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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended December 31, 1997
Commission File Number 1-8538
WESTBRIDGE CAPITAL CORP.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 73-1165000
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
777 Main Street, Fort Worth, Texas 76102
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(817) 878-3300
Registrant's Shareholder and Investor Relations Telephone Number:
(817) 878-3850
Securities Registered Pursuant to Section 12(b) of the Act:
Common Stock (par value $.10) New York Stock Exchange
$20,000,000 11.0% Senior Subordinated Notes Due 2002,
New York Stock Exchange
$70,000,000 7-1/2% Convertible Subordinated Notes Due 2004,
New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No__
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in the definitive Proxy Statement or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of voting stock held by non-affiliates of the
Registrant amounted to $3,087,892 as of March 9, 1998.
At March 9, 1998, 6,224,344 shares of Common Stock were outstanding.
2
WESTBRIDGE CAPITAL CORP.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. Business 3
ITEM 2. Properties 19
ITEM 3. Legal Proceedings 19
ITEM 4. Submission of Matters to a Vote of Security Holders 19
PART II
ITEM 5. Market for the Registrant's Common Stock and Related
Stockholder Matters 20
ITEM 6. Selected Financial Data 20
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
ITEM 8. Financial Statements and Supplementary Data 34
ITEM 9. Changes in and Disagreements on Accounting and Financial
Disclosure 74
PART III
ITEM 10 Directors and Executive Officers of the Registrant 74
ITEM 11 Executive Compensation 77
ITEM 12 Security Ownership of Certain Beneficial Owners and Management 82
ITEM 13 Certain Relationships and Related Transactions 84
PART IV
ITEM 14 Exhibits, Financial Statement Schedules and Reports
on Form 8-K 85
PART I
ITEM 1. BUSINESS
GENERAL
Westbridge Capital Corp. is an insurance holding company engaged in the
development, marketing, underwriting and administration of medical expense and
supplemental health insurance products primarily to self-employed individuals
and small business owners in both urban and rural markets. As used herein the
terms "Westbridge" or the "Company" refer to Westbridge and its consolidated
subsidiaries, unless the context requires otherwise. The Company's revenues
result primarily from (i) operating insurance companies (the "Insurance
Subsidiaries") and (ii) general insurance agencies marketing certain managed
health care plans which are underwritten by Health Maintenance Organizations
("HMOs") and other non-affiliated managed care organizations.
During the second and third quarters of 1997, the Company's Insurance
Subsidiaries experienced a sharp increase in claims submissions on Medical
Expense and Medicare Supplement products resulting in substantial losses for
such quarters. In addition, a backlog of pending claims was paid during that
period which also contributed to the second quarter's losses. Following
independent reviews of the Company's claim reserves and an independent benefit
analysis of claims, the Company was required to make substantial additions to
the Insurance Subsidiaries' claim reserves. During the fourth quarter of 1997,
the Company suspended interest payments on its 11% Senior Subordinated Notes and
its 7-1/2% Convertible Subordinated Notes, and suspended dividend payments on
its Series A Preferred Stock, resulting in various defaults and events of
default on such securities. The Company also recognized a substantial premium
deficiency by recording a non-cash charge to current expenses of approximately
$65 million in unamortized deferred policy acquisitions costs. The Company has
been working with Houlihan, Lokey, Howard & Zukin Capital since November 1997 to
assist it in exploring its strategic alternatives and is continuing active
discussions with its insurance regulatory authorities and certain of its
creditors. See "ITEM 7 - Management's Discussion and Analysis of Results of
Operations and Financial Condition."
MARKETING DISTRIBUTION SYSTEM
The Company markets health insurance products and managed care health plans
through a distribution system consisting of (i) general agencies in which the
Company has a controlling ownership interest and (ii) independently-owned
general agencies which have entered into exclusive contractual arrangements to
sell the Company's insurance products.
The Company has generally marketed its underwritten health insurance products to
individuals on a one-on-one basis through agents who are independent contractors
associated with general agencies. The Company's policies are sold to individuals
who are either not covered under group insurance protection normally available
to employees of business organizations or who wish to supplement existing
coverage. In many cases, these individuals are either owners or employees of
small business groups. In 1996, the Company began marketing managed care health
plans underwritten primarily by HMOs and other managed care organizations,
primarily in urban markets where managed care is the consumer's preferred
health-care choice.
Agents' sales contacts generally result from leads generated either by the
Company's telemarketing subsidiary or through outside sources. By utilizing a
predictive automated dialing system, the Company believes its wholly-owned
telemarketing subsidiary, Precision Dialing Services, Inc. ("PDS") is able to
generate a large number of quality sales leads. By providing its controlled and
independent general agencies and their agents with these sales leads, the
Company believes it can attract to experienced agents as well as new agents
entering the business. Consequently, the Company believes it can more easily
attract new agents and retain agents who are a part of its existing general
agencies.
The Company has sought to develop its network of controlled general agencies to
provide it with flexibility and long-term stability in its marketing
relationships. To the extent that these general agencies sell commissioned
products of HMOs and other managed care organizations, they provide additional
fee and service income to the Company.
The principal general agencies in which the Company has a controlling ownership
interest are LifeStyles Marketing Group, Inc. ("LifeStyles Marketing"), Senior
Benefits, LLC ("Senior Benefits"), Health Care-One Insurance Agency, Inc.
("Health Care-One"), Health Care-One Marketing Group, Inc. ("HCO Marketing") and
Freedom Marketing. These general agencies market a variety of insurance products
underwritten by the Company, as well as HMO, Preferred Provider Organization
("PPO") and Medicare SELECT products underwritten by independent managed care
organizations such as Blue Cross of California and UniCARE Life and Health
Insurance Company ("UniCARE"), each of which is a subsidiary of WellPoint Health
Networks Inc. ("WellPoint"). The principal independent general agencies that
sell the Company's products are Cornerstone National Marketing Corporation
("Cornerstone") and National Farm and Ranch Group, Inc. ("Farm & Ranch"), each
of which currently markets the Company's Medical Expense products.
Since prior to 1991, the Company's controlled and independent general agencies
have accounted for substantially all of the Company's first-year premiums.
During 1997, LifeStyles Marketing, Cornerstone, Senior Benefits and Farm & Ranch
each accounted for over 10% of the Company's first-year premiums and together
accounted for over 85% of the Company's first-year premiums. The Company
believes that its relationships with its general agencies are good. However,
there can be no assurance that such relationships will continue, or if they do
continue, that they will be profitable for the Company. The Company's ability to
increase production of its underwritten products is expected to remain limited
for the foreseeable future, and these limitations could adversely affect the
Company's relationships with these general agencies. The loss of, or
significantly reduced sales efforts by, any of these general agencies, and the
failure by the Company to replace such general agencies or otherwise offset such
losses, could have a material adverse affect on the Company's business,
financial condition or results of operations. In the event the Company desires
to expand its marketing distribution system, there can be no assurance that it
will be able to form additional general agency relationships or, if formed, that
such relationships will result in increased sales or profitability for the
Company.
DESCRIPTION OF PRODUCT LINES
The major product lines currently marketed and underwritten by the Company's
Insurance Subsidiaries are:
"Medical Expense Products," which include policies providing reimbursement
for various costs of medical and hospital care and offering reduced
deductibles and coinsurance payments to policy-holders which use the
Company's contracted PPOs; and
"Critical Care and Specified Disease Products," which include indemnity
policies for treatment of specified diseases and "event specific" and
"critical care" policies which provide fixed benefits or lump sum payments
upon diagnosis of internal cancer or other catastrophic diseases.
Historically, the Company has also underwritten a significant amount of
"Medicare Supplement Products" designed to provide reimbursement for certain
expenses not covered by the Medicare program. During 1997, the Company
significantly reduced its underwriting of these products in favor of marketing
the Medicare Supplement products of other insurers due to the relatively low
margins for these products.
The major managed care products which are currently marketed by the Company and
underwritten by unaffiliated HMOs and other managed care organizations are:
HMO products underwritten by Blue Cross of California;
PPO products underwritten by UniCARE; and
Medicare SELECT products underwritten by UniCARE which utilize the
Company's network of contracted Medicare SELECT providers.
Premium revenue, in thousands, for each of the Company's major underwritten
product lines is set forth below:
Year Ended December 31,
------------------------------
1997 1996 1995
-------- -------- --------
ACCIDENT AND HEALTH INSURANCE:
Medical Expense Products:
Direct business
First-year $ 26,621 $ 40,308 $ 16,352
Renewal 36,680 15,906 9,990
Acquired Business (1) 10,438 14,057 19,569
Other (3) 1,500 1,520 1,926
-------- -------- --------
Total Medical Expense Products 75,239 71,791 47,837
-------- -------- --------
Critical Care and Specified Disease Products:
Direct business
First-year 1,229 1,227 1,254
Renewal 12,216 12,520 13,009
Acquired business (1) (2) 20,052 16,465 8,901
Reinsurance assumed - 4,002 9,911
-------- -------- --------
Total Critical Care and Specified Disease Products 33,497 34,214 33,075
-------- -------- --------
Medicare Supplement Products:
Direct business
First-year 8,754 17,852 12,359
Renewal 25,124 11,895 3,011
Acquired business (1) 15,546 17,788 20,645
Other (3) 2,105 2,351 2,617
-------- -------- --------
Total Medicare Supplemental Products 51,529 49,886 38,632
-------- -------- --------
Total Accident and Health Insurance 160,265 155,891 119,544
-------- -------- --------
LIFE INSURANCE:
Total Life Insurance 832 889 549
-------- -------- --------
Total Premium Revenue $161,097 $156,780 $120,093
======== ======== ========
(1) Includes revenue from policies acquired in the acquisition of National
Financial Insurance Company ("NFIC") and American Insurance Company of
Texas ("AICT") in April 1994.
(2) Includes revenue from policies acquired in the acquisition of Freedom Life
Insurance Company of America's ("FLICA") parent, Freedom Holding Company
("FHC"), in May 1996.
(3) Represents pre-1987 discontinued lines of business.
The Company's products are designed with flexibility as to benefits and premium
payments and can be adapted to meet regional sales or competitive needs, as well
as those of the individual policyholders. These products have fixed, capped or
limited benefits and are designed to reduce the potential financial impact of
covered illnesses and injuries.
Set forth below is a summary of the principal products the Company currently
underwrites, as well as those which are no longer sold but continue to generate
premium revenue through renewals.
