UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
Commission File #0-11321
Universal American Financial Corp.
(Exact name of registrant as specified in its charter)
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New York 11-2580136
------------------------- -------------------------------
(State of Incorporation) (I.R.S. Employer I.D. Number)
Six International Drive, Suite 190, Rye Brook, NY 10573
- ------------------------------------------------- --------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (914) 934-5200
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Class on which Registered
- ----------------------------------------------- ------------------------
Common Stock, par value $.01 per share NASDAQ
Common Stock Warrants, expire December 31, 1999 NASDAQ
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 period 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
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 27, 1998 was approximately $10,978,212.
The number of shares outstanding of the Registrant's Common Stock and
Common Stock Warrants as of February 27, 1998 were 7,411,680 and 668,481,
respectively.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated:
(1)Proxy Statement for the 1998 Annual Meeting incorporated by reference
into Part III.
(2)Exhibits listed in Item 14(b), Part IV, incorporated by reference to
Form S-1 filed March 30, 1990, Forms 10-K for 1996, 1994, 1993, 1991,
1989 and 1988 and Forms 8-K for July 24, 1992, May 31, 1991 and
December 9, 1987.
<PAGE>
PART I
ITEM 1 - BUSINESS
General
Universal American Financial Corp. ("the Company" or "Universal") is a
life and accident & health insurance holding company, whose principal
subsidiaries are American Pioneer Life Insurance Company ("American Pioneer"),
American Progressive Life and Health Insurance Company of New York ("American
Progressive"), and American Exchange Life Insurance Company ("American
Exchange"), (collectively the "Insurance Subsidiaries"), and WorldNet Services
Corp. ("WorldNet"), a third party administrator ("TPA") that provides
communication, managed care and claims adjudication services to the Insurance
Subsidiaries and non-affiliated insurance companies and affinity groups. The
references below to the insurance operations of the Company are to be understood
as references to activities of the Insurance Subsidiaries. Financial items are
reported on a Generally Accepted Accounting Principles basis ("GAAP"), except
where otherwise noted.
Strategic Focus
The Company has implemented, and will continue to pursue, the following
strategies:
Internal Growth
The Company has focused its efforts to reach targeted segments of the
insurance market as defined by product or by geography. These include:
Senior market life insurance, annuity and accident & health insurance
products designed for sale primarily in New York, Florida and Texas;
Life insurance, annuity and accident and health insurance programs
sold through large independent marketing organizations.
External Growth
Since 1991, the Company has successfully acquired and integrated three
insurance companies and six blocks of business, most recently in the fourth
quarter of 1997 with the acquisition of 100% of the outstanding stock of
American Exchange and in the first quarter of 1998 with the acquisition of $12.6
million of premium from Dallas General Life Insurance Company ("Dallas
General"). The Company continues to seek out further acquisitions (See Insurance
Acquisitions Activity).
Insurance Marketing Activity
The Company has placed its emphasis on the sale of a line of products that
particularly appeal to the senior market, largely through marketing
organizations with concentrations in this market. The Company began to sell
senior market life and supplemental health insurance products in 1993 in New
York and expanded its sales effort to Florida in 1996 and Texas in 1997. The
momentum into Florida was accelerated by the acquisition of business from First
National Life Insurance Company ("First National") and into Texas by the
American Exchange and Dallas General acquisitions (See "Insurance Acquisitions
Activity").
2
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Business In Force
The Company's growth, in direct and assumed business, is shown in the
following tables as of December 31, 1995, 1996 and 1997.
Annualized Premium In Force As of December 31,
----------------------------------------
1995 (1) 1996 (1) 1997 (1)
------------ ------------ -------------
Senior Market Life Insurance:
Multiple Pay
- -------------------------------------
Asset Enhancer (2) $2,200,835 $3,191,359 $6,107,739
SL 2000 928,995 1,130,690 1,465,727
------------ ------------ -------------
Total Senior Market Life Multiple
Pay 3,129,830 4,322,049 7,573,466
------------ ------------ -------------
Special Markets: Life Insurance
- -------------------------------------
Flex-A-Vest 1,104,544 2,594,493 2,107,169
Group Life 3,477,876 4,150,000 3,888,912
Brokerage (2) 9,883,198 9,031,970 9,346,261
------------ ------------ -------------
Total Special Markets: Life
Insurance 14,465,618 15,776,463 15,342,342
------------ ------------ -------------
Senior Market: Accident & Health
- -------------------------------------
Medicare Supplement
and Select 2,739,649 58,851,455 68,404,225
Long Term Care - 2,277,686 4,546,346
Hospital Indemnity 2,587,584 2,239,207 1,888,069
------------ ------------ -------------
Total Senior Market: Accident &
Health 5,327,233 63,368,348 74,838,640
------------ ------------ -------------
Special Markets: Accident & Health
- -------------------------------------
Individual Medical 12,607,264 10,851,433 17,681,996
Other Accident &
Health (3) 2,151,332 2,144,717 3,475,324
Single Pay Life - - 87,583
------------ ------------ -------------
Total Special Markets: Accident &
Health 14,758,596 12,996,150 21,244,903
------------ ------------ -------------
Grand Total $37,681,277 $96,463,010 $118,999,351
============ ============ =============
- ------------------------------
(1) Does not include lines of business the Company has exited in its
restructuring activity (NYS DBL, NAIU Accident Pool and Group Dental)
which amounted to $18,496,266, $19,439,760 and $7,504,420 at December 31,
1995, 1996 and 1997, respectively (See "Restructuring Activity ", below).
(2) Included in the amounts shown are premiums for interest-sensitive
products. These amounts represent the portion of premium applied to the
cost of insurance (i.e. deposit premiums have been excluded).
(3) Business acquired by the Company that is not actively marketed.
The following table shows all outstanding account values for
interest-sensitive products for 1995, 1996 and 1997. For these products, the
Company earns an income on the spread between investment income on the Company's
invested assets and interest credited to these account balances.
Account Values As of December 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
Annuities $82,208,343 $88,445,217 $88,032,040
Universal
Life 33,123,308 34,686,676 35,640,097
Asset
Enhancer 3,277,185 11,407,061 21,413,550
------------ ------------ ------------
Grand Total
$118,608,836 $134,538,954 $145,085,687
============ ============ ============
3
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Senior Market
The following are the core products sold to the senior age market.
Medicare Supplement
The Company began to sell Medicare Supplement policies in January, 1994.
American Progressive has entered into Managing General Agency relationships with
three of the largest accident and health sales organizations in upstate New York
that specialize in the Senior Market to focus its marketing effort in geographic
areas in New York State where management believes competition is less formidable
than elsewhere in the State.
Recently, the Insurance Subsidiaries filed Medicare Select products with
the Texas and Florida Insurance Departments, to be sold primarily by Ameri-Life
and Health Services ("Ameri-Life"), a Managing General Agent of the Company.
American Pioneer's new Medicare Select policies have been approved by the
Florida Insurance Department and sales of this product are expected to begin in
April, 1998.
The Medicare Supplement policies offered by the Insurance Subsidiaries are
primarily on plans A, B, C and F and are underwritten on a simplified issue
basis, except that the policies sold in New York are on a guaranteed issue
basis, subject to the community rating laws of that state (See "Regulation -
Health Care Reform"). Sales amounted to $2.0 million, $3.1 million and $4.8
million in 1995, 1996 and 1997, respectively.
Home Health Care and Nursing Home
American Progressive introduced Home Health Care and Nursing Home products
in New York in early 1996. In late 1996, American Pioneer introduced a managed
care home health care product in Florida that uses preferred provider
organization ("PPO") discounts and capitation with a home health care network.
Issued premium for these long-term care products in 1996 (the first year of
sales) and in 1997 amounted to $1.3 million and $2.4 million, respectively.
Hospital Indemnity
American Progressive introduced a Senior Age Hospital Indemnity product in
mid-1993 and has premium in force in excess of $1.8 million as of December,
1997. Benefits under this product are fixed cash payments based upon the length
of hospital stays and are designed to provide money to meet needs ancillary to
hospitalization.
One, Five, Six and Seven Pay Interest Sensitive Whole Life ("Asset
Enhancer")
This program, marketed primarily by National Financial Group of
Scottsdale, Arizona, a national marketing organization under contract with
American Pioneer, and a number of other contracted large national marketing
groups, began in 1994 and is now sold actively in several states. The product is
a simplified issue interest-sensitive whole life product with one, five, six or
seven year payment options. It is designed as an interest-sensitive whole life
vehicle for seniors to facilitate estate planning and transfer assets to heirs
in an income tax-advantaged manner. In many states, the product offers an
optional nursing care and home care rider.
In addition to American Pioneer's own sales of this product, in 1996,
American Pioneer entered into an arrangement with West Coast Life Insurance
Company ("West Coast Life"), an unaffiliated "A+" rated carrier, under which
West Coast issues this product and, through an unaffiliated reinsurer, reinsures
one-third of the risk to American Pioneer. Under its contract with West Coast,
American Pioneer administers the product and the relationships with the
producers on a fee basis.
Statutory premium production of five, six and seven pay life insurance
amounted to $1.0 million, $1.6 million and $3.8 million in 1995, 1996 and 1997,
respectively. Single pay life insurance was introduced in 1995 and statutory
premium production amounted to $2.1 million, $6.2 million and $17.6 million in
1995, 1996 and 1997, respectively. These figures include the entire premium
generated by American Pioneer sales and the portion assumed by American Pioneer
on West Coast Life's sales.
4
<PAGE>
Senior Life (SL2000)
This series of low-face value, simplified issue whole life products,
introduced in late 1995, is sold by the Insurance Subsidiaries as part of their
senior market effort. The Company issued $462,000 of premium in 1996, and
$652,000 in 1997.
Special Markets
Modified Premium Term Life Insurance (Flex-A-Vest 88)
This program, sold by American Pioneer and marketed exclusively by
Interstate Specialty Marketing, Inc. of Tustin, California, began in late 1994
and is now being sold actively in several states. In states where American
Pioneer is not licensed, an arrangement has been made with Pennsylvania Life
Insurance Company ("Pennsylvania Life"), a subsidiary of PennCorp Financial,
which issues the product and reinsures a portion of each case to the Company.
American Pioneer also administers the product on a fee-basis, and maintains the
relationship with the national marketing organization.
The product is a ten-year term product with an endowment payable after the
10th year. It is designed for the middle income market as a method to provide
insurance coverage and a vehicle for retirement or college tuition funding.
Including the premium reinsured from Pennsylvania Life, American Pioneer
issued $1.1 million, $2.2 million and $1.3 of premium in 1995, 1996 and 1997,
respectively.
Group Life Insurance
Through an arrangement with Alabama Blue Cross that has persisted since
1989, an American Pioneer group life insurance information package, including a
premium quotation, goes out with most Alabama Blue Cross small group major
medical insurance premium quotation. This program had premium revenue of $3.2
million in both 1996 and 1997.
Annuities
The Company markets Single and Flexible Premium Deferred Annuities
primarily through sales organizations which concentrate in the Tax-Advantaged
Annuity Internal Revenue Code 403(b) market. Annuity products generally focus on
the senior and retirement market. The Company's Tax Shelter Annuities, sold
largely to school teachers, involve people of various ages, some of whom are
senior, but most of whom are purchasing with retirement in mind. The American
Progressive single premium annuity sold in New York, which represents the bulk
of the Company's annuity production, has a seven-year surrender charge, a
one-year rate guarantee and a maximum commission of 6%. Further penetration of
the senior annuity market is also being considered.
All of the Company's annuity products provide minimum interest rate
guarantees. The minimum guaranteed rates on the Company's annuity products
currently range from 4.0% to 5.5% annually and the contracts are designed to
permit the Company to change the credited rates annually subject to the minimum
guaranteed rate. The Company takes into account the current interest
environment, the profitability of its annuity business and its relative
competitive position in determining the frequency and extent of changes to the
interest crediting rates.
Statutory premium production of new annuities amounted to $13.7 million,
$13.6 million and $12.0 million in 1995, 1996, and 1997, respectively.
Individual Medical
The Company has approximately $17.7 million of annual premium in force of
individual medical business as of December 31, 1997. Of this amount, $6.4
million was acquired in connection with the acquisition of American Exchange,
which accounts for the majority of the $6.8 million increase in this line in the
prior table of annual premiums in force. The Company intends to market American
5
<PAGE>
Exchange's individual medical product, which product is a limited benefit policy
and is 75% reinsured to an unaffiliated reinsurer.
Recent Insurance Acquisition Activity
First National
In the fourth quarter of 1996, the Company acquired, through an assumption
reinsurance agreement, approximately $56 million of annualized senior market
premium from First National. American Pioneer initially contracted with First
National to assume $4 million of premium on group Medicare Supplement coverage
issued to the members of the Florida Retired Educators Association ("FREA").
Then, after First National was placed into Receivership by the Alabama Insurance
Department in October, 1996, American Pioneer assumed, in addition to the FREA
block, approximately $50 million of Individual Medicare Supplement premium, $1.2
million of Home Health Care premium and $0.8 million of miscellaneous life and
accident and health insurance premiums, under terms negotiated with the
Receiver. All of these assumptions were effective as of October 1, 1996.
Simultaneously with the second assumption by American Pioneer, American
Pioneer entered into a reinsurance agreement with Transamerica Occidental Life
Insurance Company ("Transamerica"), ceding 90% of the $50 million individual
Medicare Supplement premium in force to Transamerica under reinsurance terms
believed to be favorable. American Pioneer performs all the administration on
the reinsured business. In addition to the premium acquired, First National had
active relationships with about 1,000 senior market producers in Florida and
2,000 agents in other states. American Pioneer recruited certain of these
producers, especially in Florida, to sell senior market products for American
Pioneer.
Finally, in order to insure a smooth transition and to take advantage of
the relatively low cost operating environment in Pensacola, the Company acquired
or leased most of the physical operating assets used by First National,
including computer hardware and software, and hired many of First National's
Pensacola administrative employees.
American Exchange Life Insurance Company
On December 4, 1997, the Company acquired American Exchange for $6.6
million in cash, which acquisition was approved by both the Texas and Florida
Insurance Departments. American Exchange, which is licensed in Texas and two
other states, has premium revenues in excess of $16.5 million, primarily in
Medicare Supplement and other limited benefit accident & health products and has
19,800 policies in force and 1,000 insurance agents, all based in Texas.
Dallas General Medicare Supplement Block
On March 19, 1998, the Company acquired a $12.6 million block of Medicare
Supplement business from Dallas General, effective January 1, 1998. The business
was assumed by American Pioneer, which assumption was approved by the Texas and
Florida Departments of Insurance. The Dallas General block has approximately
10,000 policies in force produced by approximately 400 agents, all in Texas. In
addition, the principals of Dallas General have entered into a contract to
continue to produce business for American Pioneer through an agency
relationship.
Previous Acquisition Activity
In 1994, American Progressive acquired, by means of reinsurance, blocks of
supplemental health insurance with annualized premiums of approximately
$1,275,000. In these transactions, American Progressive assumed all liability
under the reinsured policies incurred after January 1, 1994, in exchange for its
receipt from the ceding company of cash equal to the unearned premium and active
lives reserves on the reinsured business, net of a $60,000 ceding commission,
and future premium payments from the insureds.
In May 1993, American Progressive acquired 100% of the outstanding stock
of American Pioneer, based in Orlando, Florida, which sold life and accident and
health insurance in 33 states, primarily in the southeast. American Pioneer's
parent, American Pioneer Savings and Loan Association, had been under the
6
<PAGE>
control of the Resolution Trust Company ("RTC") since May 1990. American Pioneer
had an adjusted statutory book value (book value plus asset valuation reserve)
of approximately $7,472,000, and a GAAP stockholder's equity of approximately
$14,367,000 when it was purchased by American Progressive for $6,827,000 in
cash. By December 31, 1997, American Pioneer's adjusted statutory book value had
increased to approximately $10,807,000 and its GAAP stockholder's equity was
$18,671,000.
In May 1991, the Company, through John Adams Life Insurance Company ("John
Adams"), then its only insurance company subsidiary, acquired 100% of the
outstanding common stock of American Progressive, into which John Adams then
merged on June 27, 1991, with American Progressive as the surviving company.
American Progressive was acquired from Midland National Life Insurance Company
("Midland") for (a) a cash payment of $4,197,231, and (b) 510,000 shares ($10
par value) of the Company's Series A cumulative, redeemable, convertible
preferred stock ("Series A Preferred Stock"), for a total purchase price of
$9,297,231. (The Series A Preferred Stock was redeemed by the Company on
December 30, 1994.) American Progressive's statutory book value immediately
prior to acquisition was approximately $9,200,000, its adjusted statutory book
value was approximately $9,290,000, and its GAAP stockholder's equity was
approximately $9,700,000. As of December 31, 1997, the adjusted statutory book
value was approximately $9,783,000 and the GAAP stockholder's equity was
approximately $25,010,000. American Progressive, domiciled in New York and
licensed in 24 other states, historically concentrated on the sale of individual
accident and health insurance products primarily in New York and the
northeastern United States.
Restructuring Activity
Beginning in late 1996 and continuing throughout 1997, the Company
implemented a plan to consolidate the administration of its accident and health
business for all of the Insurance Subsidiaries in Pensacola. Simultaneously, the
Company consolidated the administration if its life and annuity business in
Orlando.
As part of its decision to concentrate its marketing effort on the Senior
Market, the Company decided to discontinue certain lines of business and reduce
its emphasis on others to take advantage of the lower-cost operating environment
of its new location in Pensacola.
Consolidation of Administrative Operations
As part of the First National transaction, the Company acquired in
Pensacola a relatively low cost administrative operation with particular
experience in the senior market. This has given the Company an opportunity to
consolidate many of its administrative functions in Pensacola and reduce a
significant amount of fixed overhead costs.
In December, 1996, the Company formulated a plan to move most of the
policy administrative functions, particularly in its senior market business,
from the American Progressive office in Brewster to Pensacola. This, along with
other cost saving efforts, resulted in a reduction in the work force at the
American Progressive office from 62 as of June 30, 1996 to approximately 25 as
of December 31, 1997, with a modest resultant increase in personnel in
Pensacola, including some personnel employed by American Progressive. These
plans were announced to the employees of the Company on March 14, 1997.
Consequently, American Progressive exercised its right to cancel its lease
for 15,000 square feet in Brewster as of October, 1997 and is currently leasing
a smaller office. The cost of this consolidation, including severance costs,
relocation costs and the cancellation penalty on the Brewster lease, was
approximately $250,000 and was expensed in the fourth quarter of 1996. The
Company estimates that it will save $750,000 annually as a result of this
reorganization.
Sale of DBL Block
Although American Progressive continued to achieve modest success in selling New
York State Statutory Disability Insurance ("DBL"), the Company determined that
the book of business was too small and growing too slowly to become a major
contributor to the profits of the Company. Therefore, American Progressive sold
the block, which had approximately $5 million of annual premium in force, to an
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unaffiliated New York domiciled carrier as of December 31, 1996. The purchase
price is a minimum of $550,000 and may reach as high as $950,000 depending upon
the persistency of the business over a twelve-month period. Determination of the
final purchase price is expected to be made in the second quarter of 1998.
American Progressive continued to maintain the risk for claims incurred prior to
December 31, 1996, which claims have been fully paid. The purchaser is
responsible for all risks and reserves for 1997 and beyond.
