<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 JUNE 30, 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 - 13,507,622 shares as of June 30, 1999
<PAGE> 2
<TABLE>
<CAPTION>
INDEX
CERES GROUP, INC. AND SUBSIDIARIES
Part I. Financial Information Page
----
<S> <C> <C>
Item 1. Financial Statements (Unaudited) 3
Condensed consolidated balance sheets - June 30, 1999 and December 31, 1998 3
Condensed consolidated statements of operations - Three months ended June 30, 1999 4
and 1998; Six months ended June 30, 1999 and 1998.
Condensed consolidated statements of cash flows - Six months ended June 30, 1999 and 5
1998
Notes to condensed consolidated financial statements - June 30, 1999 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosure of Market Risk 25
Part II. Other Information 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Exhibits and Reports on Form 8-K 26
Signatures 27
Exhibits 28
</TABLE>
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<PAGE> 3
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION- ITEM 1. FINANCIAL STATEMENTS
-----------------------------------------------------------
CERES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
JUNE 30 DECEMBER 31
ASSETS 1999 1998
------------- -------------
Investments (UNAUDITED)
<S> <C> <C>
Fixed maturities:
Held to maturity at amortized cost $ -- $ 8,899,659
Available for sale, at fair value 302,965,829 80,832,097
------------- -------------
Total fixed maturities 302,965,829 89,731,756
Mortgage loans 97,136 --
Policy loans 3,701,649 94,432
------------- -------------
Total investments 306,764,614 89,826,188
Cash and cash equivalents 37,597,724 15,031,058
Cash and cash equivalents - restricted 4,325,289 4,345,322
Accrued investment income 6,000,789 1,343,297
Premiums receivable 6,394,451 2,203,690
Note receivable 7,666,981 7,367,556
Reinsurance receivable 319,878,961 41,417,031
Deferred acquisition costs 11,980,639 3,809,737
Value of business acquired 16,945,531 --
Goodwill 23,687,682 --
Property and equipment, net 14,663,232 10,061,688
Deferred federal income taxes 4,011,632 1,409,479
Other assets 6,179,551 3,418,089
------------- -------------
Total assets $ 766,097,076 $ 180,233,135
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Future policy benefits, losses and claims $ 377,351,168 $ 22,717,862
Unearned premiums 32,334,774 2,023,436
Other policy claims and benefits payable 129,024,162 72,371,769
------------- -------------
538,710,104 97,113,067
Deferred reinsurance gain 23,732,000 13,400,000
Other policyholders' funds 10,333,396 8,845,829
Federal income taxes payable 6,117,178 1,105,834
Long term debt 40,000,000 --
Mortgage note payable 8,222,095 8,283,884
Reinsurance payable 50,453,017 2,993,400
Commissions payable 6,451,152 2,978,140
Drafts outstanding 3,874,328 --
Other liabilities 34,755,940 9,677,267
------------- -------------
Total liabilities $ 722,649,210 $ 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 13,507,622 in 1999 and 11,495,172 in 1998 13,508 11,495
Additional paid-in capital 58,998,759 43,883,357
Retained earnings (deficit) (3,916,516) (9,154,986)
Accumulated other comprehensive (loss) income (11,647,885) 1,095,848
------------- -------------
Total shareholders' equity 43,447,866 35,835,714
------------- -------------
Total liabilities and shareholders' equity $ 766,097,076 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, net
Medical $ 62,199,121 $ 33,125,333 $ 114,959,211 $ 64,095,945
Specialty and other 18,494,897 2,678,716 33,168,047 5,509,536
------------- ------------- ------------- -------------
Total premiums, net 80,694,018 35,804,049 148,127,258 69,605,481
Net investment income 6,589,870 2,082,767 11,367,872 4,033,442
Net realized investment gains (losses) 62,847 745 125,990 (8,352)
Fee and other income 4,808,831 2,369,195 9,700,589 4,730,694
Amortization of deferred reinsurance gain 1,399,800 -- 2,668,000 --
------------- ------------- ------------- -------------
93,555,366 40,256,756 171,989,709 78,361,265
------------- ------------- ------------- -------------
BENEFITS, LOSSES, AND EXPENSES:
Benefits, claims, losses, and settlement expenses:
Medical 45,247,683 29,485,034 84,385,215 58,184,031
Specialty and other 15,139,628 1,804,246 26,212,131 3,748,241
------------- ------------- ------------- -------------
Total benefits, claims, losses, and
settlement expenses 60,387,311 31,289,280 110,597,346 61,932,272
Selling, general, and administrative expenses 32,350,505 11,304,981 59,629,559 20,498,625
Net amortization and change in deferral of
acquisition costs and value of business
acquired (4,733,840) 9,252 (7,787,344) 10,967
Interest expense and financing costs 913,724 708,038 1,490,964 1,332,307
------------- ------------- ------------- -------------
88,917,700 43,311,551 163,930,525 83,774,171
------------- ------------- ------------- -------------
Income (loss) before federal income taxes 4,637,666 (3,054,795) 8,059,184 (5,412,906)
Federal income tax expense 1,623,183 -- 2,820,714 --
------------- ------------- ------------- -------------
Net income (loss) $ 3,014,483 $ (3,054,795) $ 5,238,470 $ (5,412,906)
============= ============= ============= =============
Earnings (loss) per common share
Basic $ 0.23 $ (0.73) $ 0.40 $ (1.29)
Diluted $ 0.19 $ (0.73) $ 0.34 $ (1.29)
</TABLE>
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<PAGE> 5
<TABLE>
<CAPTION>
CERES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
OPERATING ACTIVITIES 1999 1998
------------- -------------
<S> <C> <C>
Net income (loss) $ 5,238,470 $ (5,412,906)
Adjustments to reconcile net income (loss) to cash
provided by operating activities:
Depreciation and amortization 1,279,807 478,528
Net realized (gains) losses (125,990) 8,352
Deferred federal income taxes 1,607,617 149,208
Changes in assets and liabilities:
Restricted cash 20,033 (394,667)
Reinsurance and premiums receivable (279,738,076) 1,846,564
Value of business acquired (1,116,531) --
Goodwill (5,853,708) --