Medical Expense Products. The Company's Medical Expense products are designed to
reimburse insureds for expenses incurred for hospital confinement, surgical
expenses, physician services, out-patient benefits and the cost of medicines
immediately following a hospital stay. Out-patient benefits and maternity
benefits are also available. The policies provide a number of options with
respect to deductibles, coinsurance percentages, maximum benefits and stop-loss
limits and offer reduced deductibles and coinsurance payments to policyholders
which use the Company's contracted PPOs. In addition, certain policies include
"inside limits" on benefits during hospital confinement. After the annual
deductible is met, the insured is responsible for a percentage of eligible
expenses up to a specified stop-loss limit. Thereafter, eligible expenses are
covered by the Company up to certain maximum policy limits.
The Company's Medical Expense products are individually underwritten based upon
medical information provided by the applicant prior to issue. Information in the
application is verified with the applicant through a tape-recorded telephone
conversation or through written correspondence. These policies are conditionally
renewable at the Company's option.
The Company's Medical Expense products are marketed primarily by Freedom
Marketing, LifeStyles Marketing, Cornerstone, and Farm & Ranch and are sold
primarily to members of non-affiliated associations which consist of
self-employed individuals, small business owners and members of the agricultural
community.
Critical Care and Specified Disease Products. The Company's Critical Care and
Specified Disease products include indemnity policies for hospital confinement
and convalescent care for treatment of specified diseases and "event specific"
and "critical care" policies which provide fixed benefits or lump sum payments
upon diagnosis of certain types of internal cancer or other catastrophic
diseases. Benefits are payable directly to the policyholder following diagnosis
of or treatment for a covered illness or injury. The payments are designed to
help reduce the potential financial impact of these illnesses or injuries and
may be used at the policyholder's discretion for any purpose, including helping
to offset non-medical expenses or medical-related expenses not paid by the
policyholder's other health insurance. The amount of benefits provided under the
Company's Critical Care and Specified Disease products is not necessarily
reflective of the actual cost expected to be incurred by the insured as a result
of the illness or injury. Critical Care and Specified Disease products are
generally guaranteed renewable.
Critical Care and Specified Disease products are generally issued by the Company
after an application form is filled out by the agent on behalf of the
prospective insured. Policies are not available to anyone who has been diagnosed
as having the disease prior to the date of policy issuance.
The Company's Critical Care and Specified Disease products are currently
marketed by LifeStyles Marketing and Freedom Marketing.
Medicare Supplement Products. During 1997, the Company significantly reduced the
production of its Medicare Supplement products in favor of marketing the
Medicare Supplement products of other insurers. Medicare Supplement products are
low margin products which require a large number of in-force policies to
generate significant profits.
The Medicare Supplement products previously sold by the Company provide coverage
for many of the medical expenses which the federal Medicare program does not
cover, such as copayments, deductibles and specified losses which exceed the
federal program's maximum benefits. The Company also underwrites a Medicare
SELECT policy which is designed to provide benefits which supplement Medicare at
attractive rates by taking advantage of arrangements with hospitals, other
health care providers and PPOs. These arrangements typically provide that a
hospital or health care provider will agree to waive Medicare's Part A initial
deductible, thereby reducing the total benefit expenses associated with a
hospital stay. The Company's Medicare Supplement Products are guaranteed
renewable.
The Omnibus Budget Reconciliation Act of 1990 mandated, among other things,
standardized policy features in Medicare Supplement plans and, in response, the
NAIC created ten model Medicare Supplement plans. In states that have adopted
the NAIC model, only those 10 policies can be sold. In November 1993, the
Company began underwriting four of the model plans.
Life Insurance. The Company began marketing its EZ-100 life plan in 1995. EZ-100
is an individually underwritten whole life insurance product designed to serve
as a complement to accident and health insurance products. EZ-100 is issued at
face amounts ranging from $3,000 to $20,000 and may be marketed by any of the
Company's general agencies.
While the Company substantially discontinued active sales of ordinary life
insurance products in 1979, it continues to receive renewal premiums on ordinary
life policies in force sold prior to that date.
HOME OFFICE OPERATIONS
The Company's operations are conducted primarily at its Fort Worth office (the
"Home Office"). See "ITEM 2 - Properties." The functions carried out at the Home
Office include policy issue and underwriting, policyowner service, claims
processing, agency service and other administrative functions such as data
processing, legal, accounting and actuarial.
The Company's policy issue and underwriting departments review policy
applications. Although industry practice does not require physical examinations
and tests before a policy is issued, the Company's underwriting personnel will
generally telephone an applicant for a Medical Expense product to verify the
information set forth in the policy application and the policy benefits being
sold and will often contact the applicant's physician in the verification
process. These telephone calls are recorded. Applicants for the Company's
Critical Care and Specified Disease products must certify in writing that they
meet certain health standards established by the Company before the policy will
be issued.
The Company's policyowner service department and agency service department are
responsible for responding to policyowner and agent requests for information or
services. The claims processing department reviews benefit claims submitted by
policyowners, determines the benefits payable and processes the claim payments.
RESERVE POLICY
The Company's reserves consist of two separate components: the claim reserves
and the policy benefit reserves. The claim reserves are established by the
Company for benefit payments which have already been incurred by the
policyholder but which have not been paid by the Company. The Company's
consulting actuary estimates these reserves based upon analysis of claim
inventories, loss ratios and claim lag studies. These estimates are developed in
the aggregate for claims incurred (whether or not reported). The claim reserves
include an amount which will not be paid out until subsequent reporting periods
but which is recorded in the current period for reporting purposes. See ITEM 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Developments".
Policy benefit reserves are established by the Company for benefit payments
which have not been incurred but which are estimated to be incurred in the
future. The policy benefit reserves are calculated according to the net level
premium reserve method and are equal to the discounted present value of the
Company's expected future policyholder benefits minus the discounted present
value of its expected future net premiums. These present value determinations
are based upon assumed fixed investment yields, the age of the insured(s) at the
time of policy issuance, expected morbidity and persistency rates, and expected
future policyholder benefits. Except for purposes of reporting to insurance
regulatory authorities and for tax filing, the Company's claim reserves and
policy benefit reserves are determined in accordance with generally accepted
accounting principles ("GAAP").
In determining the morbidity, persistency rate, claim cost and other assumptions
used in determining the Company's policy benefit reserves, the Company relies
primarily upon its own benefit payment history and upon information developed in
conjunction with actuarial consultants and industry data. The Company's
persistency rates have a direct impact upon its policy benefit reserves because
the determinations for this reserve are, in part, a function of the number of
policies in force and expected to remain in force to maturity. If persistency is
higher or lower than expected, future policyholder benefits will also be higher
or lower because of the different than expected number of policies in force, and
the policy benefit reserves will be increased or decreased accordingly.
The Company's reserve requirements are also interrelated with product pricing
and profitability. The Company must price its products at a level sufficient to
fund its policyholder benefits and still remain profitable. Because the
Company's policyholder benefits represent the single largest category of its
operating expenses, inaccuracies in the assumptions used to estimate the amount
of such benefits can result in the Company failing to price its products
appropriately and to generate sufficient premiums to fund the payment thereof.
The sharp increase in claims submissions experienced by the Company during the
second and third quarters of 1997 were indicative of inadequate pricing in the
Company's Medical Expense and Medicare Supplement products. See ITEM 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Developments".
Because the discount factor used in calculating the Company's policy benefit
reserves is based upon the rate of return of the Company's investments designed
to fund this reserve, the amount of the reserve is dependent upon the yield on
these investments. Provided that there is not material adverse experience with
respect to these benefits, changes in future market interest rates will not have
an impact on the profitability of policies already sold. Because fluctuations in
future market interest rates affect the Company's yield on new investments, they
also affect the discount factor used to establish, and thus the amount of, its
policy benefit reserves for new sales. In addition, because an increase in the
policy benefit reserves in any period is treated as an expense for income
statement purposes, market interest rate fluctuations can directly affect the
Company's profitability for policies sold in such period. It is not possible to
predict future market interest rate fluctuations.
In accordance with GAAP, the Company's actuarial assumptions are generally fixed
at the time they are made, and absent materially adverse benefit experience,
they are not generally adjusted. Nonetheless, the Company monitors the adequacy
of its policy benefit reserves on an ongoing basis by periodically analyzing the
accuracy of its actuarial assumptions. The adequacy of the Company's policy
benefit reserves may also be impacted by the development of new medicines and
treatment procedures which may alter the incidence rates of illness and the
treatment methods for illness and accident victims (such as out-patient versus
in-patient care) or prolong the life expectancy of such victims. Changes in
coverage provided by major medical insurers or government plans may also affect
the adequacy of the Company's reserves if, for example, such developments had
the effect of increasing or decreasing the incidence rate and per claim costs of
occurrences against which the Company insures. An increase in either the
incidence rate or the per claim costs of such occurrences could result in the
Company needing to post additional reserves, which could have a material adverse
effect upon its business, financial condition or results of operations.
The Insurance Subsidiaries consist of National Foundation Life Insurance Company
("NFL"), FLICA, NFIC and AICT. The Insurance Subsidiaries are required to report
their results of operations and financial position to state regulatory agencies
based upon statutory accounting practices ("SAP"). Under SAP, certain
assumptions used in determining the policy benefit reserves, such as claim costs
and investment result assumptions, are often more conservative than those
appropriate for use by the Company under GAAP. In particular, SAP interest rate
assumptions for investment results are fixed by statute and are generally lower
than those used by the Company under GAAP. Another significant difference is
that under SAP, unlike GAAP, the Company is required to expense all sales and
other policy acquisition costs as they are incurred rather than capitalizing and
amortizing them over the expected life of the policy. Although the effect of
this requirement is moderated by the allowance under SAP of an accounting
treatment known as the "two year preliminary term" reserve valuation method.
This reserve method allows the Company to defer any accumulation of policy
benefit reserves until after the second policy year. The immediate charge off of
sales and acquisition expenses and the sometimes conservative claim cost and
other valuation assumptions under SAP generally cause a lag between the sale of
a policy and the emergence of reported earnings. Because this lag can reduce the
Company's gain from operations on a SAP basis, it can have the effect of
reducing the amount of funds available for dividend distributions from the
Insurance Subsidiaries to Westbridge. See ITEM 7 - "Liquidity, Capital Resources
and Statutory Capital and Surplus - Insurance Subsidiaries".
