
Balance Sheet Impact
Deferred Acquisition Costs. We capitalize and defer costs that vary
with, and are directly associated with, the acquisition of the reinsured
policies. These expenses are deferred to the extent that such costs are deemed
recoverable from future policy revenues and are recorded as deferred acquisition
costs on the balance sheet. Such costs include reinsurance commission and
expense allowances paid to ceding life companies, and may include other
underwriting costs such as actuarial, legal and accounting fees.
Deferred acquisition costs are amortized over the lives of the
underlying policies, in conformity with the terms of the reinsurance agreement.
Under the renewable term agreements, the rate of amortization depends on the
approach utilized, static or dynamic, and is based upon assumptions applicable
at the time the policies are reinsured, such as estimates of expected investment
yields, mortality, persistency and expenses. Under the static approach, the
amortization is in proportion to the ratio of premiums collected during the then
current period to total anticipated premiums. Often the static approach is used
in the first policy year or until the business is sufficiently large to warrant
the complexity of the dynamic approach. Under the dynamic approach, the
amortization under the static approach is adjusted to reflect actual persistency
of the insurance in effect. To the extent fewer policies persist than otherwise
anticipated, the amortization will be greater under the dynamic approach than
under the static approach. Conversely, to the extent more policies persist than
otherwise anticipated, the amortization will be smaller. Currently, we use the
dynamic amortization approach for all our policies reinsured under our renewable
term agreements.
Under the coinsurance and modified coinsurance agreements, the
amortization of the deferred acquisition costs is in proportion to the ratio of
gross profits recognized during the then current period to total anticipated
future gross profits. During each accounting period, assumptions used in
calculating the amortization of the deferred acquisition expense reflect actual
experience for the then current accounting period. We also review, on a periodic
basis, our evolving experience with regard to our assumptions concerning future
experience as to mortality, persistency, investment yields and expenses in
determining our estimate of anticipated future gross profits. This periodic
review is commonly referred to as "unlocking." Our normal period of observation
is from October 1 of the previous calendar year through September 30 of the
current calendar year. If we believe variances from expected assumptions are
permanent, we will change the assumptions we use with regard to future
experience. Upon adoption of any change in assumptions used with regard to
future experience, the amortization of the deferred acquisition cost will be
recalculated and reflected during the then current accounting period.
Future Policy Benefits. Liabilities for future benefits on life
insurance policies are established in an amount adequate to meet the estimated
future obligations on the policies in effect. Policy and contract reserves are
included in "future policy benefits" on the consolidated balance sheet.
Liabilities for future policy benefits under the renewable term
agreements include provisions for claims in the course of settlement, claims
incurred but not reported and expected future claims. The liability is estimated
using assumptions such as estimates of expected investment yields, mortality,
persistency and expenses applicable at the time the reinsurance contracts are
executed.
11
Liabilities for future policy benefits under coinsurance and modified
coinsurance agreements equal reinsured policy account balances on the underlying
variable universal life policies and variable annuity contracts. With regard to
the separate account benefits reinsured on a modified coinsurance basis, we
record the liabilities as an offset to related assets as intentions and rights
under the agreements with the ceding life companies meet the appropriate
conditions governing rights of setoff. The nature of separate account benefits
does not permit us to reinsure those benefits on a coinsurance basis. We
currently reinsure the fixed portion of variable annuity contracts and variable
universal life policies only on a coinsurance basis and, accordingly, the
liabilities for that portion of the reinsurance are recorded as future policy
benefits.
Liabilities for future policy benefits reflected in the consolidated
financial statements are based on information provided to us by the ceding life
companies. Reserves established by us with respect to individual risks or
classes of business may not be the same as those established by ceding life
companies due to differing risks and assumptions regarding mortality,
persistency, investment and expenses.