Accrued investment income (517,371) (206,071)
Federal income taxes payable 3,385,993 --
Other assets (1,501,761) (986,104)
Future policy benefits, claims and funds payable 216,024,251 12,731,220
Unearned premium 17,814,134 --
Reinsurance payable 47,459,617 --
Other liabilities 15,079,572 (529,462)
Policy acquisition costs deferred (8,170,902) --
Reinsurance gain deferred (2,668,000) --
------------- -------------
Net cash by operating activities 8,217,155 7,684,662
------------- -------------
INVESTING ACTIVITIES
Purchase of fixed maturities available-for-sale (3,472,601) (18,203,555)
Proceeds from sale of fixed maturities available-for-sale 13,609,110 --
Proceeds from calls and maturities of available-for-sale 4,617,893 11,182,151
Proceeds from sales calls and maturities of held-to-maturity 3,923,138 1,004,152
Acquisition of Continental General, net of $2,212,307 cash acquired (59,787,693) --
Net additions to furniture and equipment (43,897) 728
Net purchase of investments - short-term -- (3,865,495)
Other 104,439 868
------------- -------------
Net cash used in investing activities (41,049,611) (9,881,151)
------------- -------------
FINANCING ACTIVITIES
Increase in annuity account balances 7,889,212 271,476
Decrease in annuity account balances (7,246,291) (2,172,223)
Increase in note receivable (299,425) --
Principal payments on mortgage note payable (61,789) (56,210)
Proceeds from long-term debt 40,000,000 --
Proceeds from private equity placement 15,117,415 --
Reinsurance ceding allowance, net -- (2,679,482)
------------- -------------
Net cash provided by (used in) financing activities 55,399,122 (4,636,439)
------------- -------------
Net increase (decrease) in cash 22,566,666 (6,832,928)
Cash and cash equivalents at beginning of year 15,031,058 5,632,459
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 37,597,724 $ (1,200,469)
============= =============
</TABLE>
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<PAGE> 6
CERES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- ----------------------------------------------------------------
Periods ended June 30, 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 Ceres Group, Inc., and subsidiaries (the "Company")
Annual Report on Form 10-K/A for the fiscal year ended December 31, 1998. The
condensed consolidated financial statements for June 30, 1999 include the
accounts of Provident American Life and Health Insurance Company (Provident)
acquired on 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 six
months ended June 30, 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 Six Months Ended
June 30, June 30,
1999 1998 1999 1998
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Net Income (loss) $ 3,014,483 $ (3,054,795) $ 5,238,470 $ (5,412,906)
Unrealized (loss) gain on securities (7,199,426) 152,171 (11,647,885) 295,152
Reclassification adjustment for gains
(losses) included in net income 40,201 492 81,894 (5,512)
------------ ------------ ------------ ------------
Comprehensive (loss) $ (4,144,742) $ (2,902,132) $ (6,327,521) $ (5,123,266)
============ ============ ============ ============
</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 subsidiaries. Under the provisions of the treaties, the Company cedes
between 50% and 90% 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 another reinsurance arrangement,
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
premiums and benefits, claims, losses and settlement expenses, commissions, and
other operating expenses:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Premiums
Direct $ 125,244,145 $ 63,056,446 $ 237,991,662 $ 126,627,953
Assumed 28,130,456 -- 58,693,071 --
Ceded (72,680,583) (27,252,397) (148,557,475) (57,022,472)
------------- ------------- ------------- -------------
Net premiums $ 80,694,018 $ 35,804,049 $ 148,127,258 $ 69,605,481
============= ============= ============= =============
Benefits, claims, losses, and
settlement expenses $ 134,843,715 $ 52,968,096 $ 219,879,699 $ 106,938,412
Reinsurance recoveries (74,456,404) (21,678,816) (109,282,353) (45,006,140)
------------- ------------- ------------- -------------
$ 60,387,311 $ 31,289,280 $ 110,597,346 $ 61,932,272
============= ============= ============= =============
Selling, general, and administrative
expenses:
Commissions $ 23,797,212 $ 9,189,911 $ 40,438,496 $ 18,343,076
Other operating expenses 23,274,100 5,768,832 40,692,028 13,667,081
Reinsurance expenses 11,139,135 -- 21,400,677 --
Reinsurance allowances (25,859,942) (3,653,762) (42,901,642) (11,511,532)
------------- ------------- ------------- -------------
$ 32,350,505 $ 11,304,981 $ 59,629,559 $ 20,498,625
============= ============= ============= =============
</TABLE>
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<PAGE> 8
Note 4 - Computation of Net Income (Loss) Per Common Share
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------------- --------------- --------------- -------------
<S> <C> <C> <C> <C>
Basic
Average common shares
outstanding 13,506,997 4,195,172 13,168,178 4,195,172
=========== ============ =========== ===========
Net income (loss) $ 3,014,483 $ (3,054,795) $ 5,238,470 $(5,412,906)
=========== ============ =========== ===========
Net income (loss) per
common share $ 0.23 $ (0.73) $ 0.40 $ (1.29)
=========== ============ =========== ===========
Diluted
Average common shares
outstanding 13,506,997 4,195,172 13,168,178 4,195,172
Warrants/stock options -
treasury stock method 2,278,778 -- 2,266,154 --
----------- ------------ ----------- -----------
Weighted average shares 15,785,775 4,195,172 15,434,332 4,195,172
=========== ============ =========== ===========
Net income (loss) $ 3,014,483 $ (3,054,795) $ 5,238,470 $(5,412,906)
=========== ============ =========== ===========
Net income (loss) per common
share $ 0.19 $ (0.73) $ 0.34 $ (1.29)
=========== ============ =========== ===========
</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.