REGULATION
The Company and its Insurance Subsidiaries are subject to regulation and
supervision in all jurisdictions in which they conduct business. In general,
state insurance laws establish supervisory agencies with broad administrative
powers relating to, among other things, the granting and revoking of licenses to
transact business, regulation of trade practices, premium rate levels, premium
rate increases, licensing of agents, approval of content and form of policies,
maintenance of specified minimum statutory reserves and statutory capital and
surplus, deposits of securities, form and content of required financial
statements, nature of investments and limitations on dividends to stockholders.
The purpose of such regulation and supervision is primarily to provide
safeguards for policyholders rather than to protect the interests of
stockholders.
The Company's health insurance products are subject to rate regulation by state
insurance departments, which generally require that certain minimum loss ratios
be maintained. The states in which the Company is licensed have the authority to
change the minimum mandated statutory loss ratios to which the Company is
subject, the manner in which these ratios are computed and the manner in which
compliance with these ratios is measured and enforced. Most states in which the
Company writes health insurance products have adopted the loss ratios
recommended by the National Association of Insurance Commissioners ("NAIC"). The
Company is unable to predict the impact of (i) any changes in the mandatory
statutory loss ratios relating to products offered by the Company or (ii) any
change in the manner in which these minimums are computed or enforced in the
future. The Company has not been informed by any state that it does not meet
mandated minimum ratios, and the Company believes that it is in compliance with
all such minimum ratios. In the event the Company is not in compliance with
minimum statutory loss ratios mandated by regulatory authorities, the Company
may be required to reduce or refund premiums, which could have a material
adverse effect on the Company's business, financial condition or results of
operations. Similarly, the Company's ability to increase its premium rates in
response to adverse loss ratios is subject to regulatory approval. Failure to
obtain such approval could have a material adverse effect on the Company's
business, financial condition and results of operations.
In December 1992, the NAIC adopted the Risk-Based Capital for Life and/or Health
Insurers Model Act ("the Model Act"). The Model Act provides a tool for
insurance regulators to determine the levels of statutory capital and surplus an
insurer must maintain in relation to its insurance and investment risks and
whether there is a need for possible regulatory attention. The Model Act (or
similar legislation or regulation) has been adopted in states where the
Insurance Subsidiaries are domiciled.
The Model Act provides four levels of regulatory attention, varying with the
ratio of the insurance company's total adjusted capital (defined as the total of
its statutory capital and surplus, asset valuation reserve and certain other
adjustments) to its risk-based capital ("RBC"). If a company's total adjusted
capital is less than 100 percent but greater than or equal to 75 percent of its
RBC, or if a negative trend (as defined by the regulators) has occurred and
total adjusted capital is less than 125 percent of RBC (the "Company Action
Level"), the company must submit a comprehensive plan aimed at improving its
capital position to the regulatory authority proposing corrective actions. If a
company's total adjusted capital is less than 75 percent but greater than or
equal to 50 percent of its RBC (the "Regulatory Action Level"), the regulatory
authority will perform a special examination of the company and issue an order
specifying the corrective actions that must be followed. If a company's total
adjusted capital is less than 50 percent but greater than or equal to 35 percent
of its RBC (the "Authorized Control Level"), the regulatory authority may take
any action it deems necessary, including placing the company under regulatory
control. If a company's total adjusted capital is less than 35 percent of its
RBC (the "Mandatory Control Level"), the regulatory authority must place the
company under its control. The NAIC's requirements are effective on a state by
state basis if, and when, they are adopted by the regulators in the respective
states. The Insurance Departments of the States of Delaware and Mississippi have
each adopted the NAIC's Model Act. At December 31, 1997, total adjusted capital
for NFL, a Delaware domiciled company, and FLICA, a Mississippi domiciled
company, exceeded the respective Company Action Levels.
The Texas Department of Insurance ("TDI") has adopted its own RBC requirements,
the stated purpose of which is to require a minimum level of capital and surplus
to absorb the financial, underwriting and investment risks assumed by an
insurer. Texas' RBC requirements differ from those adopted by the NAIC in two
principal respects: (i) they use different elements to determine minimum RBC
levels in their calculation formulas and (ii) they do not stipulate "Action
Levels" (like those adopted by the NAIC) where corrective actions are required.
However, the Commissioner of the TDI does have the power to take similar
corrective actions if a company does not maintain the required minimum level of
statutory capital and surplus. NFIC and AICT are domiciled in Texas and must
comply with Texas RBC requirements. At December 31, 1997, AICT's RBC exceeded
the minimum level prescribed by the TDI; however, NFIC's RBC was below the
minimum level prescribed by the TDI. As a result of the statutory losses
sustained by the Insurance Subsidiaries during 1997, certain intercompany and
large cash transactions are subject to the approval of the domiciliary states.
The Insurance Subsidiaries are subject to periodic examinations by state
regulatory authorities as part of their routine regulatory oversight process.
Texas recently completed a periodic examination of NFIC and AICT, and management
does not expect the results of these examinations to have a material effect on
the financial condition of the Company. Mississippi is currently conducting an
examination of FLICA, and the results of that examination will be available
during 1998.
Many states have enacted insurance holding company laws that require
registration and periodic reporting by insurance companies within their
jurisdictions. Such legislation typically places restrictions on, or requires
prior notice or approval of, certain transactions within the holding company
system, including, without limitation, dividend payments from insurance
subsidiaries and the terms of loans and transfers of assets within the holding
company structure.
Generally, before the Company is permitted to market an insurance product in a
particular state, it must obtain regulatory approval from that state and adhere
to that state's insurance laws and regulations which include, among other
things, specific requirements regarding the form, language, premium rates and
policy benefits of that product. Consequently, although the Company's policies
generally provide for the same basic types and levels of coverage in each of the
states in which they are marketed, the policies are not precisely identical in
each state or other jurisdiction in which they are sold. Such regulation may
delay the introduction of new products and may impede, or impose burdensome
conditions on, rate increases or other actions that the Company may wish to take
in order to enhance its operating results. In addition, federal or state
legislation or regulatory pronouncements may be enacted that may prohibit or
impose restrictions on the ability to sell certain types of insurance products
or impose other restrictions on the Company's operations. For example, certain
states in which the Company does business have adopted NAIC model statutes and
regulations relating to market conduct practices of insurance companies. Any
limitations or other restrictions imposed on the Company's market conduct
practices by the regulators of a state which has adopted the model statutes and
regulations may also be imposed by the regulators in other states which have
adopted such statutes and regulations. No assurances can be given that future
legislative or regulatory changes will not adversely affect the Company's
business, financial condition or results of operations.
Four states, Connecticut, Massachusetts, New Jersey and New York, have adopted
statutes or insurance department regulations that either prohibit sales of
policies that offer only "specified or dread disease" coverage (such as that
provided by certain of the Company's Critical Care and Specified Disease
products) or require that such coverage be offered in conjunction with other
forms of health insurance. The Company has never written insurance in those
states and does not currently intend to enter those markets. The Company has no
knowledge of legislative initiatives which would limit or prohibit the sale of
"specified or dread disease" policies in other states in which the Company
operates.
The Company may be required, under the solvency or guaranty laws of most states
in which it does business, to pay assessments (up to prescribed limits) to fund
policyholder losses or liabilities of insurance companies that become insolvent.
Insurance company insolvencies increase the possibility that such assessments
may be required. These assessments may be deferred or forgiven under most
guaranty laws if they would threaten an insurer's financial strength and, in
certain instances, may be offset against future premium taxes. The incurrence
and amount of such assessments may increase in the future without notice. The
Company pays the amount of such assessments as they are incurred. Assessments
which cannot be offset against future premium taxes are charged to expense.
Assessments which qualify for offset against future premium taxes are
capitalized and are offset against such future premium taxes. As a result of
such assessments, the Company paid approximately $28,000 during the year ended
December 31, 1997. The likelihood and amount of any other future assessments
cannot be estimated and are beyond the control of the Company.
Although the U.S. Government generally does not directly regulate the insurance
business, federal initiatives often impact the insurance business in a variety
of ways. Current and proposed federal measures which may significantly affect
the insurance business include controls on the cost of medical care, medical
entitlement programs (e.g., Medicare) and minimum solvency requirements for
insurers.
The NAIC has recently taken action on the subject of assumption reinsurance. The
Assumption Reinsurance Model Act was adopted in 1993 and is similar but, in
certain respects, less restrictive than the federal bill. The Model Act provides
a 25-month notice period and may allow a transfer after the expiration of such
period even if the assuming insurer does not have a higher rating than the
transferring insurer. The Model Act will have no legal effect until formally
adopted by the states, although it can be expected to be relied upon by
regulators in states without statutes, regulations or other defined rules
expressly governing assumption reinsurance.
INVESTMENTS
Investment income is an important source of revenue, and the Company's return on
invested assets has a material effect on net income. The Company's investment
policy is subject to the requirements of regulatory authorities regarding
maintenance of minimum statutory reserves in order to meet future policy
obligations for policies in force. Statutory reserves may only consist of
certain types of admitted investments and the percentage mix of those assets is
regulated by statute. In addition, certain assets are held on deposit in
specified states and invested in specified securities in order to comply with
state law. Although the Company closely monitors its investment portfolio,
available yields on newly-invested funds and gains or losses on existing
investments depend primarily on general market conditions. The Company's
investment portfolio is managed by Conseco Capital Management, Inc., a
registered investment advisor.
Investment policy is determined by the Investment Committees of Westbridge and
the Insurance Subsidiaries in accordance with guidelines set forth by their
respective Boards of Directors. The current policy of Westbridge and each of the
Insurance Subsidiaries is to balance the portfolio between long- and short-term
investments so as to achieve long-term returns consistent with the preservation
of capital and maintenance of adequate liquidity to meet the payment of the
Company's policy benefits and claims. The current schedule of the Company's
invested asset maturities corresponds with the Company's expectations regarding
anticipated cash flow payments based on the Company's policy benefit and claim
cycle, which the Company believes is medium term in nature. The Company invests
primarily in fixed-income securities of the U.S. Government and its related
agencies, investment grade fixed-income corporate securities and mortgage-backed
securities. Also, up to 5% of the Company's assets may be invested in higher
yielding, non-investment grade securities.
