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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 2002
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.E. No.)
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
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 and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No | |
The number of shares outstanding of the Registrant's Common Stock as of
November 1, 2002 was 52,936,988.
UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets at September 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations for the nine months ended September 30, 2002 4
and September 30, 2001
Consolidated Statements of Operations for the three months ended September 30, 2002 5
and September 30, 2001
Consolidated Statements of Stockholders' Equity and Comprehensive Income
for the nine months ended September 30, 2002 and September 30, 2001 6
Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 7
and September 30, 2001
Notes to Consolidated Financial Statements 8-16
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17-32
Item 3. Quantitative and Qualitative Disclosure of Market Risk 32-33
Item 4. Disclosure Controls and Procedures 33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Changes in Securities and Use of Proceeds 34
Item 3. Defaults upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 34
Signature 34
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 35-37
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
ASSETS SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
(Unaudited)
Investments: (In thousands)
Fixed maturities available for sale, at fair value
(amortized cost: 2002, $828,966; 2001, $786,844) $ 880,141 $ 799,218
Equity securities, at fair value (cost: 2002, $1,735; 2001, $4,339) 1,706 4,199
Policy loans 24,096 24,043
Other invested assets 2,967 3,773
------------- -------------
Total investments 908,910 831,233
Cash and cash equivalents 33,542 47,990
Accrued investment income 11,321 12,663
Deferred policy acquisition costs 84,761 66,025
Amounts due from reinsurers 220,086 212,532
Due and unpaid premiums 5,812 3,385
Deferred income tax asset 38,757 59,952
Present value of future profits and goodwill 10,685 11,921
Other assets 31,227 24,515
------------- -------------
Total assets 1,345,101 1,270,216
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 256,025 236,742
Reserves for future policy benefits 609,132 591,453
Policy and contract claims - life 6,880 6,282
Policy and contract claims - health 86,587 79,596
Loan payable 53,600 61,475
Amounts due to reinsurers 5,273 6,680
Other liabilities 51,545 57,218
------------- -------------
Total liabilities 1,069,042 1,039,446
------------- -------------
STOCKHOLDERS' EQUITY
Common stock (Authorized: 80 million shares, issued and outstanding:
2002, 53.2 million shares; 2001, 52.8 million shares) 532 528
Additional paid-in capital 157,815 155,746
Accumulated other comprehensive income 30,370 5,603
Retained earnings 88,414 69,279
Less: Treasury stock (2002, 0.2 million shares; 2001, 0.1 million shares) (1,072) (386)
------------- -------------
Total stockholders' equity 276,059 230,770
------------- -------------
Total liabilities and stockholders' equity $ 1,345,101 $ 1,270,216
============= =============
See notes to unaudited consolidated financial statements.
3
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
------------- -------------
Revenues: (In thousands, per share
amounts in dollars)
Gross premium and policyholder fees earned $ 437,388 $ 381,972
Reinsurance premiums assumed 2,434 2,124
Reinsurance premiums ceded (243,489) (212,224)
------------- -------------
Net premium and policyholder fees earned 196,333 171,872
Net investment income 43,535 43,358
Net realized (losses) gains on investments (6,210) 2,046
Fee income 9,154 8,010
------------- -------------
Total revenues 242,812 225,286
------------- -------------
Benefits, claims and expenses:
Increase in future policy benefits 10,004 8,186
Claims and other benefits 125,592 116,209
Interest credited to policyholders 8,128 7,595
Increase in deferred acquisition costs (19,891) (13,287)
Amortization of present value of future profits and goodwill 1,236 2,050
Commissions 85,767 73,572
Commission and expense allowances on reinsurance ceded (72,106) (64,308)
Interest expense 2,334 4,216
Other operating costs and expenses 72,773 59,947
------------- -------------
Total benefits, claims and other deductions 213,837 194,180
------------- -------------
Income before taxes 28,975 31,106
Federal income tax expense 9,840 11,074
------------- -------------
Net income $ 19,135 $ 20,032
============= =============
Earnings per common share:
Basic $ 0.36 $ 0.41
============= =============
Diluted $ 0.35 $ 0.41
============= =============
See notes to unaudited consolidated financial statements
4
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30,
2002 2001
------------- --------------
Revenues: (In thousands, per share
amounts in dollars)
Gross premium and policyholder fees earned $ 145,783 $ 128,119
Reinsurance premiums assumed 349 754
Reinsurance premiums ceded (80,362) (72,467)
------------- -------------
Net premium and policyholder fees earned 65,770 56,406
Net investment income 14,774 14,811
Net realized gains on investments 247 193
Fee income 3,165 2,441
------------- -------------
Total revenues 83,956 73,851
------------- -------------
Benefits, claims and expenses:
Increase in future policy benefits 3,473 2,821
Claims and other benefits 40,306 37,145
Interest credited to policyholders 2,915 2,606
Increase in deferred acquisition costs (7,035) (4,916)
Amortization of present value of future profits and goodwill 404 690
Commissions 28,342 25,278
Commission and expense allowances on reinsurance ceded (22,742) (21,709)
Interest expense 746 1,203
Other operating costs and expenses 24,670 20,014
------------- -------------
Total benefits, claims and other deductions 71,079 63,132
------------- -------------
Income before taxes 12,877 10,719
Federal income tax expense 4,558 3,797
------------- -------------
Net income $ 8,319 $ 6,922
============= =============
Earnings per common share:
Basic $ 0.16 $ 0.13
============= =============
Diluted $ 0.15 $ 0.13
============= =============
See notes to unaudited consolidated financial statements
5
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS)
Accumulated
Other
Additional Comprehensive
Common Paid-In Income / Retained Treasury
Stock Capital (Loss) Earnings Stock Total
--------- --------- ------------- --------- --------- ---------
Balance, January 1, 2001 $ 468 $ 128,625 $ 4,875 $ 40,354 $ (373) $ 173,949
Net income -- -- -- 20,032 -- 20,032
Other comprehensive income
(Note 2) -- -- 8,546 -- -- 8,546
---------
Comprehensive income (Note 2) 28,578
---------
Issuance of common stock 60 26,290 -- -- -- 26,350
Stock-based compensation -- 703 -- -- -- 703
Loans to officers -- 13 -- -- -- 13
Treasury shares purchased, at --
Cost -- -- -- (743) (743)
Treasury shares reissued -- (12) -- -- 708 696
--------- --------- --------- --------- --------- ---------
Balance, September 30, 2001 $ 528 $ 155,619 $ 13,421 $ 60,386 $ (408) $ 229,546
========= ========= ========= ========= ========= =========
Balance, January 1, 2002 $ 528 $ 155,746 $ 5,603 $ 69,279 $ (386) $ 230,770
Net income -- -- -- 19,135 -- 19,135
Other comprehensive income
(Note 2) -- -- 24,767 -- -- 24,767
---------
Comprehensive income (Note 2) 43,902
---------
Issuance of common stock (Note 5) 4 1,037 -- -- -- 1,041
Stock-based compensation -- 941 -- -- -- 941
Loans to officers 10 -- -- -- 10
Treasury shares purchased, at
cost (Note 5) -- -- -- -- (1,272) (1,272)
Treasury shares reissued (Note 5) -- 81 -- -- 586 667
--------- --------- --------- --------- --------- ---------
Balance, September 30, 2002 $ 532 $ 157,815 $ 30,370 $ 88,414 $ (1,072) $ 276,059
========= ========= ========= ========= ========= =========
See notes to consolidated financial statements.