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 $215,000 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 then 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
However, 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 for 1991 and 1992 and federal income taxes would
increase in the future relative to years subsequent to 1992 that remain open for
IRS examination. A small life company having less than $500.0 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 - Acquisitions
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 a private equity offering as described
below of $62.0 million and a special dividend received from CGIC of $22.5
million. The transaction was accounted for in accordance with the purchase
method and currently the purchase price allocation is preliminary.
Effective February 1, 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. The treaty provides for repayment of the initial
ceding allowance plus interest out of statutory profits, if any, of the
reinsured business.
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
thereafter to February 17, 2005. The loan bears interest at a variable rate
(approximately 8.57% at June 30, 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 $15.0 million.
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<PAGE> 10
The following unaudited pro forma information presents the consolidated results
of operations of the Company assuming the acquisition of Continental was
completed at the beginning of January 1998 and 1999:
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
-------------------- -------------------
<S> <C> <C>
Revenues $ 182,290,277 $ 144,313,210
Income (loss) before federal income taxes 7,172,508 (14,070,305)
Federal income tax expense 2,510,377 (1,387,837)
Earnings (loss) 4,662,131 (12,682,468)
Per common share:
Basic $ 0.35 $ (2.05)
Diluted 0.30 (2.05)
</TABLE>
The pro forma results of operations are not indicative on the actual results of
operations that would have occurred had the acquisitions been made on the date
indicated, or the results that may be obtained in the future.
Note 7 - Operating Segments
In conjunction with the Company's continued growth and refinement of defined
organization structure, the Company expanded its operating segments to the
following three distinct operating segments based upon product types: medical,
specialty and other, and corporate. Products included in the medical segment
include comprehensive major medical plans. Significant products in the specialty
and other segment include Medicare supplement, long-term care, dental, life
insurance, and annuities.
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<PAGE> 11
The corporate segment encompasses all other activities of the Company, 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>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------------------ ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Medical
Revenues
Net premiums $ 62,199,121 $ 33,125,333 $ 114,959,211 $ 64,095,945
Investment income 907,767 1,879,829 3,826,079 3,616,622
Fee and other income 6,102,684 2,369,195 12,262,642 4,730,694
------------- ------------- ------------- -------------
69,209,572 37,374,357 131,047,932 72,443,261
Expenses
Benefits and claims 45,247,683 29,485,034 84,385,215 58,184,031
Other operating expenses 22,250,763 10,160,958 41,786,242 18,624,538
------------- ------------- ------------- -------------
67,498,446 39,645,992 126,171,457 76,808,569
Segment profit (loss) before
federal income taxes $ 1,711,126 $ (2,271,635) $ 4,876,475 $ (4,365,308)
============= ============= ============= =============
Specialty and Other
Revenues:
Net premiums $ 18,494,897 $ 2,678,716 $ 33,168,047 $ 5,509,536
Investment income 5,697,269 152,419 7,512,954 314,489
------------- ------------- ------------- -------------
24,192,166 2,831,135 40,681,001 5,824,025
Expenses:
Benefits and claims 15,139,628 1,804,246 26,212,131 3,748,241
Other operating expenses 4,633,051 833,113 8,789,731 1,521,065
------------- ------------- ------------- -------------
19,772,679 2,637,359 35,001,862 5,269,306
Segment profit
before federal income
taxes $ 4,419,487 $ 193,776 $ 5,679,139 $ 554,719
============= ============= ============= =============
Corporate
Revenues:
Investment income $ 47,681 $ 51,264 $ 154,829 $ 93,979
Fee and other income 105,947 -- 105,947 --
------------- ------------- ------------- -------------
153,628 51,264 260,776 93,979
Expenses:
Interest and financing
expenses 913,724 708,038 1,490,964 1,332,307
Other operating expenses 732,851 320,162 1,266,242 363,989
------------- ------------- ------------- -------------
1,646,575 1,028,200 2,757,206 1,696,296
Segment (loss) before
federal incomes taxes $ (1,492,947) $ (976,936) $ (2,496,430) $ (1,602,317)
============= ============= ============= =============
</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. The Company also expanded the detail of its disclosures for
1999 and 1998, which included certain reclassifications.
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<PAGE> 12
Note 8 - Dispositions and Reclassification of Securities
In June 1999, the Company sold approximately $4.0 million of securities from its
held-to-maturity portfolio to meet a significant and unanticipated increase in
claim payments. The securities sold represented 44% of the held-to-maturity
portfolio and generated a realized gain of $2,000. Due to the sale and the
recent acquisition of Continental management changed the intent to hold the
remaining held-to-maturity portfolio, of approximately $5.0 million, and
transferred, as of June 30, 1999, the balance to available-for-sale and recorded
an unrealized loss of $9,000.
Note 9 - Subsequent Event
On March 18, 1999, Central announced the execution of an agreement with United
Benefit Managed Care Corporation to purchase all of the outstanding shares of
its subsidiary, United Benefit Life Insurance Company ("United Benefit Life").
On June 14, 1999, Central terminated this agreement. United Benefit Life and its
affiliate company, Insurance Advisors of America, Inc., ("Insurance Advisors"),
were obligated to Central for the entire shortfall in reserves transferred to
Central on August 1, 1998 in connection with Central's reinsurance of all of
United Benefit Life's health insurance business. This obligation was secured,
among other things, by a pledge of all of the stock of United Benefit Life. In
addition, Insurance Advisors owed Central an additional $7 million in connection
with the August 1, 1998 transaction. Pursuant to a "true up" mechanism in the
agreements between United Benefit Life and Central, it was determined that the
shortfall totaled $16.5 million. After receiving approval from the Department of
Insurance of the State of Indiana authorizing Central to assume control of
United Benefit Life, on July 21, 1999, Central foreclosed on the stock of United
Benefit Life to collect the receivable arising from the reserve shortfall.
