<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _________
Commission file number 0-8483
CERES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 34-1017531
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
17800 Royalton Road
Strongsville, Ohio 44136
------------------------
(Address of principal executive offices)
(Zip Code)
(440) 572-2400
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12,13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by the court. Yes ( ) No ( )
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.001 Par Value - 13,497,732 shares as of March 31, 1999
<PAGE> 2
INDEX
CERES GROUP, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
Page
Part I. Financial Information ----
<S> <C>
Item 1. Financial Statements (Unaudited) 3
Condensed consolidated balance sheets - March 31, 1999
and December 31, 1998 3
Condensed consolidated statements of operations -
Three months ended March 31, 1999 and 1998 4
Condensed consolidated statements of cash flows -
Three months ended March 31, 1999 and 1998 5
Notes to condensed consolidated financial statements -
March 31, 1999 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosure of Market Risk 17
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
</TABLE>
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<PAGE> 3
PART I. FINANCIAL INFORMATION- ITEM 1. FINANCIAL STATEMENTS
-----------------------------------------------------------
CERES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
ASSETS 1999 1998
---- ----
<S> <C> <C>
Investments
Fixed maturities:
Held to maturity at amortized cost $ 8,904,134 $ 8,899,659
Available for sale, at fair value 316,099,281 80,832,097
------------- -------------
Total fixed maturities 325,003,415 89,731,756
Mortgage loans 98,238 --
Policy loans 3,805,942 94,432
------------- -------------
Total investments 328,907,595 89,826,188
Cash and cash equivalents 28,154,519 15,031,058
Cash and cash equivalents - restricted 4,601,423 4,345,322
Accrued investment income 4,966,553 1,343,297
Premiums receivable 5,948,586 2,203,690
Note receivable 7,467,516 7,367,556
Reinsurance receivable 279,211,066 41,417,031
Deferred acquisition costs 7,457,765 3,809,737
Value of business acquired 16,234,476 --
Goodwill 23,055,247 --
Property and equipment, net 14,478,150 10,061,688
Deferred federal income taxes 5,742,740 1,409,479
Other assets 9,021,913 3,418,089
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Total assets $ 735,247,549 $ 180,233,135
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Future policy benefits, losses and claims $ 367,513,840 $ 22,717,862
Unearned premiums 29,501,977 2,023,436
Other policy claims and benefits payable 131,653,346 72,371,769
------------- -------------
528,669,163 97,113,067
Deferred reinsurance gain 25,131,800 13,400,000
Other policyholders' funds 11,589,314 8,845,829
Federal income taxes payable 7,502,631 1,105,834
Long term debt 40,000,000 --
Mortgage note payable 8,253,355 8,283,884
Reinsurance payable 22,513,821 2,993,400
Commissions payable 6,541,274 2,978,140
Drafts outstanding 5,294,223 --
Other liabilities 31,072,153 9,677,267
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Total liabilities 686,567,734 144,397,421
Shareholders' equity:
Non-voting preferred shares, $.001 par value, 2,000,000 shares
authorized, none issued -- --
Common shares, $.001 par value, authorized 30,000,000 shares, issued
and outstanding 13,497,732 in 1999 and 11,495,172 in 1998 13,498 11,495
Additional paid-in capital 58,908,234 43,883,357
Retained earnings (deficit) (6,930,999) (9,154,986)
Accumulated other comprehensive (loss) income (3,310,918) 1,095,848
------------- -------------
Total shareholders' equity 48,679,815 35,835,714
------------- -------------
Total liabilities and shareholders' equity $ 735,247,549 $ 180,233,135
============= =============
</TABLE>
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<PAGE> 4
<TABLE>
<CAPTION>
CERES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
1999 1998
------------ ------------
<S> <C> <C>
REVENUES:
Premiums:
Direct $ 115,650,002 $ 65,933,006
Assumed 30,562,615 --
Ceded (75,876,892) (29,770,075)
------------- -------------
Net premiums 70,335,725 36,162,931
Net investment income 4,778,002 1,950,675
Net realized gains (losses) 63,143 (9,097)
Other income 1,989,273 --