Withdrawal from NAIU Pool
Effective January 1, 1994, American Progressive entered into a pooling
agreement through National Accident Insurance Underwriters ("NAIU"), an
unaffiliated agency, and three unaffiliated insurers to underwrite travel
accident and student accident insurance policies. The results of the pool were
erratic, therefore, in August, 1996, the Company decided to allocate its capital
and efforts in its core business segments. The Company notified the accident
pool of its intention to withdraw effective December 31, 1996. As of December
31, 1996, American Progressive had approximately $8 million of annual premium in
force under this arrangement, all of which had been assumed from the other pool
participants. American Progressive continues to be exposed on business prior to
December 31, 1996 and, as of December 31, 1997, has $250,000 in reserves
remaining for this risk.
Sale of Dental Block
The Company executed an agreement, with an unaffiliated insurer, to 100%
reinsure its group dental block of business effective September 1, 1997. In
1997, the Company received an initial ceding allowance of $200,000 and
anticipates receiving additional allowances totaling $525,000 over a five-year
period. The Company will continue to perform the administration on the business
for a fee. At September 1, 1997, the annual in force premium amounted to $7.8
million.
Major Medical Reinsurance
When American Pioneer was acquired by the Company in 1993, American
Pioneer actively marketed individual major medical and major hospital policies
under strict underwriting guidelines. These policies have deductibles on a per
confinement basis ranging from $300 to $5,000, as to major hospital, and $150 to
$10,000 as to major medical. Over the past years, the Company has reduced its
marketing emphasis on this segment and has reduced its exposure through
reinsurance. In 1994, the Company had $8.7 million of annual premium in force
and carried 100% of the risk up to $60,000 per policy per year. By the beginning
of 1997, the Company had $7.0 million of premium in force and carried 50% of the
risk up to $60,000 per policy per year, or a maximum risk of $30,000 per year
per insured person.
Premium Revenue
Life Insurance and Annuities
The following table sets forth a summary of life premium revenues and
annuity considerations on first year and renewal basis for the three years ended
December 31, 1997, as determined in accordance with statutory accounting
principles ("SAP"). These amounts differ from the premiums reported in the
accompanying consolidated statement of operations, since under GAAP, the annuity
and universal life insurance policies are reported under the retrospective
deposit method prescribed by the Financial Accounting Standards Board ("FASB")
Statement No. 97 "Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the Sales of
Investments" ("Statement No. 97"). (i.e. under GAAP amounts attributable to
asset accumulation, components of interest-sensitive products are excluded from
premiums. See Note 2e of Notes to Consolidated Financial Statements for further
information).
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Year Ended December 31,
------------------------------------
1995 1996 1997(1),(2)
----------- ----------- -----------
(Amounts in accordance with
statutory accounting principles)
Life Insurance
---------------------------
Premium received,
policies written in
current year $6,141,040 $10,437,377 $11,037,680
Premium received,
policies written in 9,668,592 12,206,343 14,279,692
prior year
----------- ----------- -----------
Total Life Premium 15,809,632 22,643,720 25,317,372
----------- ----------- -----------
Annuities
---------------------------
Consideration received,
policies written in
current year 13,377,924 13,004,354 10,816,588
Consideration received,
policies written in 364,145 618,739 988,552
prior years
----------- ----------- -----------
Total Annuity 13,742,069 13,623,093 11,805,140
Consideration
----------- ----------- -----------
Total Consideration and
Premium $29,551,701 $36,266,813 $37,122,512
=========== =========== ===========
- ---------------------------------
(1)The 1997 figures include the premium revenues of American Exchange
from December 4, 1997, the date of its acquisition, which amounted to
$22,559.
(2)The life insurance amount includes premiums received on asset enhancer
business assumed from West Coast Life, which mounts to $6,370,162.
The following table presents information with respect to the Company's
number of policies in force and experience in terms of numbers of policies
issued, and reduced for surrenders, lapses or deaths for annuity and life
insurance:
1995 1996 1997
-------- -------- --------
Life Insurance Policies
----------------------------
In force, beginning of year
24,820 26,642 27,930
Acquired from First
National - 286 -
Acquired from American
Exchange - - 3,993
Issued during year
4,934 4,407 5,116
Lapsed or surrendered
during year (2,874) (3,193) (4,216)
Deaths during year
(238) (212) (217)
-------- -------- --------
In force, end of year
26,642 27,930 32,606
======== ======== ========
Annuity Policies
----------------------------
In force, beginning of year
4,090 5,437 6,833
Acquired from First
National - 40 -
Issued during year
1,956 2,119 2,856
Deaths and surrenders
during year (609) (763) (2,357)
-------- -------- --------
In force, end of year
5,437 6,833 7,332
======== ======== ========
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Accident & Health Insurance
The following table sets forth a summary of accident and health premium
revenues for the three years ended December 31, 1997:
Year Ended
December 31,
--------------------------------------
1995 1996 1997 (2)
------------ ----------- -----------
Premium received on
policies
written in current year
$5,982,178 $9,805,305 $12,284,517
Premium received on
policies
written in prior years 22,313,927 35,047,929 62,802,770
(1)
------------ ----------- -----------
Total Accident & Health
Premium $28,296,105 $44,853,234 $75,087,287
============ =========== ===========
- ----------------------------------
(1)The 1996 figures include the premium revenues of First National from
October 1, 1996, the date of its acquisition, which amounted, to
$13,498,122. The 1997 figure includes the full year of premium revenue
of First National's policies which amounted to $51,187,027.
(2)The 1997 figures include the premium revenues of American Exchange
from December 4, 1997, the date of its acquisition, which amounted to
$473,892 and $941,235 current year and renewal year, respectively.
Private Placement Financing
Series C Preferred Stock
During the second and third quarters of 1997, the Company, pursuant to a
stock purchase agreement between the Company and A.A.M. Capital Partners L.P.
("AAM"), issued 43,750 shares (par value $100) of Series C Preferred Stock for
$4,375,000, of which $2.4 million was purchased by UAFC L.P., an investment
partnership affiliated with AAM, $600,000 by Chase Equity Partners, L.P., and
$1,375,000 by Richard A. Barasch (the Chairman and Chief Executive Officer of
the Company), members of his family, and members and associates of the Company's
management. This transaction received the approval of the Florida Insurance
Department.
During the third quarter of 1997, the Company issued an additional 7,930
shares of Series C Preferred Stock for $793,000, which shares were purchased by
owners and employees of Ameri-Life & Health Services, an independent marketing
organization that sells the Company's senior market products.
The following summary of the terms of the Series C Preferred Stock and of
a Shareholders' Agreement affecting such stock, is qualified in its entirety by
reference to the Certificate of Incorporation of the Company and in the
Shareholders' Agreement.
The Series C Preferred Stock is convertible by the holders at any time at a
conversion price of $2.375 per common share (subject to anti-dilution
adjustment).
The Company can require conversion if it executes a public offering of
common stock at over $3.45 per common share (or equivalent equity), with
gross proceeds in excess of $10 million, or if the average bid price of its
common stock, for any 60 day period, exceeds $3.45, $4.25 and $5.15 per
common share in 1999, 2000 and 2001, respectively.
In the event that the Company takes certain action without the consent of
the holders of a majority of the Series C Preferred Stock, those holders who
voted against such action have the right to require its redemption at the
Redemption Price or the Call Price, (which Prices are defined below)
depending on the nature of the action taken.
10
<PAGE>
The Company has the right to call all of the Series C Preferred Stock at any
time between January 1, 2000 and December 31, 2002, at a per share call price
(the "Call Price") of $150 in the year 2000 or $175 in the years 2001 and
2002, in each case increased by the redemption accrual at the rate of 8% of
the par value.
Unless converted or called earlier, the Series C Preferred Stock will be
redeemed on December 31, 2002, at a per share redemption price (the
"Redemption Price") equal to par, increased by a redemption accrual at the
rate of 8% per annum. The redemption price will be payable in two equal
installments on December 31, 2002 and December 31, 2003. The redemption
accrual is not payable upon any conversion.
No dividends will be paid on the Series C Preferred Stock, unless dividends
are paid on the common stock, in which case the Series C Preferred Stock will
participate as if converted. As of December 31, 1997, $249,790 of redemption
accruals were accumulated on the Series C Preferred Stock for the period
April 25, 1997 to December 31, 1997.
The holders of the Series C Preferred Stock (excluding a portion of such
series which may be issued without voting rights) will have the right to
elect one director of the Company.
$3 million of the proceeds of this sale were used to begin implementation
of the conversion of American Pioneer from being a direct subsidiary of
American Progressive to being a direct subsidiary of Universal. See
"Unstacking," below.
The Company, AAM, the holders of the Series C Preferred Stock, Barasch
Associates Limited Partnership ("BALP") and Richard A. Barasch entered into a
stockholders' agreement at the closing of the transaction which contained the
following conditions:
The holders of the Series C Preferred Stock were given registration rights
and informational rights.
The Series C Preferred Stockholders agreed to vote their shares for the
election of a person designated by AAM as the director elected by that
Series.
BALP and Mr. Barasch granted the Series C holders a co-sale right should
they sell any shares of the Company's common stock held by them, except to
certain "permitted transferees".
Unstacking
When American Pioneer was acquired in 1993, it became a direct subsidiary
of American Progressive. This ownership structure (the "stacking") significantly
reduced the Risk-Based Capital ratio of American Progressive as computed by the
regulators and the rating agencies and adversely affected the ratings of both
companies and their ability to write new business.
Universal and American Progressive, entered into an agreement with the
consent of the New York Insurance Department on June 27, 1996 (the "Unstacking
Agreement"), in which Universal is obligated to purchase all of the outstanding
stock of American Pioneer from American Progressive over a five-year period for
a total purchase price of $15,800,000. Under the terms of the Unstacking
Agreement, the purchase is to be implemented in segments with the purchase price
of the shares included in each segment being paid one half in cash and one half
in five-year debentures, paying interest at 8.5%. The debentures are payable by
Universal to American Progressive.
11
<PAGE>
The Unstacking Agreement is intended to make American Pioneer a direct
subsidiary of Universal, rather than an indirect subsidiary, owned through
American Progressive. This unstacking is expected to have a beneficial effect on
the ratings of both insurers. In addition, the unstacking increases the surplus
of American Progressive, improves its Risk Based Capital Ratio and, to the
extent that American Pioneer is able to pay dividends, permits the payment of
such dividends directly to Universal.
The first segments of the unstacking were consummated in September and
December of 1997. In the aggregate, Universal acquired 75% of American Pioneer
from American Progressive for $11,850,000 consisting of $5,925,000 in cash and
$5,925,000 in debentures payable to American Progressive. It is expected that
Universal will acquire the balance of American Pioneer in 1998.
The cash portion of the unstacking was performed by Universal from the
proceeds of the Series C Preferred Stock transaction with AAM, a dividend from
American Pioneer, and from the proceeds of a loan from Chase Manhattan Bank. See
"Liquidity and Capital Resources - The Company".
Marketing and Distribution
Historically, the Insurance Subsidiaries sold their products through a
traditional general agency system. The Company now, however, seeks to structure
arrangements with independent marketing organizations, licensed as general
agents, that sell particular products and programs meeting particular market
niches or needs. One such arrangement, with an organization that focuses on
individual sales of deposit-term life insurance policies to moderate income
buyers, produced 14% of the Company's individual life insurance sales in 1996.
Another such arrangement with an organization that makes individual sales of
interest sensitive whole life insurance policies through single or multi-year
premium payments to middle age and senior age buyers produced 73% of the
Company's individual life insurance sales in 1996. In 1996, American Pioneer
entered into an agreement with West Coast Life, an A+ life insurance subsidiary
of Nationwide Insurance Company, to be the lead company for the sale of the
Asset Enhancer products. The agreement calls for American Pioneer, West Coast
Life and Reinsurance Company of Hannover ("RCH") to each participate in
one-third of the risk and for American Pioneer to be the administrator of the
product on a fee basis. A similar arrangement was entered into with Pennsylvania
Life with respect to the Flex-A-Vest 88 Term Life Insurance product. An
arrangement with a marketing organization in one state, which primarily sells
Blue Cross/Blue Shield health insurance, accounted for almost all of the
Company's group life sales.
In 1997, no general agent produced as much as 5% of the Company's accident
and health insurance premiums or life insurance premiums and only one general
agent produced more than 5% of the Company's annuity premiums (24%). The agents,
general agents and producers are paid purely on a commission basis and are not
Company employees. In this marketing area, the Company believes that the Company
offers competitive commission rates and seeks to provide innovative products and
quality service to its independent general agents. In particular, the Company
believes that it provides a higher level of agent support and is more responsive
to its agents in the field than many larger organizations with which it
competes. The various State Departments of Insurance regulate compensation that
the Company pays its agents on certain products.
The Company, through the Insurance Subsidiaries, is licensed to market its
products in 45 states and in the District of Columbia. However, approximately
78% of its 1997 premium and annuity considerations came from the states of
Florida (34%), New York (17%), Texas (16%), North Carolina
(5%), Alabama (3%), and Georgia (3%).
Competition
The Company competes with other insurance and financial services
companies, including large multi-line organizations, both in connection with the
sale of insurance and asset accumulation products and in acquiring blocks of
business. Many of these organizations have substantially greater capital and
surplus, larger and more diversified portfolios of life and health insurance
policies, larger agency sales operations and higher ratings. In addition, it has
12
<PAGE>
become increasingly difficult for small companies to compete effectively with
their larger competitors for traditional life and annuity sales in part as a
result of heightened consumer and agent awareness of the financial size of
companies.
The Company has met, and seeks to continue to meet, these competitive
pressures by offering a high level of service and accessibility to its field
force and by developing specialized products and marketing approaches.
Ratings
American Pioneer, American Progressive and American Exchange have been
designated "B+ (Very Good)", "B (Adequate)" and "B- (Adequate)", respectively,
by A.M. Best. In evaluating a company's financial and operating performance,
A.M. Best reviews profitability, leverage and liquidity as well as the quality
of the book of business, the adequacy and soundness of reinsurance programs, the
quality and estimated market value of assets, reserve adequacy and the
experience and competence of management. A.M. Best's ratings are based upon
factors relevant to policyholders, agents, insurance brokers and intermediaries
and are not directed to the protection of investors. According to A.M. Best's
published material, a "B+", "B" or "B-" rating is assigned to companies which,
in its opinion, have demonstrated very good (B+) or adequate (B), (B-) overall
performance when compared to the standards it has established. Companies rated
(B+) have a good ability to meet their obligations to policyholders. "B" and
"B-" rated companies have an adequate ability to meet their policyholder
obligations, but their financial strength is vulnerable to adverse changes in
underwriting or economic conditions. Standard and Poors rates American Pioneer,
American Progressive and American Exchange as "BBq", "Bq" and "BBBq",
respectively, which means that, based on their publicly available information,
they are currently able to meet policyholder obligations, although, as to "Bq",
that ability is especially vulnerable to adverse economic and underwriting
conditions. The Insurance Subsidiaries are not currently known to be rated by
the Duff and Phelps or Moody's rating organizations. Although a higher rating by
A.M. Best or another insurance rating organization could have a favorable effect
on the Company's business, management believes that its marketing has enabled,
and will continue to enable, the Insurance Subsidiaries to compete effectively.
Underwriting Procedures
Premiums charged on insurance products are based, in part, on assumptions
about the expected mortality and morbidity experience. In that regard, the
Company has adopted and follows detailed uniform underwriting procedures
designed to assess and quantify certain insurance risks before issuing
individual life insurance, certain health insurance policies and certain annuity
policies to individuals. These procedures are generally based on industry
practices, reinsurer underwriting manuals and the Company's prior underwriting
experience. To implement these procedures, each Insurance Subsidiary employs an
experienced professional underwriting staff.
Applications for insurance to be underwritten are reviewed to determine if
any additional information is required to make an underwriting decision, which
depends on the amount of insurance applied for and the applicant's age and
medical history. Such additional information may include medical examinations,
statements from doctors who have treated the applicant in the past and, where
indicated, special medical tests. If deemed necessary, the Company uses
investigative services to supplement and substantiate information. For certain
coverages, the Company may verify information with the applicant by telephone.
After reviewing the information collected, the Company either issues the policy
as applied for, issues the policy with an extra premium charge due to
unfavorable factors, issues the policy excluding benefits for certain conditions
for a period of time or rejects the application. For certain of its coverages,
13
<PAGE>
the Company has adopted simplified policy issue procedures in which the
applicant submits a single application for coverage typically containing only a
few health-related questions instead of a complete medical history. In New York
and other states, certain of the Company's products, including Medicare
supplement, are subject to "Community Rating" laws which severely limit or
prevent underwriting of individual applications. See "Regulation - Health Care
Reform".
Acquired Immune Deficiency Syndrome ("AIDS"), which has received wide
publicity because of its serious public health implications, presents special
concerns to the life and health insurance industry. The Company considers AIDS
information in underwriting and pricing decisions in accordance with applicable
laws. Applicants for life insurance coverage equal to or exceeding $100,000 and
for major medical and major hospital coverages must submit to a blood or urine
test, which includes AIDS antibody screening. The Company's own mortality and
morbidity experience to date reflects no unduly adverse impact as a result of
any acceleration of AIDS-related life insurance claims. The Company is
continuing to monitor developments in this area but is necessarily unable to
predict the long-term impact of this problem on the life insurance industry, in
general, or on the Company, in particular.
Investments
The Company's investment policy is to balance the portfolio between
long-term and short-term investments so as to continue to achieve investment
returns consistent with the preservation of capital and maintenance of liquidity
adequate to meet payment of policy benefits and claims. The Company invests in
assets permitted under the insurance laws of the various states in which it
operates, such laws generally prescribe the nature, quality of and limitations
on various types of investments which may be made. The Company currently engages
the services of an unrelated investment advisor, Asset Allocation and Management
Company, to manage the Company's fixed maturity portfolio, under the direction
of the management of the Insurance Subsidiaries and in accordance with
guidelines adopted by their respective Boards of Directors. The Company's policy
is not to invest in derivative programs or other hybrid securities, except for
GNMA's, FNMA's and investment grade corporate collateralized mortgage
obligations. It invests primarily in fixed maturity securities of the U.S.
Government and its agencies and in corporate fixed maturity securities with
investment grade ratings of "Baa3" (Moody's), "BBB-" (Standard & Poor's) or
better. However, the Company does own some investments that are rated "BB" or
below (together 3.2% and 2.1% of total fixed maturities as of both December 31,
1996 and 1997, respectively). As of December 31, 1997 all securities were
current in the payment of principal and interest.