Pursuant to our reinsurance agreement with Hannover, Hannover is responsible for
80% of the amount of the shortfall. Approximately $12.0 million has been
credited to the total indebtedness as a result of our foreclosure. In addition,
all of the renewal commissions due Insurance Advisors from United Benefit Life
have been foreclosed upon, extinguishing the approximately $11.5 million balance
of the reserve shortfall and Insurance Advisors other indebtedness. In July,
Hannover repaid the balance of the reserve shortfall which had been advanced by
Central, and, as a result, Central no longer holds any receivable from United
Benefit Life or Insurance Advisors. At the date of the foreclosure, United
Benefit Life's assets primarily included real estate, bonds, reinsurance
receivables, and other receivables.
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<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- -------------------------------------------------------------------------------
OF OPERATIONS
-------------
The following discussion should be read in conjunction with our consolidated
condensed financial statements and accompanying notes and other financial
information included elsewhere.
GENERAL
The Company provides a broad spectrum of managed care, health insurance and
specialty products and services to more than 410,000 medical members. The
Company distributes its products on a national basis through approximately
50,000 independent, licensed agents to the growing and under-served individual
and small business markets and to the senior market. Through the implementation
of cost containment programs and our underwriting and product expertise, the
Company has reduced medical costs and underwriting risks and increased fee-based
revenue. As a result, the Company's medical loss ratio for the quarter ended
June 30, 1999 declined to 73% from 89% for the same quarter of 1998. The medical
loss ratio for the six months ended June 30, 1999 declined to 73% from 91% for
the same period in 1998.
In 1996 and 1997, Central, our then-principal subsidiary, experienced
substantial losses incurred in connection with newly-issued group health
insurance policies, greater than anticipated utilization new state and federal
mandates and reductions in profitability arising out of industry-wide pricing
competition. In June 1997, in order to address the continued decline in
Central's surplus, the Company borrowed $5.2 million from Huntington National
Bank, $5.0 million of which was contributed to the surplus of Central.
In December 1997, Central entered into a reinsurance treaty with Hannover in
which Central transferred to Hannover $24.6 million of reserve liability. In
return for Hannover's reinsurance of this liability, Central transferred $14.6
million in assets to Hannover. The reinsurance treaty, which is on a 50/50
quota-share basis, provided Central with a $10.0 million initial ceding
allowance, which increased Central's statutory surplus. The treaty provides for
repayment of the initial ceding allowance plus interest out of statutory
profits, if any, of the reinsured business. The combination of the $14.0 million
surplus note which was invested in connection with a $20.0 million bridge loan
arranged by Strategic Acquisition Partners, LLC and the $10.0 million ceding
allowance provided an additional $24.0 million to the statutory capital and
surplus of Central, increasing statutory levels in excess of regulatory
risk-based capital requirements and alleviating the regulatory concerns that
were created in 1996 and continued in 1997.
Since January 1, 1998, the Company (1) began executing a new business plan
designed to increase premium rates, reduce costs and emphasize acquisitions; (2)
underwent a change in control; (3) completed a private placement of our common
stock in July 1998 in which the Company issued and sold 7,300,000 shares of
common stock at $5.50 per share and warrants to purchase an additional 3,650,000
shares of common stock at an exercise price of $5.50 per share (the "Equity
Warrants") for an aggregate purchase price of approximately $40.2 million (the
"July Transaction"); (4) entered into an agreement with United Benefit Life in
August 1998 to reinsure 100% of the major medical policies of United Benefit
Life, covering approximately 100,000 lives with
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estimated annual premiums of $100.0 million; (5) acquired Provident American
Life & Health Insurance Company from Provident American Corporation on December
31, 1998 for $5.5 million in cash; (6) acquired Continental and CGIC from The
Western and Southern Life Insurance Company of Cincinnati, Ohio, on February 17,
1999 for $84.5 million in cash; (7) completed a private placement of common
stock in February 1999 to provide funds for the Continental acquisition, in
which 2,000,000 shares of common stock were issued and sold at $7.50 per share;
and (8) acquired United Benefit Life in July 1999 through foreclosure
(collectively, the "Restructuring Transactions").
Because of the Restructuring Transactions and the acquisitions of Provident,
Continental, and United Benefit Life, the Company has undergone significant
changes since January 1, 1998. The acquisitions of Provident and Continental had
no impact on results of operations in 1998. The financial information for the
quarter and six months ended June 30, 1999 includes the operations of
Continental for February and March in the first quarter, its full operations in
the second quarter, and the financial operations of Provident for the entire
period.
RECENT EVENTS
On August 1, 1998, Central entered into an agreement with United Benefit Life to
reinsure 100% of the major medical policies of United Benefit Life in effect
prior to August 1, 1998, covering approximately 100,000 members with estimated
annual premiums of $100.0 million. The agreement also provides that Central will
reinsure 100% of all major medical policies written by United Benefit Life from
and after August 1, 1998. Central also began administering all of United Benefit
Life's major medical policies as of August 1, 1998. In addition, Central entered
into an agreement with Insurance Advisors, to market the policies to be issued
by United Benefit Life which Central reinsured. At the same time, Central ceded
80% of the business in force on August 1, 1998 to Hannover, thereby retaining a
net risk of 20%. Additionally, Central ceded 50% of the policies to be written
by United Benefit Life from and after August 1, 1998 and reinsured by Central to
Hannover.
On July 31, 1998, United Benefit Life held approximately $13.5 million in
reserves. Hannover paid to Central an initial ceding allowance of $20.0 million
for its 80% portion of the reinsurance. The treaty provides for repayment of
the initial ceding allowance plus interest out of statutory profits, if any, of
the reinsured business. Central paid to United Benefit Life this ceding
commission which was applied to the known reserve shortfall. Reserves for
estimated claims of $36.5 million were assumed by Central, for which United
Benefit Life transferred assets of $33.5 million, including the $20.0 million
ceding allowance provided by Central.
