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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
COMMISSION FILE #0-11321
UNIVERSAL AMERICAN FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2580136
------------------ --------------------------
(State of Incorporation) (I.R.S. Employer I.D. Number)
Six International Drive, Suite 190, Rye Brook, NY 10573
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (914) 934-5200
Securities registered pursuant to Section 12 (b) of the Act:
Name of Each Exchange
Title of Class on which Registered
-------------- -------------------
Common Stock, par value $.01 per share NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--------------- -------------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 1, 2002 was approximately $134,000,000.
The number of shares outstanding of the Registrant's Common Stock as of
March 1, 2002 was 52,925,027.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated:
(1) Proxy Statement for the 2002 Annual Meeting incorporated by reference into
Part III.
(2) Exhibits listed in Part IV, Item 14 (a) incorporated by reference to Proxy
Statement dated July 12, 1999, Forms 8-K dated August 13, 1999 and March
16, 2001, Form 8-K/A dated March 16, 2001.
PART I
ITEM 1 - BUSINESS
GENERAL
We are the holding company for a group of life insurance companies that
sell life and supplemental health insurance products designed for the senior
market and the self-employed market, and administrative services companies that
specialize in providing outsourcing capabilities for senior market insurance and
non-insurance programs. We have been able to achieve rapid, and profitable,
growth as a result of our focus on our core markets, enhanced by several
acquisitions that have been additive financially and strategically. During the
three years ended December 31, 2001, our net income has increased from $9.6
million to $28.9 million, our gross premium has increased from $252.6 million to
$513.6 million, our total assets have grown from $272.6 million to $1.3 billion
and our stockholder's equity has grown from$28.3 million to $230.8 million.
SENIOR MARKET OPPORTUNITY
We believe that attractive growth opportunities exist in serving the
senior market. The population of persons over age 65 in the United States is
projected to grow from the current level of approximately 35 million to
approximately 70 million by 2030, according to the U.S. Census Bureau. The shift
in population toward individuals over age 65 presents significant opportunities
for us to sell our insurance products, especially supplemental health insurance.
Further, as health and medical technologies increase life expectancy, we believe
that seniors and their adult children will increasingly focus on elder care
needs and the services required, including insurance, to address those needs.
OUR OPERATING SEGMENTS
We manage our business through the following operating segments:
SENIOR MARKET BROKERAGE
Our senior market brokerage segment focuses on selling insurance products
designed for the senior market, including Medicare supplement, Medicare select,
long term care, senior life insurance and annuities through independent
marketing organizations and general agencies. This segment's operations are
conducted primarily by the following subsidiaries:
- American Pioneer Life Insurance Company
- American Progressive Life & Health Insurance Company of New York
- Constitution Life Insurance Company
CAREER AGENCY
Our career agency segment traditionally concentrated on selling fixed
benefit accident and sickness disability insurance and individual life insurance
products to the middle-income self-employed market. This segment has recently
expanded its focus to include senior market products as well. The producers in
our career agency segment are contracted to sell products only with our
companies; however, they may sell products of other companies through programs
sponsored by us. This segment's operations are conducted by the following
subsidiaries:
- Pennsylvania Life Insurance Company
- PennCorp Life Insurance Company (Canada)
2
ADMINISTRATIVE SERVICES
Our administrative companies, primarily CHCS Services, Inc., provide
outsourcing services that support insurance and non-insurance products,
primarily for the senior market. CHCS Services, Inc. has emerged as a leading,
full-service administrator of senior insurance products and an innovator in
geriatric care management. We utilize state of the art technology and a national
network of highly trained health care professionals to provide the
administrative platform for these insurance and insurance-related products and
services. Currently, we provide services to more than 45 insurers and generated
fee income of $32.8 million in 2001 from both unaffiliated ($16.9 million) and
affiliated companies ($15.9 million).
SPECIAL MARKETS
We maintain a special markets segment to manage blocks of business that
are no longer within our core focus. The products in this segment include
traditional, interest-sensitive and group life insurance, individual major
medical and other accident and health insurance. In the fourth quarter of 2000,
we decided to exit our individual major medical business to the extent permitted
by the policy form. Approximately $3.3 million of annualized major medical
premium in force is not cancelable by us and will continue to be managed in our
special markets segment.
CORPORATE
The results of operations of our corporate segment include the expenses of
our holding company, including the costs associated with being a public company,
and the interest payable on our debt.
OUR BUSINESS STRATEGY
The principal components of our business strategy are to:
- Develop and market competitive and innovative insurance products,
with an emphasis on the senior market;
- Expand our brokerage and career distribution channels through
additional recruiting and geographic expansion;
- Build our fee-based administrative business in order to complement
our risk-based insurance business;
- Sharpen our focus on core business by exiting lines of business that
do not fit within our strategy or core competencies;
- Employ conservative risk management techniques, including
maintaining a high quality investment portfolio, disciplined pricing
and prudent use of reinsurance;
- Pursue selective acquisitions that fit our strategic and financial
criteria in order to supplement our internal growth;
- Execute efficiently, especially in regard to integrating the
operations of companies and blocks of business that we acquire.
3
RECENT ACQUISITIONS, DIVESTITURES AND CAPITAL MARKET ACTIVITY
Equity Offering
In the third quarter of 2001, we completed a secondary equity offering in
which we sold 5.7 million shares of our common stock and raised $26.0 million,
net of expenses. In addition, 2.2 million shares were sold by some of our
shareholders as part of the offering. The primary reason for the offering was to
enhance the capital of our insurance subsidiaries to support our growth and to
improve our risk based capital ratios used by regulators and rating agencies to
evaluate the adequacy of capital of insurance companies. Out of the proceeds of
the offering, $9.3 million was contributed to the capital and surplus of our
insurance subsidiaries, $5.5 million was used to reduce the intercompany
debenture between our parent holding company and American Progressive and the
balance was held for general corporate purposes.
Acquisition of Administrative Service Companies
In November 2001, we acquired assets from Living Strategies, Inc., a
privately held company based in Bala Cynwyd, Pennsylvania, including certain
contracts, trademarks and proprietary web-based technology. Living Strategies is
a recognized provider of employer-sponsored elder care programs, providing
assistance and support to those dealing with the aging of their parents and
family members. As a result of the acquisition of the Living Strategies assets,
we have enhanced our technology infrastructure and expanded the audience for our
elder care management services.
In August 2000, we acquired Capitated HealthCare Services, Inc. ("CHCS") a
privately held administrator of long term care products located in Weston,
Florida. At the time of the acquisition, CHCS performed outsourcing services for
more than 30 insurance companies. This acquisition enhanced our expertise in the
long term care business.
In January 2000, we acquired American Insurance Administration Group,
Inc., a privately-held third party administrator of senior health products
located in Clearwater, Florida. At the time of the acquisition, American
Insurance Administration Group administered $125 million of senior market
premium. This acquisition strengthened our expertise and capacity to administer
senior market products.
1999 Acquisition
In July 1999, we acquired six insurance companies, including the insurance
subsidiaries that comprise our Career Agency segment, and other assets from
PennCorp Financial Group. This acquisition enhanced our prospects for internal
growth by increasing our scale, expanding our geographic reach and adding the
career agency marketing channel to supplement our senior market brokerage
marketing channel.
In January 2000, we began to integrate the operations of the acquired
companies from Raleigh, North Carolina into our existing locations in Toronto,
Pensacola and Orlando. We completed this integration in February 2001.
Cancellation of Major Medical Insurance
In the fourth quarter of 2000, we decided to exit our individual major
medical business to the extent permitted by the policy form. Out of the $31.3
million of cancelable premium that was in force on December 31, 2000,
approximately $2.4 million of annualized major medical premium in force remained
in force on December 31, 2001, and we anticipate the balance will be cancelled
by the end of 2002. We will not be able to cancel approximately $3.3 million of
major medical premium.
4
ADMINISTRATIVE SERVICES
We have built our administrative services capabilities through internal
development and acquisition. Through our wholly owned subsidiary, CHCS
Services, Inc., we provide outsourcing services that support insurance and
non-insurance products, primarily for the senior market. Our administrative
services operations are located in Pensacola, Clearwater and Weston, Florida. We
are in the process of closing the Clearwater office and consolidating the
operations to Pensacola and Weston.
We perform a full range of administrative services for senior market
insurance products, primarily Medicare supplement and long term care, for both
affiliated and unaffiliated companies. The services include policy underwriting
and issuance, policy billing and collecting, telephone verification,
policyholder services, claims adjudication, clinical case management, care
assessment and referral to health care facilities.
We are also increasingly performing similar services, particularly in the
long term care area, for non-insurance products offered both by insurance and
non-insurance companies. For example, we have begun to market our Nurse
Navigator(TM) product, a non-insurance elder care service product that includes
health related information and referrals and access to nationwide networks of
geriatric care nurses and long term care providers available on a discounted
basis.
We utilize state of the art technology and a national network of highly
trained health care professionals to provide the administrative platform for
these insurance and insurance-related products and services. The information
technology includes imaging and workflow processes to ensure maximum efficiency
in policy issue, policy administration and claims processing. Our propriety
network of over 3,500 registered nurses and social workers provides personalized
support and care for our senior programs nationwide. In addition, our propriety
network of approximately 5,500 discount providers is an integral part of our
geriatric care management services. We have established a customer contact
center that provides around the clock access to our nurses on staff and can
handle calls in 11 different languages.