6
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
----------- -------------
(In thousands)
Cash flows from operating activities:
Net income $ 19,135 $ 20,032
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes 8,389 6,188
Change in reserves for future policy benefits 16,323 17,472
Change in policy and contract claims 7,589 2,395
Change in deferred policy acquisition costs (19,891) (13,287)
Amortization of present value of future profits and goodwill 1,236 2,050
Change in policy loans (54) 1,014
Change in accrued investment income 1,342 (562)
Change in reinsurance balances (8,302) (10,392)
Realized losses (gains) on investments 6,210 (2,046)
Change in restructuring liability -- (2,514)
Change in income taxes payable (2,452) 1,292
Other, net (7,209) (8,350)
----------- -----------
Net cash provided by operating activities 22,316 13,292
----------- -----------
Cash flows from investing activities:
Proceeds from sale or maturity of fixed maturities available for sale 195,033 233,639
Cost of fixed maturities purchased available for sale (238,949) (266,334)
Change in amounts held in trust by reinsurer (1,456) (1,069)
Proceeds from sale of equity securities 2,768 11
Cost of equity securities purchased (639) (1,273)
Change in other invested assets 806 (530)
Change in due from/to broker (4,420) --
Cost of equipment purchased (1,883) --
----------- -----------
Net cash used by investing activities (48,740) (35,556)
----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 1,042 26,362
Cost of treasury stock purchases (1,272) (743)
Change in policyholder account balances 19,283 268
Change in reinsurance balances on policyholder account balances 798 881
Principal repayment on loan payable (7,875) (5,550)
----------- -----------
Net cash provided by financing activities 11,976 21,218
----------- -----------
Net decrease in cash and cash equivalents (14,448) (1,046)
Cash and cash equivalents at beginning of period 47,990 40,250
----------- -----------
Cash and cash equivalents at end of period $ 33,542 $ 39,204
=========== ===========
Supplemental cash flow information:
Cash paid during the period for interest $ 1,744 $ 4,601
=========== ===========
Cash paid during the period for income taxes $ 4,186 $ 1,881
=========== ===========
See notes to unaudited consolidated financial statements
7
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim financial information herein is unaudited, but in the opinion
of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results reported in these consolidated
financial statements should not be regarded as necessarily indicative of the
results that may be expected for the entire year. The consolidated financial
statements should be read in conjunction with the Form 10-K for the year ended
December 31, 2001. Certain reclassifications have been made to prior year's
financial statements to conform with current period classifications.
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP") and
consolidate the accounts of Universal American Financial Corp. ("Universal
American" or the "Parent Company") and its subsidiaries (collectively the
"Company"), American Progressive Life & Health Insurance Company of New York
("American Progressive"), American Pioneer Life Insurance Company ("American
Pioneer"), American Exchange Life Insurance Company ("American Exchange"),
Pennsylvania Life Insurance Company ("Pennsylvania Life"), Peninsular Life
Insurance Company ("Peninsular"), Union Bankers Insurance Company ("Union
Bankers"), Constitution Life Insurance Company ("Constitution"), Marquette
National Life Insurance Company ("Marquette"), PennCorp Life Insurance Company,
a Canadian company ("PennCorp Life (Canada)"), and CHCS Services, Inc.
The insurance company subsidiaries are licensed to sell life and accident
and health insurance in all fifty states, the District of Columbia and all the
provinces of Canada. The principal insurance products are Medicare supplement,
fixed benefit accident and sickness disability insurance, long term care, home
health care, senior life insurance and annuities. The Company distributes these
products through an independent general agency system and a career agency
system. The career agents focus on sales for Pennsylvania Life and PennCorp Life
(Canada) while the independent general agents sell for American Pioneer,
American Progressive and Constitution. CHCS Services, Inc., the Company's
administrative company, acts as a service provider for both affiliated and
unaffiliated insurance companies for senior market insurance and non-insurance
programs.
2. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the nine
months ended September 30, 2002 and 2001 are as follows:
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2002 2001
----------- -----------
(in thousands)
Net income $ 19,135 $ 20,032
Other comprehensive income 24,767 8,546
----------- -----------
Comprehensive income $ 43,902 $ 28,578
=========== ===========
8
The components of other comprehensive income and the related tax effects
for each component for the nine months ended September 30, 2002 and 2001 are as
follows:
NINE MONTHS ENDED SEPTEMBER 30, 2002 NINE MONTHS ENDED SEPTEMBER 30, 2001
-------------------------------------- ----------------------------------------
Before Tax Before Tax
Tax Expense Net of Tax Expense Net of Tax
Amount (Benefit) Tax Amount Amount (Benefit) Amount
---------- ---------- ---------- ---------- ---------- ----------
(in thousands)
Net unrealized gain arising during
the year (net of deferred
acquisition costs) $ 31,412 $ 10,998 $ 20,414 $ 18,833 $ 6,591 $ 12,242
Reclassification adjustment for
losses (gains) included in net
income 6,210 2,173 4,037 (2,046) (717) (1,329)
---------- ---------- ---------- ---------- ---------- ----------
Net unrealized gains 37,622 13,171 24,451 16,787 5,874 10,913
Currency translation adjustments 486 170 316 (3,261) (894) (2,367)
---------- ---------- ---------- ---------- ---------- ----------
Other comprehensive income $ 38,108 $ 13,341 $ 24,767 $ 13,526 $ 4,980 $ 8,546
========== ========== ========== ========== ========== ==========
The components of comprehensive income, net of related tax, for the three
months ended September 30, 2002 and 2001 are as follows:
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2002 2001
------------- ---------------
(in thousands)
Net income $ 8,319 $ 6,922
Other comprehensive income 18,261 10,922
------------ ------------
Comprehensive income $ 26,580 $ 17,844
============ ============
The components of other comprehensive income and the related tax effects
for each component for the three months ended September 30, 2002 and 2001 are as
follows:
THREE MONTHS ENDED SEPTEMBER 30, 2002 THREE MONTHS ENDED SEPTEMBER 30, 2001
--------------------------------------- ----------------------------------------
Before Tax Before Tax
Tax Expense Net of Tax Tax Expense Net of
Amount (Benefit) Amount Amount (Benefit) Tax Amount
---------- ---------- ---------- ---------- ---------- ----------
(in thousands)
Net unrealized gain arising during
the year (net of deferred
acquisition costs) $ 30,021 $ 10,513 $ 19,508 $ 19,311 $ 6,758 $ 12,553
Reclassification adjustment for
gains included in net income (247) (88) (159) (193) (68) (125)
---------- ---------- ---------- ---------- ---------- ----------
Net unrealized gains 29,774 10,425 19,349 19,118 6,690 12,428
Currency translation adjustments (1,674) (586) (1,088) (2,316) (810) (1,506)
---------- ---------- ---------- ---------- ---------- ----------
Other comprehensive income $ 28,100 $ 9,839 $ 18,261 $ 16,802 $ 5,880 $ 10,922
========== ========== ========== ========== ========== ==========
9
3. EARNINGS PER SHARE
A reconciliation of the numerators and the denominators of the basic and
diluted EPS for the nine months ended September 30, 2002 and 2001 is as follows:
NINE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------ ------------ ------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 53,034
Less: Weighted average treasury shares (97)
------------
Basic EPS
Net income applicable to common shareholders $ 19,135 52,937 $ 0.36
============ ============
Effect of Dilutive Securities
Incentive stock options 3,753
Director stock options 200
Agents and others stock options 999
Treasury stock assumed from proceeds of options (3,559)
------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 19,135 54,330 $ 0.35
============ ============ ============
NINE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------ ------------ ------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 48,514
Less: Weighted average treasury shares (58)
------------
Basic EPS
Net income applicable to common shareholders $ 20,032 48,456 $ 0.41
============ ============
Effect of Dilutive Securities
Incentive stock options 2,934
Director stock options 139
Agents and others stock options 772
Treasury stock assumed from proceeds of options (3,061)
------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 20,032 49,240 $ 0.41
============ ============ ============
10
A reconciliation of the numerators and the denominators of the basic and
diluted EPS for the three months ended September 30, 2002 and 2001 is as
follows:
THREE MONTHS ENDED SEPTEMBER 30, 2002
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------ ------------ ------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 53,142
Less: Weighted average treasury shares (104)
------------
Basic EPS
Net income applicable to common shareholders $ 8,319 53,038 $ 0.16
============ ============
Effect of Dilutive Securities
Incentive stock options 3,452
Director stock options 190
Agents and others stock options 958
Treasury stock assumed from proceeds of options (3,301)
------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 8,319 54,337 $ 0.15
============ ============ ============
THREE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------ ------------ ------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 51,692
Less: Weighted average treasury shares (41)
------------
Basic EPS
Net income applicable to common shareholders $ 6,922 51,651 $ 0.13
============ ============
Effect of Dilutive Securities
Incentive stock options 3,630
Director stock options 162
Agents and others stock options 732
Treasury stock assumed from proceeds of options (3,563)
------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 6,922 52,612 $ 0.13
============ ============ ============
11
4. INVESTMENTS
As of September 30, 2002 and December 31, 2001, fixed maturity securities
are classified as investments available for sale and are carried at fair value,
with the unrealized gain or loss, net of tax and other adjustments (deferred
policy acquisition costs), included in accumulated other comprehensive income.