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Therefore, reserve liabilities assumed by Central exceeded by $3.0 million the
cash transferred to Central by United Benefit Life as reimbursement for this
assumption. This $3.0 million reserve shortfall was reflected in a note
receivable payable to Central by United Benefit Life. Insurance Advisors joined
in United Benefit Life's $3.0 million obligation. In addition, Central entered
into an agency agreement with respect to the marketing of United Benefit Life's
policies with Insurance Advisors in exchange for a $7.0 million note receivable.
The agreements between the parties provided for a "true up" which required
United Benefit Life and Insurance Advisors to be jointly liable for any
difference between the indicated reserve of $36.5 million and the actual
liabilities as of August 1, 1998. The obligations of United Benefit Life and
Insurance Advisors to Central were secured by a pledge by the parent company of
United Benefit Life, United Benefit Managed Care Corporation, of 100% of the
stock of United Benefit Life and the pledge by Insurance Advisors of all of the
commissions due Insurance Advisors or to become due from United Benefit Life.
Recently, an independent actuarial firm was retained by Central to calculate the
amount of actual reserves required of United Benefit Life as of August 1, 1998.
The actual required reserves were estimated to be approximately $50.0 million at
August 1, 1998 pursuant to the actuary's calculations. Therefore, United Benefit
Life owed Central and Hannover, as reinsurer, approximately $16.5 million.
Insurance Advisors was jointly responsible for this amount, in addition to the
$7.0 million outstanding on its original note.
On March 18, 1999, Central announced the execution of an agreement with United
Benefit Managed Care Corporation to purchase all of the outstanding shares of
its subsidiary, United Benefit Life. On June 14, 1999, Central terminated this
agreement. Instead, because of the reserve shortfall, after receiving approval
from the Department of Insurance of the State of Indiana authorizing Central to
assume control of United Benefit Life on July 21, 1999, Central foreclosed on
the stock of United Benefit Life to collect the receivable arising from the
reserve shortfall. Pursuant to our reinsurance agreement with Hannover, Hannover
is responsible for 80% of the amount of the shortfall. Approximately $12.0
million has been credited to the total indebtedness as a result of our
foreclosure of United Benefit Life. In addition, all of the renewal commissions
due Insurance Advisors from United Benefit Life have been foreclosed upon,
extinguishing the approximately $11.5 million balance of the reserve shortfall
and other Insurance Advisors indebtedness. In July, Hannover repaid the balance
of the reserve shortfall which had been advanced by Central, and, as a result,
Central no longer holds any receivable from United Benefit Life or Insurance
Advisors. At the date of the foreclosure, United Benefit Life's assets primarily
included real estate, bonds, reinsurance receivables, and other receivables.
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 1999 COMPARED TO QUARTER ENDED JUNE 30, 1998
For the quarter ended June 30, 1999, total net premiums were $80.7 million, an
increase of 125.4%, from $35.8 million for the same quarter in 1998. Medical
premiums for the quarter ended June 30, 1999 were $62.2 million compared to
$33.1 million for the quarter ended June 30, 1998, an increase of 87.8%.
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The increase in medical premiums was the result of $13.5 million attributable to
Provident and Continental, $7.4 million for reinsurance assumed and $8.2 million
from new business and rate increases for Central. Specialty and other premiums,
which includes primarily dental, long-term care, Medicare supplement, annuities
and life insurance, were $18.5 million for the quarter ended June 30, 1999
compared to $2.7 million for the quarter ended June 30, 1998, an increase of
590.4%. The increase in specialty and other premiums was the result of $14.6,
million, or 92.4%, from Continental and the remainder from Provident.
Net investment income increased to $6.6 million for the second quarter of 1999
from $2.1 million for the second quarter of 1998, an increase of 216.4%.
Continental's portion of the increase was $4.7 million.
Fee and other income increased to $4.8 million for the quarter ended June 30,
1999 compared to $2.4 million for the same quarter of 1998, an increase of
103.0%. This increase was primarily attributed to $2.0 million in administrative
fees for business reinsured through Provident and United Benefit Life. The
balance represents a defalcation recovery. The amortization of deferred
reinsurance gain of $1.4 million for the quarter ended June 30, 1999 represents
the recognition of the ceding commission allowances received on our reinsurance
agreements. The unamortized amount of $23.7 million for the quarter ended June
30, 1999 is accounted for as a deferred reinsurance gain on the consolidated
condensed balance sheet.
Total benefits, claims and settlement expenses increased to $60.4 million for
the quarter ended June 30, 1999 compared to $31.3 million for the same quarter
in 1998, an increase of 93.0%. Approximately $22.8 million of the $29.1 million
total increase was attributable to Provident and Continental. The remaining
approximately $6.0 million was attributable to an increase of claims at Central
and United Benefit. Medical benefits, claims, losses and settlement expenses
were $45.2 million for the quarter ended June 30, 1999 compared to $29.5 million
for the same quarter in 1998, an increase of 53.5%. The medical loss ratio was
72.7% for the quarter ended June 30, 1999 compared to 89.0% for the same quarter
of 1998. Cost reduction and benefit programs modifications implemented in 1998,
such as rate increases, underwriting changes, claim procedures, and additional
managed care, led to the reduction in the medical loss ratio. The specialty
benefit ratio was 81.9% for the second quarter of 1999 compared to 67.4% for the
second quarter of 1998. Specialty and other benefits, claims, losses and
settlement expenses were $15.1 million for the quarter ended June 30, 1999
compared to $1.8 million for the same quarter of 1998, an increase of 739.1%.
The increase in the specialty benefit ratio is primarily due to a higher loss
ratio of Continental's Medicare supplement business and the inclusion of
Continental's interest sensitive life insurance and annuity benefits and
reserves.
