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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, 2003
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in the Securities Exchange Act Rule 12b-2): Yes[x] No [ ]
The number of shares outstanding of the Registrant's Common Stock as of
November 1, 2003 was 53,966,454.
UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Operations - Three Months 4
Consolidated Statements of Operations - Nine Months 5
Consolidated Statements of Stockholders' Equity and Comprehensive Income 6
Consolidated Statements of Cash Flows 7
Notes to Consolidated Financial Statements 8-21
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 22-40
Item 3. Quantitative and Qualitative Disclosure of Market Risk 40-41
Item 4. Controls and Procedures 41
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 42
Item 2. Changes in Securities and Use of Proceeds 42-43
Item 3. Defaults Upon Senior Securities 43
Item 4. Submission of Matters to a Vote of Security Holders 43
Item 5. Other Information 43
Item 6. Exhibits and Reports on Form 8-K 43-44
Signature 44
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 45-48
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(unaudited)
(In thousands)
ASSETS
Investments
Fixed maturities available for sale, at fair value
(amortized cost: 2003, $1,076,037; 2002, $884,054) $ 1,143,682 $ 934,950
Equity securities, at fair value (cost: 2003, $1,481, $1,661) 1,537 1,645
Policy loans 25,823 23,745
Other invested assets 1,588 2,808
----------- -----------
Total investments 1,172,630 963,148
Cash and cash equivalents 72,594 36,754
Accrued investment income 13,720 11,885
Deferred policy acquisition costs 125,271 92,093
Amounts due from reinsurers 220,111 220,100
Due and unpaid premiums 6,565 6,066
Deferred income tax asset 6,882 35,842
Present value of future profits and other amortizing intangible 44,801 2,987
assets
Goodwill and other indefinite lived intangible assets 13,117 7,973
Other assets 31,909 24,820
----------- -----------
Total assets 1,707,600 1,401,668
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 397,495 271,578
Reserves for future policy benefits 711,607 627,174
Policy and contract claims - life 7,254 6,718
Policy and contract claims - health 100,945 88,216
Loan payable 45,938 50,775
Company obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures 55,000 15,000
Amounts due to reinsurers 4,459 7,285
Other liabilities 48,750 48,153
----------- -----------
Total liabilities 1,371,448 1,114,899
----------- -----------
STOCKHOLDERS' EQUITY
Common stock (Authorized: 80 million shares,
issued: 2003, 54.1 million shares;
2002, 53.2 million shares) 541 532
Additional paid-in capital 164,024 158,264
Accumulated other comprehensive income 42,971 29,887
Retained earnings 129,370 99,406
Less: Treasury stock (2003, 0.1 million shares;
2002, 0.2 million shares) (754) (1,320)
----------- -----------
Total stockholders' equity 336,152 286,769
----------- -----------
Total liabilities and stockholders' equity $ 1,707,600 $ 1,401,668
=========== ===========
See notes to unaudited consolidated financial statements.
3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 2003 2002
- ------------------------------------------------------------------------ ----------------- -----------------
(IN THOUSANDS, PER SHARE AMOUNTS IN DOLLARS)
Revenues:
Direct premiums and policyholder fees earned $ 184,417 $ 145,783
Reinsurance premiums assumed 6,190 349
Reinsurance premiums ceded (66,966) (80,362)
--------- ---------
Net premiums and policyholder fees earned 123,641 65,770
Net investment income 15,078 14,774
Net realized gains (losses) on investments 582 247
Fee and other income 2,623 3,165
--------- ---------
Total revenues 141,924 83,956
--------- ---------
Benefits, claims and expenses:
Net increase in future policy benefits 10,112 3,473
Net claims and other benefits 74,505 40,306
Interest credited to policyholders 4,023 2,915
Net increase in deferred acquisition costs (15,097) (7,035)
Amortization of present value of future profits and other intangibles 1,051 404
Commissions 35,736 28,342
Commission and expense allowances on reinsurance ceded (15,755) (22,742)
Interest expense 1,327 746
Other operating costs and expenses 28,325 24,670
--------- ---------
Total benefits, claims and expenses 124,227 71,079
--------- ---------
Income before taxes 17,697 12,877
Income tax expense 6,281 4,558
--------- ---------
Net income $ 11,416 $ 8,319
========= =========
Earnings per common share:
Basic $ 0.21 $ 0.16
========= =========
Diluted $ 0.21 $ 0.15
========= =========
See notes to unaudited consolidated financial statements.
4
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002
- ------------------------------------------------------------------------ ----------------- -----------------
(IN THOUSANDS, PER SHARE AMOUNTS IN DOLLARS)
Revenues:
Direct premiums and policyholder fees earned $ 522,396 $ 437,388
Reinsurance premiums assumed 18,928 2,434
Reinsurance premiums ceded (216,888) (243,489)
--------- ---------
Net premiums and policyholder fees earned 324,436 196,333
Net investment income 44,888 43,535
Net realized gains (losses) on investments 1,878 (6,210)
Fee and other income 9,701 9,154
--------- ---------
Total revenues 380,903 242,812
--------- ---------
Benefits, claims and expenses:
Net increase in future policy benefits 20,048 10,004
Net claims and other benefits 207,041 125,592
Interest credited to policyholders 10,381 8,128
Net increase in deferred acquisition costs (34,405) (19,891)
Amortization of present value of future profits and other intangibles 2,246 1,236
Commissions 100,847 87,744
Commission and expense allowances on reinsurance ceded (56,176) (72,106)
Interest expense 3,400 2,334
Early extinguishment of debt (Note 10) 1,766 -
Other operating costs and expenses 79,762 70,796
--------- ---------
Total benefits, claims and expenses 334,910 213,837
--------- ---------
Income before taxes 45,993 28,975
Income tax expense 16,029 9,840
--------- ---------
Net income $ 29,964 $ 19,135
========= =========
Earnings per common share:
Basic $ 0.56 $ 0.36
========= =========
Diluted $ 0.55 $ 0.35
========= =========
See notes to unaudited consolidated financial statements.
5
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS)
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN COMPREHENSIVE RETAINED TREASURY
NINE MONTHS ENDED SEPTEMBER 30, STOCK CAPITAL INCOME / (LOSS) EARNINGS STOCK TOTAL
- --------------------------------- --------- ---------- --------------- --------- ---------- ----------
2002
Balance, January 1, 2002 $ 528 $ 155,746 $ 5,603 $ 69,279 $ (386) $ 230,770
Net income - - - 19,135 - 19,135
Other comprehensive income
(Note 8) - - 24,767 - - 24,767
---------
Comprehensive income 43,902
---------
Issuance of common stock (Note 9) 4 1,037 - - 1,041
Stock-based compensation - 941 - - 941
Repayments of Loans to officers - 10 - - - 10
Treasury shares purchased, at
cost (Note 9) - - - (1,272) (1,272)
Treasury shares reissued (Note 9) - 81 - - 586 667
--------- --------- --------- --------- --------- ---------
Balance, September 30, 2002 $ 532 $ 157,815 $ 30,370 $ 88,414 $ (1,072) $ 276,059
========= ========= ========= ========= ========= =========
2003
Balance, January 1, 2003 $ 532 $ 158,264 $ 29,887 $ 99,406 $ (1,320) $ 286,769
Net income - - - 29,964 - 29,964
Other comprehensive income
(Note 8) - - 13,084 - - 13,084
---------
Comprehensive income 43,048
---------
Issuance of common stock (Note 9) 9 4,190 - - - 4,199
Stock-based compensation - 900 - - - 900
Repayments of Loans to officers - 653 - - - 653
Treasury shares purchased, at
cost (Note 9) - - - - (477) (477)
Treasury shares reissued (Note 9) - 17 - - 1,043 1,060
--------- --------- --------- --------- --------- ---------
Balance, September 30, 2003 $ 541 $ 164,024 $ 42,971 $ 129,370 $ (754) $ 336,152
========= ========= ========= ========= ========= =========
See notes to unaudited consolidated financial statements.