14
<PAGE>
The following table summarizes the Company's investment portfolio as of
December 31, 1996 and 1997:
<TABLE>
Investment Portfolio
December 31,1996 December 31,1997
---------------------------- ------------------------
Carrying Value Percent of Carrying Percent of
Total Value Total
(Fair Value) Carrying (Fair Carrying
Value Value) Value
--------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Fixed Maturity
Securities:
U.S. Government and
government agencies $12,177,564 8.42% $11,026,445 6.92%
Mortgage and asset 35,371,543 24.45% 58,725,145 36.83%
backed
Investment grade 70,092,550 48.44% 51,217,648 32.13%
corporates
Non-investment grade 3,850,510 2.66% 2,616,470 1.64%
corporates
--------------- ------------ ----------- -----------
Total fixed maturity 121,492,167 83.97% 123,585,708 77.52%
securities
Cash and cash 15,403,450 10.65% 25,014,019 15.69%
equivalents
Other Investments:
Policy loans 6,421,251 4.44% 7,185,014 4.51%
Mortgage loans 1,199,110 0.83% 2,562,008 1.60%
Real property tax liens 131,729 0.09% 136,713 0.09%
Equity securities 33,562 0.02% 945,116 0.59%
--------------- ------------ ----------- -----------
Total invested assets $144,681,269 100.00% $159,428,578 100.00%
=============== ============ ============ ===========
</TABLE>
The following table shows the distribution of the contractual maturities
of the Company's portfolio of fixed maturity securities by carrying value as of
December 31, 1997. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties:
Contractual Maturities of Fixed Maturity Securities
Percent of
Carrying Total Fixed
Available for Sale Value Maturities
------------ ------------
Due in 1 year or less
$4,305,300 3.48%
Due After 1 year through 5 21,326,267 17.26%
years
Due after 5 years through 19,401,221 15.70%
10 years
Due after 10 years 16,604,110 13.44%
Mortgage and asset backed 61,948,810 50.12%
securities
------------ ------------
$123,585,708 100.00%
============ ============
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<PAGE>
The following table shows the distribution by carrying value of the
Company's fixed maturity securities portfolio according to the ratings assigned
by Standard & Poor's Corporation, along with related estimated fair values, as
of December 31 1996, and 1997:
Distribution of Fixed Maturity Securities by
Rating
December 31, 1996 December 31, 1997
----------------------- -----------------------
Carrying % of Carrying % of
Standard Value Total Value Total
&
Poor's (Estimated Fixed (Estimated Fixed
Rating Fair Value) Investment Fair Value) Investment
---------- ------------ ---------- ------------ ---------
AAA $46,981,664 38.67% $55,914,846 45.23%
AA 7,598,298 6.25% 7,713,721 6.24%
A 21,383,442 17.60% 31,225,481 25.27%
BBB 41,678,253 34.31% 26,115,190 21.13%
BB 3,519,260 2.90% 2,218,232 1.79%
B 398,238 0.32%
- -
D 331,250 0.27%
- -
------------ ---------- ------------ ---------
Total $121,492,167 100.00% $123,585,708 100.00%
============ ========== ============ =========
At December 31, 1996 and 1997, 96.8% and 97.9%, respectively, of the
Company's fixed maturity investments were investment grade corporate fixed
maturity securities (i.e., those rated "BBB-" or higher by Standard & Poor's
Corporation or "Baa3" or higher by Moody's Investors Service). This included
approximately $39,144,400, at December 31, 1996, and $42,837,114, at December
31, 1997, of collateralized mortgage obligations secured by residential
mortgages. These amounts represented approximately 32% and 35% of the Company's
fixed maturity portfolio at December 31, 1996 and 1997, respectively. Certain
classes of mortgage-backed securities are subject to significant prepayment
risk. This is due to the fact that in periods of declining interest rates,
mortgages may be repaid more rapidly than scheduled, as individuals refinance
higher rate mortgages to take advantage of the lower rates then available. As a
result, holders of mortgage-backed securities may receive higher prepayments on
their investments, which they may not be able to reinvest at an interest rate
comparable to the rate paid on such mortgage-backed securities. At December 31,
1996 and 1997, less than investment grade fixed maturity securities had
aggregate carrying values (held at fair value) of $3,850,510 and $2,616,470,
respectively, amounting to 2.7% and 1.6%, respectively, of total investments and
1.6% and 1.0%, respectively, of total invested assets. The Company's holdings of
less than investment grade corporate fixed maturity securities are diversified
and the investment in any one such security at both December 31, 1996 and 1997
was less than $1,000,000, which was approximately 0.4% as of each date. The
Company wrote down the value of certain securities, considered to have been
subject to an-other-than temporary decline in value, by $195,000 in 1995, which
was included in net realized gains on investments in the consolidated statements
of operations. The Company did not write down the value of any securities during
1996 or 1997.
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<PAGE>
Investment Income
Investment income is an important part of the Company's total revenues and
profitability. Management cannot predict the impact that changes in future
interest rates will have on the Company's financial statements. The following
table shows the investment results of the Company's total invested asset
portfolio, for the three years ended December 31, 1997 (excluding the realized
gain on the sale of a non-operating subsidiary in 1997):
Investment Results
Years Ended December 31,
-------------------------------------------
1995 1996 1997
-------------- -------------- -------------
Total invested assets, end of
period $135,602,668 $144,681,269 $159,428,478
Net investment income $8,945,280 $9,850,083 $10,022,658
Yield on average cash and
investments 6.97% 7.08% 6.81%
Net realized investment gains
on the sale of securities $673,868 $240,075 $563,047
Reserves
In accordance with applicable insurance regulations, the Company has
established, and carries as liabilities in its statutory financial statements,
actuarially determined reserves that are calculated to satisfy its policy and
contract obligations. Reserves, together with premiums to be received on
outstanding policies and contracts and interest thereon at certain assumed
rates, are calculated to be sufficient to satisfy policy and contract
obligations. The actuarial factors used in determining such reserves are based
on statutorily prescribed mortality tables and interest rates. Reserves
maintained also include unearned premiums, premium deposits, reserves for claims
that have been reported but are not yet paid, reserves for management's estimate
for claims that have been incurred but have not yet been reported and claims in
the process of settlement.
The reserves reflected in the Company's consolidated financial statements
are calculated in accordance with GAAP. These reserves are based upon the
Company's best estimates of mortality and morbidity, persistency, expenses and
investment income, with appropriate provisions for adverse deviation. The
Company uses the net level premium method for all non-interest-sensitive
products and the retrospective deposit method for interest-sensitive products.
GAAP reserves differ from statutory reserves due to the use of different
assumptions regarding mortality and morbidity, and interest rates and the
introduction of lapse assumptions into the GAAP reserve calculation.
Reinsurance
Assumption of Asset Enhancer from West Coast Life
Beginning in 1997, the Company began to assume asset enhancer business
written by West Coast Life. The agreement calls for West Coast Life to retain
33.3% of the business written and cede the remaining 66.7% to Reassurance
Company of Hannover ("RCH"). RCH, in turn, cedes 50% of this amount to American
Pioneer, so all companies share in one-third of the risk. Under the agreement,
American Pioneer performs all the underwriting and administration of the
business for a fee. The underlying assets, which are maintained in a trust
account, are managed by West Coast Life pursuant to the recommendation of an
investment committee, which committee is comprised of a representative from each
17
<PAGE>
company. Total premiums issued on this business in 1997, on a statutory basis,
amounted to $15.6 million for single-pay and $3.4 million for multiple-pay
business.
Assumption from First National Life
In the fourth quarter of 1996, the Company acquired, through an assumption
reinsurance agreement, approximately $56 million of annualized senior market
premium from First National. American Pioneer initially contracted with First
National to assume $4 million of premium on group Medicare Supplement coverage
issued to the members of FREA. Then, after First National was placed into
Receivership by the Alabama Insurance Department in October, 1996, American
Pioneer assumed approximately an additional $50 million of Individual Medicare
Supplement premium, $1.2 million in Home Health Care premium and $0.8 million in
miscellaneous life and accident and health insurance premiums, under terms
negotiated with the Receiver. All of these assumptions were effective as of
October 1, 1996. The Company received approval from the Florida Insurance
Department to report the premiums assumed from First National as direct premium
written.
Simultaneously with the second assumption by American Pioneer, American
Pioneer entered into a reinsurance agreement with Transamerica Occidental Life
Insurance Company ("Transamerica"), ceding 90% of the $50 million Individual
Medicare Supplement to Transamerica under reinsurance terms believed to be
favorable. American Pioneer will perform all the administration on the reinsured
business.
Other Assumed
As part of its strategy of acquiring blocks of business, the Company has
acquired several blocks of business through reinsurance.
American Progressive participates in a modified coinsurance agreement with
an unaffiliated insurer under an agreement entered into in 1986. The business
assumed consists of non-participating premium-paying Whole Life and increasing
premium Whole Life policies. At December 31, 1997, premiums in force ceded to
American Progressive under this arrangement were approximately $350,000, the
amount of insurance in force was approximately $24.2 million and the reserves
assumed were approximately $4.7 million.
In 1994, the Company assumed 100% of the risk and premium on certain
accident and health insurance policies written by three insurers not affiliated
with the Company: North American Company for Life and Health Insurance, North
American Company for Life and Health Insurance of New York and Baptist Life
Insurance Company of New York. At December 31, 1997, the premium in force on
these policies was approximately $720,000 and the associated reserves were
approximately $503,000.
Ceded
Consistent with the general practice of the life insurance industry, the
Company reinsures portions of the coverage provided by its life insurance
products to unaffiliated insurance companies under various reinsurance
agreements. Such agreements allow the Company to write policies in amounts
larger than the risk it is willing to retain on any one life, and to continue
writing a larger volume of new business. The mortality risk retention limit on
each policy varies generally between $25,000 and $75,000. The Company cedes
insurance primarily on an "automatic" basis and receives allowances from its
reinsurers ranging from 100% to 142% of the reinsurers' premium in the first
policy year and at varying rates of up to 40% in renewal years. Reinsurance is
not maintained on any of the annuity policies in force.
The Company has "excess of loss" reinsurance agreements with unaffiliated
insurance companies on its accident and health insurance policies to reduce the
liability on individual risks to $60,000 at American Pioneer, $200,000 at
American Progressive and $50,000 at American Exchange. On December 31, 1996 the
Company effected a "quota share" reinsurance agreement with another unaffiliated
reinsurer (rated A+ by A.M. Best) to cede 50% of the remaining $60,000 of
18
<PAGE>
individual accident and health insurance risk at American Pioneer. The limited
benefit medical risks at American Exchange are 75% reinsured to an unaffiliated
reinsurer.
The Company reinsures, on a quota share basis to unaffiliated reinsurers,
certain of its senior accident and health business as follows: American Pioneer
Medicare supplement - 75%; American Progressive Medicare supplement - 50%;
American Progressive hospital indemnity - 25%; and American Exchange Medicare
supplement - 75%. The Company's long term care products (nursing home and home
health care) are 75% reinsured to an unaffiliated reinsurer with stop loss
coverage after the third benefit year. The Company's managed care home health
care product is 30% reinsured with an unaffiliated reinsurer. Under these
various treaties, the Company performs all the underwriting and administration
and receives various allowances for commission and expenses. In addition, the
Company has a quota share agreement on its Accidental Death and Dismemberment
policies under which the reinsurer receives 90% of all premiums and pays 90% of
all losses and the Company receives allowances ranging from 20%-30% of the ceded
premium. American Pioneer also reinsures all of the risk in excess of two years
of benefits on certain disability income policies.
As part of its restructuring, the Company sold all of its New York
Statutory DBL insurance in force and a major part of the risk on its major
medical policies to unaffiliated insurers. (See "Restructuring Activity Sale of
DBL Block" and "Major Medical Reinsurance").
The Company is contingently liable to pay claims in the unlikely event
that a reinsurer fails to meet its obligations under the reinsurance agreement.
The Company's primary reinsurers are currently rated A+ (Superior) and A
(Excellent) by A.M. Best. To the Company's knowledge, no reinsurer of business
ceded by the Company has been unable to pay any policy claims on any reinsured
business. The reinsurance agreements are subject to cancellation on 90 days
notice as to future business, but policies reinsured prior to such cancellation
remain reinsured as long as they remain in force. Management believes that if
its reinsurance agreements were canceled it would be able to obtain other
reinsurance arrangements on satisfactory terms to enable it to continue writing
new business.
WorldNet
Restructuring
WorldNet was formed in 1992 when Universal acquired the assets and client
base of a firm that provided claims administration, managed care and traveler's
medical assistance to insurance companies (foreign and domestic) and affinity
groups including credit card companies. The revenues of WorldNet grew from 1992
through 1995, in part due to acquisition, but WorldNet sustained significant
operating losses. In 1996, Universal imposed a restructuring effort in WorldNet,
which reduced revenues from unprofitable contracts, but also reduced its
operating losses.
As part of the First National transaction, the Company acquired a low-cost
administrative facility in Pensacola, Florida. By incorporating this facility
and much of its employee base into the WorldNet corporate structure, WorldNet
has expanded its capacity to service the Insurance Subsidiaries as well as
unaffiliated third parties. As a result of the addition of the revenues from the
Insurance Subsidiaries, amounting to approximately 74% of WorldNet's revenues,
WorldNet showed a profit of $911,000 in 1997 after incurring losses of $271,000
in 1996 and $665,000 in 1995.
General
WorldNet is a fee-based company whose primary services are to provide
medical managed care and assistance to people traveling away from their homes
and to act as a third party administrator and service provider to the Insurance
Subsidiaries. These, and other related services, are sold by WorldNet to
insurance companies (for their insureds), credit card companies (for their card
members) and associations (for their members).
19
<PAGE>
Additionally, WorldNet provides valuable support to the Company's
underwriters, making telephone contact with potential insureds and verifying
potential insureds' information on life and accident & health applications.
Management plans to further incorporate WorldNet's telecommunications
capabilities to gather and verify underwriting data and to assist with
policyholder servicing of its insurance products.
International Managed Care
WorldNet has achieved a significant portion of its revenue from the sale
of managed care, cost containment and claims adjudication services to foreign
(to date, primarily Canadian) insurers for their insureds while they are in the
United States. WorldNet arranges access to appropriate medical care, manages the
care and cost while the case is in process and often arranges evacuation to the
country of origin. WorldNet also provides complete claims adjudication services
including coordination of benefits, subrogation and audits. The clients who use
WorldNet's managed care services include a number of large insurers in Canada
and Europe.
Travel Assistance and Related Claims Adjudication
WorldNet's travel assistance product is sold as an enhancement for its
clients' cardholders, policyholders and members. The service provides 24-hour
telephone access to assistance for medical, legal and other problems that arise
especially while away from home. Related to this function, WorldNet also
provides claims adjudication for travel-related insurance products such as
baggage, collision damage waiver and trip-cancellations.
Operations
WorldNet operates a 24-hour multi-lingual communications center in Miami,
Florida and a third party administrative office in Pensacola, Florida. As of
December 31, 1997, the Miami location had 38 full time employees and the
Pensacola location had 76 full time employees. The company has developed and
acquired proprietary software applications that have been customized for its
market.
Revenues
WorldNet's revenues for years ended December 31, 1995, 1996 and 1997
were as follows:
Year Ended December 31,
---------------------------------------
1995 1996 1997
----------- ------------- ----------
Pensacola administrative
revenue (1) $ - $ - $5,318,242
Managed care and claims
adjudication 2,099,438 1,513,962 1,583,933
Travel and other
assistance 971,103 658,379 355,640
----------- ------------- -----------
$3,070,541 $2,172,341 $7,257,815
=========== ============= ===========
- ----------------------------
(1)Included in the Pensacola revenue amount is $5,230,574 of fees earned
from the Insurance Subsidiaries, which fees were eliminated in the
consolidated financial statements.
20
<PAGE>
Regulation
General
The Insurance Subsidiaries, like other insurance companies, are subject to
the laws, regulations and supervision of the states in which they are domiciled
(New York in the case of American Progressive, Florida in the case of American
Pioneer and Texas in the case of American Exchange) and in various other states
in which they are authorized to transact business. The purpose of such laws and
regulations is primarily to provide safeguards for policyholders rather than to
protect the interest of stockholders.
The insurance laws regulate, among other things, capitalization,
permissible investments, premium rates on statutory disability insurance and
other health insurance policy forms, the form and content of policies which may
be offered, specified methods of accounting (statutory accounting or SAP) for
detailed financial statements submitted to the various Insurance Departments and
minimum capital and surplus required to continue in operation.
Most states have enacted legislation or adopted administrative regulations
covering such matters as the acquisition of control of insurance companies and
transactions between insurance companies and the persons controlling them.
Additional requirements are often imposed as a condition of approval of the
acquisition of an insurance company, as occurred in the case of the Company's
acquisition of American Pioneer, American Progressive and American Exchange. The
nature and extent of the legislation and administrative regulations now in
effect vary from state to state and most states require administrative approval
of the acquisition of control of an insurance company incorporated in the state,
whether by tender offer, exchange of securities, merger or otherwise, and
require the filing of detailed information regarding the acquiring parties and
the plan of acquisition. The approval of the domiciliary insurance department is
also required before a controlling interest (10% as to New York and Texas, 5% as
to Florida) of an insurance company, or of a holding company which owns such an
insurance company, can be acquired or transferred. Every insurance company which
is authorized to do business in the state and is a member of an "insurance
holding company system" is generally required to register as such with the
insurance regulatory authorities and file periodic reports concerning its
relationships with the insurance holding company. Material transactions between
registered insurance companies and members of the holding company system are
required to be "fair and reasonable" and in some cases are subject to
administrative approval, and the books, accounts and records of each party are
required to be so maintained as to clearly and accurately disclose the precise
nature and details of the transactions.
Each Insurance Subsidiary is required to file detailed reports with the
insurance department of each state in which it is licensed to conduct business,
and its books and records are subject to examination by each such insurance
department. In accordance with the insurance codes of their domiciliary states
and the rules and practices of the National Association of Insurance
Commissioners ("NAIC"), the Insurance Subsidiaries are examined periodically by
examiners of New York, Florida, Texas and by representatives (on an
"association" or "zone" basis) of the other states in which they are licensed to
do business. American Progressive was examined in 1995 for the three years ended
December 31, 1994 by the New York State Insurance Department. American Pioneer
was examined in 1997 for the year ended December 31, 1995 by the Florida
Insurance Department. American Exchange was examined in 1995 for the year ended
December 31, 1994 by the Texas Insurance Department. The Company has complied
with all recommendations made on such reports, and no issues were raised which
the Company deems to be material.
Many states require deposits of assets for the protection of policyholders
either in those states or for all policyholders. At December 31, 1996 and 1997,
securities totaling $7,779,000 and $7,122,000, respectively (approximately 5.4%
21
<PAGE>
and 4.5%, respectively, of the carrying value of the Company's invested assets),
were on deposit with various state treasurers or custodians. Such deposits must
consist of securities that comply with the standards established by the
particular state.
Codification of Statutory Accounting Practices
The NAIC is in the process of codifying statutory accounting practices
("Codification"). Codification will likely change, to some extent, prescribed
statutory accounting practices and may result in changes to the accounting
practices that the Insurance Subsidiaries use to prepare its statutory-basis
financial statements. Codification, which is expected to be approved by the NAIC
in 1998, will require adoption by the various states before it becomes the
prescribed statutory basis of accounting for insurance companies domesticated
within those states. Accordingly, before Codification becomes effective for the
Insurance Subsidiaries, the Florida, New York and Texas Insurance Departments
must adopt Codification as the prescribed basis of accounting on which domestic
insurers must report their statutory-basis results to the Insurance Department.
At this time it is unclear whether the Florida, New York and Texas Insurance
Departments will adopt Codification. However, based on current draft guidance,
management believes that the impact of Codification will not be material to the
Insurance Subsidiaries' statutory-basis financial statements.
Insurance Regulatory Changes
The NAIC and state insurance regulators have recently become involved in a
process of re-examining existing laws and regulations and their application to
insurance companies. This re-examination has focused on insurance company
investment and solvency issues, risk-based capital guidelines, assumption
reinsurance, interpretations of existing laws, the development of new laws, the
interpretation of nonstatutory guidelines, and the circumstances under which
dividends may be paid. The NAIC has encouraged states to adopt model NAIC laws
on specific topics such as holding company regulations and the definition of
extraordinary dividends. It is not possible to predict the future impact of
changing state regulation on the operations of the Company.