FAIR VALUE DISCLOSURE
Investments. We classify all fixed maturities and equity securities as
"available for sale." Such securities are reported at fair value. Fixed
maturities available for sale are so classified based upon the possibility that
such securities could be sold prior to maturity if that action enables us to
execute our investment philosophy and appropriately match investment results to
operating and liquidity needs. Unrealized gains and losses on marketable equity
securities available for sale, less applicable income taxes, are reported as a
separate component of "accumulated other comprehensive income (loss)" within
stockholders' equity.
Investment income is recognized as it accrues or becomes legally due.
Realized gains or losses on sales of investments are included in income, as are
write-downs of securities where declines in value are deemed to be other than
temporary. The cost of investment securities sold is determined based upon the
specific identification method.
Other Financial Assets and Liabilities. The carrying value of cash and
cash equivalents, reinsurance receivables and payables, short-term debt, accrued
expenses and accounts payable approximate their fair values due to the
short-term nature of these accounts. The carrying value of future policy
benefits approximates its fair value as credited interest approximates current
market rates.
OUR CURRENT REINSURANCE AGREEMENTS
The life insurance and annuity policies that we have reinsured to date
are underwritten and issued by Western Reserve Life, American Skandia, Zurich
Life and Pacific Life. The following table indicates the percentage of our
reinsurance revenues derived from our ceding life companies:
NINE
MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
--------------- -------------
2000 2001 2002
---- ---- -------------
Western Reserve........................... 88% 89% 91%
American Skandia.......................... 10% 9% 8%
Zurich Life............................... 2% 2% 1%
Pacific Life(1)........................... -- 0% 0%
--- --- ---
Total..................................... 100% 100% 100%
=== === ===
- -------------------------
(1) This agreement was effective as of January 1, 2001.
12
The following table indicates, by ceding life company: (1) the names
and types of insurance products we currently reinsure; (2) the type of
reinsurance agreement applicable to each; (3) policy issue dates reinsured under
each agreement; and (4) the commencement date of the reinsurance.
REINSURANCE
PRODUCT REINSURANCE POLICY ISSUE COMMENCEMENT
CEDING LIFE COMPANY REINSURED PRODUCT NAME TYPE(1) TYPE(2) DATES DATE
- ------------------- ---------------------- ------- ----------- ------------ ------------
Western Reserve Freedom Equity Protector VUL MRT 1/92 to 12/99 7/96
Western Reserve Financial Freedom Builder VUL MRT 7/97 to 3/98 7/97
Western Reserve Financial Freedom Builder VUL Co/Modco 4/98 to 12/98 4/98
Western Reserve Financial Freedom Builder VUL MRT 1/99 to 3/01 10/99
Western Reserve Financial Freedom Builder VUL Co/Modco 4/01 to 12/01 01/02
Western Reserve Financial Freedom Builder VUL MRT 1/02 to present 10/99
Western Reserve Freedom Elite Builder VUL Co/Modco 7/01 to 12/01 1/02
Zurich Life Power VUL VUL MRT 9/96 to 3/01 9/96
Pacific Life Select Exec II VUL YRT 1/01 to present 1/01
American Skandia Imperium VA Modco 1/97 to present 1/97
Western Reserve Freedom Wealth Creator VA Co/Modco 1/98 to 12/01 1/98
Western Reserve Freedom Premier VA Co/Modco 10/00 to present 10/00
- ------------------------
(1) "VUL" means variable universal life product. "VA" means variable
annuity product.
(2) "MRT" means monthly renewable term. "YRT" means yearly renewable term.
"Co/Modco" means coinsurance and modified coinsurance.
Under our reinsurance agreements with the ceding life companies, we
currently reinsure variable life insurance and variable annuity policies on
either a renewable term basis or a coinsurance and modified coinsurance basis.
The policies we reinsure on a renewable term basis represented 56% of our
reinsurance revenues for the quarter ended September 30, 2002. The policies we
reinsure on a coinsurance and modified coinsurance basis represented 44% of our
reinsurance revenues for the same period. Of the 44%, 25% relates to variable
life insurance policies and 19% relates to variable annuity policies.