6
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002
- --------------------------------------------------------------------------------- ---------- ----------
(In thousands)
Cash flows from operating activities:
Net income $ 29,965 $ 19,135
Adjustments to reconcile net income to net cash provided by operating activities,
net of balances acquired (see Note 3 - Business Combination):
Deferred income taxes 13,081 8,389
Change in reserves for future policy benefits 11,746 16,323
Change in policy and contract claims (682) 7,589
Change in deferred policy acquisition costs (34,405) (19,891)
Amortization of present value of future profits and other intangibles 2,246 1,236
Net accretion of bond discount (2,613) (2,673)
Amortization of capitalized loan origination fees 2,119 398
Change in policy loans (34) (54)
Change in accrued investment income (615) 1,342
Change in reinsurance balances 12,640 (8,302)
Realized losses (gains) on investments (1,878) 6,210
Change in income taxes payable (1,493) (2,452)
Other, net 2,473 (4,934)
--------- ---------
Net cash provided (used) by operating activities 32,550 22,316
--------- ---------
Cash flows from investing activities:
Proceeds from sale or redemption of fixed maturities 221,808 195,033
Cost of fixed maturities purchased (286,771) (238,949)
Change in amounts held in trust by reinsurer - (1,456)
Proceeds from sale of equity securities 2,104 2,768
Cost of equity securities purchased (697) (639)
Change in other invested assets 6 806
Change in due from / to broker (1,404) (4,420)
Purchase of business, net of cash acquired (Note 3) (58,940) -
Other investing activities (861) (1,883)
--------- ---------
Net cash used by investing activities (124,755) (48,740)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 4,852 1,042
Cost of treasury stock purchases (477) (1,272)
Change in policyholder account balances 87,680 19,283
Change in reinsurance on policyholder account balances 827 798
Principal repayment on loan payable (6,887) (7,875)
Early extinguishment of debt (Note 10) (62,950) -
Issuance of new debt (Note 10) 65,000 -
Issuance of trust preferred securities (Note 11) 40,000 -
--------- ---------
Net cash provided by financing activities 128,045 11,976
--------- ---------
Net increase (decrease) in cash and cash equivalents 35,840 (14,448)
Cash and cash equivalents at beginning of period 36,754 47,990
--------- ---------
Cash and cash equivalents at end of period $ 72,594 $ 33,542
========= =========
Supplemental cash flow information:
Cash paid during the period for interest $ 3,497 $ 1,744
========= =========
Cash paid during the period for income taxes $ 4,061 $ 4,186
========= =========
See notes to unaudited consolidated financial statements.
7
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim financial information herein is unaudited, but in the
opinion of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results of operations for the three months and
nine months ended September 30, 2003 and 2002 are not necessarily indicative of
the results to be expected for the full year. The accompanying consolidated
financial statements and notes should be read in conjunction with the Company's
Annual Report on Form 10-K for the year ended December 31, 2002. Certain
reclassifications have been made to prior year's financial statements to conform
to current period classifications.
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP") and
consolidate the accounts of Universal American Financial Corp. ("Universal
American" 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)"), Pyramid Life Insurance Company
("Pyramid Life"), CHCS Services, Inc. and UAFC Statutory Trusts I,II,III and V.
Pyramid Life was acquired on March 31, 2003 and its operating results
prior to the date of acquisition are not included in Universal American's
consolidated results of operations.
Collectively, the insurance company subsidiaries are licensed to sell
life and accident & health insurance and annuities in all fifty states, the
District of Columbia and all the provinces of Canada. The principal insurance
products are Medicare Supplement/Select, fixed benefit accident and sickness
disability insurance, long term care, senior life insurance and fixed annuities.
The Company distributes these products through an independent general agency
system and a career agency system. The career agents focus on sales for
Pennsylvania Life, Pyramid Life and Penncorp Life (Canada) while the independent
general agents sell for American Pioneer, American Progressive, Constitution and
Union Bankers. CHCS Services, Inc., the Company's administrative services
company, acts as a service provider for both affiliated and unaffiliated
insurance companies for senior market insurance and non-insurance programs.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" ("SFAS 145"). SFAS 145 requires any gain or loss on
extinguishments of debt to be presented as a component of continuing operations
(unless specific criteria are met) whereas SFAS No. 4 required that such gains
and losses be classified as an extraordinary item in determining net income. The
Company adopted these provisions on January 1, 2003, as required. The other
provisions of SFAS No. 145 were not relevant to the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 requires
costs associated with exit or disposal activities (including restructurings) to
be recognized when the costs are incurred, rather than at a date of commitment
to an exit or disposal plan. This standard nullifies EITF Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Under SFAS 146, a liability related to an exit or disposal activity is not
recognized until such liability has actually been incurred whereas under EITF
Issue No. 94-3 a liability was recognized at the time of a commitment to an exit
or disposal plan. The provisions of this standard are
8
effective for exit or disposal activities initiated after December 31, 2002. The
Company adopted this standard on January 1, 2003.
The Company has various stock-based compensation plans for its
employees, directors and agents, which are more fully described in Notes 2 and 8
to the Consolidated Financial Statements included in the Company's 2002 Annual
Report on Form 10-K. In December 31, 2002, the FASB issued SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure" ("SFAS
148"). The Company uses the fair value method of accounting for stock-based
awards granted to agents, however, the intrinsic value method of accounting is
used for stock-based awards granted to employees and directors. Accordingly,
compensation cost is not recognized when the exercise price of an employee's
stock option is equal to or exceeds the fair market value of the stock on the
date the option is granted. SFAS 148 requires companies using the intrinsic
value method of accounting to disclose, on a quarterly basis, the effect on
reported net income and earnings per share as if compensation expense was based
on the fair value method of accounting for all stock-based awards. The following
table illustrates the pro forma net income and pro forma earnings per share as
if the Company had applied the fair value based method of accounting to all
stock-based awards during each period presented (using the Black-Scholes
option-pricing model for stock options).
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002
- -------------------------------------------------------- ---------------- ----------------
(In thousands, except per share amounts)
Reported net income $ 29,964 $ 19,135
Add back: Stock-based compensation expense included in
reported net income, net of tax 1,101 1,128
Less: Stock based compensation expense determined under
fair value based method for all awards, net of tax (2,104) (1,978)
------------ ------------
Pro forma net income $ 28,961 $ 18,285
============ ============
Net income per share:
Basic, as reported $ 0.56 $ 0.36
Basic, pro forma $ 0.54 $ 0.35
Diluted, as reported $ 0.55 $ 0.35
Diluted, pro forma $ 0.53 $ 0.34
Pro forma compensation expense reflected for prior periods is not
indicative of future compensation expense that would be recorded by the Company
upon its adoption of the fair value based recognition provisions of SFAS 123 on
January 1, 2004. Future expense may vary based upon factors such as the number
of awards granted by the Company, the then-current fair market value of such
awards and the transition provisions adopted.
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities, an interpretation of Accounting Research Bulletin No. 51, which
requires an entity to assess its interests in a variable interest entity to
determine whether to consolidate that entity. A variable interest entity is an
entity which in which the equity investment at risk is not sufficient to permit
the entity to finance it's activities without additional subordinated support
from other parties or the equity investors do not have the characteristics of a
controlling financial interest. FIN 46 requires that a variable interest entity
be consolidated by its primary beneficiary, which is the party that will absorb
a majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both.
The provisions of FIN 46 were effective immediately for variable
interest entities created after January 31, 2003 and for variable interest
entities for which the Company obtains an interest after that date. For any
variable interest entities acquired prior to February 1, 2003, the provisions of
FIN 46, as amended by FASB Staff Position No. 46-6, are effective for the
quarter ending December 31, 2003. The Company has not acquired a variable
interest in any variable interest entities subsequent to January 31, 2003 and
does not believe that the effects of any potential variable interest entities
entered prior to February 1, 2003 will be material to the Company's operations.