The statutory filings of American Progressive, American Pioneer and
American Exchange require classifications of investments, the maintenance of an
asset valuation reserve ("AVR") and that investment gains and losses resulting
from changes in interest rate levels be deferred and taken into income over a
period of years through the interest maintenance reserve ("IMR"). Similar
requirements are not required under GAAP.
The AVR and IMR of the Insurance Subsidiaries as of December 31, 1996 and
1997 were:
1996 1997
--------- ---------
American
Progressive
AVR
$456,362 $438,371
IMR
$547,436 $752,285
American Pioneer
AVR
$646,040 $316,674
IMR(1) $(94,025) $62,361
American Exchange
AVR
$25,220 $10,877
IMR
$ - $ -
- ------------------------
(1) For statutory accounting purposes, a negative IMR is treated as a
non-admitted asset.
22
<PAGE>
New York State enacted legislation in 1992 that requires all health
insurance sold to individuals and groups with less than 50 employees, to be
offered on an open enrollment and community rated basis effective April 1, 1993.
Such insurance may continue to be sold to groups with more than 50 employees on
an underwriting basis, with premiums set to reflect expected or actual results.
The 1992 law prohibits the use of individual underwriting techniques and health
insurers must accept all who apply regardless of medical condition. The
community rating aspect of the law prohibits the use of age, sex, health or
occupational factors in rating and requires that the same average rate be used
for all persons with the same policy residing in the same location. The Medicare
supplement actively marketed by American Progressive in New York State and some
of its in force business is subject to the community rating rules. The extension
of such legislation to Florida and Texas, where significant medically
underwritten health insurance is offered, might cause a reconsideration of the
Company's existing health care coverage offerings.
Dividend and Distribution Restrictions
Under the New York State Insurance Law, the declaration or payment of a
dividend by American Progressive requires the approval of the New York
Superintendent of Insurance, who, as a matter of present policy, would not
approve such payment until American Progressive had generated sufficient
statutory profits to offset its entire negative unassigned surplus, which was
approximately $8,412,000 at December 31, 1997.
Under current Florida State insurance law, a life insurer may pay a
dividend or make a distribution without the prior written approval of the
department when:
a) the dividend is paid from that portion of the accumulated and
available surplus of the Company as is derived from the net
operating profits of its business and its net realized capital
gains;
b) the dividend is no more than the greater of (i) 10% of the
insurer's surplus as to policyholders derived from net operating
profits on its business and net realized capital gains; or (ii)
the insurer's entire net operating profits and realized net
capital gains derived during the immediately preceding calendar
year;
c) the insurer will have surplus as to policyholders equal to or
exceeding 115% of the minimum required statutory surplus as to
policyholders after the dividend or distribution is made; and
d) the insurer has filed notice with the department at least 10
business days prior to the dividend payment or distribution.
American Pioneer has the capacity to pay dividends of approximately
$430,000 during the year ending December 31, 1998. Dividends of $500,000,
$500,000 and $185,455 were paid by American Pioneer to American Progressive in
1995, 1996 and 1997, respectively and a dividend of $425,000 was paid to
Universal in 1997.
Under current Texas insurance law, a life insurer may pay dividends or make
distributions without the prior approval of the Insurance Department as long as
the dividend distributions do not exceed the greater of (i) 10% of the insurer's
surplus as to policyholders as of the preceding December 31st; or (ii) the
insurer's net gain from operations for the immediately preceding calendar year.
23
<PAGE>
Risk-Based Capital Requirements
Effective December 31, 1993, the NAIC adopted new risk-based capital
("RBC") requirements, which have also been adopted in New York, Florida and
Texas. These are intended to provide for a measurement of statutory capital and
surplus needs based on the risks in a company's mix of products and investment
portfolio. As of December 31, 1996 and 1997, American Progressive's ratios of
total adjusted capital to RBC, based on the NAIC approved model, were
approximately 261% and 484% of the Authorized Control Level, respectively. As of
December 31, 1996 and 1997, American Pioneer's ratios of total adjusted capital
to RBC, based on the NAIC approved model, were approximately 795% and 495% of
the Authorized Control Level, respectively. As of December 31, 1996 and 1997,
American Exchange's ratios of total adjusted capital to RBC, based on the NAIC
approved model, were approximately 226% and 227% of the Authorized Control
Level, respectively
Guaranty Association Assessments
All states require insurance companies to participate in guaranty
associations designed to cover certain claims against insolvent insurers. The
incurrence and amount of such assessments have increased in recent years and are
generally expected to increase further in future years. American Progressive and
American Pioneer were assessed and paid approximately $9,000 and $77,000,
respectively, in 1996 and $(1,000) (refund) and $31,000, respectively, in 1997.
The likelihood and amount of any other future assessments are now unknown and
are beyond the control of the Company.
Health Care Reform
From time to time, numerous proposals have been introduced in Congress and
the state legislatures to reform the current health care system. Proposals have
included, among other things, employer-based insurance systems, subsidized
premiums for lower income people, "managed competition" among health plans,
programs to regulate policy availability, affordability of public and private
programs and expansion of Medicare to persons under-age 65. Changes in health
care policy could significantly affect the Company's health insurance business.
In 1996, Congress enacted the Kennedy-Kassenbaum Act, which, among other
changes, restricts the ability of insurers to utilize medical underwriting and
pre-existing condition provisions in certain health insurance policies issued to
persons who were previously insured under qualifying policies. These changes,
which will become effective in stages, may have an effect on some of the
Company's policies.
Whether or not Congress passes any further health reform measures in the
foreseeable future, it is likely that health reform will continue to reappear on
the legislative agenda in the future. Such additional healthcare reform
proposals also could require standardization of major medical or long-term care
coverages, impose mandated or target loss ratios or rate regulation, require the
use of community rating or other means that further limit the ability of
insurers to differentiate among risks, or mandate utilization review or other
managed care concepts to determine what benefits would be paid by insurers.
These or other proposals could increase or decrease the level of competition
among health insurers. In addition, changes could be made in Medicare that could
necessitate revisions in the Company's Medicare Supplement products. Other
potential initiatives, designed to tax insurance premiums or shift medical care
costs from government to private insurers, could have effects on the Company's
business, some of them adverse. The Company is unable to predict what changes to
the country's health care system will be enacted, if any, or their effects on
the Company's business. See "Regulation".
24
<PAGE>
Other Possible Changes in Legislation
Since insurance is a regulated business, with a high public profile, it is
always possible that legislation may be enacted which would have an adverse
effect on the Company's business.
An important portion of the Company's insurance business is the sale of
deferred annuities and certain life insurance products, which are attractive to
purchasers in part because policyholders generally are not subject to federal
income tax on increases in the value of an annuity or life insurance contract
until some form of distribution is made from the contract. From time to time,
Congress has considered proposals to reduce or eliminate the tax advantages of
annuities and life insurance which, if enacted, might have an adverse effect on
the ability of the Company to sell the affected products in the future. The
Company is not aware that Congress is actively considering any legislation that
would reduce or eliminate the tax advantages of annuities or life insurance;
however, it is possible that the tax treatment of annuities or life insurance
could change by legislation or other means (for example, by Internal Revenue
Service regulations or judicial decisions).
Certain changes in insurance and tax laws and regulations could have a
material adverse effect on the operations of insurance companies. Specific
regulatory developments which could have a material adverse effect on the
operation of the insurance industry include, but are not limited to, the
potential repeal of the McCarran-Ferguson Act (which exempts insurance companies
from a variety of federal regulatory requirements), and adoption of laws, such
as those already in force in New York, limiting an insurer's ability to
medically underwrite and rate health insurance policies or to exclude
pre-existing conditions from coverage. In addition, the administration of such
regulations is vested in state agencies which have broad powers and are
concerned primarily with the protection of policyholders.
Federal Income Taxation of the Company
The Company files a consolidated return for federal income tax purposes,
in which American Pioneer and American Exchange are not currently permitted to
be included. At December 31, 1997 the Company (exclusive of American Pioneer and
American Exchange) had a net operating tax loss carry forwards of approximately
$11,300,000 which expire in the years 1999 to 2011.
American Pioneer and American Exchange file a separate consolidated
federal income tax return. At December 31, 1997 these companies had net
operating tax loss carry forwards, most of them incurred prior to its
acquisition by the Company, of approximately $1,100,000 which expire in the
years 2000 to 2011. As a result of changes in ownership of American Pioneer in
May 1993, use of most of the loss carry forwards of American Pioneer are subject
to annual limitations.
The Insurance Subsidiaries are taxed as life insurance companies as
provided in the Tax Code. The Omnibus Budget Reconciliation Act of 1990 amended
the Tax Code to require a portion of the expenses incurred in selling insurance
products to be capitalized and amortized over a period of years, as opposed to
an immediate deduction in the year incurred. Instead of measuring actual selling
expenses, the amount capitalized for tax purposes is based on a percentage of
premiums. In general, the capitalized amounts are subject to amortization over a
ten-year period. Since this change only affects the timing of the deductions, it
does not, assuming stability of rates, affect the provisions for taxes reflected
in the Company's financial statements prepared in accordance with GAAP. However,
by deferring deductions, the change does have the effect of increasing the
current tax expense, thereby reducing statutory surplus. Because of the
Insurance Subsidiaries' net operating loss carry forwards, there was no increase
in the Company's current income tax provision for the three years ended December
31, 1997 due to this change.
25
<PAGE>
Employees
At December 31, 1997, the Company employed approximately 231 employees,
none of whom are represented by a labor union. The Company considers its
relations with its employees to be satisfactory.
MANAGEMENT
Directors and Executive Officers of the Company and Officers of the
Subsidiaries
The following table sets forth certain information concerning the
Directors and Officers of the Company and the Officers of the subsidiaries:
Position with the Company, Present
Principal Occupation or Employment
Name Age and Past Five-Year Employment History
- ----------- --- --------------------------------------------
Richard A. Barasch 44 Director, Chairman of the Board (since
December, 1997), President and Chief
Executive Officer of the Company; Director
and President of American Progressive; and
Chairman of the Board of American Pioneer
and WorldNet. Mr. Barasch has been a
director and executive officer of the
Company since July, 1988, President since
April, 1991 and Chief Executive Officer
since June 15, 1995. He has held his
positions with the Company's subsidiaries
since their acquisition or organization by
the Company. Term as a Director expires in
2000.
Robert A. Waegelein, C.P.A.37 Senior Vice President and Chief Financial
Officer of the Company (since October,
1990) and of the Company's subsidiaries
since they were acquired or organized.
Prior to that, Mr. Waegelein, a certified
public accountant, was employed by KPMG
Peat Marwick LLP, the Company's then
independent public accountants, in
positions of increasing responsibility,
finally serving as Senior Manager.
Gary W. Bryant, C.P.A. 48 President, CEO and Director of American
Pioneer since April, 1983 and Senior Vice
President of the Company since June 15,
1995.
William E. Wehner, C.L.U. 54 Executive Vice President and Chief
Operating Officer of American Progressive
since May, 1991. Mr. Wehner was employed
for over twenty years by Mutual Life
Insurance Company of New York and its
affiliates in positions of increasing
responsibility, finally serving as Vice
President for Group Insurance.
Jerald R. Hoeft, C.P.A., C.L.U.55 Senior Vice President for American
Pioneer since October, 1997. Between 1987
and 1997, Mr. Hoeft served as Senior Vice
President and Chief Financial Officer for
Financial Benefit Group, Inc.
Guy H. Hartman, FALU, C.L.U. 62 Vice President and Chief Underwriter
(since January, 1986) and Secretary (since
January, 1994) of American Pioneer.
26
<PAGE>
Brad D. Leonard, F.S.A., M.A.A.A. 53Vice President of the Company and Senior
Vice President and Chief Actuary of
American Progressive and American Pioneer
since January, 1997. From December, 1992
to January 1997, Mr. Leonard was Vice
President & Actuary of The Federal Home
Life Insurance Companies. Prior to December
1992, he was Senior Vice President and
Chief Actuary of American Heritage Life
Insurance Company.
Sam Walden 58 Vice President - Information Systems of
American Pioneer since November, 1986.
Joan M. Ferrarone 58 Secretary of the Company and American
Progressive since June, 1995. Mrs.
Ferrarone has been employed by the Company
since 1991 and by American Progressive
since 1984 in positions of increasing
responsibility.
Marvin Barasch 75 Chairman Emeritus of the Company (since
December, 1997) and Vice-Chairman of
American Progressive (John Adams) since
July, 1988, Chairman of American
Progressive since June, 1996 and a director
of American Pioneer since May, 1993. Mr.
Barasch was Chief Executive Officer of the
Company from July 1988 to June 15, 1995.
He has been in the insurance business as an
agent and broker for over 40 years. Term
as a Director expires in 1998.
Michael A. Barasch 42 Director of the Company since July, 1988
and American Progressive (and its
predecessor, John Adams) from July, 1988 to
June, 1995. Since February 1995, Mr.
Barasch has been a member of the law firm
of Barasch and McGarry. He was a member of
the law firm of Altier and Barasch from
February, 1989 to February, 1995. Term as
a Director expires in 1999.
Stuart Becker, C.P.A. 54 Director of the Company since July, 1990.
A partner in the accounting firm of Becker
& Company, LLC and predecessors, since
1990. Mr. Becker has more than 30 years
experience as a certified public
accountant. Term as a Director expires in
2000.
David F. Bolger 65 Director of the Company since December,
1992. Since 1966, Mr. Bolger has been Chief
Executive Officer of Bolger & Co., Inc., an
investment banking firm. Term as a Director
expires in 1999.
Mark M. Harmeling 45 Director of the Company since July, 1990
and Director of American Progressive since
December, 1992. Mr. Harmeling has been
President of Bay State Realty Advisors
since January, 1994 and previously
President of Intercontinental Real Estate
Corporation, a real estate management and
development company for more than the past
five years. Mr. Harmeling is also a
27
<PAGE>
Director of the following companies:
Rochester Shoetree Corporation (since 1988)
and Applied Extrusion Technologies (since
1987). Term as a Director expires in 1998.
Bertram Harnett 74 Elected director of the Company and
American Pioneer in June 1996 and had been
a director of the Company previously (July
29, 1988 to February 9, 1989). Mr. Harnett
is President of the law firm of Harnett
Lesnick & Ripps P.A., Boca Raton, Florida,
and its predecessors since 1988, and a
practicing lawyer since 1948. He is the
author of treatises on insurance law and is
a former Justice of New York State Supreme
Court. Term as a director expires in 1998.
Walter L. Harris 46 Director of the Company since July, 1993
and of American Progressive (and its
predecessor, John Adams) since July, 1988.
Since 1979, Mr. Harris has been President
of Tanenbaum-Harber Company, Inc., a
general insurance brokerage firm. Term as
a Director expires in 1999.
Harry B. Henshel 77 Director of the Company since June, 1992.
Mr. Henshel has been Chairman of the Board
of the Bulova Corporation, a manufacturer
of timepieces located in New York City, for
more than the past five years. Mr. Henshel
is also a Director of Ponce Hotel
Corporation (since 1973) and Ampal
Industries, Inc. (since 1983). Term as a
Director expires in 2000.
Patrick J. McLaughlin 39 Director of the Company since January,
1995. Mr. McLaughlin has been Managing
Director of Emerald Capital Group, Ltd., an
asset management and consulting firm
specializing in the insurance industry,
since April 1993. Prior to that he was an
Executive Vice President and Chief
Investment Officer of Life Partners Group,
Inc. (April, 1990 to April, 1993), Managing
Director of Conning & Company (August, 1989
to April 1990) and Senior Vice President
and Chief Investment Officer of ICH
Corporation (March, 1987 to August, 1989).
Term as a Director expires in 2000.
Richard Veed 46 Director of the Company since April 25,
1997. Mr. Veed has been a Managing Partner
of AAM Investment Banking Group, Ltd. Since
October, 1993. Prior to that, he was
President of Guaranty Reassurance Corp.
from September, 1992 to May, 1993 and a
Partner at Arthur Anderson & Co. from 1987
to August, 1992. He is also a Director of
HomeVest Financial Group, Inc. Term as
Director expires in 1999.
Michael Barasch is Marvin Barasch's son. Richard Barasch is Marvin
Barasch's nephew.
All of the executive officers listed above devote their full business time
to the Company.
28
<PAGE>
All of the Company's and its subsidiaries' officers are elected
annually. The Company's directors are elected for three-year terms, classified
into three classes with the Directors in each class serving for three years,
with the terms staggered by class so that one class is elected at each annual
meeting of shareholders for a full three-year term. All officers and directors
hold office until their successors are duly elected and qualified, subject to
early removal by the Board.
The By-laws of the Company provide that the Board of Directors shall set
the number of directors and that the number of directors in each class shall be
equal, or as nearly as practical. The Company's Board of Directors consists of
eleven directors.
The Board of Directors has an Audit Committee, which also acts as a
Transactions Committee, consisting of Messrs. Becker, Bolger, Henshel, and
McLaughlin, a Compensation Committee consisting of Messrs. Becker, Harmeling and
Harris and an Executive Committee consisting of Messrs. Marvin, Richard and
Michael Barasch, Mr. Bolger and Mr. Harnett. The Audit Committee is empowered to
consult with the Company's independent auditors with respect to their audit
plans and to review their audit report and the accompanying management letters
and, as the Transactions Committee, reviews and makes recommendations to the
Board on certain capital transactions entertained by the Company. The
Compensation Committee reviews and recommends compensation, including incentive
stock option grants, of officers of the Company. The Executive Committee has the
authority to act between Board meetings on behalf of the Board, on all matters
allowed by law.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company and Wand Partners L.P., an affiliate of Wand/Universal
Investments L.P., I and II, the holders of all of the outstanding Series B
Preferred Stock, entered into a financial advisory agreement, dated December 30,
1994, under which such Wand affiliate renders advisory services to the Company
and is paid a fee of $100,000 per year for such services reduced by any
director's fees paid to the director designated by Wand. Such services and fees
are to continue as long as Wand owns 500,000 shares of Common Stock or common
stock equivalent.
Bertram Harnett, a director of the Company, is a shareholder in Harnett,
Lesnick & Ripps P.A. of Boca Raton, Florida, which was paid $269,870 in 1997 on
account of its legal services to, as well as reimbursement for disbursements
made on behalf of the Company.
ITEM 2 - PROPERTIES
The Company currently leases from unaffiliated parties: (i) approximately
9,000 square feet of office space in Rye Brook, New York, under a lease expiring
in October, 2004, (ii) 18,000 square feet in Orlando, Florida, under a lease
expiring in January, 2002; (iii) 32,000 square feet in Pensacola, Florida, under
a lease expiring in November, 2002, with two renewals at the Company's option
for a period of five years each; (iv) 3,000 square feet in Dallas, Texas, under
a lease expiring in March, 2002 and (v) 4,000 square feet in Miami, Florida,
under a lease expiring in August, 1999. These leases represent the operating
offices of American Progressive, American Pioneer, American Exchange and
WorldNet, respectively, and carry an aggregate annual rental of approximately
$700,000. The Company also leases a smaller office in Andalusia, Alabama, for an
aggregate annual rental of approximately $17,000.
29
<PAGE>
ITEM 3 - LEGAL PROCEEDINGS
No reportable litigation was pending at December 31, 1997. The Company is
party to various lawsuits arising out of the ordinary conduct of its business,
none of which, the Company believes, would have a material adverse effect upon
the business of the Company if it were to be adversely determined.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted by the Company to a vote of stockholders,
through the solicitation of proxies or otherwise, during the fourth quarter of
the fiscal year for which this report is filed.