The following table shows the sources of our service fee revenue by type
of product:
2001 2000 1999
------- ------- -------
(in thousands)
Affiliated Revenue
Medicare supplement $13,268 $ 8,467 $ 5,949
Long term care 1,607 981 572
Nurse Navigator(TM) 272 -- --
Other health insurance 358 930 1,031
Life insurance 388 135 50
------- ------- -------
Total Affiliated Revenue 15,893 10,513 7,602
------- ------- -------
Unaffiliated Revenue
Medicare supplement 9,564 9,410 --
Long term care 5,577 2,725 16
Other health insurance 554 758 1,160
Non-insurance assistance 1,242 724 512
------- ------- -------
Total Unaffiliated Revenue 16,937 13,617 1,688
------- ------- -------
Total Administrative Service Revenue $32,830 $24,130 $ 9,290
======= ======= =======
5
Included in unaffiliated revenue are fees received from a reinsurer of
100% of certain business of one of our insurance subsidiaries, which amounted to
$7.8 million and $7.6 million in 2001 and 2000. These fees, together with the
affiliated revenue, were eliminated in consolidation.
INSURANCE MARKETING AND DISTRIBUTION
Prior to 1999, we had marketed our products only through a traditional
general brokerage agency system. As a result of the acquisition of Pennsylvania
Life Insurance Company and PennCorp Life Insurance Company (Canada) in 1999, we
now distribute products through a career agency channel as well. The following
table shows our new sales (issued annualized premiums) by distribution channel
and by major product line for the three years ended December 31, 2001:
Product 2001 2000 1999
-------- -------- --------
(In thousands)
Senior Market Brokerage
Accident and Health
Medicare Supplement/Select $103,044 $ 78,213 $ 30,771
Long Term Care 3,196 4,580 4,058
Other Senior Health 262 244 241
-------- -------- --------
Total Senior Health 106,502 83,037 35,070
-------- -------- --------
Senior Life Insurance 3,240 2,106 1,495
-------- -------- --------
Total Senior Market Brokerage 109,742 85,143 36,565
-------- -------- --------
Career Agency
Accident and Health 20,154 20,750 20,000
Life Insurance 2,043 1,500 2,000
-------- -------- --------
Total Career Agency 22,197 22,250 22,000
-------- -------- --------
Special Markets
Accident and Health 1,838 6,988 8,175
Life Insurance 294 546 555
-------- -------- --------
Total Special Markets 2,132 7,534 8,730
-------- -------- --------
TOTAL ISSUED PREMIUM $134,071 $114,927 $ 67,295
======== ======== ========
The following table shows our annuity deposits by distribution channel for
the three years ended December 31, 2001:
2001 2000 1999
------- ------- -------
(In thousands)
Senior Market Brokerage $ 6,186 $ 5,188 $ 6,299
Career Agency 8,407 3,000 --
Special Markets -- -- --
------- ------- -------
TOTAL ANNUITY DEPOSITS $14,593 $ 8,188 $ 6,299
======= ======= =======
6
SENIOR MARKET BROKERAGE
This segment focuses on the sale of products designed for the senior
market such as Medicare supplement, Medicare select, long term care, senior life
insurance and annuities. We distribute these products through independent
marketing organizations and general agencies. These marketing organizations and
general agencies typically recruit and train their own agents, bearing all of
the costs incurred in connection with developing their organization. We now sell
our products through approximately 18,000 independent licensed agents in 26
states and have plans to recruit more agents and expand into additional states.
In 2001, this segment accounted for $340.7 million, or 66.0%, of our
consolidated gross premiums and $77.9 million, or 34.0%, of our consolidated net
premiums earned. New sales for this segment amounted to $109.7 million in 2001
and $85.1 million in 2000.
CAREER AGENCY
As part of the 1999 acquisition, we acquired a career agency sales force
that historically distributed fixed benefit accident and sickness disability
insurance and individual life insurance products to the self-employed market in
the United States and Canada. In contrast to independent agents, career agents
have an exclusive arrangement with us, and only sell products that we provide or
authorize. In order to maximize this distribution channel, we introduced our
senior market insured and non-insured products. As of December 31, 2001, the
career field force had 97 branch offices throughout the United States and 14
branch offices in Canada, with approximately 750 agents in the United States and
350 agents in Canada. In 2001, this segment accounted for $126.1 million, or
55.0%, of our net premiums earned. Approximately 37% of net premiums earned for
this segment were generated by our Canadian operations. The career agency
segment issued $22.2 million of new insurance premium in 2001, which was
comparable to the amount of new business issued by this segment in 2000. In
addition, the career sales force generated $1.7 million in sales of products for
our other subsidiaries, which includes $1.4 million of non insured products.
SPECIAL MARKETS
Our special market segment manages various lines of insurance that are no
longer part of our core focus, such as traditional and interest-sensitive life
insurance, group life insurance, individual major medical and other accident and
health insurance. Although we generally do not market these products to new
customers, we do continue to sell these products in limited amounts through
general agency relationships and we continue to receive premiums from existing
customers. We believe that these lines of business should be actively managed
for profit or disposed of through sale or cancellation. In December 2000, we
decided to exit the individual major medical business, which has accounted for
the majority of the production of new business in this segment. This segment had
net premiums earned of $25.2 million, or 11.0% of our consolidated total, in
2001, compared to $38.3 million, or 17.4% of our consolidated total, in 2000.
INSURANCE PRODUCTS
Our senior market brokerage segment focuses on our senior market products
(Medicare supplement, Medicare select, long term care, senior life insurance and
annuities), while our career agency segment focuses on fixed benefit disability
income, with an increasing focus on senior market products. We currently market
the following products:
SENIOR MARKET PRODUCTS -- SUPPLEMENTAL HEALTH AND LONG TERM CARE
Our core supplemental health insurance products include various Medicare
supplement and Medicare select plans. We also offer various long term care plans
consisting of fully integrated plans, nursing home only plans and stand alone
home health care plans. These products typically are guaranteed renewable for
the lifetime of the policyholder, which means that we cannot cancel the policy,
but can seek to increase premium rates on existing and future policies issued
based upon our actual claims experience. These rate increases are applied on a
uniform, nondiscriminatory state by state basis and are subject to state
regulatory approval and Federal and state loss-ratio requirements.
7
Medicare Supplement/Select
Under Federal and NAIC model regulations, adopted in substantially all
states, there are 11 standard Medicare supplement plans (Plans A through J and a
High Deductible Plan F). These policies provide supplemental coverage for many
of the medical expenses that the Medicare program does not cover, such as
deductibles, coinsurance and specified losses that exceed the Federal program's
maximum benefits. Plan A provides the least extensive coverage, while Plan J
provides the most extensive coverage. Under NAIC regulations, Medicare insurers
must offer Plan A, but may offer any of the other plans at their option. Our
insurance company subsidiaries offer Medicare supplement policies primarily on
plans A, B, C, D and F. In some areas, we also sell Medicare select policies in
conjunction with hospitals that contract with us to waive the Medicare Part A
deductible. We monitor the claim experience on our Medicare supplement and
Medicare select products and, when necessary, apply for rate increases in the
states in which we sell the products. Medicare supplement and Medicare select
issued gross premium amounted to $103.0 million in 2001 and $78.2 million in
2000, and were produced through our general agency system. We will be
introducing our High Deductible Plan F product in 2002, which provides seniors
with a lower cost plan for those who can afford a higher annual deductible. The
career agency segment began to sell Medicare supplement and Medicare select
products in 2001 and produced $0.3 million in premiums.
Long Term Care
Our long term care insurance products provide coverage, with limits
selected by the policyholders, for nursing home and assisted living care only
coverage, home health care only coverage, or an integrated combination of such
coverage. The nursing home and assisted living care products are subject to
daily fixed dollar maximum limits, have various elimination periods which must
be satisfied by the insureds and have maximum lifetime benefits or benefit
periods. The home health care products cover care needed in the insured's home,
are subject to daily or weekly maximum dollar benefits and an overall lifetime
maximum benefit or maximum benefit period. A new integrated long term care
product, combining nursing home, assisted living and home health care benefits
was introduced in late 1999 in several states and we have developed a new
nursing home-assisted living product with optional home health care riders which
we introduced in 2001. Issued premium for these long term care products
amounting to $3.2 million in 2001 and $4.6 million in 2000, were produced
through our general agency system. In addition, our career agents began to sell
these long term care products in 2000 and produced $4.0 million of issued
premium in 2001 and $3.9 million of issued premium in 2000.
SENIOR MARKET PRODUCTS -- SENIOR LIFE INSURANCE AND ANNUITIES
Senior Life
This series of low-face amount, simplified issue whole life products is
sold by both our senior market brokerage segment and our career agency segment.
Issued premium for these products was $3.2 million in 2001 and $2.1 million in
2000, and was produced primarily through the general agency system. In late
2000, our career agency segment began to sell senior life insurance and produced
$1.2 million of issued premium in 2001 and $0.6 million of issued premium in
2000
Annuities
We market single and flexible premium deferred annuities primarily
focusing on the senior and retirement markets. Our currently marketed annuity
products have a minimum guaranteed interest rate ranging from 3.0% to 4.0%
annually and current credited interest rates that range from 3.0% to 7.3%. We
have the right to change the crediting rates at any time. In exercising our
right to change the interest rate, we take into account the current interest
rate environment, the profitability of our annuity business and our relative
competitive position. Our general agency system produced $6.2 million of annuity
deposits in 2001 and $5.2 million of annuity deposits in 2000. Additionally, our
career agency system produced $8.4 million of annuity deposits in 2001 and $3.0
million of annuity deposits in 2000.
8
CAREER AGENCY PRODUCTS
Fixed Benefit Accident and Health
Fixed benefit accident and health products provide three principal types
of benefits:
- disability -- fixed periodic payments to an insured who becomes
disabled and unable to work due to an accident or sickness,
- hospital -- fixed periodic payments to an insured who becomes
hospitalized, and
- surgical -- fixed single payments that vary in amount for specified
surgical or diagnostic procedures.