Amortization of deferred reinsurance gain 1,268,200 --
------------- -------------
78,434,343 38,104,509
------------- -------------
BENEFITS, LOSSES AND EXPENSES:
Benefits, claims, losses and settlement expenses 50,210,035 30,642,992
Underwriting, acquisition and insurance expenses 27,279,054 8,952,507
Net amortization and change in deferral of acquisition
costs and value of business acquired (3,053,504) 1,715
Interest expense and financing costs 577,240 865,406
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75,012,825 40,462,620
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Income (loss) before federal income taxes 3,421,518 (2,358,111)
Federal income tax expense 1,197,531 --
============= =============
Net income (loss) $ 2,223,987 $ (2,358,111)
============= =============
Earnings (loss) per common share:
Basic $.17 $(.56)
Diluted $.15 $(.56)
</TABLE>
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<PAGE> 5
<TABLE>
<CAPTION>
CERES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
OPERATING ACTIVITIES 1999 1998
------------- ------------
<S> <C> <C>
Net income (loss) $ 2,223,987 $ (2,358,111)
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Depreciation and amortization 151,035 235,339
Net realized (gains) losses (63,143) 9,097
Deferred federal income taxes (2,337,146) 70,563
Changes in assets and liabilities:
Restricted cash (256,101) (488,076)
Reinsurance and premiums receivable (238,624,316) (449,138)
Value of business acquired (405,476) --
Goodwill (5,221,273) --
Accrued investment income 516,865 (170,121)
Federal income taxes payable 4,771,446 --
Other assets (1,235,497) 772,153
Future policy benefits, claims and funds payable 214,918,729 12,505,842
Unearned premium 14,981,337 --
Reinsurance payable 19,520,421 --
Other liabilities 12,905,802 2,100,855
Policy acquisition costs deferred (3,648,028) --
Reinsurance gain deferred (1,268,200) --
------------- -------------
Net cash by operating activities 16,930,442 12,228,403
------------- -------------
INVESTING ACTIVITIES
Purchase of fixed maturities available-for-sale (973,150) (12,667,360)
Proceeds from sale of fixed maturities available-for-sale 2,065,683 --
Proceeds from calls and maturities of available-for-sale 3,859,374 5,452,245
Proceeds from calls and maturities of held-to-maturity 509,157
Acquisition of Continental General, net of $2,212,307 cash acquired (59,787,693) --
Net additions to furniture and equipment 337,154 354,169
Net purchase of investments - short-term -- (1,541,666)
Other (956) 1,611
------------- -------------
Net cash provided used in investing activities (54,499,588) (7,891,844)
------------- -------------
FINANCING ACTIVITIES
Increase in annuity account balances 2,998,420 142,830
Decrease in annuity account balances (7,202,204) (1,207,330)
Increase in note receivable (99,960) --
Principal payments on mortgage note payable (30,529) (27,773)
Proceeds from long-term debt 40,000,000 --
Proceeds from private equity placement 15,026,880 --
Reinsurance ceding allowance, net -- (2,628,965)
------------- -------------
Net cash provided by (used in) financing activities 50,692,607 (3,721,238)
------------- -------------
Net increase in cash 13,123,461 615,321
Cash and cash equivalents at beginning of year 15,031,058 5,632,459
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 28,154,519 $ 6,247,780
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash and cash equivalents paid during the period for interest $ 459,080 $ 865,406
Cash and cash equivalents paid during the period for income taxes $ 900,000 --
</TABLE>
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<PAGE> 6
CERES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Periods ended March 31, 1999 and 1998
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K/A for the fiscal
year ended December 31, 1998. The condensed consolidated financial statements
for March 31, 1999 include the accounts of Provident American Life and Health
Insurance Company ("PALHIC") acquired December 31, 1998 and Continental General
Corporation ("Continental") acquired on February 17, 1999. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The consolidated results
for the three months ended March 31, 1999 are not necessarily indicative of the
results to be expected for the fiscal year ending December 31, 1999.