SEPTEMBER 30, 2002
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ------------------------------------- ----------- ----------- ----------- -----------
(In thousands)
US Treasury securities
and obligations of US government $ 38,096 $ 1,711 $ -- $ 39,807
Corporate debt securities 383,497 31,619 (1,855) 413,261
Foreign debt securities (1) 164,360 8,201 (668) 171,893
Mortgage- and asset-backed securities 243,013 13,813 (1,646) 255,180
----------- ----------- ----------- -----------
$ 828,966 $ 55,344 $ (4,169) $ 880,141
=========== =========== =========== ===========
(1) Primarily Canadian denominated bonds supporting our Canadian Insurance
reserves.
DECEMBER 31, 2001
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ------------------------------------- ----------- ----------- ----------- -----------
(In thousands)
US Treasury securities
and obligations of US government $ 35,719 $ 1,262 $ (11) $ 36,970
Corporate debt securities 357,431 8,990 (1,805) 364,616
Foreign debt securities (1) 157,077 2,225 (1,640) 157,662
Mortgage- and asset-backed securities 236,617 5,700 (2,347) 239,970
----------- ----------- ----------- -----------
$ 786,844 $ 18,177 $ (5,803) $ 799,218
=========== =========== =========== ===========
(1) Primarily Canadian denominated bonds supporting our Canadian Insurance
reserves.
The amortized cost and fair value of fixed maturities at September 30,
2002 by contractual maturity are shown below. Expected maturities may differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
---------- ----------
(In thousands)
Due in 1 year or less $ 41,182 $ 46,505
Due after 1 year through 5 years 110,823 113,591
Due after 5 years through 10 years 297,569 321,166
Due after 10 years 136,379 143,699
Mortgage- and asset-backed securities 243,013 255,180
---------- ----------
$ 828,966 $ 880,141
========== ==========
During the nine months ended September 30, 2002 we recognized an other
than temporary decline in the value of certain fixed maturity securities of $9.9
million (1.1% of investments), primarily as a result of the impairment of our
WorldCom bonds, which were disposed of in the third quarter at a price
approximating their carrying value after the other than temporary decline was
recognized. During the nine months ended September 30, 2001, we wrote down the
value of certain fixed maturity securities by $2.5 million (0.3% of
investments). These write downs represent management's estimate of other than
temporary declines in value and were included in net realized gains (losses) on
investments in our
12
consolidated statement of operations.
5. STOCKHOLDERS' EQUITY
Common Stock
The par value of common stock is $.01 per share with 80,000,000 shares
authorized for issuance. Changes in the number of shares of common stock
outstanding:
Common stock outstanding at December 31, 2001 52,799,899
Stock options exercised 270,866
Agent stock award 72,789
Stock purchases pursuant to Agents' Stock Purchase Plan 25,750
----------
Common stock outstanding at September 30, 2002 53,169,304
==========
Treasury Stock
During 2001, the Board of Directors approved a plan to repurchase up to
0.5 million shares of Company stock in the open market. In March 2002, the Board
of Directors approved an amendment of the plan to increase the amount of shares
available for repurchase from 0.5 million to 1.0 million shares. The primary
purpose of the plan is to fund employee stock bonuses.
During the nine months ended September 30, 2002, the Company acquired
206,421 shares on the open market for a cost of $1.3 million. The shares were
acquired as follows: 82,965 during the first quarter at a weighted average
market price of $6.56; 21,330 during the second quarter at a weighted average
market price of $7.28; and 102,126 during the third quarter at a weighted
average market price of $5.61 per share. Through September 30, 2002, the Company
had repurchased 561,508 shares for an aggregate cost of $2.7 million since the
inception of the program. As of September 30, 2002, 438,492 shares remained
available for repurchase under the program. Additional repurchases may be made
from time to time at prevailing prices, subject to restrictions on volume and
timing. In April, 2002, the Company distributed 103,291 shares in the form of
officer and employee bonuses at a weighted average market price of $6.45 per
share, at the date of distribution.
6. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS
American Progressive, American Pioneer, American Exchange, Constitution,
Marquette, Peninsular, PennCorp Life (Canada), Pennsylvania Life and Union
Bankers (collectively, the "Insurance Subsidiaries") are required to maintain
minimum amounts of capital and surplus as determined by statutory accounting.
Each of the Insurance Subsidiaries' statutory capital and surplus exceeds its
respective minimum requirement. However, substantially more than such minimum
amounts is needed to meet statutory and administrative requirements of adequate
capital and surplus to support the current level of the Insurance Subsidiaries'
operations. At September 30, 2002 the statutory capital and surplus, including
asset valuation reserve, of the U.S. insurance subsidiaries totaled $96.8
million.
The National Association of Insurance Commissioners ("NAIC") has
developed, and state insurance regulators have adopted, risk-based capital
("RBC") requirements on life insurance enterprises. At September 30, 2002 all of
the Insurance Subsidiaries maintained ratios of total adjusted capital to RBC in
excess of the Authorized Control Level.
PennCorp Life (Canada) reports to Canadian regulatory authorities based
upon Canadian statutory accounting principles that vary in some respects from
U.S. statutory accounting principles. Canadian net assets based upon Canadian
statutory accounting principles were $41.0 million as of September 30, 2002.
PennCorp Life (Canada) maintained a Minimum Continuing Capital and Surplus
Requirement Ratio ("MCCSR") in excess of the minimum requirement at September
30, 2002.
13
7. EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In June, 2001, The Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets", effective for fiscal years beginning after December 15, 2001. Under the
new rules, goodwill, and intangible assets deemed to have indefinite lives, will
no longer be amortized but will be subject to annual impairment tests in
accordance with the Statement. Other intangible assets will continue to be
amortized over their useful lives.
The Company applied the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. Application of the
non-amortization provisions of the Statement resulted in an increase in net
income of $0.3 million (less than $0.01 per diluted share) for the nine months
ended September 30, 2002. The Company performed the first of the required
impairment tests of goodwill and indefinite lived intangible assets as of
January 1, 2002 and has determined that, based on these tests, goodwill and
indefinite lived intangibles were not impaired.