Because the benefits we provide are fixed in amount at the time of policy
issuance and are not intended to provide full reimbursement for medical and
hospital expenses, payment amounts are not affected by inflation or the rising
cost of health care services. The disability income product is typically sold to
individuals in amounts which, when combined with other similar coverages, do not
provide monthly benefits in excess of $2,000, or 50% of the insured's monthly
income, if less. The hospital income product is typically sold to individuals to
provide the insured with a means of paying supplemental expenses during a
hospitalization stay and provides benefits of not more than $250 per day ($1,000
if the insured is in intensive care). The surgical product is typically sold as
a rider to an accident policy and our practice is to provide benefits of not
more than $5,000 ($2,500 if the procedure is performed on an out-patient basis).
Life Insurance
In late 2000, our career agency segment began to sell term life insurance
that provides a minimum coverage of $50,000 for a ten-year period (offered to
individuals ages 18 through 60) or a twenty-year period (offered to individuals
ages 18 through 50) as specified in the policy. Premium rates vary according to
age and sex and these policies are fully underwritten. No cash values are
accumulated in this policy and the policy can be renewed for a new term at an
increased premium on any expiration date, except for the final expiration date,
without evidence of insurability. Issued premium amounted to $0.3 million for
2001 and $0.5 million for 2000.
BUSINESS IN FORCE
As of December 31, 2001, the Company had $556.0 million of annualized
premium in force and $236.7 million in account values.
9
Our growth in direct, acquired and assumed annualized premium in force,
including only the portion of premiums on interest-sensitive products that is
applied to the cost of insurance, is shown in the following tables as of
December 31, 2001, 2000 and 1999.
ANNUALIZED PREMIUM IN FORCE
As of December 31,
----------------------------------------
2001 2000 1999
-------- -------- --------
(In thousands)
SENIOR MARKET BROKERAGE
Accident & Health
Medicare Supplement and Select Written $206,186 $115,217 $ 49,962
Medicare Supplement Acquired 157,284 149,200 154,617
Long Term Care 21,594 20,395 16,167
Hospital Indemnity 1,347 1,304 1,456
-------- -------- --------
TOTAL ACCIDENT & HEALTH 386,411 286,116 222,202
-------- -------- --------
Life
Asset Enhancer (1) 5,169 6,357 7,248
Final Expense Life 6,194 3,984 2,479
-------- -------- --------
TOTAL LIFE 11,363 10,341 9,727
-------- -------- --------
TOTAL SENIOR MARKET BROKERAGE 397,774 296,457 231,929
-------- -------- --------
CAREER AGENCY
Accident & Health
Accident & Sickness Disability 84,629 89,718 91,120
Hospital 16,229 16,635 21,614
Long Term Care Written 4,191 3,900 --
Long Term Care Acquired 10,930 9,680 12,011
-------- -------- --------
TOTAL ACCIDENT & HEALTH 115,979 119,933 124,745
LIFE (1) 13,233 13,234 15,800
-------- -------- --------
TOTAL CAREER AGENCY 129,212 133,167 140,545
-------- -------- --------
SPECIAL MARKETS
Accident & Health
Individual Medical (2) 5,675 31,422 45,442
Other Accident & Health 8,872 8,640 9,518
-------- -------- --------
TOTAL ACCIDENT & HEALTH 14,547 40,062 54,960
-------- -------- --------
Life
Group Life 3,139 3,444 3,542
Individual Life (1) 11,297 12,487 7,311
-------- -------- --------
TOTAL LIFE 14,436 15,931 10,853
-------- -------- --------
TOTAL SPECIAL MARKETS 28,983 55,993 65,813
-------- -------- --------
CONSOLIDATED
ACCIDENT & HEALTH 516,937 446,111 401,907
LIFE 39,032 39,506 36,380
-------- -------- --------
TOTAL CONSOLIDATED $555,969 $485,617 $438,287
======== ======== ========
(1) Included in the amounts shown are premiums for interest-sensitive
products. These amounts represent the portion of premium applied to
the cost of insurance (deposit premiums have been excluded).
(2) In the fourth quarter of 2000, we decided to exit our
under-performing individual major medical business to the extent
possible. We believe we will be able to cancel, by the end of 2002,
approximately $2.4 million of the $5.7 million in annualized premium
in force on December 31, 2001.
10
ACCOUNT VALUES ON INTEREST-SENSITIVE PRODUCTS
The following table shows all outstanding account values for
interest-sensitive products as of December 31, 2001, 2000 and 1999. For these
products, we earn income on the difference between investment income that we
earn on our invested assets and interest credited to these account balances.
As of December 31,
----------------------------------------
2001 2000 1999
-------- -------- --------
(In thousands)
Annuities $ 99,632 $ 98,053 $107,169
Interest-sensitive Life 137,110 135,362 131,496
-------- -------- --------
Grand Total $236,742 $233,415 $238,665
======== ======== ========
GEOGRAPHICAL DISTRIBUTION OF PREMIUM
Through our nine insurance subsidiaries, we are licensed to market our
products in all fifty states, the District of Columbia and in all the provinces
of Canada. The following table shows (by direct cash premium collected as
reported to the regulatory authorities for the full year of 2001) the
geographical distribution of premiums collected:
State/Region Collected % Total
------------ Premium -------
-------
(In thousands)
Florida $105,049 19.7%
Texas 60,953 11.5%
Canada 47,234 8.9%
New York 37,191 7.0%
Wisconsin 30,802 5.8%
Pennsylvania 25,855 4.9%
Indiana 25,521 4.8%
Ohio 23,146 4.3%
Georgia 11,986 2.3%
Mississippi 10,404 2.0%
Missouri 10,885 2.0%
North Carolina 10,861 2.0%
Oklahoma 8,928 1.6%
-------- -----
Subtotal 408,815 76.8%
All other 123,342 23.2%
-------- -----
Total $532,157 100.0%
======== =====
In 2001, no agent produced as much as 5% of our total premiums collected.
11
REINSURANCE
We enter into reinsurance arrangements with unaffiliated reinsurance
companies to limit our exposure on individual claims, to support the increased
volume of new business generated by the Senior Market brokerage segment and to
limit or eliminate risk on our non-core or under-performing blocks of business.
The table below details our gross annualized premium in force, the portion that
we ceded to reinsurers and the net amount that we retained as of December 31,
2001.
ANNUALIZED PREMIUM IN FORCE
As of December 31, 2001
----------------------------------------------------------
Gross Ceded Net % Retained
-------- -------- -------- ----------
(In thousands)
SENIOR MARKET BROKERAGE
Accident & Health
Medicare Supplement and Select Written $206,186 $142,973 $ 63,213 31%
Medicare Supplement Acquired 157,284 149,001 8,283 5%
Long Term Care 21,594 8,694 12,900 60%
Hospital Indemnity 1,347 303 1,044 78%
-------- -------- --------
TOTAL ACCIDENT & HEALTH 386,411 300,971 85,440 22%
-------- -------- --------
Life
Asset Enhancer 5,169 1,097 4,072 79%
Final Expense Life 6,194 3,008 3,186 51%
-------- -------- --------
TOTAL LIFE 11,363 4,105 7,258 64%
-------- -------- --------
TOTAL SENIOR MARKET BROKERAGE 397,774 305,076 92,698 23%
-------- -------- --------
CAREER AGENCY
Accident & Health
Accident & Sickness Disability 84,629 -- 84,629 100%
Hospital 16,229 -- 16,229 100%
Long Term Care Written 4,191 2,095 2,096 50%
Long Term Care Acquired 10,930 -- 10,930 100%
-------- -------- --------
TOTAL ACCIDENT & HEALTH 115,979 2,095 113,884 98%
-------- -------- --------
LIFE 13,233 -- 13,233 100%
-------- -------- --------
TOTAL CAREER AGENCY 129,212 2,095 127,117 98%
-------- -------- --------
SPECIAL MARKETS
Accident & Health
Individual Medical 5,675 446 5,229 92%
Other Accident & Health 8,872 6,728 2,144 24%
-------- -------- --------
TOTAL ACCIDENT & HEALTH 14,547 7,174 7,373 51%
-------- -------- --------
Life
Group Life 3,139 -- 3,139 100%
Individual Life 11,297 1,169 10,128 90%
-------- -------- --------
TOTAL LIFE 14,436 1,169 13,267 92%
-------- -------- --------
TOTAL SPECIAL MARKETS 28,983 8,343 20,640 71%
-------- -------- --------
CONSOLIDATED
ACCIDENT & HEALTH 516,937 310,240 206,697 40%
LIFE 39,032 5,274 33,758 86%
-------- -------- --------
TOTAL CONSOLIDATED $555,969 $315,514 $240,455 43%
======== ======== ========
12
We are obligated to pay claims in the event that any reinsurer to whom we
have ceded an insured claim fails to meet its obligations under the reinsurance
agreement. As of December 31, 2001, our primary reinsurers were rated "A" or
better by A.M. Best. We do not know of any instances where any of our reinsurers
has been unable to pay any policy claims on any reinsured business.
In addition to the reinsurance agreements discussed below by segment, we
reinsure portions of the coverage of our life insurance products to unaffiliated
reinsurance companies under various reinsurance agreements, which allows us to
write policies in amounts larger than the risk we are willing to retain on any
one life. Our mortality risk retention limit on each policy varies between
$25,000 and $250,000.
Our reinsurance agreements are generally subject to cancellation on 90
days notice as to future business, but policies reinsured prior to such
cancellation remain reinsured as long as they remain in force. We believe that
if any of our reinsurance agreements were canceled we would be able to obtain
other reinsurance arrangements on satisfactory terms to enable us to continue
writing new business.