The following table provides information on the Company's cash and invested
assets, in thousands, as of the dates indicated:
Year Ended December 31,
------------------------------
1997 1996 1995
-------- -------- --------
Cash and cash equivalents $ 1,030 $ 1,013 $ 2,013
-------- -------- --------
Bonds:
U.S. Government and related agencies 22,142 26,108 35,658
State, county and municipal 1,071 518 1,632
Public utilities 11,273 11,016 8,700
Industrial and miscellaneous 94,263 53,955 40,490
-------- -------- --------
Total Bonds 128,749 91,597 86,480
-------- -------- --------
Preferred stock 2,645 147 356
-------- -------- --------
Common stock 2,125 1,449 183
-------- -------- --------
Investment in Freedom Holding Company (1) - - 6,173
-------- -------- --------
Other Invested Assets:
Mortgage loans on real estate 389 658 639
Policy loans 284 282 285
Short-term investments and certificates of deposit 12,654 8,072 15,246
Investment real estate 566 - 141
-------- -------- --------
Total Other Invested Assets 13,893 9,012 16,311
-------- -------- --------
Total Cash and Invested Assets $148,442 $103,218 $111,516
======== ======== ========
(1) Represents the Company's 40% ownership interest prior to May 31, 1996. On
May 31, 1996, the Company purchased the remaining 60% ownership interest of
FLICA's parent, FHC. Subsequent to that date, the Company has consolidated
the accounts of FHC in accordance with GAAP.
Included in the invested assets of the Company outlined in the preceding table
are certain high-yield debt securities which are below a "BBB" or equivalent
rating. These high-yield debt securities amounted to less than 1.6%, 1.5% and
0.7% of the Company's total cash and invested assets at December 31, 1997, 1996
and 1995, respectively.
The following table summarizes consolidated investment results (excluding
unrealized gains or losses) for the periods shown:
Year Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(in thousands, except percentages)
Total invested assets, cash and cash equivalents $148,442 $103,218 $111,516
Net investment income (1) 9,390 7,535 7,021
Realized gains on investments 84 96 182
Average gross annual yield on total investments 7.7% 7.2% 7.0%
(1) Excludes interest on receivables from agents of $1.6 million, $1.2 million
and $0.4 million for the years ended December 31, 1997, 1996 and 1995,
respectively.
The following table summarizes the Company's fixed maturity securities,
excluding short-term investments and certificates of deposit, at December 31,
1997:
FIXED MATURITY SECURITIES
Carrying
Value(1),(2) %
-------- ------
(in thousands)
Fixed maturity securities:
U.S. Government and governmental
agencies and authorities (except
mortgage-backed) $ 11,668 9.1
States, municipalities and political
subdivisions 1,071 0.8
Finance 33,581 26.1
Public utilities 11,273 8.8
Mortgage-backed 10,474 8.1
All other corporate bonds 60,682 47.1
-------- -------
Total fixed maturity securities $128,749 100.0
======== =======
(1) At December 31, 1997, all of the Company's fixed maturity securities are
classified as available-for-sale and are carried at estimated market value.
(2) Estimated market value represents the closing sales prices of marketable
securities.
The Company's fixed maturity investment portfolio at December 31, 1997 was
composed primarily of debt securities of the U.S. Government, corporations and
mortgage-backed securities. Investments in the debt securities of corporations
are principally in publicly-traded bonds.
Mortgage-backed securities represented approximately 8.1% of the estimated
market value of the Company's total invested assets at December 31, 1997. The
Company's mortgage-backed securities portfolio consists entirely of U.S.
government agency pass-through certificates. Currently, the Company does not own
any collateralized mortgage obligations or non-agency pass-through securities.
All of these U.S. government agency pass-through securities have an investment
rating of AAA and are classified NAIC Class 1. Mortgage-backed securities
investors are compensated primarily for reinvestment risk rather than credit
quality risk. During periods of significant interest rate volatility, the
underlying mortgages may prepay more quickly or more slowly than anticipated. If
the repayment of principal occurs earlier than anticipated during periods of
declining interest rates, investment income may decline due to the reinvestment
of these funds at the lower current market rates.
The following table indicates by rating the composition of the Company's fixed
maturity securities portfolio, excluding short-term investments and certificates
of deposit, at December 31, 1997:
COMPOSITION OF FIXED MATURITY SECURITIES BY RATING
Carrying
Value(1),(2) %
------------ -------
(in thousands)
Ratings (3)
Investment grade:
U.S. Government and agencies $ 22,142 17.2
AAA 2,280 1.8
AA 9,474 7.3
A 40,266 31.3
BBB 52,178 40.5
Non-Investment grade:
BB 2,409 1.9
B - -
---------- -------
Total fixed maturity securities $ 128,749 100.0
========== =======
(1) At December 31, 1997, all of the Company's fixed maturity securities are
classified as available-for-sale and are carried at estimated market value.
(2) Estimated market value represents the closing sales prices of marketable
fixed maturity securities.
(3) Ratings are the lower of those assigned primarily by Standard & Poor's and
Moody's when available, and shown in the table using the Standard & Poor's
rating scale. Unrated securities are assigned ratings based on the
applicable NAIC designation or the rating assigned to comparable debt
outstanding of the same issuer. NAIC 1 fixed maturity securities have been
classified as "A" and NAIC 2 fixed maturity securities have been classified
as "BBB".
The NAIC assigns securities quality ratings and uniform prices called "NAIC
Designations," which are used by insurers when preparing their annual statutory
reports. The NAIC assigns designations to publicly-traded as well as
privately-placed securities. The ratings assigned by the NAIC range from Class 1
to Class 6 with Class 1 as the highest quality rating. The following table
summarizes the Company's fixed maturity securities according to NAIC
Designations and Standard & Poor's ratings at December 31, 1997:
NAIC DESIGNATIONS
Carrying
Value (1), (2) %
--------------- -------
NAIC Designations (3)
NAIC 1 (AAA, AA, A) $ 74,162 57.6
NAIC 2 (BBB) 52,178 40.5
NAIC 3 (BB) and below 2,409 1.9
--------------- -------
Total fixed maturity securities $ 128,749 100.0
=============== =======
(1) At December 31, 1997, all of the Company's fixed maturity securities are
classified as available-for-sale and are carried at estimated market value.
(2) Estimated market value represents the closing sales prices of marketable
fixed maturity securities.
(3) Generally comparable to Standard & Poor's ratings. Comparisons between NAIC
Designations and Standard & Poor's ratings are as published by the NAIC.
The scheduled maturities of the Company's fixed maturity securities, excluding
short-term investments and certificates of deposit, at December 31, 1997 were:
COMPOSITION OF FIXED MATURITY SECURITIES BY MATURITY
Carrying
Value(1),(2) %
-------- -------
Scheduled Maturity
Due in one year or less $ 3,500 2.7
Due after one year through five years 22,907 17.8
Due after five years through ten years 42,737 33.2
Due after ten years 49,131 38.2
Mortgage-backed securities 10,474 8.1
-------- -------
Total fixed maturity securities $128,749 100.0
======== =======
(1) At December 31, 1997, all of the company's fixed maturity securities are
classified as available-for-sale and are carried at estimated market value.
(2) Estimated market value represents the closing sales prices of marketable
fixed maturity securities.
REINSURANCE
Ceded. As is customary in the insurance industry, the Company's Insurance
Subsidiaries reinsure portions of the coverages it provides to its policyholders
to other insurance companies on both an excess of loss and coinsurance basis.
Cession of reinsurance is utilized by an insurer to limit its maximum loss
thereby providing a greater diversification of risk and minimizing exposures on
larger risks. Reinsurance does not discharge the primary liability of the
original insurer with respect to such insurance, but the Company, in accordance
with prevailing insurance industry practice, reports reserves and claims after
adjustment for reserves and claims ceded to other companies through reinsurance.
The Company, through NFL and FLICA, entered into a 90% Coinsurance Funds
Withheld Reinsurance Agreement (the "Coinsurance Agreement") with a reinsurer
effective July 1, 1996 on the in-force Cancer, Heart and Intensive Care
business. The Coinsurance Agreement provided an initial ceding commission of
$10.5 million, of which $8.4 million was received in cash. On May 1, 1997, the
Coinsurance Agreement was terminated and recaptured. Consistent with the terms
of the agreement, the unpaid portion of the initial ceding commission allowance
was repaid inclusive of interest at 15.0%. For the years ended December 31, 1997
and 1996, the amount repaid was approximately $8.6 million and $1.9 million,
respectively. The ceding allowance payable at December 31, 1997 and 1996,
totaled $0 and $8.6 million, respectively. During the term of the Coinsurance
Agreement, the Company maintained in trust, investments with an estimated market
value equal to 90% of the active life reserves on the reinsured business
approximating $14.7 million at December 31, 1996. See NOTE 14 - REINSURANCE and
NOTE 16 - EXTRAORDINARY ITEM to the Company's Consolidated Financial Statements.
The Company generally does not cede risks associated with its Medicare
Supplement products or Life Insurance products. However, 100% of the Company's
risks under its Accidental Death policies currently in force are reinsured. The
Company also reinsures its risks under the Medical Expense products on an excess
of loss basis so that its maximum payment to any one beneficiary during any
one-year period is limited ($100,000 in 1997) for any accident or illness. In
accordance with industry practice, the reinsurance agreements in force with
respect to these policies are terminable by either party with respect to claims
incurred after the termination date and the expiration dates.
Assumed. In the past, the Company has utilized coinsurance agreements to assume
premiums and increase revenues. NFL and FLICA were party to such arrangements
prior to NFL's acquisition of FHC. In 1996, prior to this acquisition, $4
million in premiums were assumed by NFL. Subsequent to the acquisition, those
coinsurance arrangements were canceled.
HEALTH CARE REFORM
Numerous proposals have been introduced in Congress and various state
legislatures to reform the present health care system. Proposals have included,
among other things, modifications to the existing employer-based insurance
system, a quasi-related system of "managed competition" among health plans and a
single-payer, public program. Most of these proposals are specifically directed
at the individual and small group health care market, which is a significant
portion of the Company's health business. At present, most health care reform,
other than that related to the Medicare program, is taking place at the state
level. A number of states have passed or are considering legislation that would
limit the differentials in rates that insurers could charge between new business
and renewal business with respect to similar demographic groups. State
legislation also has been adopted or is being considered that would make health
insurance available to all small groups by requiring coverage of all employees
and their dependents, by limiting the applicability of pre-existing conditions
exclusions, by requiring insurers to offer a basic plan exempt from certain
mandated benefits as well as a standard plan, and by establishing a mechanism to
spread the risk of high risk employees to all small group insurers.