Note 2 - Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income, which requires that an enterprise classify items
of other comprehensive income, as defined therein, by their nature in the
financial statements and display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in capital in the
equity section of the balance sheet. The Company adopted SFAS No. 130 in the
first quarter of 1998. The principal difference between net income as
historically reported in the consolidated statements of income and comprehensive
income is unrealized gains or losses on securities recorded in shareholders'
equity. Comprehensive loss is as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
------------------- --------------------
<S> <C> <C>
Net income (loss) $ 2,223,987 $ (2,358,111)
Unrealized (loss) gain on securities (4,448,459) 142,981
Reclassification adjustment
for gains (losses) included in
net income 41,693 (6,004)
------------------- --------------------
Comprehensive loss $ (2,182,779) $ (2,221,134)
=================== ====================
</TABLE>
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<PAGE> 7
Note 3 - Reinsurance
The Company has entered into several quota-share reinsurance treaties with
Reassurance Company of Hannover ("Hannover") on various blocks of business of
its subsidiary life insurance companies. Under the provisions of the treaties,
the Company cedes between 50% and 80% of the premiums for these policies and in
return receives reimbursement, for the same percentage, of the claims. In
addition, the Company receives a commission and expense allowance. In other
reinsurance arrangements with other reinsurers the Company also assumes certain
policies, in which it paid certain commission and expense allowances which are
classified as reinsurance expenses below. The following table summarizes the net
impact of reinsurance arrangements on benefits, claims, losses and settlement
expenses, commissions, and other operating expenses:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
------------------ ------------------
<S> <C> <C>
Benefits, claims, losses and
settlement expenses $ 85,035,984 $ 53,970,316
Reinsurance recoverable (34,825,949) (23,327,324)
------------------ ------------------
Net $ 50,210,035 $ 30,642,992
================== ==================
Underwriting, acquisition and
insurance expenses:
Commissions $ 16,641,284 $ 9,153,165
Other operating expenses 17,417,928 7,898,249
Reinsurance expenses 10,261,542 -
Reinsurance allowances (17,041,700) (8,098,907)
------------------ ------------------
$ 27,279,054 $ 8,952,507
================== ==================
</TABLE>
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<PAGE> 8
Note 4 - Computation of Net Income (Loss) Per Common Share
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
--------------------- ------------------
<S> <C> <C>
Basic
Average common shares
outstanding 12,829,359 4,195,172
===================== ==================
Net income (loss) $2,223,987 ($2,358,111)
===================== ==================
Net income (loss) per
common share $.17 $(.56)
===================== ==================
Diluted
Average common shares
outstanding 12,829,359
Warrants/stock options -
treasury stock method 2,349,954
---------------------
Weighted average shares 15,179,313
=====================
Net income $2,223,987
=====================
Net income per common share $.15
=====================
</TABLE>
Net income (loss) per common share has been computed in accordance with
Statement of Financial Accounting Standards (SFAS) No. 128. In computing diluted
earnings per share, only potential common shares that are dilutive, those that
reduce earnings per share, are included. The exercise of options and warrants is
not assumed if the result would be antidilutive, such as when a loss from
continuing operations is reported. The Company reported such a loss in the first
quarter of 1998, therefore, the basic and diluted (loss) per share are the same.
Note 5 - Federal Income Taxes
The federal income tax returns for the Company and its subsidiaries have been
examined by the Internal Revenue Service ("IRS") for 1991 and 1992. During the
third quarter of 1994, the IRS issued a proposal for adjustments to the
Company's returns for 1991 and 1992. The proposed deficiencies were
approximately $2.4 million of which $215,303 was paid in 1994 and $590,000 was
paid in 1997. The balance of approximately $1.6 million relates to whether or
not the Company's original principal operating subsidiary, Central Reserve Life
Insurance Company ("Central"), qualified as a life company for tax purposes. The
Company is vigorously protesting the proposed deficiency. Based on discussions
with counsel, management believes existing law supports the Company's position.
Therefore, the Company has not recorded a liability for the difference.
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<PAGE> 9
If the IRS were to prevail in its position that Central no longer qualified as a
life company for tax purposes, approximately $2.6 million of tax and interest
would be payable and federal income taxes would increase in the future relative
to those years that remain open for IRS examination. A small life company having
less than $500 million in total assets, is permitted, among other things, a
deduction from the first $3.0 million of income of 60% or $1.8 million.
Note 6 - Acquisition
On February 17, 1999, the Company acquired 100% of the outstanding common stock
of Continental from the Western & Southern Life Insurance Company, a mutual life
insurance company domiciled in Ohio. Continental is a holding company that
primarily conducts business through its wholly-owned subsidiary, Continental
General Insurance Company ("CGIC"), a life and accident and health insurer
domiciled in Nebraska and licensed in 49 states. Total consideration paid by the
Company for the common stock was $84.5 million. The transaction was financed
through reinsurance, debt, cash, and an equity offering as described below of
$62.0 million and a dividend received from CGIC of $22.5 million. The
transaction was accounted for in accordance with the purchase method.
Effected February 17, 1999, CGIC entered into a reinsurance treaty with
Hannover, whereby CGIC ceded 50% of its in force life, accident and health, and
annuity policies to Hannover, and retained the remaining risk. The treaty
provides an initial ceding allowance of $13.0 million which was accounted for as
a deferred reinsurance gain.
On February 17, 1999, the Company entered into a $40.0 million credit facility
with a syndicate of major commercial banks. In accordance with the terms of the
loan, the first principal payment of $3.0 million is due February 17, 2000.
Quarterly payments are due thereafter as follows: $1.0 million through February
17, 2001; $1.5 million thereafter through February 17, 2002; and $2.25 million
every three months thereafter to February 17, 2005. The loan bears interest at a
variable rate (approximately 8.47% at March 31, 1999). The Company has pledged
the common stock of Continental and Central as security for the loan. The credit
facility prohibits the payment of dividends upon the Company's common stock,
except upon compliance with certain conditions.