SENIOR MARKET BROKERAGE
We reinsure most of our senior market brokerage products to unaffiliated
reinsurers under various quota share agreements. Under these reinsurance
agreements, we reinsure a portion of the premiums earned, claims incurred and
commissions on a pro rata basis and receive additional expense allowances for
policy issue administration and premium taxes. Medicare supplement premium
currently being issued is reinsured under quota share reinsurance agreements
ranging between 50% and 75% based upon the geographic distribution. We have also
acquired various blocks of Medicare supplement premium, which we reinsure under
quota share reinsurance agreements ranging from 50% to 100%. Our long term care
products currently produced are reinsured at percentages averaging 50%, while
the long term care business acquired in 1999 is 100% retained. We reinsure
senior life insurance products currently being issued on a 50% quota share
basis.
CAREER AGENCY
Currently, we retain 100% of all life and health business issued in our
career agency segment other than the long term care and Medicare supplement
products, which we reinsure on a 50% quota share basis.
SPECIAL MARKETS
We have 50% quota share and excess of loss reinsurance agreements with
unaffiliated reinsurance companies on our medical insurance policies to reduce
the liability on individual risks to amounts ranging between $50,000 and
$250,000 per year. Under these treaties, we perform all the policy
administration and receive various allowances for commission and expenses on the
ceded portion of the premium. Excess of loss reinsurance passes the risk of
losses over a specified amount to the reinsurer, effectively capping our
exposure on any single claim to the specified amount. The major medical business
acquired in 1999 is 100% retained but has an excess of loss reinsurance
agreement limiting the liability on an individual risk to $250,000 per year.
Most of this business is in the process of being canceled.
ADMINISTRATION OF REINSURED BLOCKS OF BUSINESS
We generally retain the administration for reinsured blocks of business,
including underwriting, issue, policy maintenance, rate management and claims
adjudication and payment. In addition to reimbursement for commissions and
premium taxes on the reinsured business, we also receive allowances from the
reinsurers as compensation for our administration.
13
UNDERWRITING PROCEDURES
Premiums charged on insurance products are based, in part, on assumptions
about expected mortality and morbidity experience. We have adopted and follow
detailed uniform underwriting procedures designed to assess and quantify various
insurance risks before issuing individual life insurance, health insurance
policies and annuity policies to individuals. These procedures are generally
based on industry practices, reinsurer underwriting manuals and our prior
underwriting experience. To implement these procedures, our insurance company
subsidiaries employ an experienced professional underwriting staff.
Applications for insurance are reviewed on the basis of the answers that
the customer provides to the application questions. Where appropriate to the
type and amount of insurance applied for and the applicant's age and medical
history, additional information is required, such as medical examinations,
statements from doctors who have treated the applicant in the past and, where
indicated, special medical tests. If deemed necessary, we use investigative
services to supplement and substantiate information. For certain coverages, we
may verify information with the applicant by telephone. After reviewing the
information collected, we either issue the policy as applied for on a standard
basis, issue the policy with an extra premium charge due to unfavorable factors,
issue the policy excluding benefits for certain conditions, either permanently
or for a period of time, or reject the application. For some of our coverages,
we have adopted simplified policy issue procedures in which the applicant
submits an application for coverage typically containing only a few
health-related questions instead of a complete medical history. Under
regulations promulgated by the NAIC and adopted as a result of the Omnibus
Budget Reconciliation Act of 1990, we are prohibited from underwriting our
Medicare supplement policies for certain first-time purchasers and for
dis-enrollees from Health Maintenance Organizations (HMO's). If a person applies
for insurance within six months after becoming eligible by reason of age, or
disability in some circumstances, the application may not be rejected due to
medical conditions. For other prospective Medicare supplement policyholders,
such as senior citizens who are purchasing our products, the underwriting
procedures are limited based upon standard industry practices. In New York and
some other states, some of our products, including Medicare supplement, are
subject to guaranteed issue "Community Rating" laws that severely limit or
prevent underwriting of individual applications. See "Regulation" section of
this document.
RESERVES
In accordance with applicable insurance regulations, we have established,
and carry as liabilities in our statutory financial statements, actuarially
determined reserves that are calculated to satisfy our policy and contract
obligations. Reserves, together with premiums to be received on outstanding
policies and contracts and interest at assumed rates on such amounts, are
calculated to be sufficient to satisfy policy and contract obligations. The
actuarial factors used in determining reserves for life insurance policies are
based on statutorily prescribed mortality tables and interest rates. In
addition, reserves for accident and health insurance policies use prescribed or
permitted morbidity tables. Reserves are also maintained for unearned premiums,
for premium deposits, for claims that have been reported and are in the process
of being paid or contested and for our estimate for claims that have been
incurred but have not yet been reported.
The reserves reflected in our consolidated financial statements are
calculated in accordance with GAAP. These reserves are determined based on our
best estimates of mortality and morbidity, persistency, expenses and investment
income. We use the net level premium method for all non-interest-sensitive
products and the retrospective deposit method for interest-sensitive products.
GAAP reserves differ from statutory reserves due to the use of different
assumptions regarding mortality and morbidity, interest rates and the
introduction of lapse assumptions into the GAAP reserve calculation. See Note 2
to our consolidated financial statements.
When we acquire blocks of insurance policies or insurers owning blocks of
policies, our assessment of the adequacy of the transferred policy liabilities
is subject to risks and uncertainties. With acquired and existing businesses, we
may from time to time need to increase our claims reserves significantly in
excess of those estimated. An inadequate estimate in reserves could have a
material adverse impact on our results of operations or financial condition.
14
COMPETITION
The life and accident and health insurance industry in North America is
highly competitive. We compete with other insurance and financial services
companies, including large multi-line organizations, both in connection with the
sale of insurance and asset accumulation products and in acquiring blocks of
business. Many of these organizations have been in business for a longer period
of time and have substantially greater capital and surplus, larger and more
diversified portfolios of life and health insurance policies, larger agency
sales operations and higher ratings than we do. In addition, it has become
increasingly difficult for mid-size companies to compete effectively with their
larger competitors for insurance product sales in part as a result of heightened
consumer and agent awareness of the financial size of companies.
We believe we can meet these competitive pressures by offering a high
level of service and accessibility to our field force and by developing
specialized products and marketing approaches. We also believe that our policies
and premium rates are generally competitive with those offered by other
companies selling similar types of products in the same jurisdictions.
RATINGS
Increased public and regulatory concerns regarding the financial stability
of insurance companies have resulted in policyholders placing greater emphasis
upon company ratings and have created some measure of competitive advantage for
insurance carriers with higher ratings. A.M. Best is considered to be a leading
insurance company rating agency. In evaluating a company's financial and
operating performance, A.M. Best reviews profitability, leverage and liquidity
as well as the quality of the book of business, the adequacy and soundness of
reinsurance programs, the quality and estimated market value of assets, reserve
adequacy and the experience and competence of management. A.M. Best's ratings
are based upon factors relevant to policyholders, agents, insurance brokers and
intermediaries and are not directed to the protection of investors. In November
2001, A.M. Best upgraded the ratings for our American Pioneer, American
Progressive, Constitution Life, Pennsylvania Life and PennCorp Life Insurance
Company (Canada) subsidiaries to "B++" from "B+". In addition, A.M. Best
reaffirmed the rating for our Union Bankers subsidiary at "B+". These ratings
mean that, in A.M. Best's opinion, these companies have demonstrated "very good"
overall performance when compared to standards it has established and have a
"good" ability to meet their obligations to policyholders and are in the
"Secure" category of all companies rated by A.M. Best. A.M. Best has also
reaffirmed the rating for our Peninsular Life subsidiary at "FPR5," which means
the company has a "good" ability to meet its obligations to policyholders, based
primarily on a quantitative evaluation of Peninsular Life's financial strength
and operating performance. Currently, Peninsular has no business in force and is
available for sale. A.M. Best does not rate our other insurance company
subsidiaries.
In March 2002, Standard & Poor's assigned its "BBB+" counterparty credit
and financial strength ratings to our American Pioneer, American Progressive,
Pennsylvania Life and PennCorp Life Insurance Company (Canada) subsidiaries.
This rating means that in Standard & Poor's opinion, these companies have good
financial security characteristics, but are more likely to be affected by
adverse business conditions than are insurers that are rated higher by Standard
& Poor's. A plus (+) or minus (-) shows Standard & Poor's opinion of the
relative standing of the insurer within a rating category.
Our insurance company subsidiaries are not currently rated by Moody's
Investors Service or Duff and Phelps rating organizations. Although a higher
rating by A.M. Best, Standard & Poor's or another insurance rating organization
could have a favorable effect on our business, we believe that our marketing has
enabled, and will continue to enable, our insurance company subsidiaries to
compete effectively.
15
INVESTMENTS
Our investment policy is to balance the portfolio duration to achieve
investment returns consistent with the preservation of capital and maintenance
of liquidity adequate to meet payment of policy benefits and claims. We invest
in assets permitted under the insurance laws of the various jurisdictions in
which we operate. Such laws generally prescribe the nature, quality of and
limitations on various types of investments that may be made. We currently
engage the services of two investment advisors under the direction of the
management of our insurance company subsidiaries and in accordance with
guidelines adopted by the Investment Committees of their respective boards of
directors. Conning Asset Management Company manages our fixed maturity portfolio
in the United States, and Elliot & Page, Limited manages our Canadian fixed
maturity portfolio.