In 1996, Congress enacted HR 3103 ("Health Insurance Portability and
Accountability Act", or "HIPAA"), also commonly referred to as the
Kennedy-Kassenbaum Bill. HIPAA provisions are applicable to both insured and
self-funded employer group coverages and include minimum standards for
pre-existing condition exclusions, waiver of pre-existing condition exclusions
for individuals meeting minimum prior coverage requirements and prohibition of
health related exclusions of individuals from employer group coverage. HIPAA
also provides guaranteed acceptance of small employers with 2 to 50 employees
for insured coverage. In other respects, HIPAA's group and small group
provisions are largely in line with state small group reform laws already
enacted by the large majority of states. In the individual market, HIPAA
requires guaranteed acceptance for eligible individuals moving out of group
plans who have at least 18 months of prior coverage. However, most states have
or are expected to amend their laws to alleviate any inconsistencies with the
federal minimum standards. States which have not already enacted all of the
HIPAA group and small group standards may enact state reforms consistent with
HIPAA. The final outcome of state amendments or new legislation, as well as
federal regulations addressing these provisions, cannot be predicted.
The Company cannot predict what effect, if any, yet to be enacted health care
legislation or proposals will have on the Company if and when enacted. The
Company believes that the current political environment in which it operates
will result in continued legislative scrutiny of health care reform and may lead
to additional legislative initiatives. No assurance can be given that enactment
of any federal and/or state health care reforms will not have a material effect
on the Company's business, financial condition or results of operations.
COMPETITION
The accident and health insurance industry is a highly competitive environment
and includes a large number of insurance companies, many of which have
substantially greater financial resources, broader and more diversified product
lines, favorable ratings from A.M. Best Company, Inc. ("A.M. Best") and larger
staffs than the Company. The Company competes with other insurers to attract and
retain the allegiance of its independent agents and marketing organizations
that, at this time, are responsible for a significant portion of the Company's
revenues. Competitive factors applicable to the Company's business include
product mix, policy benefits, service to policyholders and premium rates. The
Company believes that its A.M. Best rating is not a significant factor affecting
its ability to sell its products in the markets that it serves.
Private insurers and voluntary and cooperative plans, such as Blue Cross and
Blue Shield and HMOs, provide various alternatives for defraying hospitalization
and medical expenses. Much of this insurance is sold on a group basis to
employer sponsored groups. The federal and state governments also provide
programs for the payment of the costs associated with medical care through
Medicare and Medicaid. These major medical programs generally cover a
substantial amount of the medical expenses incurred as a result of accidents or
illnesses. The Company's Medical Expense products are designed to provide
coverage which is similar to these major medical insurance programs but are sold
primarily to persons not covered by an employer sponsored group.
The Company's Critical Care and Specified Disease products are designed to
provide coverage which is supplemental to major medical insurance and may be
used to defray nonmedical as well as medical expenses. Since these policies are
sold to complement major medical insurance, the Company competes only indirectly
with these insurers providing major medical insurance. However, expansion of
coverage by other insurers could adversely affect the Company's business,
financial condition or results of operations. Medicare Supplement products are
designed to supplement the Medicare program by reimbursing for expenses not
covered by such program. To the extent that future government programs reduce
participation by private entities in such government programs, they could
adversely affect the Company's business, financial condition or results of
operations.
The Company competes directly with other insurers offering similar products and
believes that its current benefits and premium rates are generally competitive
with those offered by other companies. Management believes that service to
policyholders and prompt and fair payment of claims continue to be important
factors in the Company's ability to remain competitive.
In addition to product and service competition, there is also very strong
competition within the supplemental accident and health insurance market for
qualified, effective agents. The recruitment and retention of such agents is
extremely important to the success and growth of the Company's business.
Management believes that the Company is competitive with respect to the
recruitment and training of agents. However, there can be no assurance that the
Company's controlled general agencies will be able to continue to recruit or
retain qualified, effective agents. The inability of the Company to adequately
recruit and retain agents could have a material adverse effect upon the
Company's business, financial condition or results of operations.
Managed health care organizations also operate in a highly competitive
environment and in an industry that is currently subject to significant changes
from business consolidations, legislative reform, aggressive marketing practices
and market pressures. The Company's ability to increase its fee and service
income by continuing to expand its marketing of managed care products
underwritten primarily by HMOs and other managed care organizations may be
adversely affected by the changes affecting this industry.
EMPLOYEES
At December 31, 1997, the Company employed 345 persons. The Company has not
experienced any work stoppages, strikes or business interruptions as a result of
labor disputes involving its employees, and the Company considers its relations
with its employees to be good.
ITEM 2. PROPERTIES
On May 1, 1998, the Company intends to move its principal offices from 777 Main
Street, Fort Worth, Texas, to 110 West 7th Street, Fort Worth, Texas. The lease
for the new facility expires in April 2003. Westbridge Printing Services, Inc.
("WPS"), the Company's wholly-owned printing subsidiary which prints all
policies, forms and brochures of the Insurance Subsidiaries, maintains its
manufacturing facility at 7333 Jack Newell Boulevard North, Fort Worth, Texas,
under a lease agreement which expires in October, 2005. The Company also has
lease agreements for certain sales offices of its affiliated marketing agencies
in Arizona, California and Texas. The Company believes that the newly leased
facilities will meet its existing needs and that the leases can be renewed or
replaced on reasonable terms if necessary.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of its business operations, the Company is involved in
various claims and other business related disputes. In the opinion of
management, the Company is not a party to any pending litigation the disposition
of which would have a material adverse effect on the Company's business,
financial position or its results of operations.
On December 17, 1997, a purported class action complaint, naming the Company,
two current directors of the Company, one former director of the Company and two
underwriters of the Company's 7-1/2% Convertible Subordinated Notes as
defendants, was filed in the United States District Court for the Northern
District of Texas on behalf of persons who purchased securities of the Company
during the period October 31, 1996 through October 31, 1997. The complaint
alleges that the Company materially overstated its earnings due to the Company's
establishment of inadequate reserves for pending insurance claims. The plaintiff
seeks unspecified money damages and certain costs and expenses. Management
believes that the lawsuit is without merit and it intends to defend this action
vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders of the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCK-HOLDER MATTERS
Westbridge's Common Stock is listed on the New York Stock Exchange and traded
under the symbol "WBC." The following table sets forth for the periods indicated
the high and low sales price for the Common Stock, by quarter, as reported by
the New York Stock Exchange.
High Low
1998
First Quarter (through March 9, 1998) 0.938 0.438
1997
Fourth Quarter 4.938 0.375
Third Quarter 10.625 4.563
Second Quarter 10.125 8.875
First Quarter 12.250 9.500
1996
Fourth Quarter 9.875 7.750
Third Quarter 8.750 7.500
Second Quarter 7.875 5.875
First Quarter 7.125 5.250
On March 9, 1998, the closing price of the Common Stock on the New York Stock
Exchange was $0.625 per share. As of March 9, 1998, there were approximately
2,213 record holders of the Common Stock.
Westbridge has not paid any cash dividends on the Common Stock and does not
anticipate declaring or paying cash dividends on the Common Stock in the
foreseeable future. Both the Preferred Stock Purchase Agreement relating to the
Series A Preferred Stock and the Senior Subordinated Indenture relating to the
Senior Subordinated Notes, impose certain restrictions upon Westbridge with
respect to the payment of dividends on the Common Stock.
For information concerning statutory limitations on the payment of dividends to
Westbridge by the Insurance Subsidiaries and further discussion of the Company's
results of operations and liquidity, see ITEM 7 - "Management's Discussion and
Analysis of Financial Condition and Results of Operations", ITEM 1 "Business
- -Regulation", and NOTE 12 - STATUTORY CAPITAL AND SURPLUS to the Consolidated
Financial Statements.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The information set forth below was selected or derived from the Consolidated
Financial Statements of the Company. The information set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
of the Company and related notes.
Year Ended December 31,
------------------------------------------------------------------------------
1997 1996 (1) 1995 1994 (2) 1993
----------- ----------- ----------- ----------- -----------
(in thousands, except share data)
Statement of Operation Data:
Premiums $ 161,097 $ 156,780 $ 120,093 $ 98,703 $ 68,731
Net investment income 11,023 8,736 7,421 5,764 4,120
Fee and service income 16,700 9,534 2,336 1,759 1,411
Net realized gains on investments 84 96 182 320 1,030
----------- ----------- ----------- ----------- -----------
Total revenues 188,904 175,146 130,032 106,546 75,292
----------- ----------- ----------- ----------- -----------
Benefits and claims 136,866 94,187 70,465 53,623 33,153
Amortization of deferred policy
acquisition costs 30,873 22,907 11,553 9,711 8,159
Commissions 16,690 7,919 11,359 11,224 9,595
General and administrative expenses 31,407 27,123 21,926 16,847 14,349
Reorganization expense 4,424 - - - -
Recognition of premium deficiency 64,952 - - - -
Taxes, licenses and fees 5,995 5,951 4,101 3,230 2,724
Interest expense 7,102 4,462 2,432 3,067 2,552
----------- ----------- ----------- ----------- -----------
Total expenses 298,309 162,549 121,836 97,702 70,532
----------- ----------- ----------- ----------- -----------
(Benefit) provision for income taxes (13,268) 4,410 2,813 2,764 1,562
Equity in FHC - 74 348 345 333
(Loss) income before
extraordinary loss (96,137) 8,261 5,731 6,425 3,531
Extraordinary loss, net of
income tax 1,007 - 407 - -
----------- ----------- ----------- ----------- -----------
Net (loss) income (97,144) 8,261 5,324 6,425 3,531
Preferred stock dividends 1,572 1,650 1,650 1,190 -
----------- ----------- ----------- ----------- -----------
(Loss) income applicable to
common stockholders $ (98,716) $ 6,611 $ 3,674 $ 5,235 $ 3,531
=========== =========== =========== =========== ===========
Earnings Per Share:
Basic $ (16.07) $ 1.11 $ 0.64 $ 1.21 $ 0.84
Diluted $ (16.07) $ 0.97 $ 0.63 $ 1.04 $ 0.78
Book Value Per Share:
Basic $ (7.33) $ 7.93 $ 7.14 $ 5.95 $ 5.06
Diluted (3) $ (7.33) $ 8.07 $ 7.50 $ 6.90 $ 5.06
Weighted Average
Shares Outstanding:
Basic 6,143,000 5,978,000 5,698,000 4,335,000 4,214,000
=========== =========== =========== =========== ===========
Diluted 6,143,000 8,477,000 5,829,000 6,185,000 4,538,000
=========== =========== =========== =========== ===========
Balance Sheet Data:
Total cash and invested assets $ 148,442 $ 103,218 $ 111,516 $ 108,838 $ 57,434
Deferred policy acquisition costs 19,165 83,871 56,977 58,654 28,354
Total assets 202,856 220,716 200,999 187,581 97,067
Notes payable (4) 13,100 21,210 15,807 - -
Senior subordinated debentures
due 1996 (5) - - - 24,665 19,422
Senior subordinated notes
due 2002 (5) 19,447 19,350 19,264 - -
Convertible subordinated notes
due 2004 (6) 70,000 - - - -
Redeemable preferred stock (7) 19,000 20,000 20,000 20,000 -
Stockholders' (deficit) equity (45,418) 47,903 42,805 26,355 21,611
(1) Includes operations of FLICA's parent, FHC, from June 1, 1996.