Effective February 17, 1999, the Company entered into a series of stock
subscription agreements with a group of investors, principally Insurance
Partners, L.P. and Insurance Partners Offshore (Bermuda), L.P., both of which
were stockholders prior to the offering, wherein the Company issued 2,000,000
common shares at $7.50 per share for $15,000,000.
Note 7 - Operating Segments
The Company has identified three distinct operating segments based upon product
types, as follows: health and group life, life insurance and annuities, and
corporate and other.
Products included in the health and group life segment include Medicare
supplement, long-term care, disability, short-term major medical insurance
products and comprehensive major medical plans. Group life policies are included
in this segment because such policies are issued only in
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<PAGE> 10
conjunction with health insurance policies, and the costs of administering those
policies are incidental to the administration of the related health policies.
Products included in the life and annuity segment include universal life,
ordinary life, term insurance and annuity products. Such products are segregated
from the health and group life segment based upon significant differences in the
sales and administration of such policies, including the underwriting and claims
adjudication process.
The corporate and other segment encompasses all other activities of the
organization, including interest income and expense of the parent company.
Revenues from each segment are primarily generated from premiums charged to
external policyholders and interest earned on cash and investments, and are
summarized in the following tables:
<TABLE>
<CAPTION>
1999 1998
------------------ ------------------
<S> <C> <C>
Health and group life
Revenues $ 74,987,850 $ 37,472,864
Benefits, claims and expenses (70,561,999) (38,999,899)
------------------ ------------------
Segment profit (loss) before federal income taxes $ 4,425,851 $ (1,527,035)
------------------ ------------------
Life and annuity
Revenues $ 3,215,113 $ 602,076
Benefits, claims and expenses (3,236,304) (669,011)
------------------ ------------------
Segment loss before federal income taxes $ (21,191) $ (66,935)
------------------ ------------------
Corporate and other
Revenues $ 231,380 $ 29,569
Interest and operating expenses (1,214,522) (793,710)
------------------ ------------------
Segment loss before federal income taxes $ (983,142) $ (764,141)
------------------ ------------------
</TABLE>
The Company does not separately allocate investment or other identifiable assets
by industry segment, nor are income tax (benefits) expenses allocated by
industry segment.
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<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL: The Company is a holding company, which through its subsidiaries,
specializes in individual and small group health insurance and senior age life
and health insurance. In February 1999, the Company completed the acquisition of
Continental which provided it with immediate access to the senior age market for
life and health insurance. The financial information for the first quarter of
1999 includes the operations of Continental for February and March. Also
included in the first quarter of 1999 are the financial operations of Provident
American Life and Health Insurance Company ("PALHIC") which was acquired
December 31, 1998.
On March 18, 1999, Central announced the execution of an agreement with United
Benefit Managed Care Corporation ("United Benefit") to purchase all of the
outstanding shares of its subsidiary, United Benefit Life Insurance Company
("UBL"), a life and health insurer in Texas. The agreement is subject to board
of directors' approval and approval by the shareholders of United Benefit, and
is also subject to Central's due diligence, as well as other customary terms and
conditions. There is no assurance that the transaction will be closed. In August
1998, Central entered into an agreement with UBL to reinsure 100% of the major
medical policies of UBL. Concurrently therewith, Central ceded 80% of the
business to Hannover.
RESULTS OF OPERATIONS: During the quarter ending March 31, 1999, net premiums
were $70.3 million, up 94% from $36.2 million in the same quarter in 1998. The
increase includes $17.4 million of CGIC's premiums and $13.0 million of net
premiums assumed under the reinsurance agreement with UBL entered into August
1998. The balance of $3.0 million represents an increase in Central's business
in addition to rate increases.
Net investment income increased to $4.8 million or 144% during the first quarter
of 1999 from $2.0 million in the first quarter of 1998. CGIC's portion of the
increase was $2.7 million. Central's net investment income increased slightly
during the quarter from the same period in 1998.
Other income increased to $2.0 million for the quarter ending March 31, 1999 and
consisted of $1.7 million in administrative fees for business reinsured through
PALHIC and UBL. The balance represents interest received on promissory notes.
The amortization of deferred reinsurance gain of $1.3 million represents the
recognition of the ceding commission allowances received on the Company's
reinsurance contracts. The unamortized amount of $25.1 million is accounted for
as a deferred reinsurance gain on the consolidated condensed balance sheet.
Benefits, claims and settlement expenses increased to $50.2 million for the
quarter ending March 31, 1999 compared to $30.6 million for the same quarter in
1998. This represents a net benefit expense ratio as a percentage of premium of
71% compared to 85% in the first quarter of 1998. This figure also includes $2.1
million of benefits and claims incurred on the life and annuity segment of CGIC
for the months of February and March, 1999. Benefits, claims and settlement
expenses of Central of $35.3 million, were 68% in the first quarter of 1999
compared to 85% in the first quarter of 1998.