The following table summarizes the composition of our investment portfolio
by carrying value (which is an estimate of fair value) as of December 31, 2001
and 2000:
INVESTMENT PORTFOLIO
December 31, 2001 December 31, 2000
------------------------------------ --------------------------------------
Percent of Percent of
Carrying Value Total Carrying Value Total
(Fair Value) Carrying Value (Fair Value) Carrying Value
-------- ----- -------- -----
(In thousands)
Fixed Maturity Securities:
U.S. Government and
Government agencies (1) $ 36,970 4.1% $ 34,734 4.2%
Mortgage-backed (1) 150,993 17.1% 172,857 21.0%
Asset-backed 88,977 10.1% 85,547 10.4%
Foreign securities (2) 157,752 17.8% 145,403 17.6%
Investment grade corporates 357,292 40.4% 291,274 35.3%
Non-investment grade corporates 7,234 0.8% 21,923 2.7%
-------- ----- -------- -----
Total fixed maturity securities 799,218 90.3% 751,738 91.2%
Cash and cash equivalents 53,690 6.1% 40,250 4.9%
Other Investments:
Policy loans 24,043 2.7% 25,077 3%
Equity securities 4,199 0.5% 3,547 .4%
Other invested assets 3,773 0.4% 4,318 .5%
-------- ----- -------- -----
Total cash and invested assets $884,923 100.0% $824,930 100.0%
======== ===== ======== =====
(1) US Government and government agencies include GNMA and FMNA
mortgage-backed securities.
(2) Primarily Canadian dollar denominated bonds supporting our Canadian
insurance reserves.
16
The following table shows the distribution of the contractual maturities
of our portfolio of fixed maturity securities by carrying value as of December
31, 2001. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties:
CONTRACTUAL MATURITIES OF FIXED MATURITY SECURITIES
Percent of
Carrying Total Fixed
Available for Sale Value Maturities
------------------ ----- ----------
(In thousands)
Due in 1 year or less $ 29,535 3.7%
Due after 1 year through 5 years 113,043 14.1%
Due after 5 years through 10 years 254,435 31.8%
Due after 10 years 162,235 20.3%
Asset-backed securities 88,977 11.2%
Mortgage-backed securities 150,993 18.9%
-------- -----
$799,218 100.0%
======== =====
The following table shows the distribution of the ratings assigned by
Standard & Poors Corporation to the securities in our portfolio of fixed
maturity securities as of December 31, 2001 and 2000:
DISTRIBUTION OF FIXED MATURITY SECURITIES BY RATING
December 31, 2001 December 31, 2000
-------------------------------- ----------------------------------
(In thousands)
Carrying % of Carrying % of
Standard & Value Total Value Total
Poor's (Estimated Fixed (Estimated Fixed
Rating Fair Value) Investment Fair Value) Investment
------ ----------- ---------- ----------- ----------
AAA $259,847 32.5% $285,274 37.9%
AA 99,222 12.4% 105,749 14.1%
A 318,899 39.9% 239,420 31.9%
BBB 113,500 14.2% 99,372 13.2%
BB 5,008 0.7% 7,965 1.1%
B 2,603 0.3% 12,766 1.7%
CCC and below 139 -- 1,192 0.1%
----- -------- -----
Total $799,218 100.0% $751,738 100.0%
======== ===== ======== =====
At December 31, 2001 99.0% of our fixed maturity investments were
"investment grade". As of December 31, 2000, 97.1% of our fixed maturity
investments were "investment grade". "Investment grade" securities are those
rated "BBB-" or higher by Standard & Poor's Corporation or "Baa3" or higher by
Moody's Investors Service. This included approximately $239.9 million, as of
December 31, 2001 and $258.4 million, as of December 31, 2000, of collateralized
mortgage obligations secured by residential mortgages and asset-backed
securities, representing approximately 30% of our fixed maturity portfolio as of
December 31, 2001 and 34% of our fixed maturity portfolio as of December 31,
2000. Some classes of mortgage backed securities are subject to significant
prepayment risk, because in periods of declining interest rates, mortgages may
be repaid more rapidly than scheduled, as individuals refinance higher rate
mortgages to take advantage of the lower rates. As a result, holders of mortgage
backed securities may receive higher prepayments on their investments, which
they may not be able to reinvest at an interest rate comparable to the rate paid
on such mortgage backed securities.
17
Fixed maturity securities with a less than investment grade rating had
aggregate carrying values of $7.8 million as of December 31, 2001 and $21.9
million as of December 31, 2000, amounting to 1.0% of total investments as of
December 31, 2001 and 2.9% of total investments as of December 31, 2000. These
securities represented 0.6% of total assets as of December 31, 2001 and 1.8% of
total assets as of December 31, 2000. Our holdings of less than investment grade
fixed maturity securities are diversified and the largest investment in any one
such security as of December 31, 2001 was $2.0 million, which was less than 0.2%
of total assets. We wrote down the value of some of our fixed maturity
portfolio's securities, considered to have been subject to an
other-than-temporary decline in value, by $4.2 million in the year ended
December 31, 2001 and $0.5 million in the year ended December 31, 2000, which
were included in net realized gains (losses) on investments in our consolidated
statements of operations.
INVESTMENT INCOME
Investment income is an important part of our total revenues and
profitability. We cannot predict the impact that changes in future interest
rates will have on our financial statements.
The following table shows the investment results of our total invested
asset portfolio, for the three years ended December 31, 2001:
Years Ended December 31,
-----------------------------------------------------------
2001 2000 1999
----------- ----------- ---------
(In thousands)
Total cash and invested assets, end of period $ 884,923 $ 824,930 $ 812,297
=========== =========== =========
Net investment income $ 57,812 $ 56,945 $ 29,313
=========== =========== =========
Yield on average cash and investments 6.76% 6.88% 6.79%
=========== =========== =========
Net realized investment gains (losses) on the
sale of securities (including other than
temporary declines in market value) $ 3,078 $ 146 $ (241)
=========== =========== =========
REGULATION
General
Our insurance company subsidiaries, like other insurance companies, are
subject to the laws, regulations and supervision of the jurisdictions in which
they are domiciled. The purpose of those laws and regulations is primarily to
provide safeguards for policyholders rather than to protect the interest of
shareholders.
18
The following table sets forth the domiciles of our insurance company
subsidiaries.
NEW YORK TEXAS
American Progressive Life & American Exchange Life
Health Insurance Company of Insurance Company
New York Constitution Life Insurance
Company
FLORIDA Marquette National Life
American Pioneer Life Insurance Company
Insurance Company Union Bankers Insurance
Peninsular Life Insurance Company
Company
CANADA
PENNSYLVANIA PennCorp Life Insurance
Pennsylvania Life Insurance Company
Company
Pennsylvania Life, Constitution Life and Union Bankers are subsidiaries of
American Exchange. Marquette is a subsidiary of Constitution Life. Peninsular
Life is a subsidiary of American Pioneer Life Insurance Company. As part of its
change in ownership from American Exchange to American Pioneer, Peninsular Life
re-domesticated to Florida from North Carolina effective December 31, 2000.
Each of our insurance company subsidiaries is also subject to regulation
and supervision by the insurance department in each of the jurisdictions in
which they are admitted and authorized to transact business. Such regulation and
supervision by the insurance departments covers, among other things, the
declaration and payment of dividends by our insurance company subsidiaries, the
setting of rates to be charged for some types of insurance, the granting and
revocation of licenses to transact business, the licensing of agents, the
regulation and monitoring of market conduct and claims practices, the approval
of forms, the establishment of reserve and minimum surplus requirements, the
regulation of maximum commissions payable, the mandating of some insurance
benefits, and the form and content of financial statements required by statute.
A failure to comply with legal or regulatory restrictions may subject us to a
loss of a right to engage in some businesses or an obligation to pay fines or
make restitution, which may affect our profitability.
Most jurisdictions mandate minimum benefit standards and loss ratios for
accident and health insurance policies. Generally we are required to maintain,
with respect to our individual long term care policies, minimum anticipated loss
ratios over the entire period of coverage. With respect to our Medicare
supplement policies, generally we are required to attain and maintain an actual
loss ratio, after three years, of not less than 65 percent of premium. We
provide, to the insurance departments of all states in which we conduct
business, annual calculations that demonstrate compliance with required loss
ratio standards for both long term care and Medicare supplement insurance. We
prepared these calculations utilizing statutory lapse and interest rate
assumptions. In the event we have failed to maintain minimum mandated loss
ratios, our insurance company subsidiaries could be required to provide
retrospective refunds or prospective rate reductions. We believe that our
insurance company subsidiaries currently comply with all applicable mandated
minimum loss ratios. In addition, we actively review the loss ratio experience
of our products and make an application with the respective insurance
departments for rate increases when we determine one is needed. We cannot
guarantee that we will receive the rate increases we request.
Under Federal and NAIC model regulations, adopted in substantially all
states, there are 11 standard Medicare supplement plans (Plans A through J and a
High Deductible Plan F). Plan A provides the least extensive coverage, while
Plan J provides the most extensive coverage. Under NAIC regulations, Medicare
insurers must offer Plan A, but may offer any of the other plans at their
option.
19
Every insurance company that is a member of an "insurance holding company
system" generally is required to register with the insurance regulatory
authorities in each state in which it is authorized to do business and file
periodic reports concerning its relationships with its insurance holding
company. Material transactions between registered insurance companies and
members of the holding company system are required to be "fair and reasonable"
and in some cases are subject to administrative approval, and the books,
accounts and records of each party are required to be maintained so as to
clearly and accurately disclose the precise nature and details of any such
transactions.
Each of our insurance company subsidiaries is required to file detailed
reports with the insurance department of each jurisdiction in which it is
licensed to conduct business and its books and records are subject to
examination by each such insurance department. In accordance with the insurance
codes of their domiciliary states and the rules and practices of the NAIC, our
insurance company subsidiaries are examined periodically by examiners of each
company's domiciliary state and by representatives (on an "association" or
"zone" basis) of the other states in which they are licensed to do business.