Selling, general and administrative expenses increased to $32.4 million in the
second quarter of 1999 compared to $11.3 million in the first quarter of 1998,
an increase of 186.2%. Of this amount, commissions paid (due) to agents in the
quarter ended June 30, 1999 were $23.8 million compared to $9.2 million in the
same quarter of 1998. Included in the 1999 commissions are $13.7 million for
Provident and Continental. The remaining increase of $1.0 million 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, consisting of employee salaries and benefits and other
administrative expenses, increased to $23.3 million for the quarter ended June
30, 1999 compared to $5.8 million in the second quarter of 1998. Provident and
Continental accounted for $11.8 million of the $17.5 million increase.
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The remaining increase was primarily due to additional costs incurred for the
outsourcing of computer operations, increase in employee costs, consulting
support, acquisitions and product development to help support our increased
growth.
The net amortization and change in deferral of acquisition costs and value of
business acquired resulted in a net deferral of $4.7 million for the second
quarter of 1999 compared to a net amortization of $9,000 for the second quarter
of 1998. Continental accounts for $3.2 million of the deferral. The deferral of
first year excess associated with the significant increase in sales of new
products written by Central, Provident, and United Benefit Life, as well as the
resulting increase in excess first year expenses, accounted for the remaining
balance.
Interest expense and financing costs increased to $0.9 million in the second
quarter of 1999 compared to $0.7 million in the second quarter of 1998 as a
result of the interest expense on the $40.0 million loan under the credit
facility which began to accrue on February 17, 1999, the closing date of the
purchase of Continental.
A provision for federal income taxes of $1.6 million, or 35.0% of income before
federal taxes of $4.6 million, was established for the second quarter of 1999.
Net income for the second quarter of 1999 was $3.0 million, or $0.23 basic
earnings per share and $0.19 diluted earnings per share, compared to a net loss
of $3.1 million, or $0.73 loss per share on both a basic and diluted basis, for
the second quarter of 1998. The change in results was 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 rate increases, underwriting changes,
claim procedures and added managed care programs.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998
For the six months ended June 30, 1999, total net premiums were $148.1 million,
an increase of 112.8%, from $69.6 million for the same period in 1998. Medical
premiums for the six months ended June 30, 1999 were $115.0 million compared to
$64.1 million for the six months ended June 30, 1998, an increase of 79.4%. The
increase in medical premiums was the result of $20.1 million attributable to
Provident and Continental, $15.6 million reinsurance assumed, and $15.1 million
for rate increases and new business at Central. Specialty and other premiums
were $33.2 million for the six months ended June 30, 1999 compared to $5.5
million for the six months ended June 30, 1998, an increase of 502.0%. The
increase in specialty and other premiums was the result of $26.2 million
attributable to Continental.
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Net investment income increased to $11.4 million for the six months ended June
30, 1999 from $4.0 million for the same period of 1998, an increase of 181.8%.
Continental's portion of the increase was $7.2 million. Central's net investment
income increased slightly during the period from the same period in 1998.
Fee and other income increased to $9.7 million for the six months ended June 30,
1999 compared to $4.7 million for the same period of 1998, an increase of
105.1%. This increase was primarily attributed to $3.9 million in administrative
fees for business reinsured through Provident and United Benefit Life. The
balance represents a defalcation recovery. The amortization of deferred
reinsurance gain of $2.7 million for the six months ended June 30, 1999
represents the recognition of the ceding commission allowances received on the
Company's reinsurance agreements. The unamortized amount of $23.7 million for
the six months ended June 30, 1999 is accounted for as a deferred reinsurance
gain on the consolidated condensed balance sheet.
Total benefits, claims and settlement expenses increased to $110.6 million for
the six months ended June 30, 1999 compared to $61.9 million for the same period
in 1998, an increase of 78.6%. Provident and Continental accounted for $36.6
million of the total increase of $48.6 million. The remaining $12.0 million is
attributable to Central. Medical benefits, claims, losses and settlement
expenses were $84.4 million for the six months ended June 30, 1999 compared to
$58.2 million for the same period in 1998, an increase of 45.0%. The medical
loss ratio was 73.4% for the six months ended June 30, 1999 compared to 90.8%
for the same period in 1998. Cost reduction and benefit program modifications
implemented beginning in 1998, such as rate increases, underwriting changes,
claim procedures, and additional managed care, led to the reduction in the
medical loss ratio. Specialty and other benefits, claims, losses and settlement
expenses were $26.2 million for the six months ended June 30, 1999 compared to
$3.7 million for the same period in 1998, an increase of 599.3%. The specialty
benefit ratio was 79.0% for the six months ended June 30, 1999 compared to 68.0%
for the same period in 1998. The increase is primarily attributable to a higher
loss ratio of the Continental Medicare supplement business and inclusion of
interest sensitive life and annuity benefits and reserves.
Selling, general and administrative expenses increased to $59.6 million in the
six months ended June 30, 1999 compared to $20.5 million in the same period in
1998, an increase of 190.9%. Of this amount, commissions paid (due) to agents in
the six months ended June 30, 1999 were $40.4 million compared to $13.7 million
in the same period in 1998. Included in the 1999 commissions is $20.8 million
for Provident and Continental. The remaining increase 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, consisting of employee salaries and benefits and other administrative
expenses, increased to $40.7 million for the six months ended June 30, 1999
compared to $13.7 million in the second period in 1998. Continental accounted
for $17.0 million of the $27.0 million increase. We also incurred costs of $2.6
million for the operations of Provident in the six months ended June 30, 1999.
The remaining increase was primarily due to additional costs incurred for the
outsourcing of computer operations, hiring additional employees, consulting
support, acquisitions, and product development to help support our increased
growth.
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The net amortization and change in deferral of acquisition costs and value of
business acquired resulted in a net deferral of $7.8 million for the six month
ended June 30, 1999 compared to a net amortization of $11,000 for the same
period in 1998. Continental accounts for $5.1 million of the deferral. The
deferral of first year excess expenses associated with the significant increase
in sales of new products written by Central, Provident, and United Benefit Life,
accounted for the remaining balance.