30
<PAGE>
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Publicly Traded Securities
The Company's Common Stock has been traded in the over-the-counter market
and quoted on the Nasdaq National Market under the symbol UHCO since May 12,
1983. The 1999 Warrants have been so traded and so quoted, under the symbol
UHCOW, since September 1990. The following table sets forth the high and low
sales prices per share of Common Stock and 1999 Warrants as reported on the
Nasdaq National Market for the periods indicated.
Common Stock 1999 Warrants
------------------ -----------------
High Low High Low
-------- -------- -----------------
1995
- ----------------------------
First Quarter 3 3/8 2 1/8 1 3/4 1 3/4
Second Quarter 3 3/4 2 5/8 1 3/4 1 3/4
Third Quarter 3 5/8 2 5/8 1 3/4 1 1/4
Fourth Quarter 3 1/8 2 1/8 1 1/4 1 1/4
1996
- ----------------------------
First Quarter 3 1/8 2 1/4 1 1/2 1 1/2
Second Quarter 3 1/8 2 1 1/4 1 1/4
Third Quarter 3 1/8 2 31/32 1 3/4 1 1/4
Fourth Quarter 2 11/16 1 1/2 1 3/8 1 1/4
1997
- ----------------------------
First Quarter 2 31/64 1 3/4 1 9/32 1 1/8
Second Quarter 2 5/8 1 3/4 1 1/8 1 1/8
Third Quarter 2 5/8 1 7/8 1 3/8 1 1/8
Fourth Quarter 3 1/4 2 1 3/8 1 3/8
1998
- ----------------------------
First Quarter (through February 3 2 3/8 1 3/8 1 3/8
28)
As of February 28, 1998, there were approximately 1,700 holders of the
Common Stock and 100 holders of the 1999 Warrants. On February 28, 1998, the bid
and ask sales prices for the Common Stock were $1-7/8 and $2-1/4. On October 10,
1997, the last date on which the 1999 Warrants were traded, the sales price was
$1-3/8.
Dividends
The Company has neither declared nor paid dividends on its Common Stock
and no such dividends are likely in the foreseeable future. Any future decision
to pay dividends will be made by the Board of Directors in light of conditions
then existing, including the Company's results of operations, financial
condition and requirements, loan covenants, insurance regulatory restrictions,
business conditions and other factors. In addition, the ability of the Company
to pay cash dividends, if and when it should wish to do so, may depend on the
ability of its subsidiaries to pay dividends to the Company. See "Regulation
Dividend and Distribution Restrictions"
31
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ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below should be read in
conjunction with the consolidated financial statements of the Company, the
related notes thereto and the auditors' report thereon and "Management's
Discussion and Analysis of Financial Condition and Results of Operations". The
selected consolidated financial data presented below as of, and for each of the
years ended December 31, 1993 through 1995 are derived from the consolidated
financial statements of the Company, which have been audited and reported upon
by KPMG Peat Marwick LLP, independent certified public accountants. The selected
consolidated financial data presented below as of and for each of the years
ended December 31, 1996 and 1997, have been audited and reported upon by Ernst &
Young LLP, independent certified public accountants. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations Results
of Operations".
Year ended December 31,
---------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
(In thousands, except for per share data)
Income Statement Data:
Direct premium and
policyholder fees $24,885 $40,652 $46,145 $55,287 $99,339
Reinsurance premium assumed 616 13,564 8,866 10,522 998
Reinsurance premium ceded (3,975) (13,892) (18,200) (25,664) (62,623)
--------- --------- --------- --------- ---------
Net premium and other
policyholderfees 21,526 40,324 36,811 40,145 37,714
Net Investment income 7,974 9,239 8,945 9,850 10,023
Realized gains 676 42 674 240 1,133
Fee income 2,466 4,126 3,137 2,872 2,368
Other income 801 219 244 280 93
Total revenues 33,443 53,950 49,811 53,387 51,331
Total benefits, claims and
other deductions 31,818 51,712 47,161 53,014 48,119
Net income after taxes 1,553 2,228 2,642 104 2,119
Net income applicable to
common shareholders 1,024 3,173 2,642 104 1,870
(1)
Diluted income per share 0.14 0.37 0.25 0.01 0.18
December 31,
-------------------------------------------------------
Balance Sheet Data: 1993 1994 1995(2) 1996 1997
--------- --------- --------- --------- ----------
(In thousands, except for per share data)
Total investments
$123,038 $125,487 $135,603 $144,681 $159,429
Total assets 153,687 164,862 182,994 242,237 272,575
Policyholder account 105,091 108,777 118,609 134,539 145,085
balances
Series C Preferred Stock - - - - 5,168
Series A Preferred Stock 6,564 - - - -
Series B Preferred Stock - 4,000 4,000 4,000 4,000
Stockholders' equity 16,377 15,321 24,114 22,079 25,706
Stockholders' equity per
share of Common Stock (3) 1.87 1.83 2.89 2.53 2.96
- -------------------------
(1)After provision for Series A Preferred Stock dividends of $529,000 and
$576,000 for the years ended December 31, 1993 and 1994, respectively, and
Series C Preferred Stock dividends of $250,000 for the year ended December
31, 1997.
(2)See "Management's Discussion and Analysis of Financial Condition and Results
of Operations: Effects of Accounting Pronouncements" for a discussion of the
impact of changes in accounting principles.
(3)Stockholders' equity per share of common stock represents stockholders'
equity less the statement value of Series A and Series B Preferred Stock
divided by outstanding shares of common stock.
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ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company is an insurance holding company representing the strategic
combination of three life insurance companies, American Progressive, American
Pioneer and American Exchange and WorldNet. Management is focused on growth,
both internal, through aggressive marketing and product development programs
directed at specialty life and accident and health insurance products, and by
seeking further acquisitions of insurance companies or blocks of business. It
also has embarked on a program to streamline operations through consolidation of
administrative and processing facilities.
The Insurance Subsidiaries had consolidated revenues of approximately
$46.6 million, $51.1 million and $49.3 million for the years ended December 31,
1995, 1996, and 1997, respectively, representing 93%, 95% and 96%, of the
Company's total revenues for each period, respectively. Although American
Progressive, domiciled in New York, primarily sells its products in New York and
the northeastern United States, American Pioneer, domiciled in Florida,
primarily sells its products in Florida and the southeastern United States and
American Exchange, domiciled in Texas, exclusively sells its products in Texas,
one or more of the Insurance Subsidiaries is licensed in 45 states and in the
District of Columbia.
The Company cautions readers regarding certain forward-looking statements
contained in the following discussion and elsewhere in this report and in any
other oral or written statements, either made by, or on behalf of the Company,
whether or not in future filings with the Securities and Exchange Commission
("SEC"). Forward-looking statements are statements not based on historical
information. They relate to future operations, strategies, financial results or
other developments. In particular, statements using verbs such as "expect,"
"anticipate," "believe" or similar words generally involve forward-looking
statements. Forward-looking statements include statements that represent the
Company's products, investment spreads or yields, or the earnings or
profitability of the Company's activities.
Forward-looking statements are based upon estimates and assumptions that
are subject to significant business, economic and competitive uncertainties,
many of which are beyond the Company's control and are subject to change. These
uncertainties can affect actual results and could cause actual results to differ
materially from those expressed in any forward-looking statements made by, or on
behalf of the Company. Whether or not actual results differ materially from
forward-looking statements may depend on numerous foreseeable and unforeseeable
events or developments, some of which may be national in scope, such as general
economic conditions and interest rates. Some of these events may be related to
the insurance industry generally, such as pricing competition, regulatory
developments and industry consolidation. Others may relate to Universal
specifically, such as credit, volatility and other risks associated with the
Company's investment portfolio, and other factors. Universal disclaims any
obligation to update forward-looking information.
Results of Operations
Years Ended December 31, 1996 and 1997
The results of operations for the years ended December 31, 1996 and 1997
include the operations of American Progressive, American Pioneer and WorldNet
for the year ended December 31, 1997 and the operations of American Exchange for
the period December 4, 1997, the date of its acquisition, to December 31, 1997.
All references to per share amounts are on a diluted basis.
For the year ended December 31, 1997, the Company earned net income after
Federal income taxes of $2,119,000 ($0.18 per share) compared to $104,000 ($0.01
per share) in the prior year. Operating income before Federal income taxes
amounted to $3,211,000 for the year ended December 31, 1997 compared to $373,000
in the year ago period. In September, 1997, the Company sold AmeriFirst
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Insurance Company, an inactive insurance company, to an unaffiliated third
party, for $3,379,000 and realized a pretax gain of $569,000 ($376,000 after tax
or $0.03 per share).
Revenues. Total revenues decreased approximately $2,057,000 to
approximately $51,330,000 for the year ended December 31, 1997, compared to
total revenues of approximately $53,387,000 in the year ago period, which
decrease is primarily attributable to the Company's decision to restructure its
operations and exit certain product lines (See "Business - Restructuring
Activity").
Gross premium and policyholder fees earned and reinsurance assumed
In the year ended December 31, 1997, the Company's gross premium and
policyholder fees earned (including reinsurance assumed) amounted to
$100,337,000, a $34,528,000 increase over the $65,809,000 amount in 1996. This
gross premium increase is significantly attributable to the increase of
$37,084,000 of premiums received on the policies assumed in the fourth quarter
of 1996 from First National Life Insurance Company ("First National"), which
premiums amounted to $51,266,000 in 1997 compared to $14,182,000 in 1996. In
addition, the gross premiums on the Company's currently marketed programs
increased as follows:
Product Premium Premium
Increase Earned
---------------------------- --------------- -------------
Senior market supplemental
health $4,391,000 $11,366,000
Senior market life
insurance 773,000 2,380,000
Group life insurance
116,000 3,407,000
--------------- -------------
Totals $5,280,000 $17,153,000
=============== =============
In addition, other life insurance premium increased $2,134,000 to
$8,352,000 in 1997.
These increases totaled $44,498,000 and were offset by the net decrease in
premiums on the products terminated and not currently marketed by the Company.
Effective December 31, 1996, the Company withdrew its participation in the NAIU
specialty accident and health insurance pool and also sold its New York State
DBL business in force. The decrease in premium from the exit from these lines
amounted to $11,239,000 for the year ended December 31, 1997. Effective
September 1, 1997, the Company decided to exit the group dental business and
executed an agreement with an unaffiliated reinsurer to cede 100% of all
business earned after September 1, 1997. The premium will continue to be
received by American Pioneer and will be ceded to the reinsurer on a 100% quota
share basis. Gross premiums for the group dental business increased $1,145,000
in 1997.
Other accident and health insurance premiums increased $124,000 for the
year ended December 31, 1997. Premiums on the international medical insurance
product (which was 90% and 95% reinsured to unaffiliated reinsurers in 1997 and
1996, respectively) increased $1,264,000 in 1997, while the premiums on the
non-marketed accident and health products decreased $1,140,000 in 1997.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from its
core products, it continues to reinsure a portion of these risks to unaffiliated
reinsurers. Reinsurance premiums ceded for the year ended December 31, 1997
amounted to $62,623,000, a $36,960,000 increase from the 1996 amount of
$25,663,000. Of this increase, $30,991,000 relates to the business acquired from
First National, while $1,912,000 relates to senior market accident and health
and $174,000 relates to senior market life insurance. In addition to these
increases, the reinsurance on the international medical insurance discussed
above increased $1,058,000 in 1997, while premiums ceded on life insurance
increased $2,231,000.
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Effective January 1, 1997, the Company entered into a new reinsurance
agreement on American Pioneer's major medical/major hospital business. Under the
new treaty, the Company retains 50% of the first $60,000 in claims risk compared
to 25% under the prior agreement. As a result, premiums ceded on this product
decreased $1,719,000 in 1997. Accident and health premiums ceded on the policies
not currently marketed also decreased $1,004,000.
In connection with the restructuring activity previously discussed,
reinsurance on the NAIU pool business amounted to $1,119,000 and reinsurance on
the group dental business amounted to $2,198,000.
Net investment income of the Company increased $173,000 to $10,023,000 for
the year ended December 31, 1997, compared to $9,850,000 in the year ago period.
Realized gains on investments amounted to $1,133,000 for the year ended December
31, 1997 compared to $240,000 in the year ago period. Included in the 1997
amount is the $569,000 gain realized on the sale of AmeriFirst Insurance Company
to an unaffiliated third party.
Other revenue
Fee income amounted to $2,368,000 for the year ended December 31, 1997, a
decrease of $503,000 from the $2,871,000 amount for the year ago period. This
decrease is the result of the cancellation of WorldNet's Ontario Blue Cross
contract in 1996. The amortization of deferred revenue amounted to $93,000 for
the year ended December 31, 1997, compared to $280,000 in the year ago period.
This $187,000 decrease is the result of the full amortization of the deferred
revenue generated by the reinsurance of the major medical business on June 30,
1995, which agreement was terminated by the reinsurer on December 31, 1996 (See
"Business - Reinsurance Ceded").
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions decreased approximately $4,895,000 to $48,119,000 for the year ended
December 31, 1997, compared to $53,014,000 in the year ago period.
Claims and other benefits decreased $324,000 to $23,719,000 for the year
ended December 31, 1997 compared to $24,043,000 in the year ago period. The
increase in net claims on the business assumed from First National amounted to
$6,454,000, while net claims on the senior market accident and health increased
$775,000. As discussed above, the Company is retaining a higher amount of major
medical/major hospital business under a new reinsurance agreement and, as a
result, the Company's claims on this product increased $1,067,000 to $2,169,000.
(This increase corresponds to the $1,137,000 increase in retained premiums.) In
addition, claims on the non-marketed accident and health products increased
$367,000 in 1997.
These increases of $8,663,000 were offset by decreases in the claims
incurred on the terminated businesses (NAIU - $4,219,000; New York State DBL -
$3,712,000; group dental - $903,000). The remaining decrease of $154,000
represents a decrease in life insurance claims.
The change in reserves for the year ended December 31, 1997 amounted to an
increase of $441,000 compared to an increase of $1,855,000 in the year ago
period generating a decrease of $1,414,000. Included in the 1996 change in
reserves is $256,000 generated by the NAIU accident pool business that the
Company has exited. Interest credited to policyholders increased $32,000 to
$6,646,000.
The change in deferred acquisition costs increased $688,000 for the year
ended December 31, 1997 compared to 1996. The amount of acquisition costs
capitalized increased $1,670,000 from $5,042,000 in 1996 to $6,712,000 in 1997.
This increase is the result of the increase in new premium production in the
year ended December 31, 1997 compared to the year ago period. The amortization
of deferred acquisition costs increased $982,000 from $2,784,000 in 1996 to
$3,766,000 in 1997. This increase is the result of the increase in the asset
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<PAGE>
balance. In the year ended December 31, 1997, the Company amortized $112,000 of
the goodwill generated in the First National acquisition.
Commissions increased $5,009,000 in the year ended December 31, 1997 to
$21,089,000, compared to $16,080,000 in the year ago period. This increase is
the direct result of the $34,528,000 increase in gross premium earned discussed
above. Commissions and expense allowances on reinsurance ceded increased
$9,296,000 for the year ended December 31, 1997 to $20,300,000, compared to
$11,004,000 in the year ago period. This increase is the direct result of the
$36,960,000 increase in reinsurance premium ceded discussed above and reduces
the amounts of commissions and expenses capitalized for deferred acquisition
costs.
Other operating costs and expenses increased $1,674,000 in the year ended
December 31, 1997 to $19,358,000, compared to $17,684,000 in the year ago
period. The non-insurance companies expenses decreased $280,000 to $2,594,000
for the year ended December 31, 1997 as a result of the decrease in expenses
incurred at WorldNet - Miami.
The insurance companies' expenses amounted to $16,764,000 for the year
ended December 31, 1997 compared to $14,810,000 in the year ago period, an
increase of $1,954,000. Expenses incurred administrating the recently acquired
business from First National amounted to $4,258,000, while premium taxes
increased $768,000. These increases totaled $5,026,000 and were offset by the
decrease in new business expenses of $318,000, general overhead of the insurance
companies of $1,145,000 and expenses incurred by the NAIU pool of $1,609,000.
Years Ended December 31, 1995 and 1996
The results of operations for the year ended December 31, 1995 and 1996
include the operations of American Progressive, American Pioneer and WorldNet.
All references to per share amounts are on a diluted basis.
Net Income. For the year ended December 31, 1996, the Company earned net
income of approximately $104,000 resulting in an earnings per share applicable
to common shareholders of $0.01. For the year ended December 31, 1995, the
Company earned net income of approximately $2,642,000, resulting in an earnings
per share of $0.25.
Operating income before income taxes decreased $2,278,000 from $2,651,000
in 1995 to $373,000 in 1996. Certain individually large items account for a
significant amount of this decrease, including (i) a decrease in the operating
results of the NAIU accident pool participated in by American Progressive, which
decrease was $1,100,000; (ii) a decrease in realized gains on investment of
$434,000 and (iii) the $250,000 expense accrual made at December 31, 1996 for
the restructuring activity of the Company. These three items represent
$1,784,000 of the $2,278,000 decrease.
Revenues. Total revenues increased approximately $3,576,000 from total
revenues of approximately $49,811,000 for the year ended December 31, 1995 to
approximately $53,387,000 for the year ended December 31, 1996. Net premiums and
policyholder fees earned increased approximately $3,334,000. Supplemental health
insurance premiums at American Progressive increased approximately $1,258,000
(primarily Medicare supplement, hospital indemnity and home health care) and its
life premiums grew approximately $30,000, while American Pioneer's life premiums
grew approximately $374,000 and its group dental premiums grew approximately
$919,000. The increase in these life and supplemental health premiums of
$2,581,000 was offset by the decrease of approximately $547,000 in American
Pioneer's major hospital and major medical premiums and the decrease in American
Progressive's premiums from its other accident and health products that are no
longer being actively marketed by the Company (approximately $754,000). The
Company had an increase in premiums from the NAIU pool of $1,798,000 and the NYS
DBL business of $256,000. Realized gains on investments decreased approximately
$434,000 to approximately $240,000, compared to a gain of approximately $674,000
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<PAGE>
for the prior year. Net investment income increased approximately $905,000 from
$8,945,000 in 1995 to $9,850,000 in 1996. This increase is attributed to higher
invested assets in 1996 compared to 1995.
Fee income for the year ended December 31, 1996 reflects the fees earned
by WorldNet for managed care, travel assistance, claims administration and
communication services and the $450,000 deposit received by American Progressive
in connection with the sale of the New York DBL business. WorldNet's fee income
decreased by $716,000 which reduction primarily results from the Company's
termination of its service agreement with Liberty Mutual in February, 1996. For
the year ended December 31, 1996, the Company amortized approximately $280,000
of deferred revenue compared to $244,000 amortized in the same period in 1995.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions increased approximately $5,754,000 to $53,014,000 for the year ended
December 31, 1996. The change in future policy benefits amounted to an increase
of approximately $3,192,000. The increase in reserves for the year ended
December 31, 1996 was $1,855,000 and primarily relates to the increase in life
reserves at American Pioneer of $971,000, the increase in the unearned premium
reserve at NAIU of $256,000 and the increase in the senior market supplemental
health insurance unearned premium reserves of $628,000. This increase compares
to a decrease in 1995 of approximately $1,337,000, which decrease in 1995
primarily relates to the reduction in the 1995 NAIU premium ($491,000), the not
actively marketed accident and health business of American Progressive
($827,000) and the major hospital and major medical of American Pioneer
($430,000) offset by an increase in the senior market supplemental health
insurance reserves ($559,000). Claims and other benefits increased approximately
$1,676,000. This increase is a result of increased mortality of approximately
$516,000, increased American Progressive's senior market supplemental health
benefits of approximately $1,062,000, the claims incurred on the First National
business acquired of $1,077,000 and increased morbidity of $388,000 on the group
dental business. The runoff health business at both insurance companies had a
reduction in benefits totaling $3,145,000 due to the decision to reinsure 75% of
the major hospital and major medical benefits at American Pioneer. The benefits
incurred on the NAIU business increased $1,083,000 and NYS DBL benefits
increased $695,000. The increase in deferred acquisition costs decreased
approximately $1,106,000 and was due to the decrease in capitalized expenses of
$228,000 and the increase in amortization of $878,000.