9
In April 2003, the FASB released FAS 133, Accounting for Derivative
Instruments and Hedging Activities ("FAS 133"), Implementation Issue B-36,
Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments
That Incorporate Credit Risk Exposure That Are Unrelated or Only Partially
Related to the Creditworthiness of the Obligor Under Those Instruments ("Issue
B-36"). Under FAS 133 Issue B-36 third party credit risk under coinsurance
arrangements and debt instruments is required to be bifurcated from the host
contract and accounted for as separate assets and liabilities with changes in
these assets and liabilities recorded in the statement of operations.
The effective date of Issue B-36 is the first day of the first fiscal
quarter beginning after September 15, 2003. Beginning in the fourth quarter of
2003 the Company intends to apply the guidance prospectively for existing
contracts and all future transactions. As permitted by FAS 133, all contracts
entered into prior to January 1, 1999, were grandfathered and are exempt from
the provisions of FAS 133 that relate to embedded derivatives. Based upon the
Company's current level of modco and funds withheld reinsurance, the application
of Issue B-36 is not expected to have a material effect on the consolidated
financial position or results of operations of the Company.
3. BUSINESS COMBINATION
Pyramid Life
On March 31, 2003, Universal American completed the acquisition of all
of the outstanding common stock of Pyramid Life. In this transaction, the
Company acquired a block of in-force business as well as a career sales force
that is skilled in selling the same type of senior market insurance products
that are currently sold by Universal American. The purchase price of $57.5
million and transaction costs of $2.4 million were financed with $20.1 million
of net proceeds generated from the refinancing of the Company's credit facility
and $39.8 million of cash on hand, including a portion of the proceeds from the
trust preferred offerings completed by Universal American in December 2002 and
March 2003. (See Note 10 - Debt Refinancing and Note 11 - Trust Preferred
Securities).
Operating results generated by Pyramid Life prior to March 31, 2003,
the date of acquisition, are not included in Universal American's consolidated
financial statements. At the time of closing, the fair value of net tangible
assets of the acquired company amounted to $27.6 million. The excess of the
purchase price over the fair value of net tangible assets acquired was $32.3
million. At March 31, 2003, the Company performed the initial allocation of the
excess to identifiable intangible assets. Based on this initial allocation,
approximately $13.1 million, net of deferred taxes of $7.1 million, was assigned
to the present value of future profits acquired, which has a weighted average
life of 7 years and approximately $14.3 million, net of deferred taxes of $7.7
million, was assigned to the distribution channel acquired, which has a weighted
average life of 30 years. The remaining $4.9 million was assigned to the value
of the trademarks and licenses acquired, which are deemed to have an indefinite
life. The consolidated pro forma results of operations, assuming that Pyramid
Life was purchased on January 1, 2003 and 2002 is as follows:
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002
- ------------------------------- -------- --------
(In thousands)
Total revenue $409,794 $316,036
Income before taxes (1) $ 46,837 $ 30,030
Net income (1) $ 30,503 $ 19,790
Earnings per common share:
Basic $ 0.57 $ 0.37
Diluted (1) $ 0.56 $ 0.36
(1) The above pro forma results of operations includes excess amortization of
capitalized loan fees of $1.9 million in 2003 and $2.4 million in 2002 as a
result of the assumed refinancing of the existing debt at January 1, 2003
and 2002, respectively. This additional expense reduced net income by $1.2
million or $0.02 per diluted share in 2003 and $1.6 million or $0.03 per
diluted share in 2002. The actual amount of excess amortization reported in
2003 was $1.8 million. No excess amortization was reported in 2002.
10
The pro forma results of operations reflect management's best estimate
based upon currently available information. The pro forma adjustments are
applied to the historical financial statements of Universal American and Pyramid
Life to account for Pyramid Life under the purchase method of accounting. In
accordance with SFAS No. 141, "Business Combinations", the total purchase cost
was allocated to Pyramid Life's assets and liabilities based on their relative
fair values. These allocations are subject to valuations as of the date of the
acquisition based upon appraisals and other information at that time. Although
the time required to identify and measure the fair value of the assets acquired
and liabilities assumed in a business combination will vary with circumstances,
the allocation period should not exceed one year from the consummation of a
business combination. Management has provided its best estimate of the likely
fair values of assets and liabilities for the purpose of this pro forma
information. However, management cannot predict the potential adjustments
resulting from the actual final purchase assumptions, which could result in
differences from these pro forma estimates.
The pro forma information presented above is for disclosure purposes
only and is not necessarily indicative of the results of operations that would
have occurred had the acquisition been consummated on the dates assumed, nor is
the pro forma information intended to be indicative of Universal American's
future results of operations.
Ameriplus
On August 1, 2003, Universal American acquired 100% of the outstanding
common stock of Ameriplus Preferred Care, Inc. ("Ameriplus"). Ameriplus is
engaged in the business of creating and maintaining a network of hospitals for
the purpose of acting as network providers with respect to Medicare Select
policies. Ameriplus' network is utilized in connection with Medicare Select
policies written by subsidiaries of Universal American and can be offered to
non-affiliated parties as well. Ameriplus receives override fees when premiums
for these Medicare Select policies are collected.
The total purchase price was $2.0 million and was paid with cash of
$1.0 million and 147,711 unregistered shares of common stock of Universal
American. At the time of the closing, Ameriplus had no material tangible assets.
Substantially the entire purchase price was allocated to the estimated value of
the future override fees, with the balance assigned to goodwill. The value of
the future fees has a weighted average estimated life of approximately 5 years.
(See Note 4 - Intangible Assets for additional detail).
4. INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets", and accordingly ceased all amortization of
goodwill.
The following table shows the Company's acquired intangible assets that
continue to be subject to amortization and accumulated amortization expense.
SEPTEMBER 30, 2003 DECEMBER 31, 2002
-------------------------- --------------------------
GROSS CARRY ACCUMULATED GROSS CARRY ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------- ------------ ----------- ------------
(In thousands)
Present value of future profits:
Career Agency $20,208 $ 1,359 $ - $ -
Senior Market Brokerage 2,391 906 2,391 657
Administrative Services 7,672 6,682 7,671 6,418
Value of future override fees 1,797 8 -
Distribution Channel - Career Agency 22,055 367 - -
------- ------- ------- -------
Total $54,123 $ 9,322 $10,062 $ 7,075
======= ======= ======= =======
11
Estimated future net amortization expense (in thousands) for the
succeeding five years is as follows:
2003 - Remainder of year $ 1,045
2004 4,201
2005 4,261
2006 4,277
2007 4,224
The carrying amounts of goodwill and intangible assets with indefinite
lives as of September 30, 2003 and December 31, 2002, are shown below.
2003 2002
------- -------
(In thousands)
Career Agency $ 4,867 $ -
Senior Market Brokerage 3,893 3,893
Administrative Services 4,357 4,080
------- -------
Total $13,117 $ 7,973
======= =======
5. REINSURANCE TRANSACTIONS
Reinsurance Recapture
Effective April 1, 2003, American Pioneer entered into an agreement to
recapture approximately $48 million of Medicare supplement premium that had been
reinsured to Transamerica Occidental Life Insurance Company, Reinsurance
Division under quota share arrangements. There was no gain or loss reported on
the recapture of these agreements.
Acquisition of Marketing Organization
Effective July 1, 2003, Universal American entered into an agreement
with Swiss Re and its newly acquired subsidiary, Guarantee Reserve Life
Insurance Company ("Guarantee Reserve"), to acquire Guarantee Reserve's
marketing organization, including all rights to do business with its field
force.
Beginning July 1, 2003, the Guarantee Reserve field force continued to
write this business in Guarantee Reserve, but with Universal American performing
all administration of all new life insurance business and assuming 50% of the
risk through a quota share reinsurance arrangement. Beginning approximately
January 1, 2004, new business will be written by a Universal American
subsidiary, with 50% of the risk reinsured to Swiss Re.