(2) Includes operations of NFIC and AICT from April 12, 1994.
(3) Calculated by adding the redeemable preferred stock balance to
stockholders' equity and dividing the resultant sum by the period-end
shares outstanding plus the number of common shares issuable upon
conversion of the redeemable preferred stock as if converted at the end of
the period.
(4) At December 31, 1997, represents balances of $13.1 million outstanding
against a $20.0 million revolving line of credit.
(5) On February 28, 1995, the Company issued $20.0 million principal amount of
its 11% Senior Subordinated Notes due 2002 and issued 1,500,000 additional
shares of Common Stock. The proceeds of these offerings were used, in part,
to redeem the Senior Subordinated Debentures due 1996, on March 30, 1995.
(6) On April 29, 1997, the Company issued $65.0 million principal amount of its
7-1/2% Convertible Subordinated Notes ("Convertible Notes") due 2004. On
May 16, 1997, the Company completed the sale of an additional $5.0 million
of its Convertible Notes in connection with the underwriters' over
allotment option.
(7) At December 31, 1997 consists of 19,000 shares of Series A Preferred Stock,
which were convertible, at the option of the holders thereof, into an
aggregate of 2,259,214 shares of Common Stock at a conversion price of
$8.41 per share of Common Stock.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RECENT DEVELOPMENTS
During the second and third quarters of 1997, the Company's Insurance
Subsidiaries experienced an increase in claims submissions on Medical Expense
and Medicare Supplement products resulting in substantially increased loss
ratios. In addition, a backlog of pending claims was paid during that period
which also contributed to the second quarter's losses. Independent reviews of
the Company's claim reserves were performed as of September 30, 1997.
Additionally, an independent benefit analysis of claims was completed which
indicated that significant rate increases, which are not expected to be fully
implemented until at least September 1998, and further benefit modifications
will be required to offset the current adverse claims experience. However, until
such time as the necessary rate increases, and benefit modifications can be
fully implemented, the Company expects that it will continue to incur operating
losses. There can be no assurance that the full extent of such rate increase
requests will be approved.
In addition, policy persistency has declined in connection with the
implementation of certain rate increases together with intensified competitor
solicitation of the Company's policyholders. These events affected the future
profit margins available to absorb amortization of Deferred Policy Acquisition
Costs ("DPAC"). As a result of these adverse changes, the Company undertook a
revaluation of the recoverability of DPAC in the fourth quarter. Based on the
results of this review and the impact of future projected premium revenues and
the discontinuance of certain lines of business, the Company determined that a
premium deficiency for certain lines of business existed as of December 31,
1997. A premium deficiency occurs when the projected present value of future
premiums associated with these policies will not be adequate to cover the
projected present value of future payments for benefits and related amortization
of DPAC. Generally accepted accounting principles require the immediate
recognition of a premium deficiency by charging the unamortized DPAC to expense.
In this connection, for the quarter and year ended December 31, 1997, the
Company recorded a non-cash charge to expense of approximately $65.0 million and
incurred a significant loss for the year ended December 31, 1997. This
adjustment has no impact on the Company's cash position at December 31, 1997 and
does not impact the statutory capital and surplus of the Insurance Subsidiaries.
As a result of these losses, in November 1997, the Company engaged Houlihan,
Lokey, Howard & Zukin to act as its financial advisor to explore the Company's
strategic alternatives which may include, without limitation, a refinancing,
recapitalization or other corporate reorganization involving a significant
reduction in, or exchange of equity for, outstanding indebtedness. Since
November 1997, the Company has held discussions with the regulatory authorities
in its domiciliary states of Delaware, Texas and Mississippi and with an ad hoc
creditors' committee representing both the holders of the 11% Senior
Subordinated Notes ("Senior Subordinated Notes") due 2002 and the holders of its
7-1/2% Convertible Subordinated Notes ("Convertible Notes") due 2004.
In order to preserve capital and maintain flexibility while it considers its
strategic alternatives, the Company has suspended its scheduled debt service
payments on its Senior Subordinated Notes and Convertible Notes since November
1997 and suspended its dividend payments on its outstanding Series A Preferred
Stock since October 1997. The failure to make the scheduled interest payments
constituted payment defaults under the Indentures relating to such Notes and
became events of default thereunder as of November 17, 1997. In addition, the
failure to make such interest payments also resulted in an event of default
under its Credit Agreement with a bank. Other covenant defaults are also
existing under the Credit Agreement and the Indenture relating to the Senior
Subordinated Notes (See NOTE 7 - FINANCING ACTIVITIES). As a result of the
foregoing events of defaults, the holders of such indebtedness may declare the
outstanding principal amount thereof, together with accrued and unpaid interest
thereon, to be due and payable immediately. If such indebtedness were to be
accelerated, the Company does not have the ability to repay the indebtedness
under the outstanding Convertible Notes, the Senior Subordinated Notes and the
Credit Agreement. There can be no assurance that the Company will resume such
interest and dividend payments in the future.
The Report of Independent Accountants included herein refers to certain of the
foregoing events which are discussed in NOTE 2 to the Company's financial
statements and which raise substantial doubt about the Company's ability to
continue as a going concern. See ITEM 8 - "Financial Statements and
Supplementary Data."
IMPACT OF YEAR 2000 ISSUE
The Company is analyzing the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The Year
2000 problem is pervasive and complex as virtually every computer operation will
be affected in some way by the rollover of the two-digit year value to 00. The
issue is whether computer systems will properly recognize date-sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
Management has initiated an enterprise-wide program to prepare the Company's
computer systems, infrastructure, and facilities for the Year 2000. This program
includes working with vendors and business partners to insure they are also
prepared for the Year 2000. The Company expects to incur internal staff costs as
well as consulting and other expenses approximating $3.0 million related to
computer systems, infrastructure, and facilities enhancements necessary to
prepare for the Year 2000.
The Company expects its Year 2000 program to be completed in a timely basis;
however, the Year 2000 computer problem creates risk for the Company from
unforeseen problems in its own computer systems and from third parties with whom
the Company deals on financial transactions. Such potential, unforeseen problems
in the Company's and/or third parties' computer systems could have a material
impact on the Company's ability to conduct its business.
BUSINESS OVERVIEW
The Company derives its revenue primarily from premiums from its insurance
products and, to a significantly lesser extent, from fee and service income,
income earned on invested assets and gains on the sales or redemptions of
invested assets. The Company's primary expenses include benefits and claims in
connection with its insurance products, amortization of DPAC, commissions paid
on policy renewals, general and administrative expenses associated with policy
and claims administration, taxes, licenses and fees and interest on its
indebtedness. In addition to the foregoing expenses, Westbridge is obligated to
pay dividends on the Series A Preferred Stock if and when declared by the Board
of Directors.
Fee and service income is generated from (i) commissions received by the Company
for sales of managed care products underwritten primarily by HMOs and other
managed care organizations, (ii) telemarketing services provided by PDS, and
(iii) printing services provided by WPS.
Benefits and claims are comprised of (i) claims paid, (ii) changes in claim
reserves for claims incurred (whether or not reported), and (iii) changes in
policy benefit reserves based on actuarial assumptions of future benefit
obligations not yet incurred on policies in force.
Under generally accepted accounting principles, a DPAC asset is established to
properly match the costs of writing new business against the expected future
revenues or gross profits from the policies. The costs, which are capitalized
and amortized, consist of first-year commissions in excess of renewal
commissions and certain home office expenses related to selling, policy issue,
and underwriting. The DPAC for accident and health policies and traditional life
policies are amortized over future premium revenues of the business to which the
costs are related. The rate of amortization depends on the expected pattern of
future premium revenues for the block of policies. The scheduled amortization
for a block of policies is established when the policies are issued. However,
the actual amortization of DPAC will reflect the actual persistency and
profitability of the business. For example, if actual policy terminations are
higher than expected or if future losses are anticipated, DPAC could be
amortized more rapidly than originally scheduled or written-off, which would
reduce earnings in the applicable period. Also included in DPAC is the cost of
insurance purchased relating to acquired blocks of business.
Acquisitions. Since 1992, the Company has from time to time acquired seasoned
blocks of business to supplement its revenue. These acquisitions included blocks
of: (i) Medicare Supplement products purchased from American Integrity Insurance
Company ("AII") in September 1992, (ii) Medicare Supplement products purchased
from Life and Health Insurance Company of America ("LHI") in March 1993, (iii)
Critical Care and Specified Disease products purchased from Dixie National Life
Insurance Company ("DNL") in February 1994, (iv) policies in all of the
Company's product lines purchased in the acquisition of NFIC and AICT in April
1994, and (v) Critical Care and Specified Disease products purchased in the
acquisition of the remaining 60% ownership interest in Freedom Holding Company,
FLICA's parent, in May 1996.
Premiums. The following table shows the premiums, in thousands, received by the
Company as a result of internal sales and acquisitions. Certain
reclassifications have been made to 1996 amounts in order to conform to 1997
presentation.
Premiums (1)
--------------------------------
Year Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
Company-issued policies:
First-year premiums $ 36,800 $ 61,049 $ 34,561
Renewal premiums 78,261 47,421 36,417
-------- -------- --------
Total company-issued policy premiums 115,061 108,470 70,978
-------- -------- --------
Acquired policies:
AII 7,179 8,364 9,811
LHI 1,533 1,820 2,089
DNL 2,827 2,974 3,299
NFIC and AICT 21,061 26,207 33,110
FLICA 12,605 7,744 -
Other 831 1,201 806
Total acquired policy premiums (2) 46,036 48,310 49,115
-------- -------- --------
Total Premiums $161,097 $156,780 $120,093
======== ======== ========
(1) For a breakdown of premiums by product line, see "Business-Product Lines."