RECENT AMENDMENTS TO WESTERN RESERVE REINSURANCE AGREEMENTS
Consistent with our business plan, effective as of January 1, 2002, we
amended certain of our reinsurance agreements with Western Reserve to:
- - Convert our reinsurance of all Western Reserve Financial Freedom
Builder variable universal life policies and riders issued from April
1, 2001 through December 31, 2001, which had been reinsured by us on a
monthly renewable term basis, under which we assumed only mortality
risks on the reinsured policies, to a coinsurance and modified
coinsurance basis, under which we assumed a portion of all of the
insured risks that the life insurance company has on the reinsured
policies. The percentage of the risks assumed by us on policies
reinsured after this conversion, which is referred to as the "quota
share rate," is 20%;
- - Begin reinsuring, on a coinsurance and modified coinsurance basis at a
quota share rate of 20%, Western Reserve Freedom Elite Builder variable
universal life policies sold by the agents associated with World
Financial Group and issued from July 1, 2001 through December 31, 2001;
- - Increase our reinsurance on a coinsurance and modified coinsurance
basis, from a 10% quota share rate to a 14% quota share rate, of all
Western Reserve variable annuity policies sold by the agents associated
with World Financial Group and issued from January 1, 1999 through
December 31, 2001;
- - Begin reinsuring, on a coinsurance and modified coinsurance basis at a
quota share rate of 14%, all Western Reserve variable annuity policies
sold by the agents associated with World Financial Group and issued on
or after January 1, 2002; and
- - Cease our reinsurance of the Western Reserve Freedom Wealth Creator
variable annuity products sold, after January 1, 2002, by the agents
associated with World Financial Group, due to the limited volume of new
policies we anticipate to be written for this product; however, we will
continue to reinsure all Freedom Wealth Creator policies we reinsured
as of December 31, 2001.
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RESULTS OF OPERATIONS
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS
AND NINE MONTHS ENDED SEPTEMBER 30, 2001
The following table sets forth certain operating data as a percentage
of total revenue for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2001 2002 2001 2002
---- ---- ---- ----
(AS A PERCENTAGE OF TOTAL REVENUE)
CONSOLIDATED STATEMENTS OF INCOME DATA:
Revenues:
Premiums 62% 55% 61% 55%
Reinsured policy revenues 35 43 36 43
Net investment income 3 2 3 2
Net realized gain (loss) on investments -- -- -- --
Loss on recapture of business -- -- -- --
---- ---- ---- ----
Total revenue 100% 100% 100% 100%
Benefits and expenses:
Benefits, claims and settlement expenses 18 27 19 27
Change in future policy benefits 9 4 8 5
Reinsurance expense allowances, net 27 26 27 26
Amortization of deferred acquisition costs 9 31 11 19
Operating expenses 7 10 6 9
Costs of withdrawn offering -- 21 -- 7
Interest expense 1 1 1 1
---- ---- ---- ----
Total benefits and expenses 71 120 73 94
---- ---- ---- ----
Income (loss) before income taxes 29 (20) 27 6
Income tax benefit (expense) (8) 7 (9) (2)
---- ---- ---- ----
Net income (loss) 21% (13)% 18% 4%
==== ==== ==== ====
Revenues
Premiums. Premiums decreased by $424,000, or 9%, and $786,000, or 5%,
for the quarter and the nine months ended September 30, 2002, respectively,
compared to the same periods in 2001. The majority of this decrease was due to
the conversion of all Western Reserve Financial Freedom Builder variable
universal life policies and riders, issued from April 1, 2001 through December
31, 2001, which had been reinsured by us on a monthly renewable term basis, to a
coinsurance and modified coinsurance basis, effective January 1, 2002.
Reinsured Policy Revenues. Reinsured policy revenues increased
$714,000, or 26%, and $2.1 million, or 25%, for the quarter and the nine months
ended September 30, 2002, respectively, compared to the same periods in 2001.