Commissions decreased $265,000 to $5,076,000 for the year ended December
31, 1996. The increase in gross commissions of $4,967,000 was due to the
increase in gross premiums noted above, offset by a corresponding increase in
reinsurance allowances of $5,231,000. Other operating costs and expenses
decreased approximately $175,000. Expenses incurred by the insurance
subsidiaries during 1996 exceeded the 1995 amount by approximately $1,405,000.
New business expenses and premium taxes increased approximately $166,000, the
expenses incurred on the administration of the acquired First National business
amounted to $550,000, while the expense incurred by the NAIU accident pool
decreased $397,000. The general overhead expenses of the insurance companies
increased approximately $1,086,000, which increase directly relates to the
increase in business being administered by the Company. These administrative
general expense increases are partially recovered from the increase in these
reinsurance allowances noted above. The remaining decrease of $1,580,000 results
from a decrease of continuing operation expenses incurred by WorldNet
(approximately $1,292,000) and a decrease in the Parent Company expenses
($288,000). Amortization of the present value of future profits was
approximately $205,000 for 1995, which amount fully amortized the asset.
Liquidity and Capital Resources
The Company's need for capital has historically been to maintain or
increase the surplus of its Insurance Subsidiaries and to support the Company as
an insurance holding company, including the maintenance of its status as a
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<PAGE>
public company. In addition, the Company requires capital to fund its
anticipated growth through acquisitions of other companies and blocks of
insurance business.
The Company
The Company requires cash to pay the operating expenses necessary to
support its status as an insurance holding company (which under applicable
Insurance Department regulations must bear its own expenses), and to meet the
cost involved in being a publicly-owned company. In addition, it will require
cash to meet Universal's obligations under the Unstacking Agreement and the
debentures outstanding thereunder and to meet the quarterly amortization of the
bank loan entered into on December 10, 1997.
On December 10, 1997, the Company entered into an agreement with Chase
Manhattan Bank for a $3,500,000 five-year, secured term loan. The loan proceeds
were used to finance a segment of the intercompany sale of American Pioneer from
American Progressive to Universal and to retire the $800,000 amount outstanding
on the term loan agreement with a commercial bank. The loan agreement calls for
interest at the London Interbank Offered Rate ("LIBOR") plus 200 basis points.
In connection with this loan agreement, the Company entered into a three-year
interest rate swap agreement, (the "Swap Agreement") with Chase Securities
Corp., effective January 1, 1998, to lock in a fixed rate of 8.19% for the three
year period. Upon expiration of the Swap Agreement, the Company's interest rate
reverts to the LIBOR plus 200 basis points. The loan will be secured by a first
priority interest in all the assets of WorldNet Services Corp. and Quincy Corp.,
a pledge of 9.9% of the outstanding common shares of American Progressive and
100% of the shares of Quincy Coverage Corp.
In connection with the Unstacking Agreement (see "Business - Unstacking"),
the Company has $5,925,000 in debentures outstanding to its American Progressive
subsidiary. The debentures pay interest quarterly at the prime rate and are
payable on September 30, 2002. Management believes that the current cash
position and expected cash flows of the non-insurance companies and the
availability of dividends from American Pioneer can support the obligations of
Universal noted above for the foreseeable future. Although, there can be no
assurance as to the expected future cash flows or to the availability of
dividends from American Pioneer.
Insurance Subsidiaries
American Progressive, American Pioneer and American Exchange are required
to maintain minimum amounts of capital and surplus as determined by statutory
accounting. The minimum statutory capital and surplus requirements of American
Progressive, American Pioneer and American Exchange as of December 31, 1997 for
the maintenance of authority to do business were $2,500,000, $2,424,000 and
$770,000 respectively, but substantially more than such minimum amounts are
needed to support the current level of the Company's operations. At December 31,
1997 the adjusted statutory capital and surplus, including asset valuation
reserve, of American, American Pioneer and American Exchange was $9,783,000,
$10,807,000 and $4,230,000 respectively.
The NAIC has adopted risk based capital ("RBC") rules, which became
effective December 31, 1993 and have been adopted by New York, Florida and
Texas. See "Regulation Risk-Based Capital Requirements." The RBC rules provide
for various actions when the ratio of a company's total adjusted surplus to its
RBC falls below 200%. At December 31, 1997, American Progressive, American
Pioneer and American Exchange had RBC ratios of approximately 484%, 495% and
227% of the Authorized Control Level, respectively.
Liquidity for the life insurance subsidiaries is measured by their ability
to pay scheduled contractual benefits, pay operating expenses, and fund
investment commitments. Sources of liquidity include scheduled and unscheduled
38
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principal and interest payments on investments, premium payments and deposits
and the sale of liquid investments. These sources of liquidity for the insurance
subsidiaries significantly exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including death
benefits, benefits under accident and health policies and interest-sensitive
policy surrenders and withdrawals. The amount of surrenders and withdrawals is
affected by a variety of factors such as credited interest rates for similar
products, general economic conditions and events in the industry that affect
policyholders' confidence. Although the contractual terms of substantially all
of the Company's in force life insurance policies and annuities give the holders
the right to surrender the policies and annuities, the Company imposes penalties
for early surrenders. At December 31, 1997 the Company held reserves that
exceeded the underlying cash surrender values of its in force life insurance and
annuities by more than $12.9 million. The insurance companies have not
experienced any material changes in surrender and withdrawal activity in recent
years.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity, unanticipated
surrenders and withdrawals in a changed interest rate environment could
adversely affect earnings if the Company were required to sell investments at
reduced values in order to meet liquidity demands. The Company manages the asset
and liability portfolios in order to minimize the adverse earnings impact of
changing market rates. The Company seeks to invest in assets which have duration
and interest spread characteristics similar to the liabilities that they
support.
As a result of the decrease in economic interest rates, the net yield on
the Company's cash and invested assets decreased from 7.08% in 1996 to 6.81% in
1997. A significant portion of these securities are held to support the
liabilities for policyholder account balances, which liabilities are subject to
periodic adjustments to their credited interest rates. The credited interest
rates of the interest-sensitive policyholder account balances are determined by
management based upon factors such as portfolio rates of return and prevailing
market rates and typically follow the pattern of yields on the assets supporting
these liabilities.
At December 31, 1997, the investment portfolios of the life insurance
subsidiaries included cash and cash equivalents totaling $22,411,000, as well as
fixed maturity and equity securities that could readily be converted to cash
with carrying values (and fair values) of $124,531,000. The fair values of these
liquid investments totaled more than $146,942,000 and constituted approximately
92% of the Company's investments at December 31, 1997. At December 31, 1997, all
of the Company investments were income producing and current in interest and
principal payments. In addition, the Company has no investment in any derivative
instruments or other hybrid securities that contain any off balance sheet risk
or investments in other securities whose fair values and principal repayments
would be highly volatile to changes in interest rates, except for GNMA's, FNMA's
and investment grade corporate collateralized mortgage obligations.
Impact of Year 2000
The Company's main operating system utilizes programs that were written
using four digit codes to define the applicable year. Some of the Company's
older sytem's computer programs were written using two digits rather than
four to define the applicable year. As a result, those computer
programs have time-sensitive software that recognize a date using "00" as the
year 1900 rather than the year 2000. This could cause a system failure or
39
<PAGE>
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
The Company has completed an initial assessment and will have to modify or
replace portions of its software so that its computer systems will function
properly with respect to dates in the year 2000 and thereafter. Currently, the
Company expects the Year 2000 project costs to be limited to the allocation of
its data processing department resources and significant external expenses are
not expected. Accordingly, no specific budget for such costs has been allocated.
The project is estimated to be completed not later than December 31, 1999
which is prior to any anticipated impact on its operating systems. The Company
believes that with modifications to existing software and/or conversions of data
to existing software, the Year 2000 Issue will not pose significant operational
problems for its computer systems. However, if such modifications and
conversions are not made, or are not completed timely, the Year 2000 Issue could
have a material impact on the operations of the Company. The Company has
initiated formal communications with its significant suppliers to determine the
extent to which the Company's interface systems are vulnerable to those third
parties' failure to remediate their own Year 2000 Issues. There is no guarantee
that the systems of other companies on which the Company's systems rely will be
timely converted and would not have an adverse effect on the Company's systems.
The costs of the project and the date on which the Company believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be will be achieved
and actual results could differ materially from those anticipated. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
Effects of Accounting Pronouncements
In May 1993, the FASB issued Statement No. 115, "Accounting for Certain
Debt and Equity Securities" ("Statement No. 115"), which is effective for
fiscal years beginning after December 15, 1993, with earlier adoption
permitted. Statement No. 115 requires that debt and equity securities be
classified into three categories and accounted for as follows:
Debt securities that the Company has the positive intent and the ability to
hold to maturity would be classified as "held to maturity" and reported
at amortized cost.
Debt and equity securities that are held for current resale would be
classified as "trading securities" and reported at fair value,
with unrealized gains and losses included in earnings.
Debt and equity securities not classified as held to maturity or as trading
securities would be classified as "available for sale" and reported at
fair value. Unrealized gains and losses would not be reflected in
earnings but would be reported as a separate component of stockholders'
equity.
The Company adopted Statement No. 115 on January 1, 1994, the effect of
which increased its unrealized gains by $494,541. In November, 1995, the FASB
issued a Special Report titled "A Guide to Implementation of Statement No. 115
on Accounting for Certain Investments in Debt and Equity Securities", which
report allows enterprises to reassess the appropriateness of the classifications
of all securities held and account for any resulting reclassifications between
the investment accounts. This one-time reassessment had to be made prior to
December 31, 1996 and be appropriately disclosed in the financial statements. In
December, 1995, the Company did reassess the appropriateness of the
classifications of its securities and reclassified all of the securities
contained in the held to maturity account to the available for sale account as
they may be considered for sale prior to maturity as part of the asset/liability
management strategy. The carrying value of the securities reclassed to available
for sale amounted to $35,942,303 and the fair value amounted to $36,098,026.
This transfer resulted in the Company increasing its unrealized gains by
$155,723. As changes in interest rates occur, the carrying value of the
40
<PAGE>
securities classified as available for sale, as well as any securities which may
in the future be classified as held for maturity, will be impacted. Typically,
as interest rates rise, the carrying value of these securities may decline.
Conversely, if interest rates decline, the carrying value of these securities
may increase. Management cannot predict the impact that changes in future
interest rates will have on the Company's financial statements.
In October, 1995, the FASB issued Statement No. 123, "Accounting for
Stock-Based Compensation" ("Statement No. 123") which requires companies to
recognize compensation expense for stock options based on their fair value on
the date of grant and is effective for financial statements for fiscal years
beginning after December 15, 1995, with earlier adoption permitted. Statement
No. 123 allows companies to remain under the existing method of accounting for
stock options, Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25"). If companies elect to remain under APB No.
25 then the companies are required to disclose the pro forma effects of
Statement No.123 on their net income and earnings per share resulting from the
grant of these options and other stock awards. Under APB No. 25, to the extent
the exercise price of the Company's stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
The Company has elected to follow APB No. 25 and related interpretations in
accounting for its stock options and will disclose the pro forma effects of
Statement No.123 on the Company's net income and earnings per share in the
footnotes to the financial statements. Pro forma effects of Statement No.123
result in additional compensation expense for December 31, 1995, 1996 and 1997
of $11,000, $133,000 and $183,000 respectively. The results of which reduce
earnings per share for December 31, 1995, 1996 and 1997 on a pro forma basis,
$0.00, $0.01 and $0.02, respectively.
The Company adopted FASB Statement No. 128, "Earnings per Share",
("Statement No. 128") as of December 31, 1997 and restated prior year earnings
per share ("EPS") amounts. Statement No. 128 replaces primary EPS with basic
EPS. Basic EPS excludes dilution and is computed by dividing income available to
common shareholders, (after deducting the redemption accrual on the Series C
Preferred Stock), by the weighted average number of shares outstanding for the
period. Diluted EPS gives the dilutive effect of the stock options, warrants and
Series B and C preferred stock outstanding during the year. See Note 2j in the
accompanying financial statements for the computation of basic and diluted EPS
and the impact on the reported results.
In June, 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards Statement No. 130, "Reporting
Comprehensive Income" ("Statement No. 130"), effective for years beginning after
December 15, 1997. Statement No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general purpose financial statements. Statement No.
130 requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements and requires that the accumulated balance of other comprehensive
income be displayed separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet. The adoption of Statement
No. 130 will only affect the presentation of the statement of income and the
balance sheet and will not affect results of operations or financial position.
Also in June, 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("Statement No. 131"),
effective for years beginning after December 15, 1997. Statement No. 131
requires that a public company report financial and descriptive information
about its reportable operating segments pursuant to criteria that differ from
current accounting practice. Operating segments, as defined, are components of
an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision-maker in deciding how to
allocate resources and in assessing performance. The financial information to be
reported includes segment profit and loss, certain revenue and expense items and
segment assets and reconciliations to corresponding amounts in the general
purpose financial statements. Statement No. 131 also requires information about
revenues from products or services, countries where the company has operations
or assets and major customers. The adoption of Statement No. 131 will not affect
41
<PAGE>
results of operations or financial position. The Company is still evaluating its
options as to segment disclosures under Statement No. 131.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary schedules are listed in the
accompanying Index to Consolidated Financial Statements and Financial
Statement Schedules on Page F - 1.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
42
<PAGE>
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of the Registrant
is set forth in Part I, Item 1, under the caption "Executive Officers and
Directors".
ITEM 11 - EXECUTIVE COMPENSATION
Information regarding executive compensation is incorporated by reference
to Universal American Financial Corp.'s definitive proxy statement to be filed
pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120
days after the end of the Company's fiscal year ended December 31, 1997.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding beneficial ownership of Universal American Financial
Corp.'s voting securities by directors, officers and persons who, to the best
knowledge of the Company, are known to be the beneficial owners of more than 5%
of the Company's voting securities as of December 31, 1997, is incorporated by
reference to Universal American Financial Corp.'s definitive proxy statement to
be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
within 120 days after the end of the Company's fiscal year ended December 31,
1997.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
incorporated by reference to Universal American Financial Corp.'s definitive
proxy statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934 within 120 days after the end of the Company's fiscal year
ended December 31, 1997.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 and 2 Financial Statements and Financial Statement Schedules
See separate index to Financial Statements and Financial Statement
Schedules on Page F - 1.
3 Exhibits and Reports on Form 8-K
(a) Exhibits
3(a) Restated Certificate of Incorporation, consisting of:
(i) Restated Certificate of Incorporation filed October 4,
1993, is hereby incorporated by reference to Exhibit
3(a)(3) to Form 10-Q dated November 11, 1994.
(ii) Certificate of Correction of Restated Certificate of
Incorporation, dated December 13, 1993, is hereby
incorporated by reference to Exhibit 3(a)(2) to Form
10-K dated March 28, 1994.
43
<PAGE>
(iii) Certificate of Amendment to Restated Certificate of
Incorporation relating to Series B Preferred Stock, is
hereby incorporated by reference to Exhibit 3.2(III) to
Form 8-K dated January 18, 1995.
(iv) Certificate of Correction of the Certificate of
Amendment of the Certificate of Incorporation relating
to Series C-1 and C-2 Preferred Stock, filed
April 23, 1997
3(b) By-Laws, as amended, are hereby incorporated by reference to Exhibit
3(b) to Form 10-K for 1989.
4(a) Form of Warrant Certificate:
(i) for Warrants registered under the Exchange Act of 1934,
as amended, is hereby incorporated by reference to
Exhibit 4 to Current Report on Form 8-K dated July 24,
1992; and
(ii) for Warrants not so registered under the Exchange Act of
1934, is hereby incorporated by reference to Exhibit 4.2
to Form S-1 filed March 30, 1990, as amended by the
Warrant Exchange Agreement dated July 15, 1992, filed as
Exhibit 28(I) to Current Report on Form 8-K dated July
24, 1992.
10(a) Agreement dated March 7, 1994 among Registrant and Midland with
Exhibit A is hereby incorporated by reference to Exhibit 10(d)(1) to
Form 10-K for 1993.
10(b) Stock Subscription Agreement as of August 12, 1994, between
Registrant and Wand/Universal L.P., as amended by Agreement dated
November 23, 1994 is incorporated by reference to Exhibit 10(e) to
Current Report on Form 8-K dated August 12, 1994 and Exhibit 10.4(1)
to Current Report on Form 8-K dated January 18, 1995.
10(c) Financial Advisory Agreement as of September 1, 1994 between
Registrant and Wand Partners L.P. is incorporated by reference to
Exhibit 10(f) to Current Report on Form 8-K dated August 12, 1994.
10(d) Shareholder Agreement among the Registrant, Wand/Universal
Investments L.P., Barasch Associates Limited Partners and Others,
dated December 30, 1994 is incorporated by reference to Exhibit
10(d) to Form 10-K for 1994.
10(e) Special Commitments to the Superintendent of Insurance of the State
of New York, dated January 6, 1995, signed by:
(i) the Registrant, American Progressive, BALP and NMRB
Corp. and
(ii) WAND, Wand (Universal) Inc., David S. Callard and Bruce
W. Schnitzer are incorporated by reference to Exhibit
10(e) to Form 10-K for 1994.
10(g) Stock purchase agreement between Registrant and AAM Capital
Partners, L.P. dated July 7, 1997, including:
(i) Exhibit 10, proposed Certificate of Amendment of
Incorporation relating to Series C Preferred Stock; and
44
<PAGE>
(ii) Exhibit 11, proposed shareholder agreement.
Incorporated by reference to Exhibit 10(g) to Form 10K for 1996.
11 Computation of basic and diluted earnings per share, incorporated by
reference to Note 2k of Notes to Consolidated Financial Statements
for 1997, included in this Form 10K.
22 List of Subsidiaries:
Name
Place of Incorporation
American Progressive Life & Health
Insurance Company of New York New York
American Pioneer Life Insurance Company Florida
American Exchange Life Insurance Company Texas
Quincy Coverage Corporation New York
WorldNet Services Corp. Florida
WorldNet Services Corp. Ontario, Canada
23(a) Consent of Ernst & Young LLP
23(b) Consent of KPMG Peat Marwick LLP
(b) Reports on Form 8-K
None
45
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 27th day of
March 1998.
UNIVERSAL AMERICAN FINANCIAL CORP.
