<PAGE> 1
Securities and Exchange Commission
Washington, D.C. 20549
FORM 8-K/A
(Amendment No. 1)
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report: February 17, 1999
(Date of earliest event reported)
Ceres Group, Inc.
(Exact Name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 0-8483 34-1017531
-------- ------ ----------
(State or other jurisdiction of (Commission File Number) (IRS Employer Identification Number)
Incorporation)
</TABLE>
17800 Royalton Road, Strongsville, Ohio 44136
--------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
(440) 572-2400
--------------
(Registrant's telephone number, including area code)
<PAGE> 2
Item 7. Financial Statements and Exhibits.
On March 4, 1999, Ceres Group, Inc. ("Ceres") filed a Form 8-K that
reported the acquisition of Continental General Corporation
("Continental") and its wholly-owned insurance subsidiary,
Continental General Insurance Company ("CGIC"), from the Western
and Southern Life Insurance Company of Cincinnati, Ohio, for $84.5
million in cash. In Item 7 of the Form 8-K, Ceres stated that the
audited financial statements of Continental and unaudited pro forma
financial information showing the effect of the acquisition would
be filed within 60 days of the filing of the Form 8-K. This Form
8-K/A is filed for the purpose of filing such financial statements.
(a) Financial Statements of the Business Acquired
---------------------------------------------
Audited financial statements of Continental for the years
ended December 31, 1998, 1997 and 1996.
(b) Pro Forma Financial Information
-------------------------------
Unaudited pro forma combined balance sheet of Ceres as of
December 31, 1998 and unaudited pro forma combined statement
of operations for the year ended December 31, 1998 giving
effect to the pro forma adjustments related to the
acquisition of Continental.
(c) Exhibit
--------
23 Consent of Ernst & Young LLP
1
<PAGE> 3
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 hereunto duly authorized.
Date: May 3, 1999 CERES GROUP, INC.
By: /s/ Charles E. Miller, Jr.
------------------------------------
Chief Financial Officer
2
<PAGE> 4
EXHIBIT
23 Consent of Ernst & Young LLP
3
<PAGE> 5
Report of Independent Auditors
Board of Directors
Continental General Corporation
We have audited the accompanying consolidated balance sheets of Continental
General Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, changes in shareholder's equity,
and cash flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Continental
General Corporation and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
April 16, 1999
4
<PAGE> 6
<TABLE>
<CAPTION>
Continental General Corporation and Subsidiaries
Consolidated Balance Sheets
DECEMBER 31
1998 1997
---------------------------------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities, available-for-sale,
at fair value $ 425,117,535 $ 390,958,799
Mortgage loans 4,725,828 4,868,590
Surplus notes 4,986,199 4,983,741
Policy loans 3,732,503 3,433,296
---------------------------------------
Total investments 438,562,065 404,244,426
Cash and cash equivalents 3,971,549 3,986,172
Cash and cash equivalents--restricted 400,000 400,000
Accrued investment income 6,772,813 6,587,691
Premiums receivable 2,717,469 2,180,796
Deferred acquisition costs 39,265,710 41,204,312
Value of business acquired 10,816,747 12,748,673
Reinsurance receivable 290,105 240,826
Property and equipment, net 3,800,734 3,864,027
Other assets 1,294,197 1,394,442
---------------------------------------
TOTAL ASSETS $ 507,891,389 $ 476,851,365
=======================================
</TABLE>
5
<PAGE> 7
<TABLE>
<CAPTION>
1998 1997
---------------------------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Policy liabilities and accruals:
Future policy benefits, losses and claims $ 343,203,940 $ 313,017,935
Unearned premiums 27,105,725 24,229,538
Other policy claims and benefits payable 33,182,811 27,262,234
---------------------------------------
403,492,476 364,509,707
Notes payable to Western and Southern Life
Insurance Company 11,819,602 11,819,602
Deferred federal income taxes 7,315,246 11,402,373
Drafts outstanding 5,413,878 3,826,921
Federal income taxes payable 161,864 882,254
Accrued commissions, expenses and taxes 4,484,248 3,994,198
Other liabilities 7,592,861 5,308,914
---------------------------------------
Total liabilities 440,280,175 401,743,969
---------------------------------------
Shareholder's equity:
Common shares, $.01 par value,
6,500,000 shares authorized;
4,301,176 shares issued and outstanding 43,012 43,012
Additional paid-in capital 6,396,653 6,396,653
Retained earnings 52,435,093 61,028,679
Accumulated other comprehensive income 8,736,456 7,639,052
---------------------------------------
Total shareholder's equity 67,611,214 75,107,396
---------------------------------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 507,891,389 $ 476,851,365
=======================================
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 8
<TABLE>
<CAPTION>
Continental General Corporation and Subsidiaries
Consolidated Statements of Operations
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------------------------------
<S> <C> <C> <C>
REVENUES
Premiums:
Direct $ 193,709,704 $ 165,321,968 $ 127,804,257
Assumed 623,444 640,533 704,030
Ceded (3,608,505) (3,782,262) (3,469,928)
------------------------------------------------------
190,724,643 162,180,239 125,038,359
Net investment income 29,408,351 26,931,334 23,483,849
Net realized gains 730,240 432,512 3,044,231
Other income 1,948,045 2,036,309 2,261,863
------------------------------------------------------
Total revenues 222,811,279 191,580,394 153,828,302
BENEFITS, LOSSES AND EXPENSES
Benefits, claims, losses and settlement expenses 164,140,622 135,368,328 98,429,204
Underwriting, acquisition and operating expenses 52,722,205 48,715,713 39,024,432
Amortization of deferred acquisition costs 17,171,385 12,360,165 9,462,031
Interest expense 709,200 845,600 545,600
------------------------------------------------------
234,743,412 197,289,806 147,461,267
------------------------------------------------------
(Loss) income before federal income taxes (11,932,133) (5,709,412) 6,367,035
Federal income tax (benefit) expense (4,123,689) (1,965,082) 2,265,725
------------------------------------------------------
NET (LOSS) INCOME $ (7,808,444) $ (3,744,330) $ 4,101,310
======================================================
Basic and diluted (loss) earnings per common share $ (1.82) $ (.87) $ .95
Basic and diluted weighted-average common shares
outstanding 4,301,176 4,301,176 4,301,176
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 9
<TABLE>
<CAPTION>
Continental General Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholder's Equity
Accumulated
Additional Other Total
Common Paid in Retained Comprehensive Shareholder's
Stock Capital Earnings Income (Loss) Equity
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 43,012 $ 6,396,653 $ 62,765,411 $ 10,701,473 $ 79,906,549
Cash dividends paid (1,046,856) (1,046,856)
Comprehensive loss:
Net income 4,101,310 4,101,310
Other comprehensive income, net:
Unrealized holding loss on
securities (6,669,459) (6,669,459)
Reclassification adjustment for
gains included in operations (1,978,750) (1,978,750)
-----------
Other comprehensive loss (8,648,209)
-----------
Comprehensive loss (4,546,899)
----------------------------------------------------------------------------------
Balance, December 31, 1996 43,012 6,396,653 65,819,865 2,053,264 74,312,794