Examinations are currently pending by Florida, New York, Pennsylvania and Texas.
We do not believe that there are any material issues with respect to the
examinations in progress that would have a material adverse impact on the
financial position or results of operations of the companies under examination.
Many states require deposits of assets by insurance companies for the
protection of policyholders either in those states or for all policyholders.
Nonetheless, these deposited assets remain part of the total assets of the
company. As of December 31, 2001, securities totaling $32.4 million,
representing approximately 3.9% of the carrying value of our total investments,
were on deposit with various state treasurers or custodians. As of December 31,
2000, securities totaling $33.1 million, representing approximately 4.2% of
total assets, were on deposit. These deposits must consist of securities that
comply with the standards established by the particular state.
PennCorp Life, our Canadian domiciled subsidiary, and the Canadian branch
of Pennsylvania Life are subject to provincial regulation and supervision in
each of the provinces of Canada in which they carry on business. Provincial
insurance regulation is concerned primarily with the form of insurance contracts
and the sale and marketing of insurance and annuity products, including the
licensing and supervision of insurance marketing personnel. Individual annuity
products and the underlying segregated funds to which they relate are subject to
guidelines adopted by the Canadian Council of Insurance Regulators and
incorporated by reference into provincial insurance regulations. These
guidelines govern a number of matters relating to the sale of these products and
the administration of the underlying segregated funds. During the first quarter
of 2002, the Canadian Branch of Pennsylvania Life was merged into PennCorp Life,
consolidating our Canadian operations into a single entity. This transaction was
approved by the Office of the Superintendent of Financial Institutions, in
Canada, and the Pennsylvania Department of Insurance.
Codification of Statutory Accounting Practices
In 1998, the NAIC approved a codification of statutory accounting
principles, which became effective January 1, 2001 and will serve as a
comprehensive and standardized guide to statutory accounting principles. The
adoption of the codification increased the capital and surplus of our U.S.
insurance subsidiaries by approximately $11.0 million at January 1, 2001, due
primarily to the recognition of certain loss carryforwards as deferred tax
assets.
20
Other Insurance Regulatory Changes
The NAIC and state insurance regulators have recently become involved in a
process of re-examining existing laws and regulations and their application to
insurance companies. This re-examination has focused on insurance company
investment and solvency issues, risk-based capital guidelines, assumption
reinsurance, interpretations of existing laws, the development of new laws, the
interpretation of nonstatutory guidelines, and the circumstances under which
dividends may be paid. The NAIC has encouraged states to adopt model NAIC laws
on specific topics as follows:
- investment reserve requirements;
- risk-based capital standards;
- codification of insurance accounting principles;
- additional investment restrictions;
- restrictions on an insurance company's ability to pay dividends; and
- product illustrations.
The NAIC is currently developing new model laws or regulations, including
product design standards and reserve requirements. While the Federal government
currently does not regulate the insurance business directly, Federal legislation
and administrative policies in a number of areas, such as Medicare, employee
benefits regulation, age, sex and disability-based discrimination, financial
services regulation and Federal taxation, can significantly affect the insurance
business. It is not possible to predict the future impact of changing regulation
on our operations or the operations of our insurance company subsidiaries.
Since 1993, New York State has required that all health insurance sold to
individuals and groups with less than 50 employees be offered on an open
enrollment and community rated basis. The community rating aspect of the law
prohibits the use of age, sex, health or occupational factors in rating and
requires that the same average rate be used for all persons with the same policy
residing in the same location. Such insurance may continue to be sold to groups
with more than 50 employees on an underwritten basis, with premium set to
reflect expected or actual results. The Medicare supplement policies actively
marketed by American Progressive in New York State and some of its in force
business are subject to the community rating rules. Similar legislation is in
effect for certain products in other states. The extension of such legislation
to Florida, Texas and other states where we offer significant medically
underwritten health insurance could cause us to reconsider our health care
coverage offerings in any such state.
Dividend and Distribution Restrictions
Under the insurance law of Pennsylvania, in the case of Pennsylvania Life,
and Texas, in the case of American Exchange, Constitution Life, Marquette
National Life and Union Bankers, a life insurer may pay dividends or make
distributions from accumulated earnings without the prior approval of the
insurance department, provided they do not exceed the greater of 10% of the
insurer's surplus as to policyholders as of the preceding December 31 or the
insurer's net gain from operations for the immediately preceding calendar year.
21
Under current Florida State insurance law, American Pioneer and Peninsular
Life may pay a dividend or make a distribution without the prior written
approval of the insurance department when:
- the dividend is paid from that portion of the insurer's accumulated
and available surplus as is derived from the net operating profits
of its business and its net realized capital gains;
- the dividend is no more than the greater of:
- 10% of the insurer's surplus as to policyholders derived from
net operating profits on its business and net realized capital
gains; and
- the insurer's entire net operating profits and realized net
capital gains derived during the immediately preceding
calendar year;
- the insurer will have surplus as to policyholders equal to or
exceeding 115% of the minimum required statutory surplus as to
policyholders after the dividend or distribution is made; and
- the insurer has filed notice with the department at least 10
business days prior to the dividend payment or distribution.
Under the New York State Insurance Law, the declaration or payment of a
dividend by American Progressive requires the approval of the New York
Superintendent of Insurance, who, as a matter of present policy, would not
approve such payment until American Progressive had generated sufficient
statutory profits to offset its entire negative unassigned surplus, which was
approximately $7.7 million at December 31, 2001.
Under current Canadian law, a life insurer may pay a dividend after such
dividend declaration has been approved by its board of directors and upon at
least 10 days prior notification to the Superintendent of Financial
Institutions. In considering approval of a dividend, the board of directors must
consider whether the payment of such dividend would be in contravention of the
Insurance Companies Act of Canada.
In 2001, Union Bankers paid an ordinary dividend to American Exchange of
$1.7 million. Union Bankers also distributed its investment in the common stock
of Marquette to American Exchange in the form of an extraordinary dividend.
American Exchange, in turn, contributed Marquette to Constitution Life.
Additionally, Peninsular paid an extraordinary dividend of $1.9 million to
American Pioneer in 2001.
In 2000, Pennsylvania Life paid ordinary dividends to American Exchange of
$2.9 million and Union Bankers paid ordinary dividends to American Exchange of
$2.0 million. Additionally, Peninsular Life paid an extraordinary dividend of
$1.5 million to our holding company in 2000.
Based on the current dividend regulations of the respective states, it is
estimated that in 2002, Pennsylvania Life would be able to pay ordinary
dividends of up to approximately $8.4 million and Constitution would be able to
pay ordinary dividends of up to approximately $1.7 million to American Exchange
without prior approval from the respective insurance departments. Additionally,
in 2002 Peninsular Life would be able to pay ordinary dividends of up to
approximately $0.7 million to American Pioneer without prior approval from the
Florida Insurance Department. We do not anticipate that our remaining insurance
subsidiaries will be able to pay ordinary dividends in 2002.
22
Risk-Based Capital Requirements
The NAIC's risk-based capital requirements for insurance companies adopted
by state regulators take into account asset risks, interest rate risks,
mortality and morbidity risks and other relevant risks with respect to the
insurer's business and specify varying degrees of regulatory action to occur to
the extent that an insurer does not meet the specified risk-based capital
thresholds, with increasing degrees of regulatory scrutiny or intervention
provided for companies in categories of lesser risk-based capital compliance.
Our Canadian domiciled subsidiary, PennCorp Life, and the Canadian branch of
Pennsylvania Life are subject to minimum continuing capital and surplus
requirements which Canadian regulators use to assess financial strength and to
determine when regulatory intervention is needed. As of December 31, 2001 all of
our U.S. insurance company subsidiaries maintained ratios of total adjusted
capital to risk-based capital in excess of the authorized control level and
PennCorp Life and the Canadian branch of Pennsylvania Life maintained minimum
continuing capital and surplus requirement ratios in excess of minimum
requirements. However, should our insurance company subsidiaries' capital
position decline in the future, their continued ability to pay dividends and the
degree of regulatory supervision or control to which they are subjected might be
affected.
Guaranty Association Assessments
Our insurance company subsidiaries can be required, under solvency or
guaranty laws of most jurisdictions in which they do business, to pay
assessments to fund policyholder losses or liabilities of unaffiliated insurance
companies that become insolvent. These assessments may be deferred or forgiven
under most solvency or guaranty laws if they would threaten an insurer's
financial strength and, in most instances, may be offset against future premium
taxes. None of our insurance company subsidiaries has ever incurred any
significant costs of this nature. The likelihood and amount of any future
assessments are now unknown and are beyond our control.
Health Care Financing Reform
From time to time, numerous proposals have been considered, and in some
cases enacted, in Congress and the state legislatures to reform aspects of the
health care financing system.
The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"),
a significant federal health care financing reform, restricted the ability of
insurers to utilize medical underwriting and pre-existing condition provisions
in health insurance policies issued to persons who were previously insured under
qualifying policies. These changes affect only a small part of the coverages we
write, but may have an adverse effect on them. HIPAA also mandates the adoption
of standars for the exchange of electronic health information and contains
privacy requirements that will govern the handling, use and security of
protected customer information, which will become effective in stages in 2002
through 2003. We have implemented some of the changes in our business procedures
needed to comply with these requirements, and are in the process of implementing
others. We anticipate that we will meet all the requirements which become
effective in 2002 and 2003, but the cost of doing so is not yet fully
determined.
On the state level in 2000, the NAIC amended its Model Long Term Care
Insurance Regulation to include provisions intended to assure that rates on long
term care insurance policies, under which the insurer reserves the right to
increase premiums, are initially set high enough to make such increases
unlikely. This amendment has thus far been adopted only in some states where we
sell, or intend to sell, such policies, and may become more widely adopted.