This increase was due to: (1) the conversion of certain Financial Freedom
Builder variable universal life policies and riders, as described above; (2) the
reinsurance, at a quota share ratio of 20%, of the Western Reserve Freedom Elite
Builder variable universal life policies sold by the agents associated with
World Financial Group and issued from July 1, 2001 through December 31, 2001;
(3) the increase in our reinsurance on a coinsurance and modified coinsurance
basis, from a 10% quota share rate to a 14% quota share rate, of all Western
Reserve variable annuity policies sold by the agents associated with World
Financial Group and issued from January 1, 1999 through December 31, 2001; and
(4) an increase in surrender revenues in 2002 compared to 2001. These increases
were partially offset by a decrease in mortality and expense charges and
asset-based allowances resulting from the decline in variable annuity separate
account balances.
Net Investment Income and Net Realized Gain on Investments. Net
investment income decreased $53,000, or 24%, and $17,000, or 3%, for the quarter
and the nine months ended September 30, 2002, respectively, compared to the same
periods in 2001, primarily due to the decreased size of our investment
portfolio, because of the $7.2 million payment to Western Reserve in April 2002
relating to the amendments to our reinsurance agreements effective January 1,
2002, and also due to a greater portion of our assets being invested in cash and
cash equivalents in 2002. The sale of fixed maturity securities for the nine
months ended September 30, 2002 resulted in a net realized gain on investments
of
14
$7,000 compared to a net realized gain on investments of $4,000 for the
comparable period in 2001. These gains were caused by a decline in market
yields, which resulted in an increase in the fair value of invested securities.
Benefits and Expenses
Benefits, Claims and Settlement Expenses. Benefits, claims and
settlement expenses increased $728,000, or 52%, and $2.3 million, or 52%, for
the quarter and nine months ended September 30, 2002, respectively, compared to
the same periods in 2001. The increase was primarily associated with a lower
incidence of life insurance death claims in 2001 compared to the incidence of
death claims in 2002, the increasing age of the policies reinsured and an
increase in variable annuity death claims. The aggregate face value of insurance
underlying the policies we reinsured at September 30, 2002 was $8.7 billion
compared to $9.3 billion at September 30, 2001.
Change in Future Policy Benefits. Change in future policy benefits
decreased $389,000, or 52%, and $723,000, or 37%, for the quarter and the nine
months ended September 30, 2002, respectively, compared to the same periods in
2001. The majority of this decrease was due to the conversion of all Western
Reserve Financial Freedom Builder variable universal life policies and riders,
issued from April 1, 2001 through December 31, 2001, which had been reinsured by
us on a monthly renewable term basis, to a coinsurance and modified coinsurance
basis, effective January 1, 2002.
Reinsurance Expense Allowances, Net. Net reinsurance expense allowances
increased $7,000, or less than 1%, and $91,000, or 1%, for the quarter and the
nine months ended September 30, 2002, respectively, compared to the same periods
in 2001. These amounts are reflective of the increase in business in force
primarily attributable to the amendments to our reinsurance agreements effective
January 1, 2002 offset by the decrease in business in force due to normal lapse
and surrender activity.
Amortization of Deferred Acquisition Costs. Amortization of deferred
acquisition costs increased $1.7 million, or 235%, and $2.1 million, or 78%, for
the quarter and the nine months ended September 30, 2002, respectively, compared
to the same periods in 2001. Higher than expected surrender experience,
including "unlocking" our near term surrender assumptions to reflect the
increase in our surrender experience (akin to industry-wide surrender
experience), and lower than expected investment performance of the separate
account balances contributed to $1.3 million and $1.6 million of the increase in
amortization for the quarter and nine months ended September 30, 2002,
respectively, as compared to the same periods in 2001. We will complete our
annual review of our future experience assumptions during fourth quarter 2002.
In addition, amortization increased due to new business reinsured, including the
amendments to our reinsurance agreements with Western Reserve effective January
1, 2002.
Operating Expenses. Operating expenses increased $299,000, or 58%, and
$881,000, or 65%, for the quarter and the nine months ended September 30, 2002,
respectively, compared to the same periods in 2001. These expenses include
salaries and benefits, professional fees for legal, actuarial and accounting
expenses and other operating expenses. The majority of the increase for the
quarter ended September 30, 2002 was attributable to a $195,000 increase in
salaries, bonuses, benefits and recruiting expenses due to the employment of
additional staff, a $63,000 increase in legal fees, and a $26,000 increase in
our directors and officers' insurance premiums.