Cash dividends paid (1,046,856) (1,046,856)
Comprehensive income:
Net loss (3,744,330) (3,744,330)
Other comprehensive income, net:
Unrealized gain on securities 5,866,921 5,866,921
Reclassification adjustment for
gains included in operations (281,133) (281,133)
-----------
Other comprehensive income 5,585,788
-----------
Comprehensive income 1,841,458
----------------------------------------------------------------------------------
Balance, December 31, 1997 43,012 6,396,653 61,028,679 7,639,052 75,107,396
Cash dividends paid (785,142) (785,142)
Comprehensive loss:
Net loss (7,808,444) (7,808,444)
Other comprehensive income, net:
Unrealized gain on securities 1,572,060 1,572,060
Reclassification adjustment for
gains included in operations (474,656) (474,656)
-----------
Other comprehensive income 1,097,404
-----------
Comprehensive loss (6,711,040)
----------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ 43,012 $ 6,396,653 $ 52,435,093 $ 8,736,456 $ 67,611,214
==================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
8
<PAGE> 10
Continental General Corporation and Subsidiaries
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net (loss) income (7,808,444) (3,744,330) 4,101,310
Adjustments to reconcile net (loss) income to cash
provided by operating activities:
Depreciation and amortization (446,704) (140,463) (3,579)
Deferral of acquisition costs (18,832,783) (20,872,708) (14,387,284)
Amortization of deferred acquisition costs and value of business acquired 19,103,311 14,091,976 9,462,031
Deferred federal income taxes (4,678,038) (3,163,979) (2,639,666)
Changes in assets and liabilities:
Cash and cash equivalents-restricted - - (50,000)
Federal income tax payable (720,390) (3,718,878) (1,477,824)
Premiums receivable (536,673) (83,545) (176,572)
Reinsurance receivable (49,279) 54,308 71,819
Accrued investment income (185,122) (1,096,677) (1,156,995)
Other assets 100,244 18,220 1,008,106
Insurance liabilities 36,733,927 36,196,776 21,677,938
Outstanding drafts 1,586,957 574,348 484,059
Accrued commissions, expenses and taxes 275,656 333,431
Other liabilities 2,773,997 17,274 8,980,734
------------------------------------------
Net cash provided by operating activities 27,041,003 18,407,978 26,227,508
INVESTING ACTIVITIES
Purchases of fixed maturities available-for-sale (66,721,166) (62,371,612) (68,835,395)
Net change in policy loans (299,207) (137,864) (478,724)
Proceeds from sales of fixed maturities available-for-sale 38,294,991 20,504,486 16,130,167
Proceeds from sale of surplus note 1,061,006
Purchases of mortgage loans - (3,754,219) -
Proceeds from paydowns on mortgage loans 142,762 55,058 1,182,878
Net disposals of furniture, fixtures and electronic data processing equipment 63,293 189,353 34,529
------------------------------------------
Net cash used in investing activities (28,519,327) (45,514,798) (50,905,539)
FINANCING ACTIVITIES
Increase in notes payable to Western and Southern Life Insurance Company - 5,000,000 -
Dividends paid (785,142) (1,046,856) (1,046,856)
Policyholder account deposits 26,692,485 39,656,599 37,948,796
Policyholder account withdrawals (24,443,643) (16,856,521) (13,207,054)
------------------------------------------
Net cash provided by financing activities 1,463,700 26,753,222 23,694,886
Net decrease in cash and cash equivalents (14,624) (353,598) (983,145)
Cash and cash equivalents at beginning of year 4,386,172 4,739,770 5,722,915
------------------------------------------
Cash and cash equivalents at end of year 4,371,548 4,386,172 4,739,770
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE> 11
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
A. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
SUMMARY OF BUSINESS
Continental General Corporation, a wholly-owned subsidiary of The Western and
Southern Life Insurance Company ("Western and Southern"), operates primarily
through its wholly-owned subsidiary, Continental General Insurance Company
("CGIC"). CGIC is a stock life insurance company domiciled in Nebraska. CGIC
offers Medicare supplement and individual major medical products, distributed
through independent agents. CGIC also offers long-term care, ordinary life,
universal life, and annuity products. CGIC is licensed in 49 states and the
District of Columbia. Approximately 59% of premium volume is generated from
seven states: Florida, Georgia, Minnesota, Nebraska, Illinois, Texas and
Wisconsin.
SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of
Continental General Corporation and its wholly-owned subsidiaries (collectively,
the "Company"). All intercompany transactions have been eliminated in
consolidation.
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP"), which differ from accounting
practices prescribed or permitted by the Nebraska Department of Insurance (see
Note H) A summary of significant accounting policies is as follows:
INVESTMENTS
Available-for-sale bonds, equity securities, and non-redeemable preferred
stocks are reported at fair value. Changes in fair values of available-for-sale
securities, after adjustment of deferred acquisition costs ("DAC"), if any, and
deferred income taxes, are reported as unrealized appreciation or depreciation
directly in shareholder's equity under accumulated other comprehensive income
and, accordingly, have no effect on operations. DAC offsets to the unrealized
appreciation or depreciation represent valuation adjustments or reinstatements
of DAC that would have been required as a charge or credit to operations had
such unrealized amounts been realized.
Premiums and discounts arising from the purchase of mortgage-backed securities
are amortized using the interest method over the estimated remaining term of the
securities, adjusted for anticipated prepayments.
10
<PAGE> 12
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
A. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
Realized gains and losses on the sale of investments are determined using the
specific-identification method.
The estimated fair value of investments is based upon quoted market prices,
where available, or on values obtained from independent pricing services.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and all highly liquid securities with
maturities of 90 days or less when purchased. Cash and cash
equivalents-restricted includes amounts held on deposit with various state
insurance departments to satisfy regulatory requirements.
DEFERRED ACQUISITION COSTS
The costs (principally commissions) of acquiring traditional life,
interest-sensitive products and accident and health contracts, certain expenses
of the policy issue and underwriting department, and certain agency expenses,
all of which vary with and are primarily related to the production of new
business, have been deferred. Deferred acquisition costs of traditional life and
accident and health contracts are amortized over the premium payment period of
the related policies using the same assumptions as were used for computing
liabilities for future policy benefits, together with appropriate expense
assumptions. For interest-sensitive life products, deferred acquisition costs
are amortized over the lives of the policies in relation to the present value of
estimated gross profits from surrender charges and investment, mortality and
expense margins. Policy acquisition costs deferred were $18,832,783 in 1998,
$20,872,708 in 1997 and $14,387,284 in 1996. Of the policy acquisition costs
deferred, commissions represented 58.4% in 1998, 60.3% in 1997 and 62.3% in
1996.