Where it is adopted, these rules could increase the cost of policies sold by us
and by our competitors. We have not determined the impact this model regulation
could have on our long term care insurance business.
Some states have enacted, and others states are considering, small group
insurance and rating reforms, which generally limit the ability of insurers and
health plans to use risk selection as a method of controlling costs for small
group businesses. These laws may generally limit or eliminate use of
pre-existing condition exclusions, experience rating, and industry class rating
and limit the amount of rate increases from year to year.
23
Congress and various states are considering some form of the "Patients'
Bill of Rights." This legislation, if enacted, is designed to provide consumers
more freedom of choice in the selection of doctors, facilities, and treatments.
Although the bill was originally conceived to regulate health maintenance
organizations, it will affect all facets of the nation's health care delivery
system, including insurers. The pending federal legislation, known as the
Bipartisan Patient Protection Act of 2001:
- requires a more stringent timeframe for claims review and
processing, utilization review and internal and external appeals
processes;
- provides that insureds have greater access to non-formulary drugs,
clinical trials, physicians, specialists and emergency care; and
- allows insureds to bring suit after exhaustion of the administrative
appeals process.
These changes, if enacted, are expected to result in higher total medical costs,
which could encourage more partnerships and associations between medical
providers and insurers to control costs, more community-based health
organizations, and greater use of higher deductibles to lower insurance costs
and reduce administrative expenses of smaller claims.
Proposals for further federal reforms have included, among other things,
restricting coverage of deductible and co-payments on Medicare supplement
policies, expansion of Medicare to provide prescription drug benefits, provide
coverage to persons under age 65 and employer-based insurance systems, subsidize
premiums for lower income people and programs, regulate policy availability,
affordability of public and private programs standardization of major medical or
long term care coverages, impose mandated or target loss ratios or rate
regulation, and require the use of community rating or other means that further
limit the ability of insurers to differentiate among risks, or mandate
utilization review or other managed care concepts to determine what benefits
would be paid by insurers.
In addition to federal regulation, many states have enacted, or are
considering, various health care reform statutes. These proposed reforms relate
to, among other things, managed care practices, such as waiting period
restrictions on pre-existing conditions, credit for certain prior coverage, and
limitations on rate increases and guaranteed renewability for small business
plans and policies for individuals. Most states have also enacted patient
confidentiality laws that prohibit the disclosure of confidential medical
information, some of which, as permitted by HIPAA, are more restrictive than
HIPAA's rules protecting health information privacy.
These or other reform proposals could necessitate revisions in our
Medicare supplement products, and could increase or decrease the level of
competition among health care insurers and could significantly affect our health
insurance business, although it is not possible to predict which proposals will
be adopted and what their effect will be.
Other potential initiatives, designed to tax insurance premiums or shift
medical care costs from government to private insurers, could affect our
business, perhaps adversely.
Other Possible Changes in Legislation
Since insurance is a regulated business, with a high public profile, it is
always possible that legislation may be enacted which would have an adverse
effect on our business.
A portion of our insurance business is the sale of deferred annuities and
life insurance products, which are attractive to purchasers in part because
policyholders generally are not subject to Federal income tax on increases in
the value of an annuity or life and health insurance contract until some form of
distribution is made from the contract. From time to time, Congress has
considered proposals to reduce or eliminate the tax advantages of annuities and
life insurance, which, if enacted, might have an adverse effect on our ability
to sell the affected products in the future. We are not aware that Congress is
actively considering any legislation that would reduce or eliminate the tax
advantages of annuities or life or health insurance. However, it is possible
that the tax treatment of annuities or life or health insurance products could
change by legislation or other means, such as Internal Revenue Service
regulations or judicial decisions.
24
Other potential changes in insurance and tax laws and regulations could
also have a material adverse effect on the operations of insurance companies.
Examples of regulatory developments that could have a material adverse effect on
the operation of the insurance industry include, but are not limited to, the
potential repeal of the McCarran-Ferguson Act, which exempts insurance companies
from a variety of Federal regulatory requirements). In addition, the
administration of insurance regulations is typically vested in state agencies
that have broad powers and are concerned primarily with the protection of
policyholders.
EMPLOYEES
As of March 1, 2002, we employed approximately 860 employees, none of whom
is represented by a labor union in such employment. We consider our relations
with our employees to be good.
ITEM 2 - PROPERTIES
The Company currently leases the following office space, representing
primarily the operating offices of American Progressive, American Pioneer,
Pennsylvania Life, CHCS Services, Inc., PennCorp Life (Canada) and CHCS:
Type of Square Annual
Location Space Footage Rent Lease Expiration
-------- ----- ------- ---- ----------------
Rye Brook, New York Office 9,000 $174,000 October 2004
Orlando, Florida Office 2,500 41,000 August 2003
Office 24,000 395,000 February 2005
Office 5,300 88,000 June 2005
Pensacola, Florida Warehouse 5,100 18,000 June 2005
Office 21,600 161,000 November 2007(1)
Office/
Warehouse 18,800 51,000 November 2007
Warehouse 6,000 28,000 November 2007
Rental housing
1,200 15,000 August 2002
McKinney, Texas Office 240 2,850 March 2002
Mississauga, Ontario, Office 42,000 299,000 July 2011
Canada Warehouse 2,600 10,500 November 2004
Clearwater, Florida Office 14,300 252,000 December 2002
Weston, Florida Office 16,200 216,000 June 2008
Andalusia, Alabama Office 1,200 17,000 August 2002
(1) This lease includes one renewal, at our option, for an additional
five years.
25
ITEM 3 - LEGAL PROCEEDINGS
No reportable litigation was pending at December 31, 2001. We are party to
various lawsuits arising out of the ordinary conduct of the business of our
subsidiary corporations, none of which, we believe, would have a material
adverse effect upon our business if it were to be adversely determined.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted by us to a vote of stockholders, through
the solicitation of proxies or otherwise, during the fourth quarter of the
fiscal year for which this report is filed.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF PUBLICLY TRADED SECURITIES
Our common stock has been traded in the over-the-counter market and quoted
on the Nasdaq National Market under the symbol UHCO since May 12, 1983. The
following table sets forth the high and low sales prices per share of our common
stock as reported on the Nasdaq National Market for the periods indicated.
Common Stock
------------------
High Low
------ --------
2000
-----------------------------
First Quarter $4.625 $3.500
Second Quarter 4.156 3.250
Third Quarter 5.250 3.688
Fourth Quarter 4.375 3.813
2001
-----------------------------
First Quarter $5.563 $3.438
Second Quarter 7.000 4.625
Third Quarter 6.310 4.510
Fourth Quarter 7.650 5.270
2002
-----------------------------
First Quarter (through March 1) $6.990 $5.610
As of March 1, 2002, there were approximately 1,793 holders of record of
our common stock. On March 1, 2002, the closing bid and ask sales prices for our
common stock were $6.490 and $6.500.
DIVIDENDS
We have neither declared nor paid dividends on our common stock. Any
future decision to pay dividends will be made by our board of directors in light
of conditions then existing, including our results of operations, financial
condition and requirements, loan covenants, insurance regulatory restrictions,
business conditions and other factors. In addition, our ability to pay cash
dividends, if and when we should wish to do so, may depend on the ability of our
subsidiaries to pay dividends to our holding company and on compliance with the
covenants in our credit facility. See "Regulation - Dividend and Distribution
Restrictions".
26
ITEM 6 - SELECTED FINANCIAL DATA
As of or for the year ended December 31,
---------------------------------------------------------------------------
2001 2000 (4) 1999 (2) 1998 1997 (3)
--------- --------- --------- --------- ---------
INCOME STATEMENT DATA: (in thousands, except per share data)
Direct premium and policyholder fees $ 513,575 $ 451,323 $ 252,553 $ 131,044 $ 99,339
Reinsurance premium assumed 2,549 3,055 1,751 998 998
Reinsurance premium ceded (286,918) (234,625) (138,827) (89,546) (62,623)
---------- ---------- ---------- --------- ---------
Net premium and other policyholder fees 229,206 219,753 115,477 42,496 37,714
Net investment income 57,812 56,945 29,313 10,721 10,023
Realized gains (losses) 3,078 146 (241) 256 1,133
Fee and other income 10,847 7,247 3,587 2,616 2,460
---------- ---------- ---------- --------- ---------
Total revenues 300,943 284,091 148,136 56,089 51,330
Total benefits, claims and other deductions 257,580 251,025 132,080 52,157 48,119
---------- ---------- ---------- --------- ---------
Income before taxes 43,363 33,066 16,056 3,932 3,211
Net income after taxes 28,925 22,885 9,813 2,608 2,119
Net income applicable to common
shareholders (1) 28,925 22,885 9,633 2,174 1,870
OTHER DATA:
Net operating income (5) $ 26,924 $ 22,790 $ 9,790 $ 2,008 $ 1,134
Return on average equity 13.3% 14.9% 11.9% 8.0% 7.8%
Ratio of intangibles to equity (6) 33.8% 35.2% 30.1% 106.7% 103.6%
PER SHARE DATA:
Earnings per share:
Basic $ 0.58 $ 0.49 $ 0.42 $ 0.29 $ 0.26
Diluted $ 0.57 $ 0.49 $ 0.34 $ 0.20 $ 0.18
Net operating income per share (5):
Basic $ 0.54 $ 0.49 $ 0.42 $ 0.27 $ 0.16
Diluted $ 0.53 $ 0.48 $ 0.35 $ 0.19 $ 0.11
Book value per share:
Basic $ 4.38 $ 3.72 $ 2.92 $ 3.18 $ 2.96
Tangible book value per share (7):
Basic $ 2.90 $ 2.41 $ 2.04 $ (0.77) $ (0.67)
27
As of December 31,
------------------------------------------------------------------------------
BALANCE SHEET DATA: 2001 2000 1999 1998 1997
---------- ---------- ---------- -------- --------
(In thousands, except for per share data)
Total cash and investments $ 884,923 $ 824,930 $ 812,297 $164,674 $159,429
Total assets 1,275,916 1,189,864 1,153,421 283,302 272,575
Policyholder related liabilities 914,073 884,011 877,347 228,958 207,173
Loan payable 61,475 69,650 70,000 4,750 3,500
Series B Preferred Stock -- -- -- 4,000 4,000
Series C Preferred Stock -- -- -- 5,168 5,168
Series D Preferred Stock -- -- -- 2,250 --
Stockholders' equity 230,770 173,949 133,965 28,318 25,706
STATUTORY DATA (8):
Statutory capital and surplus $ 123,785 $ 101,367 $105,281 $21,076 $19,835
Asset valuation reserve 3,985 5,384 5,585 1,205 766
Adjusted capital and surplus $ 127,270 $ 106,751 $110,866 $22,281 $20,601
- --------------------------------------------
(1) After provision for Series C Preferred Stock dividends of $180, $434 and
$289 for the years ended December 31, 1999, 1998 and 1997, respectively.