8. BUSINESS SEGMENT INFORMATION
The Company's principal business segments are: Career Agency, Senior
Market Brokerage and Administrative Services. The Company also reports the
corporate activities of our holding company in a separate segment. During 2002
we modified the way we report segment information by combining our previously
defined Senior Market Brokerage and Special Markets segments into one segment,
Senior Market Brokerage. Our decision to combine the two segments was based on
the significant reduction in the insurance in force in the Special Markets
segment as a result of our exit from the major medical line of business.
Reclassifications have been made to conform prior year amounts to the current
year presentation. A description of these segments follows:
CAREER AGENCY -- The Career Agency segment is comprised of the operations
of Pennsylvania Life and PennCorp Life (Canada), both of which we acquired
in 1999. PennCorp Life (Canada) operates exclusively in Canada, while
Pennsylvania Life operates in the United States. The Career Agency segment
includes the operations of a career agency field force, which distributes
fixed benefit accident and sickness disability insurance, life insurance,
supplemental senior health insurance and annuities in the United States
and Canada. The career agents are under exclusive contract with either
Pennsylvania Life or PennCorp Life (Canada).
SENIOR MARKET BROKERAGE -- This segment includes the operations of our
other insurance subsidiaries, primarily American Pioneer, American
Progressive and Constitution, that distribute senior market products
through general agency and brokerage distribution systems. The products
include Medicare supplement/select, long term care, senior life insurance
and annuities. In 2002, we combined our Special Markets segment with our
Senior Market Brokerage segment.
ADMINISTRATIVE SERVICES -- The Company acts as a third party administrator
and service provider for both affiliated and unaffiliated insurance
companies, primarily with respect to senior market insurance products and
non-insurance products. The services that we perform include policy
underwriting, telephone and face-to-face verification, policyholder
services, claims adjudication, case management, care assessment and
referral to health care facilities.
CORPORATE -- This segment reflects the activities of our holding
company, including the payment of interest on our debt, certain senior
executive compensation, and the expense of being a public company.
14
Intersegment revenues and expenses are reported on a gross basis in each
of the operating segments but eliminated in the 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 and
Senior Market Brokerage segments and interest on notes issued by the Corporate
segment to the other operating segments.
Financial results by segment for the nine months ended September 30, 2002
and 2001 are as follows:
Income (Loss) Income (Loss)
Before Before
Revenue Income Taxes Revenue Income Taxes
------------ ------------ ------------ ------------
September 30, 2002 September 30, 2001
----------------------------- -----------------------------
(in thousands)
Career Agency $ 119,567 $ 23,309 $ 120,539 $ 21,503
Senior Market Brokerage 120,705 11,374 96,063 9,518
Administrative Services 30,891 5,564 24,259 4,777
------------ ------------ ------------ ------------
Subtotal 271,163 40,247 240,861 35,798
Corporate 268 (5,062) 277 (6,738)
Intersegment revenues (22,409) -- (17,898) --
------------ ------------ ------------ ------------
Segment total 249,022 35,185 223,240 29,060
Adjustments to segment total
Net realized (losses) gains (6,210) (6,210) 2,046 2,046
------------ ------------ ------------ ------------
$ 242,812 $ 28,975 $ 225,286 $ 31,106
============ ============ ============ ============
Financial results by segment for the three months ended September 30, 2002
and 2001 are as follows:
Income (Loss) Income (Loss)
Before Before
Revenue Income Taxes Revenue Income Taxes
------------ ------------ ------------ ------------
September 30, 2002 September 30, 2001
----------------------------- -----------------------------
(in thousands)
Career Agency $ 39,779 $ 8,344 $ 39,324 $ 6,784
Senior Market Brokerage 40,862 4,128 32,029 4,145
Administrative Services 11,179 1,888 8,261 1,656
------------ ------------ ------------ ------------
Subtotal 91,820 14,360 79,614 12,585
Corporate 46 (1,730) 119 (2,059)
Intersegment revenues (8,157) -- (6,075) --
------------ ------------ ------------ ------------
Segment total 83,709 12,630 73,658 10,526
Adjustments to segment total
Net realized (losses) 247 247 193 193
------------ ------------ ------------ ------------
$ 83,956 $ 12,877 $ 73,851 $ 10,719
============ ============ ============ ============
15
Identifiable assets by segment as of September 30, 2002 and December 31,
2001 are as follows:
September 30, 2002 December 31, 2001
------------------ -----------------
Career Agency $ 681,173 $ 605,758
Senior Market Brokerage 680,605 663,069
Administrative Services 22,403 30,930
----------- -----------
Subtotal 1,384,181 1,229,757
Corporate 379,332 313,709
Intersegment assets (1) (418,412) (343,250)
----------- -----------
$ 1,345,101 $ 1,270,216
=========== ===========
(1) Intersegment assets include the elimination of the parent holding
company's investment in its subsidiaries as well as the elimination of
other intercompany balances.
9. FOREIGN OPERATIONS
A portion of the Company's career agency segment is conducted in Canada
through PennCorp Life (Canada). The assets and liabilities of the Canadian
business are located in Canada where the insurance risks are written. Revenues,
excluding capital gains, of the career agency segment by geographic area are as
follows:
For the nine months ended For the three months ended
September 30, September 30,
-------------------------- ---------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands)
Revenues
United States $ 78,099 $ 77,971 $ 25,943 $ 25,010
Canada 41,468 42,568 13,836 14,314
---------- ---------- ---------- ----------
Total $ 119,567 $ 120,539 $ 39,779 $ 39,324
========== ========== ========== ==========
16
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
We caution readers regarding certain forward-looking statements contained
in the following discussion and elsewhere in this report and in any other oral
or written statements, either made by, or on behalf of the Company, whether or
not in future filings with the Securities and Exchange Commission ("SEC").
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 that represent our
products, investment spreads or yields, 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 made by us, or
on our behalf. Whether or not actual results differ materially from
forward-looking statements may depend on numerous foreseeable and unforeseeable
events or developments, some of which may be national in scope, such as general
economic conditions and interest rates. Some of these events may be related to
the insurance industry generally, such as pricing competition, regulatory
developments and industry consolidation. Others may relate to us specifically,
such as credit, volatility and other risks associated with our investment
portfolio, and other factors. We disclaim any obligation to update
forward-looking information.
INTRODUCTION
The following analysis of our consolidated results of operations and
financial condition should be read in conjunction with the consolidated
financial statements and related consolidated footnotes included elsewhere.
We own nine insurance companies (collectively, the "Insurance
Subsidiaries"): American Progressive Life & Health Insurance Company of New York
("American Progressive"), American Pioneer Life Insurance Company ("American
Pioneer"), American Exchange Life Insurance Company ("American Exchange"),
Constitution Life Insurance Company ("Constitution"), Marquette National Life
Insurance Company ("Marquette"), Peninsular Life Insurance Company
("Peninsular"), Pennsylvania Life Insurance Company ("Pennsylvania Life"),
PennCorp Life Insurance Company ("PennCorp Life (Canada)") and Union Bankers
Insurance Company ("Union Bankers"). The insurance company subsidiaries are
licensed to sell life and accident and health insurance in all fifty states, the
District of Columbia and all the provinces of Canada. In addition to the
Insurance Subsidiaries, we own a third party administrator, CHCS Services, Inc.,
that administers senior market business for more than 40 unaffiliated insurance
companies, as well as our own companies.