11
<PAGE> 13
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
A. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
VALUE OF BUSINESS ACQUIRED
A portion of the purchase price paid for the Company by Western and Southern in
1990 was allocated to the value of business acquired based on the
actuarially-determined present value of the expected pre-tax future profits
from the business assuming a discount rate of 13.75%. Interest is accrued on
the balance annually at a rate consistent with the rate credited on the
acquired policies on the acquisition date. Recoverability of the value of
business acquired is evaluated periodically by comparing the current estimate
of the present value of expected pretax future profits to the unamortized asset
balance. If such current estimate is less than the existing asset balance, the
difference would be charged to expense. Value of business acquired is being
amortized over the estimated remaining life of the related insurance inforce
using assumptions consistent with those used in computing reserves. Interest is
credited to the unamortized balance based on interest rates ranging from 4.75%
to 8.75%.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost less allowances for depreciation and
amortization. The home office building is depreciated on the straight-line
method over 30 years. Depreciation for other property and equipment is computed
on the straight-line basis over the estimated useful lives of the equipment,
principally five to seven years.
FUTURE POLICY BENEFIT RESERVES
Liabilities for future policy benefits on ordinary life insurance have generally
been provided on a net level premium method based upon estimates of future
investment yield, mortality, and withdrawals using the Company's experience and
actuarial judgment with an allowance for possible unfavorable deviation from the
expected experience. Future policy benefits for annuity policies in the
accumulation phase have been calculated based on the participants' aggregate
account values. The liability for future policy benefit reserves for annuities
has been computed using the following assumptions: (i) the guaranteed interest
rate on policies currently being issued is 3.25%, and (ii) estimates of future
mortality and withdrawals are based on experience and established industry
tables. Liabilities for a future policy reserves for accident and health
policies are computed based on estimates of future morbidity and withdrawals
based on experience and established industry tables. Where no established
industry tables are available, estimates of morbidity are based on a
combination of pricing assumptions and emerging Company experience.
12
<PAGE> 14
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
A. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
LIFE AND ACCIDENT AND HEALTH CLAIM RESERVES
Liabilities for unpaid life and accident and health claims, which include a
provision for estimated costs to investigate and settle claims, are estimated
based upon past experience for pending, incurred but not reported, and reopened
claims. Estimates for accident and health claims incurred but not paid are
computed using actuarially-determined factors based on a combination of claim
completion and claim cost methods, utilizing durational experience, seasonal
cycle, changes in health care practice, changes in inflation rates, and the
claims backlog. Although considerable variability is inherent in such estimates,
management believes that the liabilities for unpaid life and accident and health
claims are adequate. The estimates are continually reviewed and adjusted as
necessary as experience develops or new information becomes known. Such
adjustments are included in current operations.
PREMIUM REVENUE
Ordinary life premiums are recognized as revenue when they become due. Accident
and health premiums are recognized as revenue over the terms of the policies.
Amounts received from contracts which do not subject the Company to risks
arising from policyholder mortality or morbidity, principally universal life
and annuity products, are not reflected in premium revenue; rather, such
amounts are accounted for as deposits and are included in future policy
benefits, losses and claims.
FEDERAL INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
13
<PAGE> 15
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
A. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
EARNINGS PER SHARE
Basic earnings per share are computed by dividing the income available to common
shareholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if common stock equivalents were exercised and shared in the earnings of
the Company. During the three year period ended December 31, 1998, the Company
had no common stock equivalents which would be dilutive.
COMPREHENSIVE INCOME
In accordance with FASB Statement No. 130, Reporting Comprehensive Income the
Company reports unrealized gains or losses on the Company's available-for-sale
securities net of taxes and DAC adjustments in other comprehensive income.
OPERATING SEGMENTS
In June 1997, the FASB issued Statement No. 131, Disclosures About Segments of
an Enterprise and Related Information ("FAS 131"). FAS 131 requires that a
public business enterprise report a measure of segment profit or loss, certain
specific revenue and expense items, and segment assets. It requires
reconciliations of total segment revenues, total segment profit or loss, total
segment assets, and other amounts disclosed for segments to corresponding
amounts in the enterprise's general-purpose financial statements. FAS 131 also
requires that a public business enterprise report descriptive information about
the way that the operating segments were determined, the products and services
provided by the operating segments, differences between the measurements used in
reporting segment information and those used in the enterprise's general-purpose
financial statements, and changes in the measurement of segment amounts from
period to period. See Note M for additional information on the Company's
segments.
USE OF ESTIMATES
The consolidated financial statements reflect estimates and judgments made by
management that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and revenues and expenses for the reporting period. Actual results
could differ significantly from those estimates.
14
<PAGE> 16
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
B. INVESTMENTS
The amortized cost and estimated fair value of securities available-for-sale as
of each December 31, are as follows:
<TABLE>
<CAPTION>
Amortized Gross Unrealized Estimated
---------------------------------
Cost Gains Losses Fair Value
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998:
U.S. Treasury securities $ 1,637,408 $ 193,061 $ 301 $ 1,830,168
Obligations of states,
municipalities and political
subdivisions 4,558,609 282,521 4,841,130
Corporate bonds 298,727,804 21,019,913 2,153,344 317,594,373
Foreign bonds 3,748,928 410,112 4,159,040
Mortgage-backed securities 93,340,084 3,370,840 18,100 96,692,824
-------------------------------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 402,012,833 $ 25,276,447 $ 2,171,745 $425,117,535
===================================================================
1997:
U.S. Treasury securities $ 1,622,984 $ 163,059 $ 2,729 $ 1,783,314
Obligations of states,
municipalities and political 4,573,269 188,771 4,762,040
subdivisions
Corporate bonds 261,870,236 14,379,573 933,921 275,315,888
Foreign bonds 3,722,683 209,797 3,932,480
Mortgage-backed securities 101,353,239 4,009,718 197,880 105,165,077
-------------------------------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 373,142,411 $ 18,950,918 $ 1,134,530 $ 390,958,799
===================================================================
</TABLE>
The amortized cost and estimated fair value of fixed maturities at December 31,
1998, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
------------------------------------
<S> <C> <C>
Due in one year or less $ 847,165 $ 873,307
Due after one year through five years 35,861,630 38,024,889
Due after five years through ten years 189,203,260 199,643,244
Due after ten years 82,760,694 89,883,271
Mortgage-backed securities 93,340,084 96,692,824
------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 402,012,833 $ 425,117,535
====================================
</TABLE>
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without penalties.