6. EARNINGS PER SHARE
The reconciliation of the numerators and the denominators of the basic
and diluted EPS is as follows:
INCOME SHARES PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, (NUMERATOR) (DENOMINATOR) AMOUNT
-------------------------------- ----------- ------------- ---------
(In thousands, per share amounts in dollars)
2003
Weighted average common stock outstanding 53,837
Less: Weighted average treasury shares (103)
------
Basic EPS:
Net income applicable to common shareholders $ 11,416 53,734 $0.21
======== =====
Effect of Dilutive Securities 1,598
------
Diluted EPS:
Net income applicable to common
shareholders plus assumed conversions $ 11,416 55,332 $0.21
======== ====== =====
12
INCOME SHARES PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, (NUMERATOR) (DENOMINATOR) AMOUNT
-------------------------------- ----------- ------------- ---------
(In thousands, per share amounts in dollars)
2002
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 1,299
------
Diluted EPS:
Net income applicable to common
shareholders plus assumed conversions $ 8,319 54,337 $0.15
======== ====== =====
INCOME SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, (NUMERATOR) (DENOMINATOR) AMOUNT
------------------------------- ----------- ------------- ---------
(In thousands, per share amounts in dollars)
2003
Weighted average common stock outstanding 53,521
Less: Weighted average treasury shares (150)
------
Basic EPS:
Net income applicable to common shareholders $ 29,964 53,371 $0.56
======== =====
Effect of Dilutive Securities 1,386
------
Diluted EPS:
Net income applicable to common
shareholders plus assumed conversions $ 29,964 54,757 $0.55
======== ====== =====
INCOME SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, (NUMERATOR) (DENOMINATOR) AMOUNT
------------------------------- ----------- ------------- ---------
(In thousands, per share amounts in dollars)
2002
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 1,393
------
Diluted EPS:
Net income applicable to common
shareholders plus assumed conversions $ 19,135 54,330 $0.35
======== ====== =====
13
7. INVESTMENTS
Fixed maturity securities are classified as investments available for
sale and are carried at fair value, with the unrealized gain or loss, net of tax
and other adjustments (deferred policy acquisition costs), included in
accumulated other comprehensive income.
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
CLASSIFICATION COST GAINS LOSSES VALUE
- --------------------------------------------- ----------- ---------- ---------- ----------
(In thousands)
SEPTEMBER 30, 2003
US Treasury securities
and obligations of US government $ 71,050 $ 1,221 $ (16) $ 72,255
Corporate debt securities 531,633 42,802 (5,147) 569,288
Foreign debt securities (1) 205,853 18,841 (123) 224,571
Mortgage- and asset-backed securities 267,501 10,616 (549) 277,568
----------- -------- -------- ----------
$ 1,076,037 $ 73,480 $ (5,835) $1,143,682
=========== ======== ======== ==========
DECEMBER 31, 2002
US Treasury securities
and obligations of US government $ 90,189 $ 1,670 $ (9) $ 91,850
Corporate debt securities 374,087 30,323 (1,667) 402,743
Foreign debt securities (1) 166,689 10,072 (216) 176,545
Mortgage- and asset-backed securities 253,089 12,621 (1,898) 263,812
----------- -------- -------- ----------
$ 884,054 $ 54,686 $ (3,790) $ 934,950
========== ======== ======== ==========
(1) Primarily Canadian dollar denominated bonds owned by our Canadian insurance
subsidiary.
The amortized cost and fair value of fixed maturities by contractual
maturity are shown below. Expected maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
SEPTEMBER 30, 2003
-------------------------
AMORTIZED FAIR
COST VALUE
---------- ----------
(In thousands)
Due in 1 year or less $ 25,648 $ 26,881
Due after 1 year through 5 years 147,261 155,217
Due after 5 years through 10 years 326,176 358,633
Due after 10 years 310,278 326,248
Mortgage- and asset-backed securities 266,674 276,703
---------- ----------
$1,076,037 $1,143,682
========== ==========
During the nine months ended September 30, 2003, the Company wrote down
the value of certain fixed maturity securities by $0.5 million. During the nine
months ended September 30, 2002, the Company wrote down the value of certain
fixed maturity securities by $9.9 million (1.1% of investments), primarily as a
result of the impairment of our WorldCom holdings, that were subsequently sold
in July 2002. These write downs represent management's estimate of other than
temporary declines in value and were included in net realized gains on
investments in our consolidated statement of operations.
14
8. COMPREHENSIVE INCOME
The components of other comprehensive income and the related tax
effects for each component are as follows:
2003 2002
---------------------------------- ----------------------------------
BEFORE TAX NET OF BEFORE TAX NET OF
TAX EXPENSE TAX TAX EXPENSE TAX
THREE MONTHS ENDED SEPTEMBER 30, AMOUNT (BENEFIT) AMOUNT AMOUNT (BENEFIT) AMOUNT
- ----------------------------------- --------- --------- --------- --------- --------- ---------
(In thousands)
Net unrealized (loss) gain on
investments arising during the
year (net of deferred acquisition
cost adjustment) $(12,635) $ (4,421) $ (8,214) $ 30,021 $ 10,513 $ 19,508
Less:
Reclassification adjustment
for gains included in net
income (582) (204) (378) (247) (88) (159)
-------- -------- -------- -------- -------- --------
Net unrealized (losses) gains (13,217) (4,625) (8,592) 29,774 10,425 19,349
Currency translation adjustments (459) (161) (298) (1,674) (586) (1,088)
-------- -------- -------- -------- -------- --------
Other comprehensive (losses) income $(13,676) $ (4,786) $ (8,890) $ 28,100 $ 9,839 $ 18,261
======== ======== ======== ======== ======== ========
2003 2002
---------------------------------- ----------------------------------
BEFORE TAX NET OF BEFORE TAX NET OF
TAX EXPENSE TAX TAX EXPENSE TAX
NINE MONTHS ENDED SEPTEMBER 30, AMOUNT (BENEFIT) AMOUNT AMOUNT (BENEFIT) AMOUNT
- ----------------------------------- --------- --------- --------- --------- --------- ---------
(In thousands)
Net unrealized gain on investments
arising during the year (net of
deferred acquisition cost
adjustment) $ 14,888 $ 5,207 $ 9,681 $ 31,412 $ 10,998 $ 20,414
Less:
Reclassification adjustment
for losses (gains) included in net
income (1,878) (657) (1,221) 6,210 2,173 4,037
-------- -------- -------- -------- -------- --------
Net unrealized gains 13,010 4,550 8,460 37,622 13,171 24,451
Currency translation adjustments 7,114 2,490 4,624 486 170 316
-------- -------- -------- -------- -------- --------
Other comprehensive income $ 20,124 $ 7,040 $ 13,084 $ 38,108 $ 13,341 $ 24,767
======== ======== ======== ======== ======== ========
9. 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 issued
were as follows:
NINE MONTHS ENDED SEPTEMBER 30, 2003 2002
---------- -----------
Common stock issued, beginning of year 53,184,381 52,799,899
Stock options exercised 368,867 270,866
Stock issued in connection with acquisition 147,711 -
Agent stock award 31,770 72,789
Stock purchases pursuant to agents' stock purchase plans 352,039 25,750
---------- ----------
Common stock issued, end of period 54,084,768 53,169,304
========== ==========
15
Treasury Stock
The Board of Directors approved a plan to repurchase up to one million
shares of Company stock in the open market. The primary purpose of the plan is
to fund employee stock bonuses.