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<PAGE> 12
Cost reduction and benefit programs implemented in 1998 such as rating actions,
underwriting changes, claim procedures and additional managed care led to the
reduction in the benefit ratios.
Underwriting, acquisition and insurance expenses increased to $27.3 million in
the first quarter of 1999 compared to $9.0 million for the same period in 1998.
Of this amount, commissions for the quarter ending March 31, 1999 were $16.6
million compared to $9.1 million in the first quarter of 1998. Included in the
1999 commissions is $7.0 million for CGIC. The remaining increase of $500,000
represents the increase in commissions for Central. This increase was due to the
combination of higher commission rates and an increase in new business sold in
1999. Other operating expenses increased to $17.4 for the quarter ending March
31, 1999 compared to $7.9 for the same quarter in 1998. CGIC accounts for $5.0
million of the $9.5 million increase. The Company also incurred costs of $1.0
million for the operations of PALHIC in the first quarter of 1999. The remaining
increase is primarily due to additional costs incurred for the outsourcing of
computer operations, consulting support, acquisitions, and product development
to help support the Company's increased growth.
The net amortization and deferral of acquisition costs and value of business
acquired resulted in a net deferral of $3.1 million in the first quarter of 1999
compared to a net amortization of $1,715 in the same quarter of 1998. CGIC
accounts for $1.9 million of the deferral. The significant increase in sales of
new products written by Central, PALHIC, and UBL and the resulting increase in
excess first year expenses accounts for the remaining balance.
Interest expense and financing costs were reduced to $577,210 the first quarter
of 1999 compared to $865,406 in the first quarter of 1998 as a result of the
repayment of the $20.0 million loan in July 1998. In 1999, interest expense on
the $40.0 million loan under the Company's Credit Facility began to accrue on
February 17, 1999, the closing date of the purchase of CGIC.
A provision for federal income taxes of $1.2 million or 35% of income before
federal taxes of $3.4 million was established for the period.
Net income for the first quarter of 1999 was $2.2 million or $.17 basic earnings
per share and $.15 diluted earnings per share compared to a loss from operations
of $2.4 million and $.56 loss per share on both a basic and diluted basis for
the same period in 1998. The change in results are primarily due to: a
significant increase in revenues resulting from acquisitions and increased gross
premium writings; and decreased benefit, claim and settlement expenses as a
percentage of premiums resulting from rating actions, underwriting changes,
claim procedures, and added managed care programs.
OPERATING SEGMENT INFORMATION: The Company has identified three distinct
operating segments based upon product types, as follows: health and group life,
life insurance and annuities, and corporate and other.
Products included in the health and group life segment include Medicare
supplement, long-term care, disability, short-term major medical insurance
products and comprehensive major medical plans. Group life policies are included
in this segment because such policies are issued only in conjunction with health
insurance policies, and the costs of administering those policies are incidental
to the administration of the related health policies.
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<PAGE> 13
Products included in the life and annuity segment include universal life,
ordinary life, term insurance, and annuity products. Such products are
segregated from the health and group life segment based upon significant
differences in the sales and administration of such policies, including the
underwriting and claims adjudication process.
The corporate and other segment encompasses all other activities of the
organization, including interest income and expense of the parent company.
The health and group life segment had net revenues of $75.0 million in the first
quarter of 1999 compared to $37.5 million in 1998. The major reasons for the
increase of approximately $38 million is due to the addition of approximately
$17.0 million from CGIC and $13.0 million of assumed premiums in 1999. The
remaining increase was for premium increases in Central and the collection of
fees for administrating the reinsured business assumed. Total benefits, claims
and expenses for the health and group life segment were $70.6 million in 1999
and $39.0 million in 1998. The increase includes approximately $16 million of
benefits, claims and expenses for CGIC. The remaining increase of $15 million is
primarily due to claims and expenses related to the UBL business assumed in
August 1998.
The life and annuity segments had revenues of $3.2 million for the first quarter
in 1999 compared to $602,076 in 1998. The increase is entirely attributed to the
Continental business acquired in February 1999. Benefits, claims and expenses
were $3.2 million for 1999 compared to $669,011 in 1998. Again, the increase is
attributed to CGIC.
Corporate and other revenues were $231,380 for 1999 compared to $29,569 for
1998. The increase was primarily due to $124,232 for and interest income of the
Company. The increase in interest and operating expenses to $1.2 million in 1999
from $793,710 in 1998 was primarily due to benefit charges for certain stock
awards.