(2) Includes the results of the companies acquired in the 1999 Acquisition,
since their acquisition on July 30, 1999.
(3) Includes the results of American Exchange since its acquisition on
December 1, 1997.
(4) Includes the results of AIAG since its acquisition on January 6, 2000, and
CHCS since its acquisition on August 10, 2000.
(5) Represents net income applicable to common shareholders, excluding
realized gains, net of tax.
(6) Represents the ratio of intangible assets (the sum of deferred acquisition
costs, goodwill and present value of future profits) to shareholders'
equity.
(7) Represents the amount of total assets less intangible assets (the sum of
deferred acquisition costs, goodwill and present value of future profits),
less total liabilities, divided by total shares outstanding.
(8) Includes capital and surplus of PennCorp Life (Canada) of C$32,314 as of
December 31, 2001, C$30,421 as of December 31, 2000, and C$31,531 as of
December 31, 1999 as reported to the Office of the Superintendent of
Financial Institutions Canada, converted at the related exchange rates of
C$0.6261 per U.S. $1.00 as of December 31, 2001, C$0.6671 per U.S. $1.00
as of December 31, 2000 and C$0.6900 per U.S. $1.00 as of December 31,
1999.
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ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following together with our financial statements and
the notes to financial statements included elsewhere herein.
FORWARD-LOOKING STATEMENTS
Certain statements in this report or incorporated by reference into this
report and oral statements made from time to time by our representatives
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
statements not based on historical information. They relate to future
operations, strategies, financial results or other developments. In particular,
statements using verbs such as "expect," "anticipate," "believe" or similar
words generally involve forward-looking statements. Forward-looking statements
include statements about development and distribution of our products,
investment spreads or yields, the impact of proposed or completed acquisitions,
the adequacy of reserves or the earnings or profitability of our activities.
Forward-looking statements are based upon estimates and assumptions that are
subject to significant business, economic and competitive uncertainties, many of
which are beyond our control and are subject to change. These uncertainties can
affect actual results and could cause actual results to differ materially from
those expressed in any forward-looking statements. Whether or not actual results
differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable risks and uncertainties, some of which relate
particularly to our business, such as our ability to set adequate premium rates
and maintain adequate reserves, our ability to compete effectively and our
ability to grow our business through internal growth as well as through
acquisitions. Other risks and uncertainties may be related to the insurance
industry generally or the overall economy, such as regulatory developments,
industry consolidation and general economic conditions and interest rates. We
disclaim any obligation to update forward-looking statements.
OVERVIEW
We offer life and health insurance designed for the senior market and the
self-employed market in all fifty states, the District of Columbia and all of
the provinces of Canada. We also provide administrative services to other
issuers by servicing their senior market products. Our principal insurance
products are Medicare supplemental health insurance, fixed benefit accident and
sickness disability insurance, long term care insurance, senior life insurance,
annuities and other individual life insurance. Our principal business segments
are: career agency, senior market brokerage, special markets and administrative
services. We also report the corporate activities of our holding company in a
separate segment. A description of these segments follows:
CAREER AGENCY -- Our career agency segment is comprised of the operations
of Pennsylvania Life Insurance Company and PennCorp Life Insurance Company of
Canada, both of which we acquired in 1999. PennCorp Life (Canada) operates
exclusively in Canada, while Pennsylvania Life operates in both the United
States and Canada. The career agency segment includes the operations of a career
agency field force, which distributes fixed benefit accident and sickness
disability insurance, life insurance and supplemental senior health insurance in
the United States and Canada. The career agents are under exclusive contract
with either Pennsylvania Life or PennCorp Life (Canada) and sell only products
that we provide. During the first quarter of 2002, the Canadian Branch of
Pennsylvania Life was merged into PennCorp Life (Canada), consolidating our
Canadian operations into a single entity. This transaction was approved by the
Office of the Superintendent of Financial Institutions and the Pennsylvania
Department of Insurance.
SENIOR MARKET BROKERAGE -- Our senior market brokerage segment focuses on
selling insurance products designed for the senior market, such as Medicare
supplement, long term care, senior life insurance and annuities. We distribute
these products through independent marketing organizations and general agencies.
29
SPECIAL MARKETS -- We have accumulated various blocks of business,
primarily as a result of acquisitions, that are not part of our core business
focus. We manage the run off of these blocks of business in our special markets
segment. The products in this segment include traditional, interest-sensitive
and group life insurance, individual major medical and other accident and health
insurance.
ADMINISTRATIVE SERVICES -- We act as a third party administrator and
service provider for both affiliated and unaffiliated insurance companies,
primarily with respect to various senior market products and a growing portion
of non-insurance products. The services that we perform include policy
underwriting, telephone verification, policyholder services, claims
adjudication, clinical case management, care assessment and referral to health
care facilities.
CORPORATE -- This segment reflects the activities of our holding company,
including the payment of interest on our debt and our public company
administrative expenses.
Intersegment revenues and expenses are reported on a gross basis in each
of the operating segments but are eliminated in our consolidated results. These
eliminations affect the amounts reported on the individual financial statement
line items, but do not change operating income before taxes. The significant
items eliminated include intersegment revenue and expense relating to services
performed by the administrative services segment for the career agency, senior
market brokerage and special market segments and interest on notes issued by the
corporate segment to the other operating segments.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP"). The
preparation of our financial statements in conformity with GAAP requires us to
make estimates and assumptions that affect the amounts of assets and liabilities
and disclosures of assets and liabilities reported by us at the date of the
financial statements and the revenues and expenses reported during the reporting
period. As additional information becomes available or actual amounts become
determinable, the recorded estimates may be revised and reflected in operating
results. Actual results could differ from those estimates. Accounts that, in our
judgment, are most critical to the preparation of our financial statements
include policy liabilities and accruals, deferred policy acquisition costs,
valuation of certain investments and deferred taxes.
Policy liabilities and accruals
We calculate and maintain reserves for the estimated future payment of
claims to our policyholders using the same actuarial assumptions that we use in
the pricing of our products. For our accident and health insurance business, we
establish an active life reserve plus a liability for due and unpaid claims,
claims in the course of settlement and incurred but not reported claims, as well
as a reserve for the present value of amounts not yet due on claims. Many
factors can affect these reserves and liabilities, such as economic and social
conditions, inflation, hospital and pharmaceutical costs, changes in doctrines
of legal liability and extracontractual damage awards. Therefore, the reserves
and liabilities we establish are based on extensive estimates, assumptions and
prior years' statistics. When we acquire other insurance companies or blocks of
insurance, our assessment of the adequacy of transferred policy liabilities is
subject to similar estimates and assumptions. Establishing reserves is an
uncertain process, and it is possible that actual claims will materially exceed
our reserves and have a material adverse effect on our results of operations and
financial condition. Our net income depends significantly upon the extent to
which our actual claims experience is consistent with the assumptions we used in
setting our reserves and pricing our policies. If our assumptions with respect
to future claims are incorrect, and our reserves are insufficient to cover our
actual losses and expenses, we would be required to increase our liabilities
resulting in reduced net income and shareholders' equity.
30
Deferred policy acquisition costs
The cost of acquiring new business, principally commissions and certain
expenses of the agency, policy issuance and underwriting departments, all of
which vary with, and are primarily related to the production of new and renewal
business, have been deferred. These costs are being amortized in relation to the
present value of expected gross profits on the policies arising principally from
investment, mortality and expense margins in accordance with Statement of
Financial Accounting Standards No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments", for interest sensitive life and annuity
products and in proportion to premium revenue using the same assumptions used in
estimating the liabilities for future policy benefits in accordance with
Statement of Financial Accounting Standards No. 60, "Accounting and Reporting by
Insurance Enterprises", for non-interest sensitive life and all accident &
health products.
The determination of gross profits is an inherently uncertain process, and
relies on assumptions including the persistency of the policies issued as well
as anticipated losses, commissions and expenses. It is possible that the actual
profits from the business will vary materially from the assumptions used in the
determination and amortization of deferred acquisition costs. Deferred policy
acquisition costs are written off to the extent that it is determined that
future policy premiums and investment income or gross profits would not be
adequate to cover related losses and expenses.
Investment valuation
Fair value of investments is based upon quoted market prices, where
available, or on values obtained from independent pricing services. For certain
mortgage and asset-backed securities, the determination of fair value is based
primarily upon the amount and timing of expected future cash flows of the
security. Estimates of these cash flows are based upon current economic
conditions, past credit loss experience and other circumstances.
We regularly evaluate the amo