OVERVIEW
Our principal business segments are: Career Agency, Senior Market
Brokerage and Administrative Services. We also report the corporate activities
of our holding company in a separate segment. During 2002 we modified the way we
report segment information by combining our previously defined Senior Market
Brokerage and Special Markets segments into one segment, Senior Market
Brokerage. Our decision to combine the two segments was based on the significant
reduction in the insurance in force in the Special Markets segment as a result
of our exit from the major medical line of business. Reclassifications have been
made to conform prior year amounts to the current year presentation. A
description of these segments follows:
17
CAREER AGENCY -- The Career Agency segment is comprised of the operations
of Pennsylvania Life and PennCorp Life (Canada), both of which we acquired
in 1999. PennCorp Life (Canada) operates exclusively in Canada, while
Pennsylvania Life operates in the United States. The Career Agency segment
includes the operations of a career agency field force, which distributes
fixed benefit accident and sickness disability insurance, life insurance,
supplemental senior health insurance and annuities in the United States
and Canada. The career agents are under exclusive contract with either
Pennsylvania Life or PennCorp Life (Canada).
SENIOR MARKET BROKERAGE -- This segment includes the operations of our
other insurance subsidiaries, primarily American Pioneer, American
Progressive and Constitution, that distribute senior market products
through general agency and brokerage distribution systems. The products
include Medicare supplement/select, long term care, senior life insurance
and annuities. In 2002, we combined our Special Markets segment with our
Senior Market Brokerage segment.
ADMINISTRATIVE SERVICES -- The Company acts as a third party administrator
and service provider for both affiliated and unaffiliated insurance
companies, primarily with respect to senior market insurance products and
non-insurance products. The services that we perform include policy
underwriting, telephone and face-to-face verification, policyholder
services, claims adjudication, case management, care assessment and
referral to health care facilities.
CORPORATE -- This segment reflects the activities of our holding company,
including the payment of interest on our debt, certain senior executive
compensation, and the expense of being a public company.
Intersegment revenues and expenses are reported on a gross basis in each
of the operating segments. 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 and Senior Market Brokerage 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. In our judgment, the
accounts involving estimates and assumptions that are most critical to the
preparation of our financial statements are policy and claim liabilities,
deferred policy acquisition costs, the valuation of certain investments and
deferred taxes. There have been no changes in our critical accounting policies
during the current year.
18
RESULTS OF OPERATIONS - CONSOLIDATED OVERVIEW
The following table presents operating income by segment along with a
reconciliation to net income:
For the three months ended For the nine months ended
September 30, September 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(in thousands)
Career agency $ 8,344 $ 6,784 $ 23,309 $ 21,503
Senior market brokerage 4,128 4,145 11,374 9,518
Administrative services 1,888 1,656 5,564 4,777
--------- --------- --------- ---------
Segment operating income 14,360 12,585 40,247 35,798
Corporate (1,730) (2,059) (5,062) (6,738)
--------- --------- --------- ---------
Operating income before realized gains and
federal income taxes 12,630 10,526 35,185 29,060
Federal income taxes on operating items (4,471) (3,729) (12,013) (10,358)
--------- --------- --------- ---------
Net operating income 8,159 6,797 23,172 18,702
Realized gains (losses) net of tax 160 125 (4,037) 1,330
--------- --------- --------- ---------
Net income $ 8,319 $ 6,922 $ 19,135 $ 20,032
========= ========= ========= =========
Per share data (diluted):
Net operating income (1) $ 0.15 $ 0.13 0.43 $ 0.38
Realized gains (losses) net of tax -- -- (0.08) 0.03
--------- --------- --------- ---------
Net income $ 0.15 $ 0.13 $ 0.35 $ 0.41
========= ========= ========= =========
(1) We evaluate the results of operations of our segments based on operating
income by segment. Operating income excludes realized gains (losses). This
differs from generally accepted accounting principles, which includes the
effect of realized gains (losses) in the determination of net income. The
schedule above reconciles our operating income to net income in accordance
with generally accepted accounting principles.
Three months ended September 30, 2002 and 2001
Consolidated net income after Federal income taxes increased by $1.4
million to $8.3 million, or $0.15 per share, in the third quarter of 2002,
compared to $6.9 million, or $0.13 per share, in 2001. The effective tax rate
for the Company was 35.4% for both 2002 and 2001.
Operating income before realized gain (losses) and Federal income taxes
increased by $2.1 million to $12.6 million in 2002 compared to $10.5 million in
2001. A summary of the operating results by segment is presented below, with
additional detail by segment in the sections that follow.
Operating income from the Career Agency segment increased by $1.6 million,
or 23%, compared to the third quarter of 2001. This reflects an increase in new
sales and improved loss ratios primarily for our disability business.
Operating results for the Senior Market Brokerage segment were unchanged
compared to the third quarter of 2001. An increase in claims relating to a
discontinued block of home health care policies, offset the improved loss ratios
in the Medicare supplement/select lines.
19
Operating income for the Administrative Services segment improved by $0.2
million or 14%, compared to the third quarter of 2001. This improvement is
primarily a result of the increase in Medicare premiums being serviced by our
administrative services company.
The operating loss from the Corporate segment decreased by 16%, compared
to the third quarter of 2001, primarily due to a decrease in the interest cost
relating to our outstanding debt.
Nine Months ended September 30, 2002 and 2001
Consolidated net income after Federal income taxes decreased by $0.9
million to $19.1 million, or $0.35 per share, for the first nine months of 2002,
compared to $20.0 million, or $0.41 per share,for 2001. Included in net income
were realized losses of $6.2 million, pre-tax, for the first nine months of
2002, compared to realized gains of $2.0 million, pre-tax for 2001. The realized
losses for 2002 relate primarily to recognition of other than temporary declines
in the value of our WorldCom bonds, which were disposed of in the third quarter
at a price approximating their carrying value after the other than temporary
decline was recognized. Realized gains for 2001 were generated primarily during
the first quarter of 2001 as a result of efforts to utilize tax capital loss
carry forwards and to limit exposure to foreign exchange risk. The effective tax
rate for the Company was 34.0% for 2002 as compared to 35.6% in 2001.
Operating income before realized gains (losses) and Federal income taxes
increased by $6.1 million to $35.2 million in 2002 compared to $29.1 million in
2001. A summary of the operating results by segment is presented below, with
additional detail by segment in the sections that follow.
Operating income from the Career Agency segment increased by $1.8 million
compared to the nine months ended September 30, 2001. This reflects an increase
in new sales and improved loss ratios for our disability business.
The Senior Market Brokerage segment improved its operating results by 20%
or $1.9 million compared to the first nine months of 2001. This improvement is
primarily the result of improved loss ratios for our Medicare supplement/select
business. However, this was partially offset by an increase in claims relating
to a block of home health care policies that we stopped selling in 2000.
Operating income for the Administrative Services segment improved by $0.8
million or 17%, compared to the first nine months of 2001. This improvement is
primarily a result of the increase in Medicare supplement premiums being
serviced by our administrative services company.
The operating loss from the Corporate segment decreased by $1.7 million or
25% over the first nine months of 2001. This decrease is primarily due to a
decrease in the interest cost relating to our outstanding debt.
20
SEGMENT RESULTS - CAREER AGENCY
For the three months ended For the nine months ended
September 30, September 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands)
Net premiums and policyholder fees:
Life and annuity $ 3,435 $ 3,254 $ 10,769 $ 10,394
Accident & health 27,621 27,274 83,339 84,564
---------- ---------- ---------- ----------
Net premiums 31,056 30,528 94,108 94,958
Net investment income 8,631 8,645 25,118 24,533
Other income 92 151 341 1,048
---------- ---------- ---------- ----------
Total revenue 39,779 39,324 119,567 120,539
---------- ---------- ---------- ----------
Policyholder benefits 18,482 20,494 58,576 63,352
Interest credited to policyholders 713 413 2,020 1,369
Change in deferred acquisition costs (3,804) (3,122) (10,812) (9,241)
Commissions and general expenses, net of
Allowances 16,044 14,755 46,474 43,556
---------- ---------- ---------- ----------
Total benefits, claims and other deductions 31,435 32,540 96,258 99,036
---------- ---------- ---------- ----------
Segment operating income $ 8,344 $ 6,784 $ 23,309 $ 21,503
========== ========== ========== ==========
Three months ended September 30, 2002 and 2001
Operating income from the Career Agency segment increased by $1.6 million,
or 23%, compared to the third quarter of 2001. This reflects an increase in new
sales and improved loss ratios primarily for our disability business.