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------------------------------- ----------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
COST PER COST PER
SHARES AMOUNT SHARE SHARES AMOUNT SHARE
--------- -------- -------- --------- -------- --------
(In thousands) (In thousands)
Treasury stock beginning of year 241,076 $ 1,320 $ 5.48 80,982 $ 386 $ 4.76
Shares repurchased 72,978 477 6.54 206,421 1,272 6.16
Shares Distributed in the form of
employee bonuses (189,931) (1,043) 5.58 (103,291) (586) 6.45
-------- ------- -------- -------
Treasury stock, end of period 124,123 $ 754 $ 6.08 184,112 $ 1,072 $ 5.82
======== ======= ======== =======
Through September 30, 2003, the Company had repurchased 691,450 shares
at an aggregate cost of $3.5 million. As of September 30, 2003, 308,550 shares
remained available for repurchase under the program. Additional repurchases may
be made from time to time at prevailing prices, subject to restrictions on
volume and timing.
Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income are as
follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(in thousands)
Net unrealized appreciation on investments $ 67,701 $ 50,880
Deferred acquisition cost adjustment (6,091) (2,320)
Unrealized depreciation of interest rate swap (40) -
Foreign currency translation gains (losses) 4,540 (2,574)
Deferred tax on the above (23,139) (16,099)
----------- -----------
Accumulated other comprehensive income $ 42,971 $ 29,887
=========== ===========
10. DEBT REFINANCING
Prior Credit Facility
As of January 1, 2003, the outstanding balance of the Company's
existing loan was $50.8 million. In January 2003, the Company made a scheduled
principal payment of $2.8 million, and in March, 2003 made a principal payment
of $5.0 million from a portion of the proceeds from the issuance of Trust
Preferred securities (see Note 11 - Trust Preferred Securities). These payments
reduced the outstanding balance to $42.9 million, which was repaid from the
proceeds of the new loan obtained in connection with the acquisition of Pyramid
Life. The early extinguishment of the existing debt resulted in the immediate
amortization of the capitalized loan origination fees relating to that debt,
causing a pre-tax expense of approximately $1.8 million.
New Credit Facility
In connection with the acquisition of Pyramid Life (see Note 3 -
Business Combination), the Company obtained a new credit facility on March 31,
2003 to repay the existing loan and provide funds for the acquisition of Pyramid
Life. This $80 million credit facility consists of a $65 million term loan which
was drawn to fund the acquisition and a $15 million revolving loan facility none
of which has been drawn as of September 30, 2003. The facility calls for
interest at the London Interbank Offering Rate for one, two or three months
("LIBOR"), at the option of the Company, plus 300 basis points (currently 4.1%).
Due to the variable interest rate for this loan, the Company would be subject to
higher interest costs if short-term
16
interest rates rise. Principal repayments are scheduled over a five-year period
with a final maturity date of March 31, 2008. The Company incurred loan
origination fees of approximately $2.1 million, which were capitalized and are
being amortized on a straight-line basis over the life of the loan. The Company
pays an annual commitment fee of 50 basis points on the unutilized facility. The
obligations of the Company under the new credit facility are secured by 100% of
the common stock of the Company's U.S. insurance subsidiaries and 65% of the
Company's Canadian subsidiary. In addition, the obligations are guaranteed by
CHCS Services Inc. and other direct and indirect subsidiaries of the Company
(collectively the "Guarantors") and secured by all of the assets of each of the
Guarantors.
In accordance with the Credit Agreement, 50% of the net proceeds from
the $30 million Trust Preferred securities issued in May 2003 (see Note 11 -
Trust Preferred Securities) were used to pay down the new term loan. Future
scheduled principal payments were reduced as a result of this repayment,
primarily in 2006 and 2007. In 2003, the Company has made regularly scheduled
principal payments of $4.1 million. During the nine months ended September 30,
2003, the Company paid $1.2 million in interest and fees in connection with the
new credit facility and $1.1 million in connection with the prior credit
facility. During the nine months ended September 30, 2002, the Company paid $1.7
million in interest and fees in connection with the prior credit facility.
On October 30, 2003, $6.0 million of the proceeds from an additional
$20 million Trust Preferred offering (see Note 11 - Trust Preferred Securities)
was used to further reduce the outstanding balance of the new term loan to $39.9
million. A waiver was requested and received to limit the required repayment
from the proceeds of the Trust Preferred offering to $6.0 million.
The following table shows the schedule of principal payments (in
thousands) remaining on the Company's new term loan, as of October 30, 2003,
(reflecting the $6.0 million repayment) with the final payment in March 2008:
2003 - Remainder of year $ 1,766
2004 7,488
2005 8,623
2006 8,922
2007 9,607
2008 3,532
---------
Total $ 39,938
=========
11. TRUST PREFERRED SECURITIES
Separate subsidiary trusts of the Company (the "Trusts") have issued a
combined $55.0 million in thirty year trust preferred securities (the "Capital
Securities") as of September 30, 2003, as detailed in the following table:
Maturity Amount Spread Rate as of
Date Issued Term Over LIBOR September 30, 2003
- -------------------- -------------- ------------------- ---------- ------------------
(In thousands)
December, 2032 $ 15,000 Fixed/Floating (2) 6.7%
March, 2033 10,000 Floating 400 5.3%
May, 2033 15,000 Floating 420 5.5%
May, 2033 15,000 Fixed/Floating (1) 7.4%
--------
$ 55,000
========
(1) The rate on this issue is fixed at 7.4% for the first five years, after
which it is converted to a floating rate equal to LIBOR plus 410 bps.
(2) Effective September, 2003, Universal American entered into a swap
agreement whereby we will pay a fixed rate of 6.7% in exchange for a
floating rate of LIBOR plus 400 bps. The swap contract ends in December
2007.
17
The Trusts have the right to call the Capital Securities at par after
five years from the date of issuance. The proceeds from the sale of the Capital
Securities, together with proceeds from the sale by the Trusts of their common
securities to the Company, were invested in thirty year floating rate junior
subordinated deferrable interest debentures of the Company (the "Junior
Subordinated Debt"). A portion of the proceeds were used to pay down existing
debt in connection with the acquisition of Pyramid Life (see Note 3 - Business
Combination), with the balance to be held for general corporate purposes.
The Capital Securities represent an undivided beneficial interest in
the Trusts' assets, which consist solely of the Junior Subordinated Debt.
Holders of Capital Securities have no voting rights. The Company owns all of the
common securities of the Trusts. Holders of both the Capital Securities and the
Junior Subordinated Debt are entitled to receive cumulative cash distributions
accruing from the date of issuance, and payable quarterly in arrears at a
floating rate equal to the three-month LIBOR plus a spread. The floating rate
resets quarterly and is limited to a maximum of 12.5% during the first sixty
months. Due to the variable interest rate for this security the Company would be
subject to higher interest costs if short-term interest rates rise. The Capital
Securities are subject to mandatory redemption upon repayment of the Junior
Subordinated Debt at maturity or upon earlier redemption. The Junior
Subordinated Debt is unsecured and ranks junior and subordinate in right of
payment to all present and future senior debt of the Company and is effectively
subordinated to all existing and future obligations of the Company's
subsidiaries. The Company has the right to redeem the Junior Subordinated Debt
after five years from the date of issuance.
The Company has the right at any time, and from time to time, to defer
payments of interest on the Junior Subordinated Debt for a period not exceeding
20 consecutive quarters up to the debentures' maturity date. During any such
period, interest will continue to accrue and the Company may not declare or pay
any cash dividends or distributions on, or purchase, the Company's capital stock
nor make any principal, interest or premium payments on or repurchase any debt
securities that rank equally with or junior to the Junior Subordinated Debt. The
Company will have the right at any time to dissolve the Trusts and cause the
Junior Subordinated Debt to be distributed to the holders of the Capital
Securities. The Company has guaranteed, on a subordinated basis, all of the
Trusts' obligations under the Capital Securities including payment of the
redemption price and any accumulated and unpaid distributions to the extent of
available funds and upon dissolution, winding up or liquidation but only to the
extent the Trusts have funds available to make such payments. The Capital
Securities have not been and will not be registered under the Securities Act of
1933, as amended (the "Securities Act"), and will only be offered and sold under
an applicable exemption from registration requirements under the Securities Act.