15
<PAGE> 17
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
B. INVESTMENTS--CONTINUED
Proceeds, gross realized gains, and gross realized losses from the sale of fixed
maturities available-for-sale, excluding calls, maturities, and pay downs, are
summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------------------------------
<S> <C> <C> <C>
Proceeds $ 7,555,740 $ 11,938,814 $ 6,461,944
Gross realized gains 458,610 300,546 70,862
Gross realized losses 145,879
</TABLE>
The following is a summary of net investment income by category of investments:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------------------------------
<S> <C> <C> <C>
Fixed maturities $ 28,675,032 $ 26,316,987 $ 23,000,024
Mortgage loans 418,992 216,173 184,398
Policy loans 258,091 237,798 223,007
Cash equivalents 56,236 160,376 76,420
------------------------------------------------------
TOTAL NET INVESTMENT INCOME $ 29,408,351 $ 26,931,334 $ 23,483,849
======================================================
</TABLE>
At December 31, 1998, the Company had certificates of deposit and fixed maturity
securities with a carrying value of $3,536,000 on deposit with various state
insurance departments to satisfy regulatory requirements.
At December 31, 1998, the Company held no unrated or less-than-investment grade
bonds. Management performs periodic evaluations of the relative credit standings
of the issuers of bonds held in the Company's portfolio. These evaluations are
considered by management in its overall investment strategy.
16
<PAGE> 18
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
C. PROPERTY AND EQUIPMENT
Significant components of property and equipment are stated at cost, and are
summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------------------
<S> <C> <C>
Home office building $ 2,930,739 $ 2,930,739
Land 489,483 489,483
Furniture, fixtures and data processing equipment 2,414,576 2,232,223
------------------------------------
5,834,798 5,652,445
Less accumulated depreciation 2,034,064 1,788,418
------------------------------------
TOTAL $ 3,800,734 $ 3,864,027
====================================
</TABLE>
Depreciation expense for the years ended December 31, 1998, 1997 and 1996 was
$245,646, $352,673, and $224,950, respectively.
D. VALUE OF BUSINESS ACQUIRED
The changes in the unamortized value of business acquired are summarized as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
1998 1997
------------------------------------
<S> <C> <C>
Balance at beginning of year $ 12,748,673 $ 14,480,484
Interest on unamortized balance 829,841 983,435
Amortization (2,761,767) (2,715,246)
------------------------------------
BALANCE AT END OF YEAR $ 10,816,747 $ 12,748,673
====================================
</TABLE>
The estimated percentage of the December 31, 1998 balance to be amortized over
the next five years is as follows:
<TABLE>
<CAPTION>
1999 2000 2001 2002 2003
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Percent amortization 13.2% 11.7% 10.5% 9.3% 8.8%
</TABLE>
17
<PAGE> 19
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
E. REINSURANCE ARRANGEMENTS
In the ordinary course of business, CGIC maintains reinsurance arrangements with
other insurers. These arrangements are designed to limit the maximum amount of
exposure that CGIC retains on any given policy. For ordinary claims, CGIC's
maximum retention is $125,000, for group life claims, the maximum retention is
$100,000, and for accident and health claims, maximum retention on individual
claims is $150,000.
The following table summarizes the net impact of reinsurance arrangements on
benefits, claims, losses and settlement expenses and commissions:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------------------------------
<S> <C> <C> <C>
Benefits, claims, losses and settlement
expenses $ 165,802,631 $ 137,248,068 $ 100,374,649
Reinsurance recoverable 1,662,009 1,879,740 1,945,445
------------------------------------------------------
$ 164,140,622 $ 135,368,328 $ 98,429,204
======================================================
Commissions:
Direct $ 42,731,780 $ 41,980,653 $ 32,473,382
Reinsurance allowance 751,676 820,074 800,771
------------------------------------------------------
$ 41,980,104 $ 41,160,579 $ 31,672,611
======================================================
</TABLE>
CGIC remains obligated for amounts ceded in the event that the reinsurers do not
meet their obligations.
18
<PAGE> 20
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
F. OTHER POLICY CLAIMS AND BENEFITS PAYABLE
The following table reflects the activity in the liability for other policy
claims and benefits payable, net of reinsurance recoverables, as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $ 27,262,234 $ 22,737,678 $ 22,479,117
Incurred claims, net of reinsurance,
related to:
Current year 128,911,836 109,606,184 84,962,142
Prior years 3,034,527 (1,610,256) (5,827,536)
------------------------------------------------------
Total incurred 131,946,363 107,995,928 79,134,606
Paid claims, net of reinsurance, related to:
Current year 99,223,522 83,036,934 63,753,221
Prior years 26,802,264 20,434,438 15,122,824
------------------------------------------------------
Total paid 126,025,786 103,471,372 78,876,045
------------------------------------------------------
BALANCE AT END OF YEAR $ 33,182,811 $ 27,262,234 $ 22,737,678
======================================================
</TABLE>
The foregoing table indicates that a $3,034,527 deficiency in the December 31,
1997 reserves emerged during 1998, a $1,610,256 redundancy in the December 31,
1996 reserves emerged during 1997, and that a $5,827,536 redundancy in the
December 31, 1995 reserves emerged during 1996. The deficiency that emerged
during 1998 resulted from greater utilization and claim severity than initially
anticipated. Redundancies that emerged during 1997 and 1996 resulted from lower
utilization and claim severity than initially anticipated.
G. RELATED PARTY TRANSACTIONS
At December 31, 1998 and 1997, the Company owed its parent, Western and
Southern, $11,819,602 pursuant to outstanding promissory notes. These notes are
unsecured, and bear interest at 8%. The notes are due on June 1, 1999, and
interest on the notes is due quarterly. In February 1999, the parent converted
the notes into additional contributed capital to the Company, and forgave all
interest due subsequent to September 30, 1998 (see Note N). Interest paid on the
notes during 1998, 1997, and 1996 did not differ materially from interest
expense.
The Company's parent provides certain administrative services to the Company,
including executive management and investment management services. Charges
allocated to the Company for such services were $587,618, $562,410 and $496,042
for 1998, 1997, and 1996, respectively.
19
<PAGE> 21
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
H. STATUTORY FINANCIAL INFORMATION
The Company's insurance subsidiary, CGIC is required to file Annual Statements
with state insurance regulatory authorities to whose jurisdiction CGIC is
subject. These Annual Statements are prepared on an accounting basis prescribed
or permitted by the Nebraska Department of Insurance ("statutory-basis"), which
differs from GAAP. Prescribed accounting practices include a variety of
publications of the National Association of Insurance Commissioners ("NAIC"), as
well as state laws, regulations and general and administrative rules. Permitted
statutory accounting practices encompass all accounting practices not
prescribed.