Revenues. Net premiums for the quarter increased by approximately 2% for
the segment compared to the third quarter of 2001. Canadian operations accounted
for approximately 35% of the net premiums for the third quarter of 2002 and 36%
of the net premiums for the third quarter of 2001. New sales during the third
quarter of 2002 increased by 6% over the third quarter of 2001. This increase
was driven by a 14% increase in sales in Canada. The increase in production in
the U.S. came from sales of our senior market products, such as senior life,
long term care and Medicare supplement, which accounted for 51% of the new sales
in the U.S. The Career agents also sold $8.8 million of fixed annuities in the
third quarter of 2002. New sales do not have a direct impact on net premium due
to the fact that our retention on most of the new premium is only 50% and
annuity deposits are not reported as premium.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, decreased by approximately 10% over the third quarter of
2001. Overall loss ratios for the segment improved from 67% for the third
quarter of 2001 to 60% for the third quarter of 2002, primarily on our
disability business, as a result of active rate and claims management. Interest
credited increased by $0.3 million, as a result of the increase in fixed
annuities.
The increase in deferred acquisition costs was approximately $0.7 million
more in the third quarter of 2002, compared to the increase in the third quarter
of 2001. This increase is primarily the result of an increase in commissions and
the underwriting and issue costs for the Career Agency segment associated with
the increase in new business, including annuities.
Commissions and other operating expenses increased by approximately $1.3
million or 9% in the third quarter of 2002 compared to 2001. The increase
relates primarily to the increase in new business, including fixed annuities.
21
Nine Months ended September 30, 2002 and 2001
Operating income from the Career Agency segment increased $1.8 million, or
8%, compared to the nine months ended September 30, 2001. This reflects an
increase in new sales and improved loss ratios primarily for our disability
business.
Revenues. Net premiums for the first nine months of 2002 fell by
approximately 1% for the segment compared to the first nine months of 2001.
Canadian operations accounted for approximately 35% of the net premiums for both
the first nine months of 2002 and 2001. New sales during the first nine months
of 2002 increased by 11% over the first nine months of 2001. This increase was
driven by a 14% increase in sales in Canada and a 10% increase in the U.S. The
increase in production in the U.S. came from sales of our senior market
products, such as senior life, long term care and Medicare supplement, which
accounted for 48% of the new sales in the U.S. The Career agents sold $13.3
million of fixed annuities during the first nine months of 2002.
Net investment income increased by approximately 2% compared to the first
nine months of 2001. This is due to an increase in the invested asset base,
primarily as a result of the increased sales of annuity products, partially
offset by a decrease in yields.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, decreased by approximately 8% over the first nine months
of 2001. Overall loss ratios for the segment improved from 67% for the first
nine months of 2001 to 62% for 2002, primarily on our disability business, as a
result of active rate and claims management. Interest credited increased by $0.7
million, consistent with the increase in fixed annuities.
The increase in deferred acquisition costs was approximately $1.6 million
more in the first nine months of 2002, compared to the increase in 2001. This
increase is primarily the result of an increase in commissions and the
underwriting and issue costs for the Career Agency segment associated with the
increase in new business, including annuities.
Commissions and other operating expenses increased by approximately $2.9
million or 7% in the first nine months of 2002 compared to 2001. The increase
relates primarily to the increase in new business, including annuities.
SEGMENT RESULTS - SENIOR MARKET BROKERAGE
For the three months ended For the nine months ended
September 30, September 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands)
Net premiums and policyholder fees:
Life and annuity $ 4,176 $ 4,125 $ 13,714 $ 12,621
Accident & health 30,538 21,753 88,511 64,293
---------- ---------- ---------- ----------
Net premiums 34,714 25,878 102,225 76,914
Net investment income 6,102 6,116 18,209 19,044
Other income 46 35 271 105
---------- ---------- ---------- ----------
Total revenue 40,862 32,029 120,705 96,063
---------- ---------- ---------- ----------
Policyholder benefits 25,297 19,472 77,020 61,043
Interest credited to policyholders 2,202 2,193 6,108 6,226
Change in deferred acquisition costs (3,231) (1,794) (9,079) (4,037)
Amortization of present value of future
profits and goodwill 25 124 100 343
Commissions and general expenses, net
of allowances 12,441 7,889 35,182 22,970
---------- ---------- ---------- ----------
Total benefits, claims and other deductions 36,734 27,884 109,331 86,545
---------- ---------- ---------- ----------
Segment operating income $ 4,128 $ 4,145 $ 11,374 $ 9,518
========== ========== ========== ==========
22
The table below details the gross premiums and policyholder fees before
reinsurance for the major product lines in the Senior Market brokerage segment
and the corresponding average amount of premium retained. Our insurance
subsidiaries reinsure our senior market brokerage products to unaffiliated third
party reinsurers under various quota share agreements. Medicare
supplement/select written premium in force as of December 31, 2001, is reinsured
under quota share reinsurance agreements ranging between 50% and 75% based upon
the geographic distribution. During the first quarter of 2002, we increased our
retention on certain new business written from 25% to 50%. We are considering to
increase our retention on new business further by the end of the year. We have
also acquired various blocks of Medicare supplement premium, which are reinsured
under quota share reinsurance agreements ranging from 75% to 100%. Under these
reinsurance agreements, we reinsure the claims incurred and commissions on a pro
rata basis and receive additional expense allowances for policy issue,
administration and premium taxes.
For the three months ended September 30,
2002 2001
-------------------- --------------------
Gross Net Gross Net
Premiums Retained Premiums Retained
-------- -------- -------- --------
(in thousands)
Medicare supplement acquired $ 36,469 12% $ 36,886 6%
Medicare supplement/select
written 62,022 34% 42,115 31%
Other senior supplemental health 6,155 60% 5,562 62%
Other health 3,157 37% 6,725 44%
Senior life insurance 2,094 56% 2,002 72%
Other life 3,626 87% 3,700 73%
-------- --------
Total gross premiums $113,523 31% $ 96,990 27%
======== ========
For the nine months ended September 30,
2002 2001
-------------------- --------------------
Gross Net Gross Net
Premiums Retained Premiums Retained
-------- -------- -------- --------
(in thousands)
Medicare supplement acquired $111,779 8% $112,808 6%
Medicare supplement/select
written 182,080 35% 115,317 31%
Other senior supplemental health 18,571 60% 16,965 61%
Other health 10,226 45% 23,362 50%
Senior life insurance 7,646 67% 5,837 69%
Other life 10,850 79% 11,596 74%
-------- --------
Total gross premiums $341,152 30% $285,885 27%
======== ========
Three months ended September 30, 2002 and 2001
Operating results for the Senior Market Brokerage segment were unchanged
compared to the third quarter of 2001. An increase in claims relating to a
discontinued block of home health care policies offset the improved loss ratios
in the Medicare supplement/select lines.
Revenues. New production of our Senior Market products amounted to $17.7
million in the current quarter. This represents a 17% decrease compared to
$21.3
23
million in the third quarter last year. As we anticipated, new sales of our
Medicare products have slowed since Health Maintenance Organizations ("HMOs")
are not disenrolling members as much as in prior years. We have continued to
expand geographically and have increased our recruiting efforts to further
augment our production. Additionally, $6.0 million of fixed annuities were sold
during the quarter, representing a 213% increase over the third quarter last
year.