(Registrant)
By: /s/ Richard A. Barasch
-----------------------
Richard A. Barasch
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 27, 1998 by the following persons in the
capacities indicated:
Signatures Title
/s/ Richard A. Barasch Chairman of the Board,
- ----------------------------- Chief Executive Officer and
President, Richard A. Barasch (Principal Executive Officer)
Director
/s/ Robert A. Waegelein Senior Vice President and
- ---------------------------- Chief Financial Officer
Robert A. Waegelein (Principal Accounting Officer)
/s/ Marvin Barasch Chairman Emeritus and Director
- ---------------------------
Marvin Barasch
/s/ Michael A. Barasch Director
- --------------------------
Michael A. Barasch
/s/ Stuart Becker Director
- --------------------------
Stuart Becker
/s/ David F. Bolger Director
- --------------------------
David F. Bolger
/s/ Mark M. Harmeling Director
- --------------------------
Mark M. Harmeling
/s/ Bertram Harnett Director
- --------------------------
Bertram Harnett
/s/ Walter L. Harris Director
- --------------------------
Walter L. Harris
/s/ Harry B. Henshel Director
- --------------------------
Harry B. Henshel
/s/ Patrick J. McLaughlin Director
- --------------------------
Patrick J. McLaughlin
/s/ Richard Veed Director
- --------------------------
Richard Veed
46
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULES OF THE REGISTRANT:
Independent Auditors' Reports F-2 & F-3
Consolidated Balance Sheets as of December 31, 1996 and 1997 F-4
Consolidated Statements of Operations
for the Three Years Ended December 31, 1997 F-5
Consolidated Statements of Stockholders' Equity
for the Three Years Ended December 31, 1997 F-6
Consolidated Statements of Cash Flows
for the Three Years Ended December 31, 1997 F-7
Notes to Consolidated Financial Statements F-9
Schedule I -- Summary of Investments - other than investments in related parties
(incorporated in Note 4 to Consolidated Financial Statements)
Schedule II -- Condensed Financial Information of Registrant F-36
Schedule III -- Supplementary Insurance Information F-39
Schedule IV -- Reinsurance (incorporated in Note 8 of Notes to
Consolidated Financial Statements)
Other schedules were omitted because they were not applicable
Exhibit 23 -- Consent of Independent Auditors F-40 & F-41
<PAGE>
Independent Auditors' Report
----------------------------
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated balance sheets of Universal
American Financial Corp. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the two years in the period ended December 31, 1997. Our
audits also included the financial statement schedules as listed in the Index at
Item 14(a). These consolidated financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Universal American Financial Corp. and subsidiaries at December 31, 1997 and
1996, and the consolidated results of its operations and its cash flows for the
two years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
Ernst & Young LLP
New York, New York
March 25, 1998
F-2
<PAGE>
Independent Auditors' Report
----------------------------
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows for the year ended December 31, 1995 of
Universal American Financial Corp. (formerly Universal Holding Corp.) and
subsidiaries. In connection with our audit of the consolidated financial
statements, we also have audited the consolidated financial statement schedules
for the period indicated above as listed in the accompanying index. These
consolidated financial statements and financial statements schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedules based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements of Universal American
Financial Corp. referred to above present fairly, in all material respects, the
results of their operations and their cash flows for the year ended December 31,
1995 in conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
New York, New York
March 26, 1996
F-3
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1997
<TABLE>
1996 1997
------------------- -------------------
<S> <C> <C>
ASSETS
Investments (Notes 2c and 4)
Cash and cash equivalents $ 15,403,450 $ 25,014,019
Fixed maturities available for sale, at fair value
(amortized cost $122,511,012 and $121,119,346, respectively) 121,492,167 123,585,708
Equity securities, at fair value (cost $46,133 and $987,081, respectively) 33,562 945,116
Policy loans 6,421,251 7,185,014
Property tax liens 131,729 136,713
Mortgage loans 1,199,110 2,562,008
------------------- -------------------
Total investments 144,681,269 159,428,578
Accrued investment income 2,875,497 3,357,624
Deferred policy acquisition costs (Note 2d) 19,091,514 20,832,060
Amounts due from reinsurers 60,838,289 76,576,040
Due and unpaid premiums 2,712,021 548,271
Deferred income tax asset (Note 5) 2,069,876 105,413
Goodwill 3,529,529 4,508,596
Present value of future profits 1,281,807
-
Other assets 6,438,743 5,936,947
------------------- -------------------
Total assets 242,236,738 272,575,336
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances (Note 2e) 134,538,954 145,085,687
Reserves for future policy benefits 40,156,185 38,327,612
Policy and contract claims - life 1,167,213
1,186,702
Policy and contract claims - health 24,628,019 22,592,441
Short-term debt (Note 10)
800,000 -
Loan payable (Note 10) 3,500,000
-
Amounts due to reinsurers 11,129,232 17,769,695
Deferred revenues 264,745
357,957
Other liabilities 12,743,775
7,361,163
------------------- -------------------
------------------- -------------------
Totals liabilities 220,158,212 241,451,168
------------------- -------------------
Series C Preferred Stock (Issued and outstanding 51,680) (Note 6) - 5,168,000
------------------- -------------------
Redemption accrual on Series C Preferred Stock - 249,790
------------------- -------------------
Commitments and contingencies (Note 11)
STOCKHOLDERS' EQUITY (Note 7)
Series B Preferred Stock (Issued and outstanding 400 and 400, respectively)
4,000,000 4,000,000
Common stock (Authorized, 20,000,000 issued
and outstanding 7,149,221 and 7,325,860, respectively) 71,492 73,259
Common stock warrants (Authorized, issued and outstanding 668,481) - -
Additional paid-in capital 16,049,888 15,992,497
Net unrealized investment gains (losses) (Note 4) (972,237) 841,620
Retained earnings 2,929,383 4,799,002
------------------- -------------------
Total stockholders' equity 22,078,526 25,706,378
------------------- -------------------
Total liabilities and stockholders' equity $ 242,236,738 $272,575,336
=================== ===================
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Years Ended December 31, 1997
<TABLE>
1995 1996 1997
----------------- --------------- ----------------
<S> <C> <C> <C>
REVENUE: (Notes 2e and f)
Gross premiums and policyholder fees earned $46,145,360 $55,286,610 $99,339,251
Reinsurance premiums assumed 8,866,010 10,521,987 997,836
Reinsurance premiums ceded (18,200,433) (25,663,224) (62,622,721)
----------------- --------------- ----------------
Net premiums and policyholder fees earned (Note 9) 36,810,937 40,145,373 37,714,366
Net investment income (Note 4) 8,945,280 9,850,083 10,022,658
Realized gains on investments (Note 4) 673,868 240,075 1,132,521
Fee income 3,137,294 2,871,319 2,367,763
Amortization of deferred revenue (Note 2g) 244,202 280,335 93,212
----------------- --------------- ----------------
Total revenues 49,811,581 53,387,185 51,330,520
================= =============== ================
BENEFITS, CLAIMS AND OTHER DEDUCTIONS:
Increase (decrease) in future policy benefits (1,337,161) 1,854,539 440,936
Claims and other benefits 22,367,066 24,042,876 23,719,208
Interest credited to policyholders 6,089,860 6,614,176 6,645,716
Increase in deferred acquisition costs (3,317,523) (2,257,617) (2,945,672)
Amortization of present value of future profits 204,564
- -
Amortization of goodwill 111,819
- -
Commissions 11,113,566 16,080,245 21,089,466
Commission and expense allowances
on reinsurance ceded (5,773,288) (11,004,623) (20,300,483)
Other operating costs and expenses 17,813,643 17,684,697 19,358,303
----------------- --------------- ----------------
Total benefits, claims and other deductions 47,160,727 53,014,293 48,119,293
----------------- --------------- ----------------
Operating income before taxes 2,650,854 372,892 3,211,227
Federal income tax expense (Note 5) 9,032 269,017 1,091,818
----------------- --------------- ----------------
Net income 2,641,822 103,875 2,119,409
Redemption accrual on Series C Preferred Stock (Note 6) 249,790
- -
----------------- --------------- ----------------
Net Income applicable to common shareholders $ 2,641,822 $ 103,875 $ 1,869,619
================= =============== ================
Earnings per common share (Note 2 j):
Basic $0.42 $0.01 $0.26
================= =============== ================
Diluted $0.25 $0.01 $0.18
================= =============== ================
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Three Years Ended December 31, 1997
<TABLE>
Net
Series B Additional Unrealized Retained
Preferred Common Paid-In Investment Earnings
Stock Stock Capital Gain (Loss) (Deficit) Total
-------------- ------------ ---------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 $4,000,000 $61,763 $14,501,889 $(3,426,746) $ 183,686 $15,320,592
Issuance of common stock - 7,812 1,347,653 - - 1,355,465
Transfer of investments from
held to maturity to
available
for sale - - - 155,723 - 155,723
Change in net unrealized
investment gain (loss) 4,640,674
- - - - 4,640,674
Net income
- - - - 2,641,822 2,641,822
-------------- ------------ ---------------- ---------------- -------------- ---------------
Balance, December 31, 1995 4,000,000 69,575 15,849,542 1,369,651 2,825,508 24,114,276
Issuance of common stock
- 1,917 200,346 - - 202,263
Change in net unrealized
investment gain (loss)
- - - (2,341,888) - (2,341,888)
Net income
- - - - 103,875 103,875
-------------- ------------ ---------------- ---------------- -------------- ---------------
Balance, December 31,1996 4,000,000 71,492 16,049,888 (972,237) 2,929,383 22,078,526
Issuance of common stock - 1,767 272,253 - - 274,020
Issuance of Series C
Preferred Stock
- - (329,644) - - (329,644)
Change in net unrealized
investment gain (loss)
- - - 1,813,857 - 1,813,857
Redemption accrual on
Series C Preferred Stock
- - - - (249,790) (249,790)
Net income
- - - - 2,119,409 2,119,409
-------------- ------------ ---------------- ---------------- -------------- ---------------
Balance, December 31,1997 $4,000,000 $73,259 $15,992,497 $ 841,620 $ 4,799,002 $25,706,378
============== ============ ================ ================ ============== ===============
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Years Ended December 31, 1997
<TABLE>
1995 1996 1997
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,641,822 $ 103,875 $ 2,119,408
Adjustments to reconcile net income to net cash
used by operating activities:
Deferred income taxes 269,017 1,091,818
-
Change in reserves for future policy benefits (575,449) 3,526,269 (3,997,414)
Change in policy and contract claims (158,474) (2,713,062)
677,167
Change in deferred policy acquisition costs (3,317,523) (2,257,617) (2,945,673)
Change in deferred revenue (244,202) (280,336)
(93,212)
Amortization of present value of future profits
204,564 - -
Amortization of goodwill
- - 111,819
Change in policy loans (111,995) (746,103) (589,250)
Change in accrued investment income (260,817) (427,870) (368,951)
Change in reinsurance balances (4,596,165) (11,773,467) (4,963,108)
Change in due and unpaid premium (1,194,152) 114,812 2,269,874
Realized gains on investments (673,868) (240,075) (1,132,520)
Other, net 1,010,861 1,509,292 8,817,664
----------------- ----------------- -----------------
Net cash used by operating activities (6,081,246) (9,908,865) (12,028,101)
----------------- ----------------- -----------------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for sale 50,442,336 18,329,599 35,962,815
Proceeds from redemption of fixed maturities held to maturity 928,180
- -
Proceeds from redemption of fixed maturities available for 8,049,240 25,436,976 9,029,804
sale
Proceeds from redemption of fixed maturities held to maturity 2,210,089
- -
Cost of fixed maturities purchased available for sale (68,529,621) (48,466,456) (37,932,859)
Cost of fixed maturities purchased held to maturity (795,741)
- -
Change in amounts held in trust for reinsurer (5,154,802)
- -
Proceeds from sale of equity securities 506,250 337,022
-
Cost of equity securities purchased (501,250) (689,802)
-
Change in other invested assets (1,367,882)
76,571 269,702
Proceeds from sale of subsidiary, net of cash held 2,020,496
- -
Purchase of business, net of cash acquired 1,685,010 (4,080,033)
-
----------------- ----------------- -----------------
Net cash used by investing activities (7,618,946) (2,740,169) (1,875,241)
----------------- ----------------- -----------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 1,355,465 202,263 274,020
Proceeds from the issuance of Series C Preferred Stock 4,838,356
- -
Increase in policyholder account balances 9,831,827 15,930,118 10,546,733
Change in short-term debt (800,000)
- -
Increase in loan payable 3,500,000
- -
Change in notes payable (1,618,062) (369,698)
-
----------------- ----------------- -----------------
Net cash provided from financing activities 9,569,230 15,762,683 18,359,109
----------------- ----------------- -----------------
Net (decrease) increase in cash and cash equivalents (4,130,962) 3,113,649 9,610,569
----------------- ----------------- -----------------
Cash and cash equivalent at beginning of year 16,420,763 12,289,801 15,403,450
----------------- ----------------- -----------------
Cash and cash equivalent at end of year $ 12,289,801 $ 15,403,450 $ 25,014,019
================= ================= =================
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
For the Three Years Ended December 31, 1997
<TABLE>
1995 1996 1997
----------------- -------------- -------------
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 96,289 $ 83,852 $ 77,389
================= ============== =============
Income taxes $ - $ - $ -
================= ============== =============
Supplemental schedule of non-cash investing
and financing activities:
Implementation of Statement 115 (Note 2c):
Transfer of securities held to maturity
to available for sale $ 36,098,026 $ - $ -
================= ============== =============
</TABLE>
F-8
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND COMPANY BACKGROUND:
Universal American Financial Corp. (the "Company" or "Universal"
formerly, Universal Holding Corp.) was incorporated under the laws of the State
of New York in August 1981, for the purpose of conducting insurance and related
business primarily through its then wholly-owned subsidiary, John Adams Life
Insurance Company of New York ("John Adams"). On May 17, 1991, the Company
acquired 100% of the outstanding common stock of American Progressive Life &
Health Insurance Company of New York ("American Progressive") and on June 27,
1991 merged John Adams into American Progressive. In 1988, the Company organized
Quincy Coverage Corp. ("Quincy") an insurance agent and broker. In January,
1992, the Company began operations in WorldNet Services Corp. ("WorldNet"), a
provider of managed care and assistance to travelers. On May 26, 1993, the
Company acquired 100% of the outstanding common stock of American Pioneer Life
Insurance Company ("American Pioneer"). On December 4, 1997, the Company
acquired 100% of the outstanding common stock of American Exchange Life
Insurance Company ("American Exchange") (See Note 3).
The Company's marketing emphasis is to sell products particularly
appealing to the senior market place, and largely through marketing
organizations with concentrations in this market. The Company began to sell
senior market life and accident and health insurance products in 1993 in New
York and expanded its sales effort to Florida in 1996 and to Texas in 1997. The
momentum into Florida was accelerated by the acquisition of business from First
National Life Insurance Company, while the expansion into Texas was accelerated
by the acquisition of American Exchange (See Note 3). The core products sold to
the senior age market include Medicare supplement, home health care, nursing
home, hospital indemnity and senior life insurance. In addition, the Company
sells certain program life insurance and annuity products through independent
marketing organizations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. Basis of Presentation: The significant accounting policies
followed by Universal American Financial Corp. and
subsidiaries that materially affect financial reporting are
summarized below. The accompanying consolidatedfinancial
statements have been prepared in accordance with generally
accepted accounting principles (GAAP) which,as to American
Progressive, American Pioneer and American Exchange, differ
from statutory accounting practices prescribed or permitted
by regulatory authorities. The preparation of financial
statements in conformity with GAAP requires management to
make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the
financial statements and the reported revenues and expenses
during the reporting period. Actual results could differ from
those estimates.
b. Principles of Consolidation: The accompanying consolidated
financial statements include the accounts of Universal
American Financial Corp. and its wholly-owned subsidiaries,
including the operations of American Exchange since December
4, 1997, the date of its acquisition. All material
intercompany transactions and balances have been eliminated.
F-9
<PAGE>
c. Investments: Investments are shown on the following bases:
The Company follows Financial Accounting Standards Board
("FASB") Statement No. 115, "Accounting for Certain Debt and
Equity Securities" ("Statement No. 115"). Statement No. 115
requires that debt and equity securities be classified into
three categories and accounted for as follows: Debt securities
that the Company has the positive intent and the ability to
hold to maturity are classified as "held to maturity" and
reported at amortized cost. Debt and equity securities that
are held for current resale are classified as "trading
securities" and reported at fair value, with unrealized gains
and losses included in earnings. Debt and equity securities
not classified as held to maturity or as trading securities
are classified as "available for sale" and reported at fair
value. Unrealized gains and losses on available for sale
securities are excluded from earnings and reported as a
separate component of stockholders' equity, net of tax and
deferred policy acquisition cost adjustment.
In November, 1995, the FASB issued a Special Report titled "A
Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities", which
report allowed enterprises to reassess the appropriateness of
the classifications of all securities held at the time of the
Special Report issuance. In December, 1995, the Company
reassessed the appropriateness of the classifications of its
securities and reclassified all of the securities contained in
the held to maturity account to the available for sale account
as they may be considered for sale prior to maturity as part
of the asset/liability management strategy. The carrying value
of the securities reclassed to available for sale amounted to
$35,942,303 and the fair value amounted to $36,098,026. This
transfer resulted in the Company increasing its unrealized
gains by $155,723, net of tax and deferred policy acquisition
cost adjustment.
As of December 31, 1996 and 1997, all fixed maturity
securities were classified as available for sale and were
carried at fair value, with the unrealized gain or loss, net
of tax and other adjustments (deferred policy acquisition
costs), included in stockholders' equity. Equity securities
are carried at current fair value. Policy loans and mortgage
loans are stated at the unpaid principal balance. Short-term
investments are carried at cost which approximates fair value.
Property tax liens are carried at cost. Investment income is
recorded when earned. Realized investment gains and losses on
the sale of securities are based on the specific
identification method. Unrealized gains and losses from
revaluation of equity investments and fixed maturity
securities to current market value are reflected in
stockholders' equity.
d. Deferred Policy Acquisition Costs: The cost of acquiring
new business, principally commissions and certain
expenses of the agency, policy issuance and underwriting
departments, all of which vary with, and are primarily
related to the production of new and renewal business, have
been deferred. These costs are being amortized in
relation to the present value of expected gross profits on
the policies arising principally from investment,
mortality and expense margins for FASB Statement No. 97,
"Accounting and Reporting by Insurance Enterprises for
Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments", ("Statement No.
97") products and in proportion to premium revenue using the
same assumptions used in estimating the liabilities
for future policy benefits for FASB Statement No. 60,
"Accounting and Reporting by Insurance Enterprises",
("Statement No. 60") products. Deferred policy acquisition
costs would be written off to the extent that it is
determined that future policy premiums and investment
income or gross profits would not be adequate to cover
related losses and expenses.
F-10
<PAGE>
There were no write-offs for the years ended December 31,
1995, 1996 and 1997. Details with respect to deferred policy
acquisition costs for the three years ended December 31, 1997
are as follows:
Balance at January 1, 1995 $14,485,850
Capitalized costs 5,270,498
Adjustment relating to unrealized
gain on available for sale securities (613,715)
Amortization
(2,578,183)
--------------------
Balance at December 31, 1995 16,564,450
Capitalized costs
5,042,137
Adjustment relating to unrealized
loss on available for sale securities
269,447
Amortization
(2,784,520)
--------------------
Balance at December 31, 1996
19,091,514
Capitalized costs
6,712,207
Adjustment relating to unrealized
gain on available for sale securities
(1,205,127)
Amortization
(3,766,534)
--------------------
Balance at December 31, 1997
$20,832,060
====================
e. Recognition of Revenues, Contract Benefits and Expenses for
Investment and Universal Life Type Policies: Revenues
for universal life-type policies and investment products
consist of mortality charges for the cost of insurance
and surrender charges assessed against policyholder account
balances during the period. Benefit claims incurred
in excess of policyholder account balances are expensed.