The statutory-basis capital and surplus of CGIC at December 31, 1998 and 1997,
as reported in the Annual Statements filed with regulatory authorities, was
$37,021,018 and $41,669,677, respectively, and the statutory-basis net (loss)
income for 1998, 1997, and 1996 was $(3,403,382), $(7,688,033), and $3,127,940,
respectively.
At December 31, 1998, total statutory capital and surplus of CGIC is
approximately $36,821,000 in excess of minimum regulatory requirements.
CGIC is subject to certain Risk-Based Capital ("RBC") requirements as specified
by the NAIC. The RBC model serves as a benchmark for the regulation of life and
accident and health insurance companies by state insurance regulators. At
December 31, 1998, CGIC exceeded the minimum RBC requirements.
The amount of dividends which CGIC can pay is subject to certain regulatory
restrictions. At December 31, 1998, CGIC can pay approximately $3,702,000 in
dividends without the prior authorization of the Nebraska Insurance
Commissioner.
20
<PAGE> 22
I. FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return with its parent,
Western & Southern.
Federal income tax expense (benefit) is composed of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-----------------------------------------------------------
<S> <C> <C> <C>
Current $ 554,349 $ 1,198,897 $ 4,905,391
Deferred (4,678,038) (3,163,979) (2,639,666)
-----------------------------------------------------------
$ (4,123,689) $ (1,965,082) $ 2,265,725
===========================================================
</TABLE>
Income tax expense attributable to income from operations differs from the
amounts computed by applying the U.S. federal income tax rate of 35%. Those
effects are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-----------------------------------------------------------
<S> <C> <C> <C>
Expected tax expense (benefit) at 35% $ (4,176,247) $ (1,988,294) $ 2,228,462
Non deductible dues 3,328
Disallowed meals and entertainment 9,550 3,335 3,591
Other 39,680 19,877 33,672
-----------------------------------------------------------
$ (4,123,689) $ (1,965,082) $ 2,265,725
===========================================================
</TABLE>
21
<PAGE> 23
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
I. FEDERAL INCOME TAXES--CONTINUED
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------------------
<S> <C> <C>
Deferred tax assets:
Reserves for future policy benefits $ 8,094,000 $ 3,219,000
Supplemental contracts 2,468,000 2,434,000
Other 4,924,627
--------------------------------------
10,562,000 10,577,627
Deferred tax liabilities:
Deferred acquisition costs 3,719,000 6,225,000
Bond discount accretion 1,756,000 1,368,000
Net unrealized appreciation on investment securities 8,087,000 9,925,000
Value of business acquired 3,787,000 4,462,000
Other 528,246
--------------------------------------
17,877,246 21,980,000
--------------------------------------
NET DEFERRED TAX LIABILITIES $ 7,315,246 $ 11,402,373
======================================
</TABLE>
Federal income taxes paid during 1998, 1997, and 1996 was $706,727, $4,840,447,
and $0, respectively.
J. COMMITMENTS AND CONTINGENCIES
The Company is involved in litigation and may become involved in potential
litigation arising in the ordinary course of business. In the opinion of
management, the effects, if any, of such litigation are not expected to be
material to the Company's consolidated financial condition or results of
operations.
K. EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution retirement savings plan (the "401(k)
Plan") for all eligible employees. Employees over age 21 become eligible to
participate in the 401(k) Plan after 12 months of service. Participants may
contribute up to 10% of their pretax annual compensation, up to a maximum
established by federal law. The 401(k) Plan provides for Company contributions
equal to 2% of each participants pretax compensation, and a matching
contribution of 50%, not to exceed 1% of the participant's pretax compensation.
In addition, the Board of Directors may annually approve a discretionary
contribution. The Company's total contributions to the 401(k) Plan in 1998,
1997, and 1996 were $410,988, $403,478, and $380,936, respectively.
22
<PAGE> 24
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
L. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value of financial instruments are based upon quoted market prices, where
available, or on values obtained from independent pricing services. In cases
where quoted market prices are not available, fair value is based on estimates
using present value or other valuation techniques. These techniques are
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. Although fair value estimates are calculated
using assumptions that management believes are appropriate, changes in
assumptions could cause these estimates to vary materially. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in the immediate
settlement of the instruments.
The tax ramifications of the related unrealized gains and losses can have a
significant effect on fair value estimates and have not been considered in the
estimates.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures:
FIXED MATURITY SECURITIES--Fair value for fixed maturity securities is
based on quoted market prices, where available. For fixed maturity
securities not actively traded, fair value is estimated using values
obtained from independent pricing services.
MORTGAGE LOANS, SURPLUS NOTES, POLICY LOANS--The carrying amounts reported
in the consolidated balance sheets for these instruments approximate their
fair value.
CASH AND CASH EQUIVALENTS AND PREMIUMS RECEIVABLE--The carrying amounts
reported in the consolidated balance sheets for these instruments
approximate their fair values.
ANNUITY AND UNIVERSAL LIFE RESERVES--Fair values for annuity and universal
life reserves included in the liability for future policy benefit, losses
and claims are the amounts payable on demand.
OTHER POLICYHOLDERS' CLAIMS AND NOTES PAYABLE--The carrying amount reported
in the consolidated balance sheets for these instruments approximates their
fair value.
23
<PAGE> 25
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
L. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS--CONTINUED
Carrying amounts and estimated fair values of financial instruments at each
December 31 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------- -----------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-----------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS
Fixed maturities
available-for-sale $425,117,535 $425,117,535 $390,958,799 $390,958,799
Mortgage loans 4,725,828 4,725,828 4,868,590 4,868,590
Surplus notes 4,986,199 4,986,199 4,983,741 4,983,741
Policy loans 3,732,503 3,732,503 3,433,296 3,433,296
Cash and cash equivalents 4,371,549 4,371,549 4,386,172 4,386,172
Premiums receivable 2,717,469 2,717,469 2,180,796 2,180,796
LIABILITIES
Annuity reserves 207,536,307 197,568,617 198,088,566 187,341,921
Universal life reserves 58,282,069 51,350,194 54,627,865 48,026,007
Other policyholders'
claims 30,182,811 30,182,811 27,262,234 27,262,234
Notes payable 11,819,602 11,819,602 11,819,602 11,819,602
</TABLE>
M. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company has identified three distinct operating segments based upon product
types, as follows: accident and health, life and annuity, and other. Management
has defined operating segments based on product types due to the significant
differences in the sales and administration of different product types,
including the underwriting and claims adjudication processes.
Products included in the accident and health segment include Medicare
supplement, individual major medical, long-term care, disability, and dental
products. Products included in the life and annuity segment include universal
life, ordinary life, and annuity products.
The Company's other segment consists principally of its Continental Print &
Photo Company subsidiary, which provides printing services to the Company and
others.