Gross premium increased $16.5 million, or 17% over 2001 despite the slow
down in new production. The increase in gross premium over the third quarter of
2001 includes a $19.9 million, or 47%, increase on Medicare supplement/select
business written by the Insurance Subsidiaries as a result of continued new
sales. In addition, premiums increased due to normal rate increases implemented
by the Company and better than assumed persistency. Other supplemental health
premium, which includes long term care, nursing home and home health care
increased 11%, or $0.6 million. These increases were partially offset by a
decrease of $3.6 million, or 53%, in other health premium, primarily as a result
of our decision to exit the major medical line of business.
Net premiums for the third quarter of 2002 increased by approximately 34%,
compared to 2001, to $34.7 million. Net premiums grew more than gross premium as
a result of our decision to reinsure less premium and retain more risk. The net
amount of premium retained increased from 27% in 2001 to 31% in 2002 due to the
increase in retention on new Medicare supplement/select premiums written from
25% to 50%, effective January 2002.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, increased by approximately $5.8 million, or 30%,
compared to the third quarter of 2001 due primarily to higher annualized premium
in force in our Medicare supplement lines, even though our loss ratio for this
line improved. Additionally, we experienced an increase in claims in a block of
home health care business that we stopped selling in 2000. We are being
proactive, particularly with respect to rate management for this block of
business, so that we can mitigate its effect on the earnings of the segment.
The increase in deferred acquisition costs was approximately $1.4 million
more in the third quarter of 2002, than the increase in the third quarter of
2001. The increase in deferred acquisition costs relates primarily to our higher
retention on new business.
Commissions and other operating expenses increased by approximately $4.6
million or 58% in the third quarter of 2002 compared to 2001. The following
table details the components of commission and other operating expenses:
For the three months ended September 30,
2002 2001
------------------- ------------------
(in thousands)
Commissions $ 19,574 $ 16,695
Other operating costs 14,996 12,449
Reinsurance allowances (22,129) (21,255)
---------- ----------
Commissions and general expenses, net of
allowances $ 12,441 $ 7,889
========== ==========
The ratio of commissions to gross premiums remained unchanged at 17%
compared to the third quarter of 2001. Other operating costs as a percentage of
gross premiums also remained unchanged, at 13%, compared to the third quarter
2001. Commission and expense allowances received from reinsurers as a percentage
of the premiums ceded decreased to 28% during the third quarter of 2002 compared
to 30% in 2001.
Nine Months ended September 30, 2002 and 2001
The Senior Market Brokerage segment improved its operating results by 20%
or $1.9 million
24
compared to the first nine months of 2001. This improvement is the result of
continued growth of Medicare supplement/select business combined with improved
loss ratios. However, this was partially offset by an increase in claims
relating to a block of home health care policies that we stopped selling in
2000.
Revenues. New production of our Senior Market products amounted to $77.1
million for the first nine months of 2002. This represents a 1% decrease
compared to last year. As we anticipated, new sales of our Medicare products
have slowed since Health Maintenance Organizations ("HMOs") are not disenrolling
as many members as in prior years. We have continued to expand geographically
and have increased our recruiting efforts to further augment our production.
Additionally, $9.9 million of fixed annuities were sold during the first nine
months of 2002, representing a 72% increase over last year.
Gross premium increased $55.3 million, or 19%, over the first nine months
of 2001 to $341.2 million. The increase in gross premium includes a $66.8
million increase, or 58%, in Medicare supplement/select business as a result of
continued new sales, rate increases and better than assumed persistency. We also
experienced a $1.6 million, or 9%, increase in other senior supplemental health
premium and a $1.8 million, or 31% increase in senior life insurance premium.
These increases were partially offset by a decrease of $13.1 million, or 56%, in
other health premium, primarily as a result of our decision to exit the major
medical line of business.
Net premiums for the first nine months of 2002 increased by approximately
$25.3 million, or 33%, compared to 2001. Net premiums grew more than gross
premiums as a result of our decision to reinsure less premium and retain more
risk. The net amount of premium retained increased from 27% in 2001 to 30% in
2002 due to the increase in our retention of risk on Medicare supplement/select
premiums written.
Net investment income decreased by $0.8 million compared to the first nine
months of 2001. This is due primarily to a decline in investment yields.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, increased by approximately $16.0 million, or 26%,
compared to the first nine months of 2001 due primarily to higher annualized
premium in force, primarily Medicare supplement/select. Overall, loss ratios of
the segment improved over the first nine months of 2001, due primarily to the
implementation of rate increases on our Medicare supplement/select business.
However, this improvement was offset by an increase in claims in a block of home
health care business that we stopped selling in 2000.
The increase in deferred acquisition costs was approximately $5.0 million
more in the first nine months of 2002, than the increase in the first nine
months of 2001. The increase in deferred acquisition costs relates primarily to
our higher retention on new business.
Commissions and other operating expenses increased by approximately $12.2
million, or 53%, in the first nine months of 2002 compared to 2001. The
following table details the components of commission and other operating
expenses:
For the nine months ended September 30,
2002 2001
----------------- ------------------
(in thousands)
Commissions $ 60,154 $ 49,206
Other operating costs 45,207 36,779
Reinsurance allowances (70,179) (63,015)
---------- ----------
Commissions and general expenses, net of
allowances $ 35,182 $ 22,970
========== ==========
The ratio of commissions to gross premiums increased to 17.6% during the
first nine months of 2002, from 17.2% in 2001. Other operating costs as a
percentage of gross premiums remained unchanged at 13% compared to the first
nine months of 2001. Commission and expense allowances
25
received from reinsurers as a percentage of the premiums ceded decreased to 29%
for the first nine months of 2002 compared to 30% for 2001.
SEGMENT RESULTS - ADMINISTRATIVE SERVICES
For the three months ended For the nine months ended
September 30, September 30,
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
Service fee and other income $ 11,069 $ 8,215 $ 30,543 $ 24,088
Net investment income 110 46 348 171
-------- -------- -------- --------
Total revenue 11,179 8,261 30,891 24,259
-------- -------- -------- --------
Amortization of present value of future profits
and goodwill 379 566 1,136 1,700
General expenses 8,912 6,039 24,191 17,782
-------- -------- -------- --------
Total expenses 9,291 6,605 25,327 19,482
-------- -------- -------- --------
Segment operating income 1,888 1,656 5,564 4,777
-------- -------- -------- --------
Depreciation, amortization and interest 716 765 2,103 2,278
-------- -------- -------- --------
Earnings before interest, taxes, depreciation
and amortization (1) $ 2,604 $ 2,421 $ 7,667 $ 7,055
======== ======== ======== ========
(1) For our Administrative Services segment, we evaluate results based on
earnings before interest, taxes, depreciation and amortization, which is
not in accordance with generally accepted accounting principles.