Costs of Withdrawn Offering. During October 2002, we withdrew the
registration statement for our proposed initial public offering of 9.5 million
shares of common stock. Offering costs related to our withdrawn offering were
$1.7 million for the quarter and nine months ended September 30, 2002. These
costs, which consisted primarily of legal, printing, accounting, and actuarial
fees, were expensed during the quarter ended September 30, 2002. We did not
incur any similar expenses in 2001.
Interest Expense. Interest expense remained the same, and increased
$2,000, or 1%, for the quarter and nine months ended September 30, 2002,
respectively, compared to the same periods in 2001. The increase was due to the
interest associated with the $7.2 million settlement paid to Western Reserve on
April 2, 2002 to fund the reinsurance amendments that were effective January 1,
2002.
Income Taxes. Due to lower levels of income before income taxes, income
taxes decreased $1.2 million, or 182%, and $1.6 million, or 77%, for the quarter
and the nine months ended September 30, 2002, respectively, compared to the same
periods in 2001. Income before income taxes is comprised of income subject to
taxes that is recognized and due in the current period and income subject to
taxes that is recognized during the current period but is due in future periods.
The "small life insurance company deduction" available under Section 806 of the
Internal Revenue Code
15
for qualifying life insurance companies can reduce the effective federal income
tax rate from 34% to less than 20% depending upon the amount of current taxable
income. As of September 30, 2001 and 2002, we had no current taxable income and
as a result, we were unable to take advantage of any of the small life insurance
company deduction. During 2001 and 2002 our effective tax rate was 34%.
In accordance with SFAS No. 109, Accounting for Income Taxes, we have
$11.7 million of net operating loss carryforwards which begin to expire in 2018.
These net operating loss carryforwards at a 34% effective tax rate are included
as an offset to the deferred tax liability. It is our belief that it is more
likely than not that the deferred tax assets will be realized as an offset
against future taxable income, however, if we do not have sufficient taxable
income in the future to utilize this asset, a write-off may result thereby
reducing our net income.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of cash flow have been premiums received from the
ceding life companies, investment income, proceeds from the sale of invested
assets, issuance of common and preferred stock, and short- and long-term
financing. In addition to cash flow to meet operating expenses, our liquidity
requirements relate primarily to the payment of gross reinsurance allowances,
investment purchases, debt service and reinsurance claims.
We generally receive premiums in advance of our making related benefits
and claims payments. Under the renewable term reinsurance agreements, premiums
typically vary in proportion to the expected mortality claims reinsured. Our
cash inflows under the renewable term agreements are premiums for the mortality
risk reinsured. Our cash outflows are reinsurance expense allowances and death
benefit claims. The reinsurance expense allowances represent our share of
acquisition and maintenance expenses incurred by the ceding life company that
are attributable to the risks reinsured by us.
Under the coinsurance and modified coinsurance agreements, since we are
reinsuring risks on essentially the same basis as that of the original policy,
reinsurance premiums are materially greater than premiums received on the
renewable term reinsurance. During the first year in which a policy is reinsured
on a coinsurance basis, we are required to reimburse the ceding life company for
our share of acquisition costs, including first year commissions and issuance
expenses. Thereafter, we reimburse the ceding life company for our share of
renewal commissions and maintenance expenses. Further, under modified
coinsurance, we allow the ceding life company to retain assets related to
reserves in support of reinsured policy benefits (e.g., cash values).
Accordingly, because of the type of reinsurance and the basis reinsured, the net
first year cash outlays could be as much as, or more than, that year's premiums
paid for variable universal life insurance, and as much as 10% of variable
annuity premiums. In year two and beyond, however, our cash outlays for
reinsurance allowances are significantly lower than in the first year of a
policy.