24
<PAGE> 26
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
M. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS--CONTINUED
Revenues from the accident and health and life and annuity segments are
primarily generated from premiums charged to external policyholders, and
interest earned on cash and investments. Revenues from the other segment are
primarily printing fees charged to external customers.
Financial information by segment is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-----------------------------------------------------------
<S> <C> <C> <C>
Accident and Health:
Revenues:
Net premiums $ 179,726,212 $ 150,378,174 $ 115,775,271
Investment income 6,953,797 5,546,748 5,080,780
Other income 259,689 233,616 278,682
-----------------------------------------------------------
186,939,698 156,158,538 121,134,733
Expenses:
Benefits and claims 142,097,952 112,410,445 78,660,085
Other operating expenses 61,486,764 55,257,521 45,261,923
Federal income tax benefit (5,825,756) (4,028,300) (975,546)
-----------------------------------------------------------
197,758,960 163,639,666 122,946,462
-----------------------------------------------------------
SEGMENT LOSS $ (10,819,262) $ (7,481,128) $ (1,811,729)
===========================================================
Life and Annuity:
Revenues:
Net premiums $ 10,998,431 $ 11,802,065 $ 9,263,088
Investment income 23,184,794 21,817,098 21,447,300
Other income 500,948 588,380 913,062
-----------------------------------------------------------
34,684,173 34,207,543 31,623,450
Expenses:
Benefits and claims 22,042,670 22,957,883 19,769,119
Other operating expenses 7,664,987 4,923,358 2,617,860
Federal income tax expense 1,741,781 2,214,206 3,232,764
-----------------------------------------------------------
31,449,438 30,095,447 25,619,743
SEGMENT PROFIT $ 3,234,735 $ 4,112,096 $ 6,003,707
===========================================================
Other:
Revenues $ 1,187,408 $ 1,214,313 $ 1,070,119
Expenses 1,451,039 1,740,599 1,152,280
Federal income tax (benefit) expense (39,714) (150,988) 8,507
-----------------------------------------------------------
SEGMENT LOSS $ (223,917) $ (375,298) $ (90,668)
===========================================================
</TABLE>
25
<PAGE> 27
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
M. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS--CONTINUED
Following is a reconciliation of segment (loss) profit to consolidated (loss)
income:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-----------------------------------------------------------
<S> <C> <C> <C>
Segment (loss) profit:
Accident and health $ (10,819,262) $ (7,481,128) $ (1,811,729)
Life and annuity 3,234,735 4,112,096 6,003,707
Other (223,917) (375,298) (90,668)
-----------------------------------------------------------
CONSOLIDATED (LOSS) INCOME $ (7,808,444) $ (3,744,330) $ 4,101,310
===========================================================
</TABLE>
The Company does not separately allocate investments or other identifiable
assets by industry segment.
N. SUBSEQUENT EVENTS
Effective February 17, 1999, CGIC entered into a reinsurance treaty with
Reassurance Company of Hannover ("Hannover"), whereby CGIC ceded 50% of its
life, accident and health, and annuity policies inforce at February 1, 1999 to
Hannover, and retained the remaining risk. The treaty provides an initial ceding
allowance of $13,000,000, which will be accounted for as a deferred reinsurance
gain. In connection with this transaction, the Company transferred investment
securities and accrued interest with a fair value of $187,399,112 as
consideration for the liabilities assumed by Hannover.
On February 17, 1999, 100% of the outstanding common stock of the Company was
acquired by Ceres Group, Inc. ("Ceres"), from Western & Southern. Ceres is a
publicly traded holding company which operates primarily through its
wholly-owned subsidiary, Central Reserve Life Insurance Company, a life and
accident and health insurer domiciled in Ohio. Total consideration paid for the
common stock was approximately $84,500,000. In connection with this transaction,
the $11,819,602 notes payable to Western & Southern was converted into
additional paid-in capital, and the Company paid an extraordinary dividend of
$22,500,000.
26
<PAGE> 28
Continental General Corporation and Subsidiaries
Notes to Consolidated Financial Statements--Continued
O. IMPACT OF YEAR 2000 (UNAUDITED)
The Company devoted significant resources throughout its business operations in
1998 to minimize the risk of potential disruption from the Year 2000 ("Y2K")
issue. This issue is a result of computer programs having been written using two
digits (rather than four) to define the applicable year. Any information
technology ("IT") systems that have time-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000, which could result in
miscalculations and system failures. The issue also extends to many "non-IT"
systems, such as operating and control systems that rely on embedded computer
chips. In addition, like every other business enterprise, the Company is at risk
from Y2K failures on the part of its major business counterparts, including
suppliers, distributors, licensees and other manufacturers, as well as potential
failures in public and private infrastructure services, including electricity,
water, gas, transportation and communications.
Systems failures resulting from the Y2K issue could adversely affect operations
and financial results in all of the Company's business segments. Failures may
affect such routine but important operations as billing and collection, payroll
operations and daily administration of policyholder claims. The Company also has
business relationships with agents and health providers, such as hospitals and
physicians across the nation. These agents and businesses are themselves reliant
on IT and embedded computer chips to conduct their operations.
1. State of Readiness - In 1998, the Company designed their systems to be
Y2K compliant. All operating systems and applications were Y2K
compliant as of December 31, 1998. Other systems such as those
controlling payroll, elevators, telephone system and other building
systems are scheduled to be completed and Y2K compliant by July 1999.
The Company prepared a list of all vendors and sent Y2K questionnaires
to each in 1998. All vendors were Y2K compliant except for two. One was
in progress and the other would not assure Y2K readiness. The Company
is presently seeking new vendors who are Y2K compliant and does not see
any problems concerning the one vendor.
2. Costs - Since the Company was designing its systems with Y2K planning
and used primarily internal personnel, the historical costs for Y2K was
approximately $1 million in 1998. The Company estimates another
$400,000 in 1999 for IT systems in the first quarter and approximately
$500,000 in the second quarter for the telephone system and other
building systems.
3. 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 also materially adversely affect the
Company. The Company 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.
4. Contingency Plans - As a precautionary measure, the Company has
developed contingency plans for all systems by department and business
function. These plans include information systems recovery, remote site
processing and manual procedures to ensure that critical business
functions continue without affecting customers and business partners.
Outside vendors have indicated that they have or are in the process of
developing contingency plans to support their customers.
At this time, the Company is aware of no Y2K compliance issues that will
negatively impact the key business processes of the Company. All Y2K compliance
plan activities are scheduled to be completed by July 1999.
27
<PAGE> 29
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS.