LIQUIDITY AND CAPITAL RESOURCES: Liquidity is the ability of an enterprise to
generate adequate amounts of cash to meet its financial commitments. The major
needs for cash are to enable the insurance subsidiaries to pay claims and
expenses as they come due. The primary sources of cash are premiums and
investment income. The Company's payments consist of current claim payments to
insureds, managed care expenses, operating expenses such as salaries, employee
benefits, commissions, taxes, and interest on debts. The Company has, in the
past, relied on the dividend from Central to enable it to pay dividends to
shareholders.
The Company discontinued paying dividends on its common stock at the end of
1996. By statute, the state regulatory authorities set minimum liquidity
standards to protect both policyholders and shareholders and limit the dividends
payable by the insurance subsidiaries to the Company.
Approximately 45% of the Company's assets are in investments, which were $328.9
million at March 31, 1999. Fixed maturities are the primary investment of the
Company and were $325.0 million or 99% of total investments at March 31, 1999.
Other investments consist of policy loans and mortgage loans. The Company is
carrying fixed maturities of $8.9 million at amortized cost (held to maturity)
and fixed maturities of $316.1 million at estimated fair value
-13-
<PAGE> 14
(available for sale) at March 31, 1999. The Company does not hold any so-called
"junk" bonds or what are generally considered high-yield type securities, and
100% of the bonds are of investment grade quality. In addition to the fixed
maturities, the Company also had $28.2 million in cash and cash equivalents at
March 31, 1999 and a $10 million line of credit with a major bank.
Assets increased to $730.4 million or 305%, from $180.2 million at December 31,
1998. This increase of $550 million was primarily due to the acquisition of
CGIC, which had assets of $524.9 million at March 31, 1999. The remaining
increase is attributable to the acquisition of PALHIC. These increases were, in
part, offset by a related increase in liabilities of $538.0 million during the
quarter to $682.6 million. CGIC's liabilities were $466.7 million and PALHIC's
were $27.2 million at March 31, 1999. The two major items of the total assets of
the Company continue to be investments (45%) and reinsurance receivable (38%).
The total policy liabilities and accruals ("reserves") was 77% of the total
liabilities at March 31, 1999, compared to 67% at March 31, 1998.
CGIC accounted for 78% of the reserves at March 31, 1999.
To provide funds for the acquisition of CGIC, the Company incurred a debt of $40
million under a Credit Agreement. The first principal payment of $3.0 million is
due February 17, 2000. Quarterly payments are due thereafter starting with $1.0
million through February 17, 2001; $1.5 million thereafter through February 17,
2002; and $2.25 million every three months thereafter to February 17, 2005.
Interest on the outstanding balance will be variable and based on whether the
Company selects a "Base Rate Loan" or a "Eurodollar Loan." At March 31, 1999 the
interest rate was 8.47%. The Credit Agreement also provides for a $10 million
line of credit which bears interest at the same rate as the $40 million loan.
There is currently no amount outstanding under the line of credit.
The Credit Agreement contains financial and other covenants with respect to the
Company that, among other matters: (1) prohibit the payment of cash dividends on
the Company's common stock, except upon compliance with certain conditions; (2)
restrict the creation of liens and sales of assets; and (3) require that the
Company maintain certain ratios. In addition, the Company has pledged the
common stock of Continental, Central and other insignificant subsidiaries as
security for the Credit Agreement. At March 31, 1999 the Company was in
compliance with the covenants contained in the Credit Agreement.
The Company believes that cash flow from operating activities will be sufficient
to meet its currently anticipated operating and capital expenditure
requirements. If additional funds are required for long-term growth, the Company
believes that these funds could be obtained through equity or debt offerings as
market conditions permit or dictate. There is no assurance that the Company will
be able to obtain such financing on terms that are favorable to the Company.
MARKET RISK AND MANAGEMENT POLICIES: The following is a description of certain
risks facing life and accident and health insurers and how the Company mitigates
those risks:
Legal/Regulatory Risk is the risk that changes in the legal or regulatory
environment in which an insurer operates will create additional expenses not
anticipated by the insurer in pricing its products. That is, regulatory
initiatives designed to reduce insurer profits or otherwise affecting the
industry in which the insurer operates, new legal theories or insurance company
insolvencies
-14-
<PAGE> 15
through guaranty fund assessments, may create costs for the insurer beyond those
recorded in the financial statements.
The Company attempts to mitigate this risk by offering a wide range of products
and by operating in many states, thus reducing its exposure to any single
product of non-Federal jurisdiction, and also by employing underwriting
practices which identify and minimize the adverse impact of this risk.
Inadequate Pricing Risk is the risk that the premium charged for insurance and
insurance related products is insufficient to cover the costs associated with
the distribution of such products which include: benefits, claims and losses,
settlement expenses, acquisition expenses and other corporate expenses. The
Company utilizes a variety of actuarial and/or qualitative methods to set such
pricing levels.