Consistent with our business plan, effective as of January 1, 2002, we
amended certain of our reinsurance agreements with Western Reserve to: (1)
convert our reinsurance of certain existing variable universal life policies
from a monthly renewable term basis to a coinsurance and modified coinsurance
basis; (2) increase our reinsurance quota share on certain variable annuity
policies; and (3) begin reinsuring certain newly issued variable universal life
and variable annuity policies. At this time we are exploring financing
strategies to fund similar transactions. The amount, timing, receipt and cost of
additional capital will determine the extent to which we will be able to take
advantage of the rights we have under our agreements with Western Reserve to
complete similar transactions. Certain of these rights will begin expiring
December 31, 2002.
In October 2002, we withdrew the registration statement for our
proposed initial public offering of 9.5 million shares of common stock due to
unfavorable market conditions. During the quarter ended September 30, 2002, we
expensed $1.7 million of deferred offering costs that were to be offset against
the proceeds of the offering. The deferred offering costs paid in prior periods
were previously reported as an asset under "prepaid expenses" on the
consolidated balance sheet and the expensing of those costs is currently shown
as "costs of withdrawn offering" on the consolidated income statement. The
withdrawal of the registration statement associated with the offering will
permit us to pursue a broader array of financing strategies.
Our cash requirements for operating and investment expenses consist of:
salaries and benefits; management service fees; investment management and
custodial fees; accounting and consulting services fees; expenses related to
regulatory issues and compliance with corporate and tax matters; and other
incidental administrative expenses. We have incurred no significant capital
expenditures during 2002.
16
Net cash flows provided by (used in) operating activities were $7.1
million and ($2.8 million) for the nine months ended September 30, 2001 and
2002, respectively. Changes in cash provided by operating activities primarily
related to: amounts of reinsurance premiums and policy revenues received;
claims, reinsurance expense allowances and operating expenses paid; and changes
in working capital. Cash flows were used in operating activities in 2002
primarily because of the $7.2 million settlement paid to Western Reserve to fund
the reinsurance amendments. Cash flows were provided by operations in 2001
because we utilized less cash to acquire new reinsurance business.
On July 30, 1999, we issued a $5 million, five-year convertible term
note to Money Services, Inc. due on July 29, 2004. Money Services is a
subsidiary of AEGON USA, Inc. Proceeds of this note were used to reduce a
portion of the outstanding principal balance on a line of credit with Money
Services from $10 million to $5 million. Interest is payable on the note at 7.5%
per annum (except in the event of redemption), on the 29th of each succeeding
January and July through and including July 29, 2004. Money Services has the
right to convert the outstanding principal balance of this note into common
stock at any time. Upon conversion, Money Services would receive 6.25 shares of
common stock for each $100 of the outstanding principal amount of the note,
which reflects our three-for-two stock split in 2001. Global Preferred has the
option to redeem the note, in whole or in part, before maturity. To redeem the
note before maturity, we must pay all principal, plus interest accrued from the
date of the note through the redemption date at a higher effective interest rate
of 9% per annum. As of September 30, 2002, we had an outstanding principal
balance on the term note of $5 million and accrued interest of $63,699.
In addition, we had a $5 million line of credit with Money Services
that we paid in full, together with the related accrued interest, on February
15, 2001. Principal payments totaled $277,285 during 2001.
Our primary source of liquidity was $4.6 million in consolidated cash
and cash equivalents at September 30, 2002. The effective duration of our fixed
maturity portfolio is 2.5 years with 100% of the fixed maturity securities
having an effective maturity of less than 10 years. Our fixed maturity portfolio
represents all of our total invested assets, and has an average Moody's quality
rating of Aa2.
Net cash flows (used in) provided by investing activities were ($7.4
million) and $520,000 for the nine months ended September 30, 2001 and 2002,
respectively. Changes in cash used in investing activities were generally a
result of our investment of excess capital generated by operating activities to
purchase fixed maturity securities. The $7.4 million of cash used in investing
activities in 2001 primarily relates to our purchase of fixed maturity
securities. Net cash flows provided by investing activities of $520,000 in 2002
were the result of proceeds generated from the sale and maturity of available
for sale securities and from the principal payments on mortgage-backed
securities offset by the purchase of available for sale securities.