The following unaudited pro forma combined statement of operations of Ceres
Group, Inc. ("Ceres") for the year ended December 31, 1998 presents results for
Ceres as if the acquisition of Continental General Corporation ("Continental")
and the private placement offering, reinsurance transaction, and the bank
financing consummated by Ceres in connection with the acquisition had occurred
at January 1, 1998. The accompanying unaudited pro forma combined balance sheet
as of December 31, 1998 gives effect to the acquisition, the private placement
offering, reinsurance transaction, and the bank financing as if they had
occurred as of December 31, 1998. The unaudited pro forma combined financial
statements do not purport to represent Ceres' financial position or the
operating results that would have been achieved had the acquisition been
consummated as of the date indicated and should not be construed as projecting
Ceres' future financial position or operating results. The unaudited proforma
combined financial statements do not reflect any projected revenue increases or
cost savings. The pro forma adjustments are based on available information and
certain assumptions that Ceres currently believes are reasonable under the
circumstances. The unaudited pro forma combined financial statements should be
read in conjunction with the accompanying notes thereto, the historical
consolidated financial statements of Continental as of and for the year ended
December 31, 1998 and the historical consolidated financial statements of Ceres
as of and for the year ended December 31, 1998. The pro forma adjustments are
applied to the historical financial statements to account for, among other
things, the acquisition using the purchase method of accounting. Under purchase
accounting, the total purchase cost for the acquisition has been allocated to
the assets and liabilities of Continental based on their fair values.
Allocations are subject to valuations as of the date of the acquisition based on
appraisals and other studies which are not yet fully completed. Accordingly, the
final allocations may be different from the amounts reflected herein. Although
the final allocations may differ, the unaudited pro forma combined financial
statements reflect management's best estimates based on currently available
information as of the date of this filing. As part of the acquisition, Ceres and
The Western and Southern Life Insurance Company ("Western & Southern"), as the
sole shareholder of Continental, intend to jointly elect treating the purchase
of Continental by Ceres as an asset acquisition for federal income tax purposes
pursuant to Section 338(h)(10) of the Internal Revenue Code of 1986, as amended.
This election allows Ceres to deduct the amortization of intangibles recorded in
the acquisition.
28
<PAGE> 30
Unaudited Pro Forma Combined Balance Sheet
As of December 31, 1998
<TABLE>
<CAPTION>
Historical
-------------------------------------
Continental Pro Forma Note Pro Forma
Ceres Group, Inc. General Corp. Adjustments Reference Combined
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
Investments:
Fixed maturities, held to maturity, at amortized cost $8,899,659 $8,899,659
Fixed maturities, available for sale, at fair value 80,832,097 $425,117,535 (184,476,518) (1a) 321,473,114
Mortgage loans 4,725,828 (4,626,489) (2) 99,339
Surplus notes 4,986,199 4,986,199
Policy loans 94,432 3,732,503 3,826,935
----------------------------------------------- --------------
Total investments 89,826,188 438,562,065 (189,103,007) 339,285,246
Cash and cash equivalents 15,031,058 3,971,549 4,626,489 (2) 5,969,096
13,000,000 (1b)
(22,500,000) (3c)
(8,160,000) (3d)
Cash and cash equivalents--restricted 4,345,322 400,000 4,745,322
Accrued investment income 1,343,297 6,772,813 (2,922,594) (1a) 5,193,516
Premiums receivable 2,203,690 2,717,469 4,921,159
Note receivable 7,367,556 7,367,556
Reinsurance receivable 41,417,031 290,105 41,707,136
Property and equipment, net 10,061,688 3,800,734 1,394,253 (4) 15,076,647
(180,028) (5a)
Deferred federal income taxes 1,409,479 4,550,000 (1c) 5,959,479
Deferred acquisition costs 3,809,737 39,265,710 (39,265,710) (6a) 3,809,737
Value of business acquired 10,816,747 (10,816,747) (6a) 15,829,000
15,829,000 (6b)
Goodwill 18,309,601 (7) 18,309,601
Other assets 3,418,089 1,294,197 (44,000) (5b) 5,828,286
1,160,000 (3a)
----------------------------------------------- --------------
TOTAL ASSETS 180,233,135 507,891,389 (214,122,743) 474,001,781
=============================================== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Future policy benefits, losses and claims 22,717,862 343,203,940 (170,736,967) (1a) 197,884,835
2,700,000 (8)
Unearned premiums 27,105,725 (13,836,204) (1a) 13,269,521
Other policy claims and benefits payable 74,395,205 33,182,811 (17,458,681) (1a) 90,119,335
----------------------------------------------- --------------
Total policy liabilities and accruals 97,113,067 403,492,476 (199,331,852) 301,273,691
Deferred reinsurance gain 13,400,000 13,000,000 (1b) 26,400,000
Other policyholders' funds 8,845,829 8,845,829
Drafts outstanding 5,413,878 5,413,878
Federal income taxes payable 1,105,834 161,864 1,448,000 (9) 2,715,698
Deferred federal income taxes 7,315,246 (7,315,246) (10) 0
Mortgage and notes payable 8,283,884 11,819,602 (11,819,602) (11) 8,283,884
Reinsurance payable 2,993,400 2,993,400
Accrued commissions, expenses and taxes 2,978,140 4,484,248 7,462,388
Notes payable 40,000,000 (3a) 40,000,000
Other liabilities 9,677,267 7,592,861 1,788,570 (12) 19,777,299
9,500 (5c)
709,101 (13)
=============================================== ==============
Total liabilities $144,397,421 $440,280,175 (161,511,529) $423,166,067
=============================================== ==============
Shareholders' equity:
Common shares 11,495 43,012 (43,012) (14) 31,495
20,000 (3b)
Additional paid-in capital 43,883,357 6,396,653 (6,396,653) (14) 58,863,357
14,980,000 (3b)
Retained earnings (deficit) (9,154,986) 52,435,093 (52,435,093) (14) (9,154,986)
Accumulated other comprehensive income 1,095,848 8,736,456 (8,736,456) (14) 1,095,848
--------------
-----------------------------------------------
Total shareholders' equity 35,835,714 67,611,214 (52,611,214) 50,835,714
----------------------------------------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $180,233,135 $507,891,389 (214,122,743) $474,001,781
=============================================== ==============
</TABLE>
29
<PAGE> 31
Unaudited Pro Forma Combined Statement of Operations
For the Year Ended December 31, 1998
<TABLE>
<CAPTION>
Historical
------------------------------------------
Continental Pro Forma Note Pro Forma
Ceres Group, Inc. General Corp. Adjustments Reference Combined
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
REVENUES
Revenues
Premiums:
Direct 264,868,186 $193,709,704 $458,577,890
Assumed 45,922,385 623,444 46,545,829
Ceded (150,005,674) (3,608,505) (71,359,306) (15a) (224,973,485)
--------------------------------------------- --------------
Total premiums 160,784,897 190,724,643 (71,359,306) 280,150,234
Net investment income 7,454,180 29,408,351 (12,605,990) (15e) 23,373,541
(883,000) (16)
Net realized gains 210,857 730,240 941,097
Other income 1,096,690 1,948,045 3,044,735
Amortization of deferred reinsurance gain 600,000 2,600,000 (15d) 3,200,000
--------------------------------------------- --------------
Total revenues 170,146,624 222,811,279 (82,248,295) 310,709,608
BENEFITS, LOSSES AND EXPENSES
Benefits, claims, losses and settlement expenses 116,058,675 164,140,622 (56,303,620) (15b) 223,895,677
Underwriting, acquisition and insurance expenses 54,368,115 52,722,205 (16,412,640) (15c) 90,677,680
Amortization of deferred acquisition costs 647,271 17,171,385 (31,136,714) (17) (13,318,058)
Amortization of Goodwill 732,384 (18) 732,384
Interest expense and financing costs 1,841,334 709,200 3,593,333 (19) 6,143,867
--------------------------------------------- --------------
Total benefits, losses and expenses 172,915,395 234,743,412 99,527,257 308,131,550
Loss before federal income taxes (2,768,771) (11,932,133) 17,278,962 2,578,058
Federal income tax expense 1,066,888 (4,123,689) 6,047,637 (20) 2,990,836
--------------------------------------------- --------------
Net income (loss) ($3,835,659) (7,808,444) 11,231,325 (412,778)
============================================= ==============
Basic and diluted gain (loss) per common share (0.49) (0.04)
Weighted average shares outstanding 7,845,172 2,000,000 (3b) 9,845,172
</TABLE>
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NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL
STATEMENTS
(1) Continental General Insurance Company ("CGIC"), a wholly owned
subsidiary of Continental entered into a reinsurance treaty with the
Reassurance Company of Hannover ("Hannover") in which 50% of the life,
accident and health, and annuity policies in force at February 1, 1999
was reinsured for a ceding allowance of $13,000,000.