The table below details service fee revenue earned by our Administrative
Services segment:
For the three months ended For the nine months ended
September 30, September 30,
2002 2001 2002 2001
-------- -------- -------- --------
(In thousands)
Affiliated Fee Revenue
Medicare supplement $ 5,325 $ 3,400 $ 13,748 $ 9,469
Long term care 601 415 1,839 1,162
Nurse Navigator(TM) 289 65 948 116
Other health insurance 19 34 65 330
Life insurance 97 94 287 293
-------- -------- -------- --------
Total Affiliated Fee Revenue 6,331 4,008 16,887 11,370
-------- -------- -------- --------
Unaffiliated Fee Revenue
Medicare supplement 2,233 2,379 6,807 7,176
Long term care 2,125 1,384 5,511 4,164
Other health insurance 104 145 339 454
Non-insurance assistance 276 299 999 924
-------- -------- -------- --------
Total Unaffiliated Fee Revenue 4,738 4,207 13,656 12,718
-------- -------- -------- --------
Total Administrative Service Fee Revenue $ 11,069 $ 8,215 $ 30,543 $ 24,088
======== ======== ======== ========
Three months ended September 30, 2002 and 2001
Operating income for the Administrative Services segment improved by $0.2
million, or 14%, over the third quarter of 2001, primarily as the result of the
increase in Medicare supplement premiums
26
serviced by our administrative services company and the reduction in the
amortization of the present value of future profits ("PVFP"). Earnings before
interest, taxes, depreciation and amortization ("EBITDA") for this segment
increased $0.2 million, or 8%, to $2.6 million, compared to the third quarter of
2001.
Service fee revenue increased by $2.9 million, or 35%, as compared to the
third quarter of 2001. In 2002, approximately 43% of the total fees earned were
from non-affiliated companies compared to 51% in 2001. The relative decrease in
the non-affiliated fees is the result of continued growth of business from our
Senior Market Brokerage segment. Affiliated fee revenue increased $2.3 million
compared to the third quarter of 2001. Unaffiliated fee revenues increased by
approximately $0.5 million. During the second quarter of 2002, we reported our
first revenues from underwriting support work we are now performing for the
consortium that is offering long term care to employees of the Federal
Government and their families, and saw an increase in these revenues in the
third quarter.
General expenses for the segment increased by $2.9 million, or 48%,
compared to the third quarter of 2001. The increase is due to the increase in
business and costs incurred to bring new clients on line.
The amortization of PVFP relates primarily to the acquisition of American
Insurance Administration Group, Inc. ("AIAG"). Approximately $7.7 million of
PVFP was established when AIAG was acquired in January, 2000. It is being
amortized in proportion to the expected profits from the contracts in force on
the date of acquisition. A large portion of the contracts had a remaining term
of three years at the date of acquisition; accordingly, the amortization is
heavily weighted to those periods. During the third quarter of 2002,
approximately $0.4 million was amortized compared to $0.6 million in 2001. As of
September 30, 2002, $1.6 million or 21%, of the original amount remains
unamortized.
Nine Months ended September 30, 2002 and 2001
Operating income for the Administrative Services segment for the first
nine months of 2002 increased by $0.8 million or 17% compared to the first nine
months of 2001. Earnings before interest, taxes, depreciation and amortization
("EBITDA") for this segment increased by $0.6 million or 9% to $7.7 million,
compared to the first nine months of 2001.
Service fee revenue increased by $6.5 million, or 27%, in the first nine
months of 2002 as compared to 2001. The growth in business from affiliates added
$5.5 million of fees during the period, while fees from unaffiliated clients
grew by $0.9 million.
General expenses for the segment increased by $6.4 million, or 36%,
compared to the first nine months of 2001. The increase is due primarily to the
increase in business and costs incurred to bring new clients on line.
Additionally, during the second quarter of 2002, we completed the closing of our
Clearwater office and the consolidation of those functions into our Pensacola
operations. General expenses were increased by approximately $0.3 million as a
result of the cost of this transition, but we expect to begin to see increased
efficiency and cost savings during the fourth quarter of 2002.
The reduction of $0.6 million in the amortization of PVFP relates
primarily to a decrease in the amounts related to the acquisition of AIAG.
27
SEGMENT RESULTS - CORPORATE
The following table presents the primary components comprising the segment's
operating loss:
For the three months ended For the nine months ended
September 30, September 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(in thousands)
Interest cost on outstanding debt $ 746 $ 1,203 $ 2,334 $ 4,216
Amortization of capitalized loan origination fees 131 132 396 397
Stock-based compensation expense 160 160 480 570
Other parent company expenses, net 693 564 1,852 1,555
--------- --------- --------- ---------
Segment operating loss $ 1,730 $ 2,059 $ 5,062 $ 6,738
========= ========= ========= =========
Three months ended September 30, 2002 and 2001
The net loss from the Corporate segment decreased by $0.3 million, or 16%,
compared to the third quarter of 2001, due primarily to a reduction in interest
cost. The decrease in the interest cost is due to a combination of a reduction
in the weighted average interest rate and lower average outstanding balance as a
result of principal repayments, compared to 2001. (See "Liquidity and Capital
Resources" for additional information regarding our credit facility).
Nine Months ended September 30, 2002 and 2001
The net loss from the Corporate segment decreased by $1.7 million, or 25%,
compared to the first nine months of 2001, due to primarily to a reduction in
interest cost, as noted above.
LIQUIDITY AND CAPITAL RESOURCES
Our capital is used primarily to support the retained risks and growth of
our insurance and administrative service company subsidiaries and to support our
parent company as an insurance holding company. In addition, we use capital to
fund our anticipated growth through acquisitions of other companies or blocks of
insurance or administrative service business.
We require cash at our parent company to meet our obligations under our
credit facility and our outstanding debentures held by our subsidiaries,
American Progressive and Pennsylvania Life. In January, 2002, our parent company
issued a debenture to Pennsylvania Life in conjunction with the transfer of the
business of Pennsylvania Life's Canadian Branch to PennCorp Life (Canada).
Repayment of the debenture is anticipated to be funded from dividends from
PennCorp Life (Canada). We also require cash to pay the operating expenses
necessary to function as a holding company (applicable insurance department
regulations require us to bear our own expenses), and to meet the costs of being
a public company.
We believe that our current cash position, the availability of the
revolving credit facility, the expected cash flows of our administrative service
company and the surplus note interest payments from American Exchange (as
explained below) can support our parent company obligations for the foreseeable
future. However, there can be no assurance as to our actual future cash flows or
to the continued availability of dividends from our insurance company
subsidiaries.
28
Contractual Obligations and Commercial Commitments
Our $80 million credit facility consists of a $70 million term loan and a
$10 million revolving loan facility. The loans call for interest at LIBOR for
one, two, three or nine months plus 350 basis points (5.3% beginning October 31,
2002). Principal repayments are due on a quarterly basis over a seven-year
period that commenced on July 31, 2000. The final maturity date of the facility
is July 31, 2006. We pay a commitment fee of 50 basis points on the unutilized
portion of the revolving facility. The term loan is secured by a first priority
security interest in 100% of the outstanding common stock of American Exchange,
American Progressive, and WorldNet Services and 65% of the outstanding common
stock of UAFC (Canada) Inc. (the parent of PennCorp Life (Canada)) and a
subordinate interest in 100% of the outstanding common stock of American
Pioneer. As of September 30, 2002, $50.6 million was outstanding under the term
loan and $3.0 million was outstanding under the revolving loan facility. We
incurred the revolving indebtedness in connection with our acquisition of CHCS
in August 2000. During the nine months ended September 30, 2002, we paid $1.7
million in interest and repaid $7.9 million in principal on the term loan.
Additionally, during October 2002, we made a regularly scheduled repayment that
further reduced the term loan to $47.8 million. During the nine months ended
September 30, 2001, we paid $4.0 million in interest and repaid $5.6 million in
principal on the term loan.
The following table shows the schedule of remaining principal payments (in
thousands), as of November 1, 2002, on the Company's outstanding term loan, with
the final payment in July 2006:
2002 $ --
2003 11,525
2004 12,400
2005 13,275
2006 10,575
----------
Total $ 47,775
==========
We are obligated under certain lease arrangements for our executive and
administrative offices in New York, Florida, Texas, and Ontario, Canada. Annual
minimum rental commitments, subject to escalation clauses und