Net cash flows used in financing activities were $277,000 and $1.1
million for the nine months ended September 30, 2001 and 2002, respectively.
Changes in cash used in financing activities in 2002 related to the cash paid
for the deferred offering costs, which were expensed in the third quarter 2002,
offset by cash paid for deferred offering costs in 2001 which had been
previously recorded as prepaid expenses on the consolidated balance sheet.
Changes in cash used in financing activities in 2001 related to principal
payments on the Money Services line of credit, which was paid in full in
February 2001.
Global Preferred Holdings, Inc. is a holding company with no direct
operations, and whose principal assets are the capital stock of Global Preferred
Re and $1.6 million of cash and invested assets, as of September 30, 2002.
Global Preferred Holdings, Inc. relies primarily on funds retained at the
holding company level, debt service on amounts loaned to Global Preferred Re,
service fees and potential dividends from Global Preferred Re to meet ongoing
cash requirements. The ability of Global Preferred Re to pay dividends to Global
Preferred Holdings, Inc. is subject to, among other things, regulatory
restrictions under the insurance laws of Bermuda. During the nine months ended
September 30, 2002, Global Preferred Re paid no dividends to Global Preferred
Holdings, Inc.
Under our reinsurance agreements, we are required to provide security
through a letter of credit for the benefit of the ceding life companies. We have
three letters of credit issued by Comerica Bank, our custodian, for the benefit
of Western Reserve, Pacific Life and Zurich Life, in the amounts of $8.5
million, $50,000 and $300,000, respectively. We assess our letter of credit
needs in support of each reinsurance agreement. If determined to be necessary,
we will undertake to develop facilities for future letters of credit and trust
arrangements in support of additional reinsurance agreements.
17
FORWARD-LOOKING STATEMENTS
Certain statements made in this report are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 and
are subject to the "safe-harbor" provisions of that Act. Additionally, any
written or oral statements made by us or on our behalf may include
forward-looking statements that reflect our current views with respect to future
events and financial performance. These statements may include, but are not
limited to statements relating to reinsurance revenues, gross profits, cash
flows and net income in future periods. Such statements often include the words
"believes," "expects," "assumes," "predicts," "continue," "potential," "should,"
"could," "can," "may," "will," "proposes," "anticipates," "intends," "plans,"
"estimates," "projects," and variations or negations of such expressions or
similar expressions. When we make forward-looking statements, we are basing them
on our management's beliefs and assumptions, using information currently
available to us. Because such forward-looking statements involve risks, both
known and unknown, and uncertainties, there are important factors that could
cause actual results to differ materially from those expressed or implied by
such forward-looking statements, including but not limited to:
- The amount, timing, receipt and cost of additional capital to
fund our exercise of the rights to increase our reinsurance
business with Western Reserve;
- A decrease in the level of demand for our reinsurance
business, or increased competition in the industry;
- Extent to which we are able to develop new reinsurance
programs;
- Adverse reinsurance experience, including death claims and
surrenders;
- Estimates of reserves;
- Assumptions used in accounting for deferred acquisition costs;
- Negotiation of reinsurance agreements;
- Our cash requirements;
- Availability of capital on acceptable terms;
- The passage of federal or state legislation subjecting our
business to additional supervision or regulation, including
additional tax regulation, in the United States or other
jurisdictions in which we operate; and
- Changes in economic conditions, including interest rate and
equity market conditions, which could affect our investment
portfolio and reinsured policy revenues.