Credit Risk is the risk that issuers of securities owned by the Company will
default or that other parties, including reinsurers that have obligations to the
Company, will not pay or perform. The Company attempts to minimize this risk by
adhering to a conservative investment strategy and by maintaining sound
reinsurance and credit and collection policies.
Interest Rate Risk is the risk that interest rates will change and cause a
decrease in the value of an insurer's investments. This change in rates may
cause certain interest-sensitive products to become uncompetitive or may cause
disintermediation. The Company attempts to mitigate this risk by charging fees
for non-conformance with certain policy provisions and/or by attempting to match
the maturity schedule of its assets with the expected payouts of its
liabilities. To the extent that liabilities come due more quickly than assets
mature, an insurer would have to sell assets prior to maturity and recognize a
gain or loss. The Company also utilizes an outside investment advisor to monitor
its securities and provide investment advice.
IMPACT OF INFLATION: Inflation rates impact the Company's financial condition
and operating results in several areas. Changes in inflation rates impact the
market value of the investment portfolio and yields on new investments.
Inflation has had an impact on claim costs and overall operating costs and
although it has been lower in the last few years, hospital and medical costs
have still increased at a higher rate than general inflation, especially in
prescription drug costs. New, more-expensive and wider use of pharmaceuticals is
inflating health care costs. The Office of Personnel Management reported the
costs of prescription drugs increased by 22% in 1998. While to a certain extent
these increased costs are offset by interest rates (investment income), the rate
of income from investments has not increased proportionately. The Company will
continue to establish premium rates in accordance with trends in hospital and
medical costs along with concentrating on various cost containment programs.
However, there can be assurance that these efforts by the Company will fully
offset the impact of inflation or that premiums will equal or exceed increasing
health care costs.
-15-
<PAGE> 16
Year 2000 Update:
- -----------------
General - A comprehensive assessment of the Year 2000 ("Y2K") was completed in
1998 by the Company and its wholly-owned subsidiaries. The Company established a
plan for compliance of all information technology ("IT") systems and "non-IT"
systems, such as operating and control systems that rely on embedded computer
chips, to ensure accurate processing of date data for Y2K and beyond. The plan
also included the identification of key vendors and business partners and
obtaining assurances that their key systems are Y2K compliant. Total cost of the
project was estimated at $5.5 million. At the end of the first quarter of 1999,
incurred costs were $4.5 million. The estimated additional costs are currently
expected to be $1 million.
Status - The Company continues to execute its plan to ensure that all systems
are Y2K compliant and expects the IT systems to be completed by July 31, 1999
and the non-IT systems in the third quarter of 1999. This includes Continental,
which the Company believes had all its operating systems and applications Y2K
compliant as of December 31, 1998. The Company estimates that all testing should
be completed by July 31, 1999.
Ongoing Activity - The Company continues to follow-up with key vendors and
business partners on compliance assurances. Contingency planning continues for
the Company's systems regarding additional back-up protection as well as for key
vendors and business partners.
Risks - Management of the Company believes it has an effective program in place
to resolve the Year 2000 issue in a timely manner. As noted above, the Company
has not yet completed all necessary phases of the Year 2000 program. In the
event that the Company does not complete any additional phases and/or the
present system were to fail, the Company would be unable to continue important
operations as billing and collection, payroll operations and daily
administration of policyholder claims. In addition, disruptions in the economy
generally resulting from Year 2000 issues could be subject to litigation for
computer systems product failure, for example, equipment shutdown or failure to
properly date business records. The amount of potential liability and lost
revenue cannot be reasonably estimated at this time.
Summary - At this time, the Company is aware of no Y2K compliance issues that
will negatively impact the key business processes of the Company or its
affiliated companies. All Y2K compliance plan activities are scheduled to be
completed by the end of the third quarter of this year.
FORWARD-LOOKING STATEMENTS: This report contains both historical and
forward-looking statements. Forward-looking statements are statements other than
historical information or statements of current condition. The forward-looking
statements relate to the plans and objectives of the Company for future
operations. In addition to statements which are forward-looking by reason of
context, the words "believe," "expect," "anticipate," "intend," "designed,"
"goal," "objective," "optimistic," "will" and other similar expressions identify
forward-looking statements. In light of the risks and uncertainties inherent in
all future projections, the inclusion of the forward-looking statements should
not be regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved.