(2) Premiums for the acquired policies include first-year premiums of
$1,090,000, $794,000 and $213,000 for the years ended December 31, 1997,
1996 and 1995, respectively.
Generally, as a result of acquisitions of policies in force and the transfer of
assets and liabilities relating thereto, the Company receives higher revenues in
the form of premiums and net investment income and experiences higher expenses
in the form of benefits and claims, amortization of DPAC, commissions and
general and administrative expenses. The Company expects that premiums, net
investment income, net realized gains on investments, benefits and claims,
amortization of DPAC, commissions and general and administrative expenses
attributable to these acquired policies will continue to decline over time as
the acquired policies lapse.
Forward-Looking Information. The preceding statement and certain other
statements contained in the Business section, Management's Discussion and
Analysis of Financial Condition and Results of Operations and the Notes to the
Consolidated Financial Statements are forward-looking statements. These
forward-looking statements are based on current expectations that could be
affected by the risks and uncertainties involved in the Company's business.
These risks and uncertainties include, but are not limited to, the effect of
economic and market conditions, the extent of any increase in future claim
submissions, the availability of sufficient statutory capital and surplus, the
ability to increase premium rates on in-force policies to offset higher than
anticipated loss ratios, actions that may be taken by insurance regulatory
authorities and the Company's creditors following recent operating losses, and
the risks described from time to time in the Company's reports to the Securities
and Exchange Commission, which include the Company's Quarterly Reports on Form
10-Q for the quarter ended March 31, 1997, June 30, 1997 and September 30, 1997,
the Company's Registration Statement on Form S-1 dated as of March 28, 1997, as
amended, and the Prospectus dated April 24, 1997. Subsequent written or oral
statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by the cautionary statements in this
Quarterly Report and those in the Company's reports previously filed with the
Securities and Exchange Commission. Copies of these filings may be obtained by
contacting the Company or the SEC.
RESULTS OF OPERATIONS
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Premiums. Premiums increased $4.3 million, or 2.7%, from $156.8 million to
$161.1 million. This increase resulted from an increase in renewal premiums from
Company-issued policies of $33.7 million, or 75.6%, and was offset by a decrease
in renewal premiums from acquired policies of $5.4 million, or 10.7%, and
decreases in first-year premiums from Company-issued and acquired policies of
$22.8 million and $1.2 million, or 38.1% and 60.0%, respectively.
The increase in renewal premiums from Company-issued policies was attributable
to an increase of $20.7 million, or 118.3% in Medical Expense premiums, an
increase of $13.0 million, or 92.2% in Medicare Supplement premiums, an increase
in Life Insurance and other premiums of $0.3 million, or 50.0%, and was offset
by a decrease of $0.3 million, or 2.4%, in Critical Care and Specified Disease
premiums.
The decrease in renewal premiums from acquired policies was attributable to a
decrease of $5.4 million, or 20.6%, from the policies acquired in the NFIC and
AICT acquisition and to a decrease of $1.8 million, or 12.6%, from the policies
acquired from AII, LHI and DNL, and was offset by an increase of $1.8 million,
or 18.4%, from the policies acquired in the FLICA acquisition.
The decrease in first-year premiums from Company-issued policies was
attributable to a decrease of $13.5 million, or 33.5% in Medical Expense
premiums, a decrease of $9.1 million, or 50.8% in Medicare Supplement premiums,
and a decrease of $0.2 million, or 40.0%, in Life Insurance and other premiums.
The decrease in first-year premiums from acquired policies was attributable to a
decrease of $1.2 million, or 60.0%, from the policies acquired in the FLICA
acquisition.
Net Investment Income. Net investment income increased $2.3 million, or 26.4%,
from $8.7 million to $11.0 million. This increase was attributable to a higher
average investment base resulting from the net proceeds received from the
Company's sale of its Convertible Notes during the second quarter.
Fee and Service Income. Fee and service income increased $7.2 million, or 75.8%,
from $9.5 million to $16.7 million. The increase was primarily due to an
increase of $6.4 million, or 81%, relating to commissions on managed care
product sales earned by the Company's controlled general agencies and an
increase of $0.8 million, or 47.1%, in other fees.
Benefits and Claims. Benefits and claims expense increased $42.7 million, or
45.3%, from $94.2 million to $136.9 million. This increase was attributable to
an increase in benefits and claims expense from Company-issued and acquired
policies of $39.2 million and $3.5 million, or 65.7% and 10.1%, respectively.
The increase in benefits and claims expense from Company-issued policies was
primarily attributable to an increase of $31.1 million, or 115.2%, from Medical
Expense products, an increase of $6.4 million, or 25.3%, from Medicare
Supplement products, an increase of $2.2 million, or 36.7%, from Critical Care
and Specified Disease products, and was offset by a decrease of $0.5 million, or
35.7% from Life Insurance and other products.
The increase in benefits and claims expense from acquired policies was primarily
attributable to an increase of $2.9 million, or 72.5%, from the policies
acquired in the FLICA acquisition, an increase of $0.3 million, or 1.4%, from
the policies acquired in the NFIC and AICT acquisition, and an increase of $0.3
million, or 3.1% from the policies acquired from AII, LHI and DNL.
During the second and third quarters of 1997, the Company's Insurance
Subsidiaries experienced an increase in claims submissions on Medical Expense
and Medicare Supplement products resulting in substantially increased loss
ratios. In addition, a backlog of pending claims was paid during that period
which also contributed to the second quarter's losses. Independent reviews of
the Company's claim reserves were performed as of September 30, 1997.
Additionally, an independent benefit analysis of claims was completed which
indicated that significant rate increases, which are not expected to be fully
implemented until at least September 1998, and further benefit modifications
will be required to offset the current adverse claims experience. However, until
such time as the necessary rate increases and benefit modifications can be fully
implemented, the Company expects that it will continue to incur operating
losses. There can be no assurance that the full extent of such rate increase
requests will be approved.
Amortization of DPAC. A portion of the Company's loss resulted from an increase
in amortization of DPAC due to lower persistency as a result of rate increase
activity on inforce business. As management requests additional rate increases
for Medical Expense and Medicare Supplement products in order to resolve premium
pricing disparities and to reduce adverse claim loss ratios, the Company's
earnings may be negatively impacted by further unanticipated increases in
amortization of DPAC during 1998.
Amortization of DPAC increased $8.0 million, or 34.9%, from $22.9 million to
$30.9 million. This increase was attributable to an increase in amortization of
DPAC from Company-issued policies of $10.9 million, or 63.7%, and was offset by
a decrease of $2.9 million, or 50.0%, from acquired policies.
The increase in amortization of DPAC from Company-issued policies was primarily
attributable to an increase of $7.6 million and $3.9 million, or 71.0% and
97.5%, from Medical Expense and Medicare Supplement products, respectively, and
was offset by a decrease of $0.5 million, or 23.8% from Critical Care and
Specified Disease products and a decrease of $0.1 million from Life Insurance
and other products.
The decrease in amortization of DPAC from acquired policies was primarily
attributable to a decrease of $2.4 million, or 104.3%, from the policies
acquired in the NFIC and AICT acquisition, a decrease of $0.7 million, or 43.8%,
from the policies acquired from AII, LHI and DNL, and was offset by an increase
of $0.2 million, or 10.5%, from the policies acquired in the FLICA acquisition.
Commissions. Commissions increased $8.8 million, or 111.4%, from $7.9 million to
$16.7 million. This increase was attributable to an increase of $4.1 million in
commissions on sales of Company-issued policies and an increase of $5.6 million,
or 114.3%, on sales of non-affiliated, managed care insurance products, and was
offset by a decrease of $0.9 million, or 14.8%, from acquired policies.
General and Administrative Expenses. General and administrative expenses
increased $4.3 million, or 15.9%, from $27.1 million to $31.4 million. This
increase was primarily attributable to increases in the allowance for doubtful
agent receivables and a change in estimate for the recognition of deferred
compensation expense. In addition, fewer policies were eligible for deferral of
acquisition costs as a result of the reduction in the Company's marketing
efforts for its underwritten insurance products beginning in the second quarter
of 1996.
Reorganization Expense. As more fully described in "Recent Developments", in
response to the losses sustained by the Company in the second and third quarters
of 1997, the Company has hired a financial advisor to explore its strategic
alternatives. The Company is responsible for paying the fees of its financial
advisor and legal counsel and has agreed to pay the fees of the financial
advisors and legal counsel to an ad hoc creditors' committee in connection with
the efforts to formulate and evaluate transactional alternatives. During 1997,
the Company incurred approximately $1.4 million in expenses during the fourth
quarter of 1997 related to these efforts. In addition, the Company incurred
approximately $3.0 million during the second quarter of 1997 in connection with
a non-recurring internal reorganization.
Recognition of Premium Deficiency. As more fully described in "Recent
Developments," in response to the significant increases in loss ratios on the
Company's Medical Expense and Medicare Supplement products and the decline in
policy persistency, the Company undertook a revaluation of the recoverability of
DPAC in the fourth quarter. Based on the results of this review and the impact
of future projected premium revenues and the discontinuance of certain lines of
business, the Company determined that a premium deficiency for certain lines of
business existed as of December 31, 1997. A premium deficiency occurs when the
projected present value of future premiums associated with these policies will
not be adequate to cover the projected present value of future payments for
benefits and related amortization of DPAC. Generally accepted accounting
principles require the immediate recognition of a premium deficiency by charging
the unamortized DPAC to expense. In this connection, for the quarter and year
ended December 31, 1997, the Company recorded a non-cash charge to expense of
approximately $65.0 million. This adjustment has no impact on the Company's cash
position at December 31, 1997 and does not impact the statutory capital and
surplus of the Insurance Subsidiaries.
Taxes, Licenses and Fees. Taxes, licenses and fees remained relatively unchanged
from the prior year at $6.0 million as increases in premium taxes due to higher
premiums levels in 1997 were offset by decreases in state levied fees and
special assessments during the same period.
Interest Expense. Interest expense increased $2.6 million, or 57.8%, from $4.5
million to $7.1 million. This increase is attributable to the accrued interest
expense related to the issuance of $70.0 million of the Company's 7-1/2%
Convertible Notes.