During the nine months ended September 30, 2003, the Company paid $1.3
million in interest in connection with the trust preferred securities.
In October, 2003, an additional $20.0 million of floating rate trust
preferred securities were issued at terms similar to the above, increasing our
total outstanding trust preferred to $75.0 million as of November 1, 2003.
12. DERIVATIVE INSTRUMENTS - CASH FLOW HEDGE
Effective September 4, 2003, the Company entered into a swap agreement
whereby it will pay a fixed rate of 6.7% on a $15.0 million notional amount
relating to the December, 2002 trust preferred issuance, in exchange for a
floating rate of LIBOR plus 400 bps, capped at 12.5%.
As of September 30, 2003, the fair value of the swap was $(40) thousand
and is included in other liabilities. Since the swap is designated and qualifies
as cash flow hedge, changes in its fair value are recorded in accumulated other
comprehensive income.
18
13. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS
The insurance subsidiaries are required to maintain minimum amounts of
capital and surplus as required by regulatory authorities. Each of the insurance
subsidiaries' statutory capital and surplus exceeds its respective minimum
requirement. However, substantially more than such minimum amounts are needed to
meet statutory and administrative requirements of adequate capital and surplus
to support the current level of the Insurance Subsidiaries' operations. At
September 30, 2003, the statutory capital and surplus, including asset valuation
reserve, of the U.S. insurance subsidiaries totaled $111.5 million. Statutory
net income for the nine months ended September 30, 2003 was $6.5 million, which
included net realized gains of $0.3 million.
The National Association of Insurance Commissioners ("NAIC") imposes
regulatory risk-based capital ("RBC") requirements on life insurance
enterprises. At September 30, 2003 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 C$60.3 million (US$44.5 million) as of
September 30, 2003. Penncorp Life (Canada) maintained a Minimum Continuing
Capital and Surplus Requirement Ratio ("MCCSR") in excess of the minimum
requirement at September 30, 2003.
14. 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. A description
of these segments follows:
CAREER AGENCY -- The Career Agency segment is comprised of the operations of
Pennsylvania Life, Penncorp Life (Canada), and, beginning March 31, 2003,
Pyramid Life. Pennsylvania Life and Pyramid Life operate in the United States,
while Penncorp Life (Canada) operates exclusively in Canada. This segment's
products include Medicare Supplement/Select, other supplemental senior health
insurance, fixed benefit accident and sickness disability insurance, life
insurance and annuities and are distributed by career agents under contract with
Pennsylvania Life, Pyramid Life or Penncorp Life (Canada).
SENIOR MARKET BROKERAGE -- This segment includes the operations of our other
insurance subsidiaries, primarily American Pioneer, American Progressive,
Constitution and Union Bankers which distribute senior market products through
non-exclusive general agency and brokerage distribution systems. The products
include Medicare Supplement/Select, other senior supplemental health (long term
care), senior life insurance and annuities.
ADMINISTRATIVE SERVICES -- CHCS Services, Inc. acts as a third party
administrator and service provider for both affiliated and unaffiliated
insurance companies, primarily with respect to senior market insurance and
non-insurance products. The services provided include policy underwriting and
issuance, telephone and face-to-face verification, policyholder services, claims
adjudication, case management, care assessment and referral to health care
facilities.
CORPORATE -- This segment reflects the activities of 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 but eliminated in the consolidated results. These
intersegment revenues and expenses affect the amounts reported on the individual
financial statement line items, but are eliminated in consolidation and do not
change operating income before taxes. The significant items eliminated include
intersegment revenue and expense relating to services performed by the
Administrative Services segment for the Career Agency and Senior Market
Brokerage segments and interest on notes issued by the Corporate segment to the
other operating segments.
19
Financial results by segment are as follows:
2003 2002
--------------------------- ----------------------------
Segment Segment
Income (Loss) Income (Loss)
Segment Before Segment Before
THREE MONTHS ENDED SEPTEMBER 30, Revenue Income Taxes Revenue Income Taxes
- -------------------------------- --------- ------------- --------- -------------
(In thousands)
Career Agency $ 74,011 $13,294 $ 39,779 $ 8,344
Senior Market Brokerage 64,957 3,498 40,862 4,128
Administrative Services 12,044 2,888 11,179 1,888
-------- ------- -------- ---------
Subtotal 151,012 19,680 91,820 14,360
Corporate 65 (2,565) 46 (1,730)
Intersegment revenues (9,735) - (8,157) -
-------- ------- -------- ---------
Segment operating total (1) 141,342 17,115 83,709 12,630
Adjustments to segment total
Net realized gains (1) 582 582 247 247
-------- ------- -------- ---------
Total $141,924 $17,697 $ 83,956 $ 12,877
======== ======= ======== =========
2003 2002
--------------------------- ----------------------------
Segment Segment
Income (Loss) Income (Loss)
Segment Before Segment Before
NINE MONTHS ENDED SEPTEMBER 30, Revenue Income Taxes Revenue Income Taxes
- --------------------------------- --------- ------------- --------- -------------
(In thousands)
Career Agency $189,151 $32,484 $119,567 $ 23,309
Senior Market Brokerage 180,869 11,906 120,705 11,374
Administrative Services 36,352 8,085 30,891 5,564
-------- ------- -------- --------
Subtotal 406,372 52,475 271,163 40,247
Corporate 135 (8,360) 268 (5,062)
Intersegment revenues (27,482) - (22,409) -
-------- ------- -------- --------
Segment operating total (1) 379,025 44,115 249,022 35,185
Adjustments to segment total
Net realized gains (1) 1,878 1,878 (6,210) (6,210)
-------- ------- -------- --------
Total $380,903 $45,993 $242,812 $ 28,975
======== ======= ======== ========
(1) We evaluate the results of operations of our segments based on
operating income by segment. Operating revenue and income excludes
realized gains and losses. This differs from generally accepted
accounting principles, which includes the effect of realized gains and
losses in the determination of total revenue and net income. Management
believes that realized gains and losses are not indicative of overall
operating trends. The schedule above reconciles our segment revenue to
total revenue and operating income to net income in accordance with
generally accepted accounting principles.
Identifiable assets by segment are as follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(In thousands)
Career Agency $ 894,475 $ 683,720
Senior Market Brokerage 762,425 707,967
Administrative Services 20,708 19,332
---------- ----------
Subtotal 1,677,608 1,411,019
Corporate 449,768 375,219
Intersegment assets (1) (419,776) (384,570)
---------- ----------
Total Assets $1,707,600 $1,401,668
========== ==========
(1) Intersegment assets include the elimination of the parent holding
company's investment in its subsidiaries as well as the elimination of
other intercompany balances.
20
15. FOREIGN OPERATIONS
A portion of the operations of the Company's Career Agency segment is
conducted in Canada through Penncorp Life (Canada). These assets and liabilities
are located in Canada where the insurance risks are written. Revenues, excluding
capital gains, of the Career Agency segment by geographic area are as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------------------------------- -------------------------------
(In thousands, in US$'s) (In thousands, in US$'s)
Revenues
United States $ 58,056 $ 25,943 $ 142,129 $ 78,099
Canada 15,955 13,836 47,022 41,468
--------- --------- --------- ---------
Total $ 74,011 $ 39,779 $ 189,151 $ 119,567
========= ========= ========= =========
Total assets and liabilities of Penncorp Life (Canada), which are
located entirely in Canada, are as follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(In thousands, in US$'s)
Assets $ 213,184 $ 175,365
========== ==========
Liabilities $ 154,178 $ 124,843
========== ==========
21
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
Certain statements in this report or incorporated by reference into
this report and oral statements made from time to time by our representatives
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements are
statements not based on historical information. They relate to future
operations, strategies, financial results or other developments. In particular,
statements using verbs such as "expect," "anticipate," "believe" 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.