These forward-looking statements are subject to change and uncertainty
that are beyond our control and have been made based upon our expectations and
beliefs concerning future developments and their potential effect on our
business. We cannot assure you that future developments will be in accordance
with our expectations or that the effect of future developments will be those we
anticipate. Actual results could differ materially from those we expect,
depending upon the outcome of certain factors, including those described in the
forward-looking statements and in the section titled "Factors That May Affect
Future Results" in our 2001 Annual Report on Form 10-K, as amended. We
18
caution readers not to place undue reliance on these forward-looking statements,
which speak only as of their dates. Except as otherwise required by federal
securities laws, we undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We seek to earn a favorable risk-adjusted total return on our assets by
engaging in an investment strategy that employs strategies to manage investment
risk. We attempt to maintain adequate liquidity in our fixed income portfolio to
fund operations and protect against unexpected events. We have diversified our
portfolio to reduce volatility. We seek to manage our credit risk through
industry and issuer diversification, and interest rate risk by monitoring the
duration and structure of our investment portfolio relative to the duration and
structure of our liability portfolio. We are exposed to potential loss from
various market risks, primarily changes in interest rates and equity prices.
Accordingly, earnings would be affected by these changes. We manage our market
risk based on investment policies approved by our board of directors.
We do not directly control the allocation of our assets to strategies
or underlying funds, nor do we control the manner in which they are invested by
underlying fund managers. We utilize an independent investment manager to invest
our assets in accordance with our investment guidelines. Conning Asset
Management Inc., a subsidiary of Swiss Reinsurance Company, has been our
investment manager since June 1998. Conning has discretionary authority to
manage our non-cash investment portfolio. As a result, the performance of our
aggregate investment portfolio depends largely on the ability of Conning to
select and manage appropriate investments. However, we consistently and
systematically monitor the strategies and funds in which we are invested, and we
believe our overall risk is limited as a result of our selected strategy. We do
not have, nor have we ever had, an affiliation with Conning, nor has Conning
disclosed any affiliation with the ceding life companies.
At September 30, 2002, the impact on our investment portfolio of an
immediate 100 basis point increase in market interest rates would have resulted
in an estimated decrease in fair value of 1.7%, or approximately $301,000, and
the impact on our investment portfolio of an immediate 100 basis point decrease
in market interest rates would have resulted in an estimated increase in fair
value of 1.5%, or approximately $280,000.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the date of this report, Global
Preferred, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, carried out
an evaluation of the effectiveness of the design and operation of the company's
disclosure controls and procedures (the "Evaluation"). Based upon the
Evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that Global Preferred's disclosure controls and procedures are effective in
ensuring that material information relating to Global Preferred, including its
consolidated subsidiary, is made known to them by others within the
organization, particularly during the period in which this quarterly report was
being prepared. There were no significant changes in Global Preferred's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the Evaluation.
19
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are currently not a party to any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
There were no changes in securities during the three months ended
September 30, 2002.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
There have been no defaults in the payment of principal or interest of
any indebtedness of the issuer.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The results of the voting by our security holders on the matters
submitted to them at our Annual Stockholders Meeting held on July 30,
2002, were reported in our Form 10-Q for the period ended June 30,
2002.
There were no other matters submitted to a vote of security holders
during the three months ended September 30, 2002.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 First Amendment to Employment Agreement by and between the
Registrant and Bradley E. Barks, effective July 30, 2002
(incorporated herein).
99.1 Certification by Edward F. McKernan, Chief Executive Officer,
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification by Bradley E. Barks, Chief Financial Officer,
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Global Preferred filed an 8-K report on August 19, 2002 regarding a
press release for second quarter earnings dated August 15, 2002.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, in the City of Duluth, State of Georgia
on the 14th day of November, 2002.
GLOBAL PREFERRED HOLDINGS, INC.
By: /s/ EDWARD F. MCKERNAN
---------------------------------------
Edward F. McKernan
Chief Executive Officer and President
and Director
By: /s/ BRADLEY E. BARKS
---------------------------------------
Bradley E. Barks
Chief Financial Officer and Senior
Vice President - Finance
21
CERTIFICATION
Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Edward F. McKernan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Global Preferred
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Edward F. McKernan
-------------------------
Edward F. McKernan
Chief Executive Officer
22
CERTIFICATION
Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Bradley E. Barks, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Global Preferred
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Bradley E. Barks
-----------------------------
Bradley E. Barks
Chief Financial Officer
23