(Benefit from) Provision for Income Taxes. During 1996, the provision for income
taxes was calculated by applying the 35% statutory federal tax rate to the
Company's pre-tax income for the year ended December 31, 1996. The change in the
(benefit from) provision for income taxes during 1997 is directly attributable
to the net loss recorded by the Company for the year ended December 31, 1997.
This net loss generated a significant amount of net operating loss carryforwards
("NOLs") that will be available for offset against taxable income generated in
future reporting periods. The Company has determined that it is more likely than
not that it will be unable to utilize all of these NOLs prior to the related
expiration dates. In this connection, the Company has recorded a valuation
allowance that significantly reduces its benefit from income taxes for the
current year from the amount that would have been derived by applying the 35%
statutory federal tax rate to the Company's pre-tax loss for the year ended
December 31, 1997. See NOTE 11 - INCOME TAXES to the Company's Consolidated
Financial Statements.
Extraordinary Item. The Company recognized an extraordinary loss on the early
extinguishment of debt in the amount of $1.0 million, net of taxes, for the year
ended December 31, 1997. This extraordinary charge is comprised of (i) $0.4
million, net of taxes, related to the termination and recapture of a block of
reinsured insurance policies and (ii) $0.6 million, net of taxes, related to the
recognition of unamortized financing fees associated with the repayment and
refinancing of the Company's revolving credit facility with Fleet National Bank.
Year Ended December 31, 1996 Compared with Year Ended December 31, 1995
Premiums. Premiums increased $36.7 million, or 30.6%, from $120.1 million to
$156.8 million. The increase was attributable to first-year and renewal premiums
of Company-issued policies increasing $26.5 million and $11.0 million, or 76.6%
and 30.2%, respectively, and was offset by a decrease in premiums from acquired
policies of $0.8 million, or 1.6%.
The increase in first-year premiums of Company-issued policies was attributable
to an increase of $26.1 million, or 154.4%, in Medical Expense premiums and an
increase of $3.3 million, or 28%, in Medicare Supplement premiums. These
increases were offset, in part, by a decrease of $3.2 million in Critical Care
and Specified Disease premiums.
The increase in renewal premiums of Company-issued policies was attributable to
an increase of $8.5 million, or 283.3%, in Medicare Supplement premiums and an
increase of $6.3, or 63%, in Medical Expense premiums. These increases were
offset, in part, by a decrease of $3.3 million in Critical Care and Specified
Disease premium.
The decrease in premiums of acquired policies was attributable to a decrease of
$6.9 million, or 20.9%, from the policies acquired in the NFIC and AICT
acquisition, and a decrease of $1.4 million, or 14.8%, from the policies
acquired from AII. These decreases were offset, in part, by an increase of $7.7
million from the policies acquired in the FLICA acquisition.
Net Investment Income. Net investment income increased $1.3 million, or 17.6%,
from $7.4 million to $8.7 million. This increase was primarily the result of a
$0.8 million increase in interest earned on receivables due from agents. The
remaining increase is due primarily to a higher average investment base which
was offset, in part, by negative cash flows from operations. The higher average
investment base resulted from the acquisition of FLICA during the year and to
amounts borrowed to finance advances to general agencies.
Fee and Service Income. Fee and service income increased $7.2 million, or 313%,
from $2.3 million to $9.5 million. The increase was primarily due to an increase
of $6.4 million of commission income on managed care product sales by the
Company's controlled general agencies and an increase of $0.9 million of
telemarketing services earned by PDS.
Benefits and Claims. Benefits and claims expense increased $23.7 million, or
33.6%, from $70.5 million to $94.2 million. Benefits and claims from
Company-issued policies increased $24.4 million, or 62.7%, and were offset, in
part, by a decrease in benefits and claims from acquired policies of $0.7
million, or 2.2%. In connection with the increase in premiums, benefits and
claims increased $8.0 million, or 61.5%, from Medicare Supplement products, an
increase of $13.8 million, or 95.2%, from Medical Expense products and an
increase of $2.6 million from Critical Care and Specified Disease products. As a
result of continued lapses from a closed block of business, benefits and claims
decreased $3.4 million, or 38.6%, from policies purchased from AII. The block of
business acquired from NFIC and AICT reflected an increase in benefits and
claims expense of $2.2 million, or 11.8%, and was primarily related to
disability income products. Additionally, benefits and claims expense increased
$0.6 million due to the recent acquisition of FLICA.
Amortization of DPAC. Amortization of DPAC increased $11.3 million, or 97.4%,
from $11.6 million to $22.9 million. The increase resulted from the growth in
sales which began in the second quarter of 1995. Amortization of DPAC increased
$3.2 million for Medical Expense products, $3.5 million for Medicare Supplement
products, and $2.8 million for Critical Care and Specified Disease products, a
portion of which was attributable to a large group policy which lapsed in 1996.
Amortization of DPAC also increased $4.1 million due to sales of new policies
underwritten by NFIC and AICT. This increase for NFIC and AICT was offset, in
part, by a $2.1 million decrease in amortization of the cost of insurance
purchased which was capitalized in connection with the Company's acquisition of
NFIC and AICT. Further offsetting this increase in amortization of DPAC was a
decrease of $2.9 million from discontinued Medicare Supplement products and
Medical Expense products. Amortization of DPAC pertaining to FLICA increased
$2.3 million related to the Critical Care and Specified Disease products.
Commissions. Commissions decreased $3.5 million, or 30.7%, from $11.4 million to
$7.9 million. This decrease was a reflection of lower overall net level
commission rates on new business production as compared to level commission
rates for products written in prior reporting periods.
General and Administrative Expenses. General and administrative expenses
increased $5.2 million, or 23.7%, from $21.9 million to $27.1 million as a
result of costs associated with expanding marketing operations and servicing a
growing base of policyholders. General and administrative expenses of
approximately $0.6 million were incurred during 1996 as a result of acquiring
the remaining interests in Senior Benefits and American Senior Security Plans.
Taxes, Licenses and Fees. Taxes, licenses and fees increased $1.9 million, or
46.3%, from $4.1 million to $6.0 million. The increase was primarily due to
growth in premium revenues along with state fees charged for examinations and
various assessments, including guaranty fund assessments.
Interest Expense. Interest expense increased $2.1 million, or 87.5%, from $2.4
million to $4.5 million. The increase was primarily due to an increase of $1.4
million associated with a revolving line of credit which became available to the
Company on December 28, 1995 and an increase of $0.7 million related to a
reinsurance treaty which was effective July 1, 1996.
Provision for Income Taxes. The provision for income taxes increased $1.6
million, or 57.1%, from $2.8 million to $4.4 million. The increase was the
result of pre-tax income increasing $4.2 million, or 49.4%.
LIQUIDITY, CAPITAL RESOURCES, AND STATUTORY CAPITAL AND SURPLUS
Westbridge
Westbridge is an insurance holding company, the principal assets of which
consist of the capital stock of its operating subsidiaries and invested assets.
Accordingly, Westbridge's sources of funds are comprised of dividends from its
operating subsidiaries, advances from non-insurance company subsidiaries, lease
payments on fixed assets and tax contributions under a tax sharing agreement
among Westbridge and its subsidiaries. Westbridge's primary obligations include
principal and interest on its indebtedness and, if and when declared by the
Board of Directors, dividends on its Series A Preferred Stock.
Dividends paid by the Insurance Subsidiaries to Westbridge are determined by and
subject to the regulations of the insurance laws and practices of the insurance
departments of their respective state of domicile. NFL, a Delaware domestic
company, may not declare or pay dividends from any source other than earned
surplus without the Delaware Insurance Commissioner's approval. The Delaware
Insurance Code defines earned surplus as the amount equal to the unassigned
funds as set forth in NFL's most recent statutory annual statement including
surplus arising from unrealized gains or revaluation of assets. Delaware life
insurance companies may generally pay ordinary dividends or make distributions
of cash or other property within any twelve month period with a fair market
value equal to or less than the greater of 10% of surplus as regards
policyholders as of the preceding December 31 or the net gain from operations
for the twelve month period ending on the preceding December 31. During 1998,
NFL is precluded from paying dividends without the prior approval of the
Delaware Insurance Commissioner as its earned surplus is negative. Further, NFL
has agreed to file for the prior approval of any dividends declared or paid for
the foreseeable future.
NFIC and AICT, Texas domestic companies, may make dividend payments from surplus
profits or earned surplus arising from its business. The Texas Insurance Code
defines earned surplus as unassigned surplus not including any unrealized gains.
Texas life insurance companies may generally pay ordinary dividends or make
distributions of cash or other property within any twelve month period with a
fair market value equal to or less than the greater of 10% of surplus as regards
policyholders as of the preceding December 31 or the net gain from operations
for the twelve month period ending on the preceding December 31. Any dividend
exceeding the applicable threshold is considered extraordinary and requires
prior approval of the Texas Insurance Commissioner. During 1998, NFIC's and
AICT's earned surplus is negative, and as such, each company is precluded from
paying dividends without the prior approval of the Texas Insurance Commissioner.
FLICA, a Mississippi domestic company, may make dividend payments only from its
actual net surplus computed as required by law in its statutory annual
statement. Mississippi life insurance companies may generally pay ordinary
dividends or make distributions of cash or other property within any twelve
month period with a fair market value not exceeding the lesser of 10% of surplus
as regards policyholders as of the preceding December 31 or the net gain from
operations for the twelve month period ending on the preceding December 31. Any
dividend exceeding the applicable threshold amount requires prior approval of
the Mississippi Insurance Commissioner. During 1998, FLICA is precluded from
paying dividends to NFL without the prior approval of the Mississippi Insurance
Commissioner as it recorded a net loss from operations for the year ended
December 31, 1997.
Generally, all states require insurance companies to maintain statutory capital
and surplus which is reasonable in relation to their existing liabilities and
adequate to their financial needs. Delaware, Texas and Mississippi also maintain
discretionary powers relative to the declaration and payment of dividends based
upon an insurance company's financial position. In light of the significant
statutory losses incurred by the Insurance Subsidiaries during the year ended
December 31, 1997, Westbridge does not expect to receive any dividend payments
from these entities for the foreseeable future.
Since November 1997, Westbridge suspended its scheduled interest payments on the
Senior Subordinated Notes, the Convertible Notes, and the dividend payments on
its Series A Cumulative Convertible Redeemable Exchangeable Preferred Stock (the
"Series A Preferred Stock"). The failure to make the scheduled interest payments
constituted payment defaults under the Indentures relating to such Notes and
became eve