Interest expense and financing costs increased to $1.5 million in the six months
ended June 30, 1999 compared to $1.3 million for the same period in 1998 as a
result of the interest expense on the $40.0 million loan under our credit
facility which began to accrue on February 17, 1999, the closing date of the
purchase of Continental.
A provision for federal income taxes of $2.8 million, or 35.0% of income before
federal taxes of $8.1 million, was established for the six months ended June 30,
1999.
Net income for the six months ended June 30, 1999 was $5.2 million, or $0.40
basic earnings per share and $0.34 diluted earnings per share, compared to a net
loss of $5.4 million, or $1.29 loss per share on both a basic and diluted basis,
for the same period in 1998. The change in results was 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 rate increases, underwriting changes,
claim procedures and added managed care programs.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability of the Company to generate adequate amounts of cash to
meet its financial commitments. The major needs for cash are to enable the
Company's insurance subsidiaries to pay claims and expenses as they come due.
The primary sources of cash are premiums and investment income. Payments consist
of current claim payments to insureds, managed care expenses, operating expenses
such as salaries, employee benefits, commissions, taxes and interests on debts.
The Company has, in the past, relied on the dividend from Central to enable it
to pay dividends to stockholders. We discontinued paying dividends on our common
stock at the end of 1996. By statute, the state regulatory authorities set
minimum liquidity standards to protect both policyholders and stockholders and
limit the dividends payable by our insurance subsidiaries to the Company.
The majority of our assets are in investments, which were $306.8 million, or
40.0% of the total assets, at June 30, 1999 and $89.8 million or 49.8% of the
total assets, at December 31, 1998. Fixed maturities are our primary investment
and were $302.9 million, or 99% of total investments, at June 30, 1999, and
$89.7 million, or 98.8% of total investments, at December 31, 1998. Other
investments consist of policy loans and mortgage loans. We are carrying fixed
maturities of $302.9 million at estimated fair value (available for sale) at
June 30, 1999 and at December 31, 1998 we carried fixed maturities of $8.9
million at amortized cost (held to maturity) and $80.8 million at estimated fair
value (available for sale).
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The Company does not hold any "junk" bonds or what are generally considered
high-yield type securities, and 100% of our bonds are of investment grade
quality. In addition to the fixed maturities, we also had $37.6 million in cash
and cash equivalents, and a $10 million line of credit with a major bank (as
described below) at June 30, 1999 and $15.0 million in cash and cash equivalents
and a $15 million line of credit with a major bank (which was replaced with the
$10.0 million line of credit) equivalents at December 31, 1998. There was no
amount outstanding on the line of credit at June 30, 1999.
Assets increased 325.1% to $776.1 million at June 30, 1999 from $180.2 million
at December 31, 1998. The increase in the six months ended June 30, 1999 was
primarily due to the acquisition of Continental, which had assets of $549.8
million at June 30, 1999, with the remaining increase attributable to the
acquisition of Provident. These increases were, in part, offset by a related
increase in liabilities of $578.3 million during the period to $772.7 million.
Continental's liabilities were $495.1 million and Provident's were $40.4 million
at June 30, 1999. The two major items of our total assets continue to be
investments (40.0%) and reinsurable receivable (41.8%).
The total policy liabilities and accruals ("reserves") were 74.5% of the total
liabilities at June 30, 1999, compared to 67.3% at June 30, 1998. Continental
accounted for 78.1% of the reserves at June 30, 1999.
To provide funds for the acquisition of Continental, the Company incurred a debt
of $40.0 million under a credit agreement. Under the terms of the credit
agreement, dated as of February 17, 1999, among the Company, various lending
institutions and The Chase Manhattan Bank, as Administrative Agent, 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 thereafter to
February 17, 2005. Interest on the outstanding balance will be determined based
on whether we select a "Base Rate Loan" or a "Eurodollar Loan". Under the Base
Rate Loan, the interest rate will be 2.5% per annum plus the higher of (x) the
rate which is 2 of 1% in excess of a federal funds rate and (y) Chase's prime
rate as in effect from time to time. Under the Eurodollar Loan, the interest
rate will be 3.5% per annum plus a Eurodollar rate, which is the arithmetic
average of the offered quotation to first-class banks in the interbank
Eurodollar market by Chase, adjusted for certain reserve requirements. At June
30, 1999, the interest rate was 8.57%. The credit agreement also provides for a
$10.0 million line of credit which bears interest at the same rate as the $40.0
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
our shares of common stock, except upon compliance with certain conditions; (2)
restrict the creation of liens and sales of assets; and (3) require that we at a
minimum maintain (a) a leverage ratio (consolidated debt to consolidated total
capital) of 0.50 to 1.00 through December 31, 1999, 0.45 to 1.00 thereafter
through December 31, 2000, 0.40 to 1.00 thereafter through December 31, 2001,
and 0.35 to 1.00 thereafter, (b) an interest coverage ratio (consolidated EBITDA
to consolidated interest expense) of 2.0 to 1 through December 31, 1999, 2.5 to
1 through December 31, 2000, and 3.0 to 1 thereafter, (c) a risk-based capital
ratio for any regulated insurance company subsidiary of the Company of not less
than 125%, and (d) consolidated net worth of $35.0 million through December
31,1999, $40.0 million thereafter through December 31, 2000, $50.0 million
thereafter through
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December 31, 2001, $60.0 million thereafter through December 31, 2002, and $70.0
million thereafter. In addition, the Company pledged the common stock of
Continental, Central and other insignificant subsidiaries as security for the
credit agreement. At June 30, 1999, we were 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 it.
OPERATING SEGMENT INFORMATION
The Company has identified three distinct operating segments based upon product
types, as follows: medical, specialty and other, and corporate and other.
Products included in the medical segment include comprehensive major medical
insurance plans.
Products included in the specialty and other segment include Medicare
supplement, long-term care, dental, life insurance, and annuities.
The corporate and other segment encompasses all our other activities, including
our interest income and expense.