-16-
<PAGE> 17
Many factors could cause the Company's actual results to differ materially and
adversely from those in the forward-looking statements, including the following:
- the failure to successfully integrate the businesses of CGIC,
PALHIC or UBL into the Company, including the failure to achieve
cost consolidations;
- rising health care costs;
- business conditions and competition in the health care industry;
- developments in health care reform and other regulatory issues;
- changes in laws and regulations affecting the Company's business;
- adverse changes in interest rates;
- unforeseen losses with respect to loss and settlement expense
reserves for unreported and reported claims;
- the Company's ability to develop, distribute and administer
competitive products and services in a timely cost-effective
manner;
- the Company's visibility in the market place and its financial
and claims paying ratings;
- the costs of defending litigation and the risk of unanticipated
material adverse outcomes in such litigation, including the
litigation with the Internal Revenue Service;
- the performance of others on whom the Company relies for
reinsurance;
- the risk that issuers of securities owned by the Company will
default or that other parties will not pay or perform;
- changes in accounting and reporting practices;
- the failure to complete the Y2K conversion, including the success
of the outside vendors in being Y2K compliant;
- the effect of any future acquisitions; and
- the failure to comply with financial and other covenants in the
Company's loan agreements.
The foregoing review of important factors should not be construed as exhaustive
and should be read in conjunction with other cautionary statements that are
included in this report, including the risks detailed under "Market Risk and
Management Policies." The Company undertakes no obligation to update
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
--------------------------------------------------------------
The information called for by this item is provided under the caption "Market
Risk and Management Policies" under Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.
PART II - OTHER INFORMATION
All items of Part II other than Item 6 are either inapplicable to Registrant,
would not require a response, or have been previously reported.
-17-
<PAGE> 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits.
(27) Financial Data Schedule
b) Reports on Form 8-K.
Current report on Form 8-K dated December 31, 1998 announcing the
acquisition of Provident American Life and Health Insurance Company by
Central Reserve Life Insurance Company, a subsidiary of the Company,
filed January 11, 1999.
Attached as exhibits were:
99.1 Press release dated December 30, 1998, issued by the
Company.
Current report on Form 8-K dated February 17, 1999 announcing the
Company's acquisition of Continental General Corporation and its
wholly-owned insurance subsidiary, Continental General Insurance
Company, filed March 4, 1999.
Attached as exhibits were:
2.1 Stock Purchase Agreement dated as of November 4, 1998 between
The Western and Southern Life Insurance Company and Ceres
Group, Inc.
4.1 Form of Voting Agreement by and among Ceres Group, Inc. and
the security holders listed on the signature pages thereof
4.2 Form of Stockholders Agreement by and among Ceres Group, Inc.
and the security holders listed on the signature pages thereof
4.3 Form of Registration Rights Agreement between Ceres Group,
Inc. and the persons and entities set forth on the signature
pages attached thereto
4.4 Rights Agreement, dated as of February 17, 1999, between Ceres
Group, Inc. and the persons and entities set forth on the
signature pages attached thereto
10.1 Credit Agreement, dated as of February 17, 1999, among Ceres
Group, Inc., the lending institutions listed from time to time
on Annex I thereto and The Chase Manhattan Bank, as
Administrative Agent
-18-
<PAGE> 19
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CERES GROUP, INC.
Date: May 24, 1999 By: /s/ Charles E. Miller, Jr.
------------------- ----------------------------------------------
Charles E. Miller, Jr.
Executive Vice President and Chief Financial
Officer (Principal Financial Officer and
Chief Accounting Officer)
-19-
<PAGE> 20
EXHIBITS
--------
(27) Financial Data Schedule
-20-
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED
CONDENSED FINANCIAL STATEMENTS FOR THE FORM 10-Q FOR THE FIRST QUARTER ENDING
MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000215403
<NAME> CERES GROUP, INC.
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 316,099,281
<DEBT-CARRYING-VALUE> 8,904,134
<DEBT-MARKET-VALUE> 8,964,137
<EQUITIES> 0
<MORTGAGE> 98,238
<REAL-ESTATE> 0
<TOTAL-INVEST> 328,907,595
<CASH> 28,154,519
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 7,457,765
<TOTAL-ASSETS> 735,247,549
<POLICY-LOSSES> 367,513,840
<UNEARNED-PREMIUMS> 29,501,977
<POLICY-OTHER> 131,653,346
<POLICY-HOLDER-FUNDS> 11,589,314
<NOTES-PAYABLE> 48,253,355
0
0
<COMMON> 13,498
<OTHER-SE> 48,666,317
<TOTAL-LIABILITY-AND-EQUITY> 735,247,549
70,335,725
<INVESTMENT-INCOME> 4,778,002
<INVESTMENT-GAINS> 63,143
<OTHER-INCOME> 3,257,473
<BENEFITS> 50,210,035
<UNDERWRITING-AMORTIZATION> (3,053,504)
<UNDERWRITING-OTHER> 27,279,054
<INCOME-PRETAX> 3,421,518
<INCOME-TAX> 1,197,531
<INCOME-CONTINUING> 2,223,987
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,223,987
<EPS-BASIC> .17
<EPS-DILUTED> .15
<RESERVE-OPEN> 0
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