INTRODUCTION
The following discussion and analysis presents a review of Universal
American and its subsidiaries as of September 30, 2003 and December 31, 2002 and
its results of operations for the three months and nine months ended September
30, 2003 and 2002. This Management's Discussion and Analysis of Financial
Condition and Results of Operation should be read in conjunction with the
consolidated financial statements as well as the MD&A included in the Company's
2002 Annual Report on Form 10-K.
We own ten 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)"), Pyramid Life
Insurance Company ("Pyramid Life") and Union Bankers Insurance Company ("Union
Bankers"). Collectively, 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, and also administers such business for our own companies. Pyramid
Life was acquired on March 31, 2003 and its operating results prior to the date
of acquisition are not included in Universal American's consolidated results of
operations.
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. A description of these segments
follows:
CAREER AGENCY -- The Career Agency segment is comprised of the operations of
Pennsylvania Life, Penncorp Life (Canada), and, beginning March 31, 2003,
Pyramid Life. Pennsylvania Life and Pyramid Life operate in the United States,
while Penncorp Life (Canada) operates exclusively in Canada. This segment's
products include Medicare Supplement/Select, other supplemental senior health
insurance, fixed benefit accident and sickness disability insurance, life
insurance, and annuities and are distributed by career agents who are under
contract with Pennsylvania Life, Pyramid Life or Penncorp Life (Canada).
22
SENIOR MARKET BROKERAGE -- This segment includes the operations of our other
insurance subsidiaries, primarily American Pioneer, American Progressive,
Constitution and Union Bankers that distribute senior market products through
non-exclusive general agency and brokerage distribution systems. The products
include Medicare Supplement/Select, other senior supplemental health (long term
care), senior life insurance and annuities.
ADMINISTRATIVE SERVICES -- CHCS Services, Inc. acts as a third party
administrator and service provider for both affiliated and unaffiliated
insurance companies, primarily with respect to senior market insurance and
non-insurance products. The services provided include policy underwriting and
issuance, telephone and face-to-face verification, policyholder services, claims
adjudication, case management, care assessment and referral to health care
facilities.
CORPORATE -- This segment reflects the activities of 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 intersegment revenue and expenses affect
the amounts reported on the individual financial statement line items, but are
eliminated in consolidation and do not change operating income before taxes. The
significant items eliminated include intersegment revenue and expense relating
to services performed by the Administrative Services segment for the Career
Agency and Senior Market Brokerage segments and interest on notes 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 related liabilities, deferred policy acquisition costs, valuation
of certain investments, intangible assets and deferred taxes. There have been no
changes in our critical accounting policies during 2003. Refer to "Critical
Accounting Policies" in the Company's 2002 Annual Report on Form 10-K for
information on accounting policies that the Company considers critical in
preparing its consolidated financial statements.
SIGNIFICANT TRANSACTIONS
Ameriplus
On August 1, 2003, Universal American acquired 100% of the outstanding
common stock of Ameriplus Preferred Care, Inc. ("Ameriplus"). Ameriplus is
engaged in the business of creating and maintaining a network of hospitals for
the purpose of acting as network providers with respect to Medicare Select
policies. Ameriplus' network is utilized in connection with Medicare Select
policies written by subsidiaries of Universal American and can be offered to
non-affiliated parties as well. Ameriplus receives override fees when premiums
for these Medicare Select policies are collected.
Acquisition of Marketing Organization
Effective July 1, 2003, Universal American entered into an agreement
with Swiss Re and its newly acquired subsidiary, Guarantee Reserve Life
Insurance Company ("Guarantee Reserve"), to acquire Guarantee Reserve's
marketing organization including all rights to do business with its field force.
Beginning July 1, 2003, the Guarantee Reserve field force continued to
write this business in Guarantee Reserve, but with Universal American performing
all administration of all new life insurance
23
business and assuming 50% of the risk through a quota share reinsurance
arrangement. Beginning approximately January 1, 2004, new business will be
written by a Universal American subsidiary, with 50% of the risk reinsured to
Swiss Re.
In the third quarter of 2003, this marketing organization produced more
than 20,000 applications and more than $8.5 million of issued annualized life
insurance premium. There can be no assurance that the producers will continue to
write this volume of business when the business is written by a Universal
American subsidiary.
Reinsurance Recapture
Effective April 1, 2003, American Pioneer entered into an agreement to
recapture approximately $48 million of Medicare Supplement premium that had been
reinsured to Transamerica Occidental Life Insurance Company, Reinsurance
Division ("TARe") under quota share arrangements. There was no gain or loss
reported on the recapture of these agreements.
Pyramid Life Acquisition
On March 31, 2003, Universal American acquired all of the outstanding
common stock of Pyramid Life. Pyramid Life specializes in selling health and
life insurance products to the senior market, including Medicare Supplement,
long term care, life insurance, and annuities. Pyramid Life markets its products
in 26 states through a career agency sales force of over 1,100 agents operating
out of 32 Senior Solutions Sales Centers. As of the closing, Pyramid Life had
approximately $120 million of premium in force. In the Pyramid Life acquisition
the Company acquired a block of in-force business, as well as a career sales
force that is skilled in selling the same type of senior market insurance
products that are currently sold by Universal American. During 2002, Pyramid
Life agents produced more than $25 million of annualized new sales. We believe
this acquisition will add further scale and efficiencies to our operations in
the senior market. Following a transition period that we estimate will take one
year, the Pyramid Life business will be administered in our cost-effective and
efficient service center. Operating results generated by Pyramid Life prior to
the date of acquisition are not included in Universal American's consolidated
financial statements. Refer to Consolidated Financial Statements Note 3 -
Business Combinations for additional information on the acquisition.
Debt Refinancing
In connection with the acquisition of Pyramid Life (see Consolidated
Financial Statements Note 3 - Business Combination), the Company refinanced its
existing credit facility. On March 31, 2003, the Company entered into an $80
million credit facility consisting of a $65 million term loan and a $15 million
revolving loan facility. None of the revolving loan facility was drawn as of
September 30, 2003 (Refer to Consolidated Financial Statement Note 10 - Debt
Refinancing). The Company used the proceeds from the new term loan to repay the
balance outstanding on its existing term loan. The early extinguishment of the
existing debt resulted in the immediate amortization of the capitalized loan
origination fees relating to that debt, resulting in a pre-tax expense of
approximately $1.8 million. A portion of the proceeds from Trust preferred
issuances in May 2003 and October 2003 were used to reduce the balance of the
term loan by a total $21.0 million during 2003.
Trust Preferred Issuances
During the nine months ended September 30, 2003, the Company issued
$40.0 million of fixed and floating rate trust preferred securities through
subsidiary trusts. An additional $20.0 million was issued in October 2003,
bringing the total to $75.0 million. These securities have terms similar to
those issued in December 2002. A portion of the proceeds was used to repay our
existing debt and the balance was retained at the parent company for general
corporate purposes (for more detailed information, see Consolidated Financial
Statements Note 11 - Trust Preferred Securities).
24
Acquisition of Block of Business
In November 2002 we entered into an agreement with Nationwide Life
Insurance Company ("Nationwide") to acquire, through a 100% quota share
reinsurance agreement, Nationwide's individual Medicare Supplement policies
representing approximately $20.0 million of annualized premium in force. In
connection with this transaction, administration of the business was transferred
to CHCS Services, Inc.