The medical segment had net revenues of $69.2 million in the second quarter of
1999 compared to $37.3 million in 1998. The major reasons for the increase were
due to the addition of approximately $11.2 million from Continental and $5.6
million of net 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, losses and settlement expenses for the medical segment
were $45.2 million in the second quarter of 1999 compared to $29.5 million in
the second quarter of 1998. The increase included approximately $8.0 million of
benefits, claims, and expenses for Continental. The remaining increase of $7.7
million was primarily due to claims and expenses related to the United Benefit
Life business assumed in August 1998.
Total corporate and other revenues were $154,000 for the second quarter of 1999
compared to $51,000 for the second quarter of 1998. The increase was primarily
due to $106,000 from Continental.
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MARKET RISK AND MANAGEMENT POLICIES
The following is a description of certain risks facing health, life and accident
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 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 us will default or
that other parties, including reinsurers that have obligations to us, 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 interests 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 if 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.
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
prescription drug costs. New, more-expensive and wider use of pharmaceuticals is
inflating healthcare costs. The Office of Personnel Management reported the
costs of prescription drugs increased by 22% in 1998.
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While to a certain extent these increased costs are offset by interest rates
(investment income), hospital charges increased, while 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 no assurance that these efforts will fully offset the impact of inflation
or that premiums will equal or exceed increasing healthcare costs.
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 second quarter of 1999,
incurred costs were $4.9 million. The estimated additional costs are currently
expected to be $600,000.
Status - The Company continues to execute its plan to ensure that all systems
are Y2K compliant and completed the IT systems in July 1999, and expects to
complete 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 completed all
testing in July 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 or its wholly-owned subsidiaries' 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 Y2K issue in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Y2K 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 such
as billing and collection, payroll operations and daily administration of
policyholder claims. In addition, disruptions in the economy generally
resulting from Y2K 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
wholly-owned subsidiaries. All Y2K compliance plan activities are scheduled to
be completed by the end of the third quarter of this year.
-23-
<PAGE> 24
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.
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
Continental, Provident, or United Benefit Life into the Company,
including the failure to achieve cost consolidations;
- any shortfall in the assets of United Benefit Life or the
commissions due to Insurance Advisors, which were foreclosed
upon on July 21, 1999;
- rising healthcare costs;
- business conditions and competition in the healthcare industry;
- developments in healthcare 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 marketplace 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;
- the failure to comply with financial and other covenants in the
Company's loan agreements; and
- the ability of the Company to obtain additional debt or equity
financing on terms favorable to the Company to facilitate
long-term growth.
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.
-24-
<PAGE> 25
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 4 and Item 5 are either inapplicable to
Registrant, would not require a response, or have been previously reported.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------
a) The Annual Meeting of Stockholders was held on June 10, 1999.
b) Proxies were solicited for the election of directors by the Company's
management pursuant to Regulation 14A under the Securities Exchange Act of
1934. No solicitation in opposition to management's nominees as listed in
the proxy statement was made. All of management's nominees were elected to
hold office until the next annual election of directors and until their
successors are elected and qualified pursuant to the vote of the
stockholders.
c) The matters voted upon were the following:
1. With respect to the election of nine directors to serve until the next
annual election of directors and until their successors are elected
and qualified.
Name For
---- ---
Andrew A. Boemi 12,565,372
Michael A. Cavataio 12,565,372
Bradley E. Cooper 12,563,250
Fred Lick, Jr. 12,543,345
Peter W. Nauert 12,564,312
John F. Novatney, Jr. 12,546,955
Richard M. Osborne 12,564,572
Robert A. Spass 12,562,747
Mark H. Tabak 12,562,247
-25-
<PAGE> 26
2. With respect to the proposal to approve the Company's 1998 Key
Employee Share Incentive Plan:
For 12,135,821
Against 348,797
Withheld 68,186
3. With respect to the proposal to approve and adopt performance-based
compensation for Peter W. Nauert, the Company's President and Chief
Executive Officer:
For 12,453,375
Against 81,589
Withheld 40,714
4. With respect to the proposal to approve and ratify Ernst & Young, LLP
as the Company's independent auditors for the fiscal year ending
December 31, 1999:
For 12,563,638
Against 1,474
Withheld 10,566
The total number of shares the Company's common stock, par value
$0.001 per share, outstanding as of the April 12, 1999 record date for
the Annual Meeting was 13,497,732.
ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K
----------------------------------------
a) Exhibits.
(27) Financial Data Schedule
b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the three months
ended June 30, 1999.
-26-
<PAGE> 27
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: August 16, 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)
-27-
<PAGE> 28
EXHIBITS
--------
(27) Financial Data Schedule
-28-
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CERES
GROUP, INC. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS AS OF JUNE 30, 1999 AND
FILED IN FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 302,965,829
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 97,136
<REAL-ESTATE> 0
<TOTAL-INVEST> 306,764,614
<CASH> 37,597,724
<RECOVER-REINSURE> 319,878,961
<DEFERRED-ACQUISITION> 11,980,639
<TOTAL-ASSETS> 766,097,076
<POLICY-LOSSES> 377,351,168
<UNEARNED-PREMIUMS> 32,334,774
<POLICY-OTHER> 129,024,162
<POLICY-HOLDER-FUNDS> 10,333,396
<NOTES-PAYABLE> 48,222,095
0
0
<COMMON> 13,508
<OTHER-SE> 58,998,759
<TOTAL-LIABILITY-AND-EQUITY> 766,097,076
148,127,258
<INVESTMENT-INCOME> 11,367,872
<INVESTMENT-GAINS> 125,990
<OTHER-INCOME> 9,700,589
<BENEFITS> 110,597,346
<UNDERWRITING-AMORTIZATION> (7,787,344)
<UNDERWRITING-OTHER> 59,629,559
<INCOME-PRETAX> 8,059,184
<INCOME-TAX> 2,820,714
<INCOME-CONTINUING> 5,238,470
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,238,470
<EPS-BASIC> .40
<EPS-DILUTED> .34
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
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