(a) Reflects the transfer of assets and reserves to Hannover required
under the reinsurance treaty. Assets at fair value were transferred
at equal value to the statutory-basis of accounting reserves ceded.
Statutory-basis of accounting reserves are calculated based on
accounting practices prescribed by the Nebraska Department of
Insurance, and differ from reserves calculated in accordance with
generally accepted accounting principles ("GAAP"). This entry
reflects the ceded reserves held by Continental calculated on a
GAAP basis.
(b) Records the deferred gain for the ceding allowance received from
Hannover under the reinsurance treaty.
(c) Records the deferred taxes on the purchase accounting adjustments
net of a valuation allowance of $7,720,623.
(2) Records the sale of mortgage loans at book value to Western & Southern.
(3) The following adjustments reflect the funding of the acquisition
purchase price of $84,500,000:
(a) Proceeds from Chase Securities arranged credit agreement of
$40,000,000 less $1,160,000 in deferred loan fees paid.
(b) Proceeds from private placement issuance of common stock of
$15,000,000.
(c) Extraordinary dividend from CGIC of $22,500,000.
(d) Cash from Ceres of $8,160,000.
(4) Reflects the fair value of the Continental home office building, from
$3,105,747 to $4,500,000.
(5) Ceres has determined that it would not benefit by continuing to operate
the Continental Print & Photo Co., a wholly owned subsidiary of
Continental. As such, a plan has been established for selling its
assets and discontinuing its operations. The following items record the
estimated liability for its closing.
(a) Records the fair value of equipment.
(b) Records the fair value of inventory.
(c) Records other costs of closing.
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(6) In accordance with the purchase method of accounting, the purchase
cost is allocated to the assets and liabilities of Continental based
upon their fair values. The existing balance of former capitalized
expenses (deferred acquisition costs) as well as the former value of
business acquired is eliminated. A new value of the business in force
is calculated using current assumptions and is categorized as value of
business acquired. These assumptions (i.e. mortality and morbidity
projections, interest rates, and expenses, etc.) varied from those used
when the Company originally placed the existing business in force.
(a) Eliminates the existing deferred acquisition costs and value of
business acquired of Continental.
(b) Establishes a new value of business acquired on existing business,
net of reinsurance.
(7) Records cost in excess of net assets of acquired subsidiaries
(Goodwill).
(8) In addition to a review and a new calculation of the value of the
existing business in force, a review was also made of the various
active life and claim reserves that were established on a historical
basis. This adjustment is made to establish additional active life
reserves for the long term care product line.
(9) Records estimated taxes payable resulting from election of Section
338(h)(10) per agreement between Western & Southern and Ceres.
(10) Eliminates the deferred taxes of Continental.
(11) Eliminates promissory notes payable by Continental to Western &
Southern. This debt was forgiven by Western & Southern and recorded as
a capital contribution prior to the sale.
(12) Records direct out-of-pocket costs of acquisition.
(13) Records estimated liability for certain employee severance costs.
(14) Adjustment to eliminate Continental's equity.
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(15) Records income effect of the reinsurance treaty with Hannover. Assumes
50% of policies in force had been ceded on January 1, 1998. Further
assumes that new policies written in 1998 are not subject to the
reinsurance treaty with Hannover.
(a) Premiums ceded.
(b) Benefits, claims, losses and settlement expenses ceded.
(c) Reinsurance expense allowance credited on business ceded.
(d) Amortization of the deferred gain (ceding allowance) received from
Hannover under the terms of the treaty.
(e) Decrease in investment income resulting from transfer of investment
securities to Hannover under reinsurance treaty ($184,476,518 x
6.833%).
(16) Decrease in investment income due to net cash decrease of $8,160,000 at
Ceres and $9,500,000 (ceding allowance on reinsurance treaty of
$13,000,000 less extraordinary dividend paid of $22,500,000) at
Continental used for purchase of common stock ($17,660,000 x 5.00%).
(17) Eliminates prior amortization of deferred acquisition costs and value
of business acquired. Record net capitalization of expenses for new
business of 1998 only, of $15,065,329 and amortization of adjusted
value of business acquired, of $1,100,000.
(18) Record the amortization of Goodwill over 25 years.
(19) Record interest expense on bank financing used to fund the acquisition
($40,000,000 x 8.5%) in addition to amortization of deferred loan fees
of $193,333.
(20) Records income tax expense (benefit) of the pro forma adjustments.
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Exhibit 23
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-62657) pertaining to the Retirement Plan for Employees of the
Central Reserve Life Insurance Company of our report dated April 16, 1999, with
respect to the financial statements of Continental General Corporation and
subsidiaries included in this Current Report (Form 8-K/A) of Ceres Group, Inc.
filed with the Securities and Exchange Commission on May 3, 1999.
/s/ Ernst & Young LLP
Cleveland, Ohio
April 29, 1999