RESULTS OF OPERATIONS - CONSOLIDATED OVERVIEW
The following table reflects each of our segments' operating income(1)
and contains a reconciliation to reported net income:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2003 2002 2003 2002
--------- -------- --------- ---------
(In thousands)
Operating Income (1):
Career Agency $ 13,294 $ 8,344 $ 32,484 $ 23,309
Senior Market Brokerage 3,498 4,128 11,906 11,374
Administrative Services 2,888 1,888 8,085 5,564
-------- ------- -------- --------
Segment operating income 19,680 14,360 52,475 40,247
Corporate & Eliminations (2,565) (1,730) (6,594) (5,062)
-------- ------- -------- --------
Pro forma operating income before income taxes (1) 17,115 12,630 45,881 35,185
Income taxes (2) (6,078) (4,471) (15,991) (12,013)
-------- ------- -------- --------
Pro forma net operating income (1) 11,037 8,159 29,890 23,172
Non-recurring items:
Early extinguishment of debt - - (1,766) -
Income taxes on non-recurring items - - 619 -
-------- ------- -------- --------
Net non-recurring items - - (1,147) -
-------- ------- -------- --------
Net Operating income 11,037 8,159 28,743 23,172
Realized gains (losses) on investments 582 247 1,878 (6,210)
Income taxes on realized gains (losses) (203) (87) (657) 2,173
-------- ------- -------- --------
Net realized gains (losses) (3) 379 160 1,221 (4,037)
-------- ------- -------- --------
Net income $ 11,416 $ 8,319 $ 29,964 $ 19,135
======== ======= ======== ========
Per share data (diluted):
Pro forma net operating income (1) $ 0.20 $ 0.15 $ 0.55 $ 0.43
Non-recurring items - - (0.02) -
Realized gains, net of tax (3) (0.01) - 0.02 (0.08)
-------- ------- -------- --------
Net income $ 0.21 $ 0.15 $ 0.55 $ 0.35
======== ======= ======== ========
(1) We describe our income as follows: "Reported net income" is income
based on generally accepted accounting principles. "Net operating
income" excludes realized gains (losses). "Pro forma operating income"
also excludes items that are non-recurring and, in the opinion of
management, are not indicative of overall operating trends. The table
above reconciles Pro forma operating income and Net operating income to
Reported net income in accordance with generally accepted accounting
principles.
(2) The effective tax rates were 35.5% and 35.4% for the quarters ended
September 30, 2003 and 2002, respectively and 34.9% and 34.1% for the
nine months ended September 30, 2003 and 2002, respectively.
(3) Tax on realized capital gains (losses) and other non-recurring items is
based on a 35.0% effective tax rate for all periods.
25
Three months ended September 30, 2003 and 2002
Net income for the third quarter of 2003 increased by $3.1 million to
$11.4 million compared to the third quarter of 2002.
Pro forma net operating income, excluding realized gains, was $11.0
million, or $0.20 per share for the third quarter of 2003, representing
increases of 35% and 33%, respectively, over the 2002 third quarter results of
$8.2 million, or $0.15 per share.
Pre-tax operating results for the Career Agency segment improved by
$5.0 million, or 59%, to $13.3 million in the third quarter of 2003 compared to
the third quarter of 2002, primarily as a result of the acquisition of Pyramid,
as well as improvement in the loss ratios in our fixed benefit disability
business.
Operating results for the Senior Market Brokerage segment decreased by
$0.6 million, or 15%, to $3.5 million compared to the third quarter of 2002,
primarily as a result of an increase in the loss ratios on our discontinued
block of Florida home health care business in the third quarter of 2003.
Operating income for the Administrative Services segment improved by
$1.0 million, or 53%, compared to the third quarter of 2002. This improvement is
primarily a result of growth in premiums managed and the scheduled reduction in
the amortization of the present value of future profits ("PVFP"). Earnings
before interest, taxes, depreciation and amortization ("EBITDA") for this
segment increased $0.8 million, or 32%, compared to the third quarter of 2002.
The operating loss from the Corporate segment increased by $0.8
million, or 48%, compared to the third quarter of 2002, due primarily to the
increase in financing costs as well as additional expenses as a result of an
increase in acquisition related activities. In connection with the acquisition
of Pyramid, we refinanced our debt and we issued trust preferred securities. Our
combined outstanding debt was $101 million at September 30, 2003 compared to $54
million at September 30, 2002. See Liquidity section for additional details.
Nine months ended September 30, 2003 and 2002
Net income for the first nine months of 2003 increased by $10.9 million
to $30.0 million compared to the first nine months of 2002. During the nine
months ended September 30, 2003, we recognized realized gains, net of tax of
$1.2 million compared to realized losses, net of tax of $4.0 million in the same
period of 2002. The difference in realized gains, net of tax, represents $5.3
million of the $10.9 million increase in net income. The losses in 2002 were
primarily a result of the recognition of an impairment of our WorldCom holdings.
In connection with the acquisition of Pyramid Life on March 31, 2003,
we refinanced our credit facility. As a result of the repayment of our existing
debt, we were required to write off the unamortized portion of the fees we
incurred for that debt. This resulted in a pre-tax, non-cash charge of $1.8
million (the "financing charge").
Pro forma net operating income, excluding realized gains and excluding
the financing charge, was $29.9 million, or $0.55 per share for the first nine
months of 2003, representing increases of 29% and 28%, respectively, over the
2002 nine month results of $23.2 million, or $0.43 per share.
Pre-tax operating results for the Career Agency segment improved by
$9.2 million, or 39%, to $32.5 million in the first nine months of 2003 compared
to the first nine months of 2002, primarily as a result of the acquisition of
Pyramid, as well as improvements in the loss ratios for our fixed benefit
disability business, as well as the strengthening of the Canadian dollar.
The Senior Market Brokerage segment improved its operating results by
$0.5 million, or 5%, to $11.9 million compared to the first nine months of 2002.
This improvement is the result of the increase in our net retained business and
improvement in our Medicare Supplement/Select loss ratios. However, this was
partially offset by an increase in claims relating to the discontinued block of
Florida home health care business.
26
Operating income for the Administrative Services segment improved by
$2.5 million, or 45%, compared to the first nine months of 2002. This
improvement is primarily a result of growth in premiums managed, the increase in
fees for underwriting of long term care policies for third party clients and the
scheduled reduction in the amortization of the PVFP. EBITDA for this segment
increased $1.9 million, or 25%, compared to the first nine months of 2002.
The operating loss from the Corporate segment increased by $1.5
million, or 30%, compared to the first nine months of 2002, due primarily to the
increase in financing costs.
SEGMENT RESULTS - CAREER AGENCY
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2003 2002 2003 2002
-------- -------- --------- ---------
(In thousands)
Net premiums and policyholder fees:
Life and annuity $ 8,064 $ 3,435 $ 20,187 $ 10,769
Accident & health 56,509 27,621 141,208 83,339
------- ------- -------- --------
Net premiums 64,573 31,056 161,395 94,108
Net investment income 9,304 8,631 27,420 25,118
Other income 134 92 336 341
------- ------- -------- --------
Total revenue 74,011 39,779 189,151 119,567
------- ------- -------- --------
Policyholder benefits 39,908 18,482 103,317 58,576
Interest credited to policyholders 1,638 713 4,019 2,020
Change in deferred acquisition costs (6,287) (3,804) (17,021) (10,812)
Amortization of present value of future profits 878 - 1,726 -
Commissions and general expenses, net of allowances 24,580 16,044 64,626 46,474
------- ------- -------- --------
Total benefits, claims and other deductions 60,717 31,435 156,667 96,258
------- ------- -------- --------
Segment operating income $13,294 $ 8,344 $ 32,484 $ 23,309
======= ======= ======== ========
The operations of Penncorp Life (Canada), which are included in the
Career Agency segment results, are transacted using the Canadian dollar as the
functional currency. The Canadian dollar has strengthened relative to the U.S.
dollar. The average conversion rate increased 10%, to 70%, for the nine months
ended September 30, 2003, from 64% for the same period of 2002. This
strengthening added approximately $0.5 million and $1.0 million to the pre-tax
results for the three and nine months ended September 30, 2003, respectively, as
compared to the same periods of the prior year. See Item 3 - Quantitative and
Qualitative Disclosures about Market Risk for additional information.
Three months ended September 30, 2003 and 2002
Pre-ta