The liability for policyholder account balances for
universal life-type policies and investment products
under Statement No. 97 are determined following a
"retrospective deposit" method and consist principally of
policy account values before any applicable surrender
charges. Credited interest rates for these products range
from 4.50% to 7.25%. For the three years ended
December 31, 1995, 1996 and 1997, one general agency of
American Progressive produced $4,477,034, $5,813,765 and
$2,884,720 of annuity receipts, respectively, which
represented approximately 41%, 43% and 24% respectively, of
total annuity receipts of American Progressive.
F-11
<PAGE>
f. Recognition of Premium Revenues and Policy Benefits for
Accident and Health Insurance Products: Premiums are
recorded when due and recognized as revenue over the period
to which the premiums relate. Benefits and expenses
are associated with earned premiums so as to result in
recognition of profits over the life of the policies.
This association is accomplished by recording a provision
for future policy benefits, establishing an unearned
premium reserve and amortizing deferred policy acquisition
costs. Claim reserves are established for future
payments not yet due on claims already incurred, primarily
relating to individual disability insurance and group
long-term disability insurance products. These reserves
are established based on past experience and are
continuously reviewed and updated with any related
adjustments recorded to current operations. Claim liabilities
represent policy benefits due but unpaid at year end and
primarily relate to individual health insurance
products. Activity in the accident and health policy and
contract claim liability is as follows:
<TABLE>
1995 1996 1997
------------------ ----------------- -----------------
<S> <C> <C> <C>
Balance at beginning of year $ 8,698,434 $ 8,681,136 $24,628,019
Less reinsurance recoverables (1,947,218) (2,650,646) (15,269,309)
------------------ ----------------- -----------------
Net balance at beginning of year 6,751,216 6,030,490 9,358,710
------------------ ----------------- -----------------
Balance acquired with First National - 3,374,535 -
Balance acquired with American Exchange - - 551,126
Incurred related to:
Current year 20,368,320 23,029,175 19,363,347
Prior years (1,578,948) (2,511,056) (2,424,332)
------------------ ----------------- -----------------
Total incurred 18,789,372 20,518,119 16,939,015
------------------ ----------------- -----------------
Paid related to:
Current year 14,830,355 15,671,699 14,405,575
Prior years 4,679,743 4,892,735 6,884,639
------------------ ----------------- -----------------
Total paid 19,510,098 20,564,434 21,290,214
------------------ ----------------- -----------------
Net balance at end of year 6,030,490 9,358,710 5,558,637
Plus reinsurance recoverables 2,650,646 15,269,309 17,033,804
------------------ ----------------- -----------------
Balance at end of year $ 8,681,136 $ 24,628,019 $22,592,441
================== ================= =================
</TABLE>
g. Deferred Revenue: The Company entered into a 90% quota share
reinsurance agreement with an unaffiliated reinsurer on
certain life insurance policies in force as of June 30, 1993.
The Company ceded $3,696,101 of life insurance reserves and
received $1,665,000 as a ceding commission, which was recorded
as deferred revenue. The Company amortized $165,104, $122,433
and $93,212 of deferred revenue during 1995, 1996 and 1997,
respectively.
The Company entered into a 75% quota share reinsurance
agreement with an unaffiliated reinsurer on the $60,000
retention of certain individual accident & health insurance
policies in force as of June 30, 1995. The Company received
$862,000 as a ceding commission, $625,000 of which was offset
by the amortization of the deferred acquisition cost asset
related to this business. The remaining $237,000 was recorded
F-12
<PAGE>
as deferred revenue and $79,098 and $157,902 was recognized as
income during 1995 and 1996, respectively, since the agreement
was canceled effective December 31, 1996.
h. Income Taxes: The Company's method of accounting for income
taxes is the asset and liability method. Under the asset and
liability method, 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.
i. Reinsurance Accounting: Amounts paid for recoverables under
reinsurance contracts are included in total assets as
reinsurance recoverable amounts. The cost of reinsurance
related to long-duration contracts is accounted for over the
life of the underlying reinsured policies using assumptions
consistent with those used to account for the underlying
policies.
j. Earnings Per Common Share: The Company adopted FASB Statement
No. 128, "Earnings per Share", ("Statement No. 128") as of
December 31, 1997 and restated prior year earnings per share
("EPS") amounts. Statement No. 128 replaces primary EPS with
basic EPS. Basic EPS excludes dilution and is computed by
dividing income available to common shareholders, (after
deducting the redemption accrual on the Series C Preferred
Stock), by the weighted average number of shares outstanding
for the period. Diluted EPS gives the dilutive effect of the
stock options, warrants and Series B and C preferred stock
outstanding during the year. A reconciliation of the
numerators and the denominators of the basic and diluted EPS
for the years ended December 31, 1995, 1996 and 1997 is as
follows:
<TABLE>
For the Year Ended December 31, 1995
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ---------------- -------------
<S> <C> <C> <C>
Net income $2,641,822
Basic EPS
Net income applicable to common shareholders 2,641,822 6,219,579 $ 0.42
=============
Effect of Dilutive Securities
Series B preferred stock 1,777,777
Convertible debenture
671,807
Non-registered warrants 2,015,760
Registered warrants
689,871
Incentive stock options
401,000
Director stock option
9,000
Treasury stock purchased from proceeds of (1,118,755)
exercise
--------------- ----------------
of options and warrants
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions 2,641,822 10,666,039 $ 0.25
=============== ================ =============
</TABLE>
F-13
<PAGE>
<TABLE>
For the Year Ended December 31, 1996
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ---------------- -------------
<S> <C> <C> <C>
Net income $ 103,875
Basic EPS
Net income applicable to common shareholders 103,875 6,999,293 $ 0.01
=============
Effect of Dilutive Securities
Series B preferred stock 1,777,777
Non-registered warrants 2,015,760
Registered warrants
668,481
Incentive stock options
266,000
Director stock option
9,000
Treasury stock purchased from proceeds of
exercise
of options and warrants (1,198,376)
--------------- ----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $ 103,875 10,537,935 $ 0.01
=============== ================ =============
</TABLE>
<TABLE>
For the Year Ended December 31, 1997
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ---------------- -------------
<S> <C> <C> <C>
Net income $2,119,409
Less: Redemption accrual on Series C preferred (249,790)
stock
---------------
Basic EPS
Net income applicable to common shareholders 1,869,619 7,241,931 $ 0.26
=============
Effect of Dilutive Securities
Series B preferred stock 1,777,777
Series C preferred stock 249,790 1,356,421
Non-registered warrants 2,015,760
Registered warrants
668,481
Incentive stock options
296,000
Director stock option
16,000
Treasury stock purchased from proceeds of (1,331,515)
exercise
--------------- ----------------
of options and warrants
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $2,119,409 12,040,855 $ 0.18
=============== ================ =============
</TABLE>
k. Cash Flow Information: Included in cash and cash equivalents
are cash on deposit, money market funds, and short term
investments which had an original maturity of three months or
less from the time of purchase.
l. Reclassifications: Certain reclassifications have been made to
prior years' financial statements to conform with current
period classifications.
F-14
<PAGE>
3. RECENT ACQUISITIONS:
American Exchange Life Insurance Company
On December 4, 1997, the Company, through its wholly-owned subsidiary,
American Pioneer, acquired 100% of the outstanding common stock of American
Exchange for $6.6 million in cash, which acquisition was approved by both the
Texas and Florida Departments of Insurance. This acquisition was accounted for
using the purchase method. American Exchange, which is licensed in Texas and two
other states, has annual premium in force in excess of $16.6 million, primarily
in Medicare Supplement and other limited benefit accident and health products
and has 19,000 policies in force and 1,000 insurance agents, all based in Texas.
The following schedule summarizes the assets acquired and liabilities assumed,
at fair value, on the date of acquisition:
Assets acquired:
Fixed maturities $6,826,474
Equity securities 317,413
Cash and cash equivalents 2,679,665
Policy loans 174,513
Accrued investment income 159,528
Other assets 298,397
----------------
Total assets acquired 10,455,990
================
Liabilities assumed
Reserves for future policy benefits 737,290
Policy and contract claims 266,048
Amounts due to reinsurers 4,036,450
Deferred Federal income taxes 435,814
Other liabilities 768,367
----------------
Total liabilities assumed 6,243,969
================
Net assets acquired 4,212,021
Present value of future profits 1,281,807
Goodwill 1,265,868
----------------
Total purchase price $ 6,759,696
================
The present value of future profits is being amortized based upon the
expected lives of the underlying products. The goodwill is being amortized over
30 years.
F-15
<PAGE>
First National Life
In the fourth quarter of 1996, the Company acquired, through an
assumption reinsurance agreement, approximately $56 million of annualized senior
market premium First National. American Pioneer initially contracted with First
National to assume $4 million of premium on group Medicare Supplement coverage
issued to the members of the Florida Retired Educators Association ("FREA").
Then, after First National was placed into Receivership by the Alabama Insurance
Department in October, 1996, American Pioneer assumed, in addition to the FREA
block, approximately $50 million of Individual Medicare Supplement premium, $1.2
million of Home Health Care premium and $0.8 million of miscellaneous life and
accident and health insurance premiums, under terms negotiated with the
Receiver. All of these assumptions were effective as of October 1, 1996.
Simultaneously with the second assumption by American Pioneer, American Pioneer
entered into a reinsurance agreement with Transamerica Occidental Life Insurance
Company ("Transamerica"), ceding 90% of the $50 million Individual Medicare
Supplement to Transamerica.
As part of the transaction negotiated with the Receiver, American
Pioneer was to receive assets equal to the liabilities assumed, primarily policy
reserves. However, as a result of the financial condition of First National,
sufficient assets were not available to fully cover these liabilities. In
addition, the Receiver was unable to cover certain amounts due to American
Pioneer. The sum of the closing shortfall and the costs of the transaction, net
of deferred tax benefits, amounted to $3,529,529, and represents goodwill which
is being amortized over 30 years.
As part of the First National transaction, the Company acquired in
Pensacola a relatively low cost administrative operation with particular
experience in the senior market. This has given the Company an opportunity to
consolidate many of its administrative functions in Pensacola and save a
significant amount of fixed overhead.
In December, 1996, the Company formulated a plan to move most of the
policy administrative functions, particularly in its senior market business,
from the American Progressive office in Brewster to Pensacola. This, along with
other cost saving efforts, resulted in a reduction in the work force at the
American Progressive office from 62 as of June 30, 1996 to approximately 25 as
of December 31, 1997 with a modest resultant increase in personnel in Pensacola,
including some personnel employed by American Progressive. These plans were
announced to the employees of the Company on March 14, 1997.
Consequently, American Progressive exercised its right to cancel its
lease for 15,000 square feet in Brewster as of December 31, 1997 and relocated
to a smaller office on January 1, 1998. The cost of this consolidation,
including severance costs, relocation costs and the cancellation penalty on the
Brewster lease, amounted to $250,000 and was expensed in the fourth quarter of
1996.
F-16
<PAGE>
4. INVESTMENTS:
As of December 31, 1996 and 1997, investments consisted of the
following:
<TABLE>
December 31,1996
-----------------------------------------------------------------------------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- ----------------------------------- ------------------- -------------------- ------------------- ------------------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 15,403,450 $ 15,403,450 $ 15,403,450
US Treasury bonds and notes $ 8,383,814 8,516,908 8,505,972 8,505,972
Corporate bonds 113,722,375 113,994,104 112,986,195 112,986,195
Common stocks 46,133 33,562 33,562
-------------------- ------------------- ------------------
Sub-total
137,960,596 $ 136,929,179 $136,929,179
===================
Property tax liens
Policy loans 131,729 131,729
Mortgage loans 6,421,251 6,421,251
1,199,110 1,199,110
-------------------- ------------------
Total investments $ 145,712,686 $144,681,269
==================== ==================
</TABLE>
<TABLE>
December 31,1997
-----------------------------------------------------------------------------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- ----------------------------------- ------------------- -------------------- ------------------- ------------------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 25,014,019 $ 25,014,019 $ 25,014,019
US Treasury bonds and notes $ 7,610,000 7,697,324 7,802,780 7,802,780
Corporate bonds 113,902,686 113,422,023 115,782,928 115,782,928
Equity Securities 987,095 945,116 945,116
-------------------- ------------------- ------------------
Sub-total $ 147,120,461 $ 149,544,843 $149,544,843
===================
Property tax liens 136,713 136,713
Policy loans 7,185,014 7,185,014
Mortgage loans 2,562,008 2,562,008
-------------------- ------------------
Total investments $ 157,004,196 $159,428,578
==================== ==================
</TABLE>
F-17
<PAGE>
The amortized cost and fair value of debt securities classified as
available for sale investments as of December 31, 1996 and 1997 are as follows:
<TABLE>
December 31, 1996
-------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------- ---------------------- -------------------- ----------------- -----------------
<S> <C> <C> <C> <C>
US Treasury securities
and obligations of
US government $ 12,141,823 $ 121,631 $ (85,890) $ 12,177,564
Corporate debt securities 74,020,305 1,167,066 (1,244,311) 73,943,060
Mortgage-backed securities 36,348,884 (1,391,551) 35,371,543
414,210
---------------------- -------------------- ----------------- -----------------
$ 122,511,012 $ 1,702,907 $ (2,721,752) $121,492,167
====================== ==================== ================= =================
</TABLE>
<TABLE>
December 31, 1997
-------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------- ---------------------- -------------------- ----------------- -----------------
<S> <C> <C> <C> <C>
US Treasury securities
and obligations of
US government $ 10,821,981 $ 224,552 $ $ 11,026,445
(20,088)
Corporate debt securities 52,427,251 1,668,511 53,834,118
(261,644)
Mortgage-backed securities 57,870,114 1,506,116 58,725,145
(651,085)
---------------------- -------------------- ----------------- -----------------
$ 121,119,346 $ 3,399,179 $ $123,585,708
(932,817)
====================== ==================== ================= =================
</TABLE>
The amortized cost and fair value of fixed maturities at December
31, 1997 by contractual maturity are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
--------------------- -------------------
Due in 1 year or less $ 4,305,104 $ 4,305,300
Due after 1 year through 5 years 20,863,285 21,326,267
Due after 5 years through 10 years 8,648,243 19,401,221
Due after 10 years 16,307,942 16,604,110
Mortgage-backed securities 60,994,772 61,948,810
--------------------- -------------------
$ 121,119,346 $ 123,585,708
===================== ===================
Included in fixed maturities at December 31, 1996 and 1997 were
securities with carrying values of $7,779,124 and $7,122,281, respectively, held
by various states as security for the policyholders of the Company within such
states. At December 31, 1997, the Company maintained $5,154,802 of fixed
maturities in a trust account on behalf of its reinsurers, which is included in
the amounts due from reinsurers on the balance sheet.
F-18
<PAGE>
Gross unrealized gains and gross unrealized losses of equity securities
as of December 31, 1996 and 1997 are as follows:
1996 1997
------------- -------------
Gross unrealized gains $ - $ 29,392
Gross unrealized losses (12,572) (71,357)
------------- -------------
Net unrealized losses $(12,572) $ (41,965)
============= =============
The components of the change in unrealized gains and losses included in
the consolidated statements of stockholders' equity for the three years ended
December 31, 1997 are as follows:
<TABLE>
1995 1996 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Change in net unrealized gains (losses):
Fixed maturities $ 5,963,167 $ (3,335,207) $ 3,485,207
Equity securities
(3,205) 18,264 (29,393)
Statement No. 115 reclassification 155,723 - -
Adjustment relating to
deferred policy acquisition costs (613,710) 269,477 (1,205,127)
---------------- ---------------- ----------------
Change in net unrealized gains
(losses) before income tax 5,501,975 (3,047,466) 2,250,687
Income tax expense (benefit) 705,578 (705,578) 436,830
---------------- ---------------- ----------------
Change in net unrealized losses $ 4,796,397 $ (2,341,888) $ 1,813,857
================ ================ ================
</TABLE>
The details of net investment income for the three years ended
December 31, 1997 are as follows:
<TABLE>
1995 1996 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Investment Income:
Fixed maturities $ 8,389,695 $ 9,048,143 $ 8,961,283
Cash and cash equivalents 531,572 731,924
801,987
Equity securities
- - 29,044
Property tax liens 58,920
(1,297) 22,639
Policy loans 363,390 487,740
495,623
Mortgage loans 102,293
86,858 102,737
---------------- ---------------- ----------------
Gross investment income 9,445,870 10,353,368 10,413,313
Investment expenses 500,590 503,285
390,655
---------------- ---------------- ----------------
Net investment income $ 8,945,280 $ 9,850,083 $10,022,658
================ ================ ================
</TABLE>
F-19
<PAGE>
Gross realized gains and gross realized losses included in the
consolidated statements of operations for the three years ended December 31,
1997 are as follows:
<TABLE>
1995 1996 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Realized gains:
Fixed maturities, available for sale $ 1,070,230 $ 363,927 $ 760,381
Fixed maturities, held to maturity
6,921 - -
Equity securities - 5,000 629,847
---------------- ---------------- ----------------
Total realized gains 1,077,151 368,927 1,390,228
---------------- ---------------- ----------------
Realized losses:
Fixed maturities, available for sale (385,223) (128,852) (257,707)
Fixed maturities, held to maturity
(3,060) - -
Equity securities
(15,000) - -
---------------- ---------------- ----------------
Total realized losses (403,283) (128,852) (257,707)
---------------- ---------------- ----------------
Net realized gains $ 673,868 $ 240,075 $ 1,132,521
================ ================ ================
</TABLE>
In 1997, the Company realized a gain of $569,474 on the sale of
AmeriFirst Insurance Company, a non-operating subsidiary. During the year ended
December 31, 1995, the Company wrote down the value of certain fixed maturity
securities by $194,955 which was included in net realized gains on investments.
5. INCOME TAXES:
The Company files a consolidated return for federal income tax
purposes, in which American Pioneer and American Exchange are not currently
permitted to be included. American Pioneer and American Exchange file a separate
consolidated federal income tax return.
The Company's federal income tax expense consisted of:
1995 1996 1997
------------- --------------- -----------------
Current $ 9,032 $ - $ -
Deferred - 269,017 1,091,818
------------- --------------- -----------------
Total tax expense $ 9,032 $ 269,017 $1,091,818
============= =============== =================
In 1997, a deferred tax liability related to the acquisition of
American Exchange was established and amounted to $435,814. In 1996, a deferred
tax asset related to the acquisition of certain business from First National was
established and amounted to $305,000. A deferred tax benefit for 1995 was
$1,642,819, which amount was charged directly to the present value of future
profits since the benefit was derived from the recognition of acquired tax loss
carryforwards of American Pioneer that previously were included in the valuation
allowance.
F-20
<PAGE>
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying value of assets and liabilities for financial
reporting purposes and the amount used for income tax purposes. The tax effects
of temporary differences that give rise to significant portions of the deferred
tax assets and deferred tax liabilities at December 31, 1996 and 1997 are as
follows:
<TABLE>
1996 1997
--------------- ----------------
<S> <C> <C>
Deferred tax assets:
Reserves for future policy benefits $4,689,676 $4,503,445
Deferred revenues 121,705 90,013
Net operating loss carryforwards 4,507,233 4,239,539
AMT credit carryforward 106,947 107,262
Investment valuation differences 185,849 120,488
Unrealized losses on investments 319,569 -
Other 147,061 176,797
--------------- ----------------
Total gross deferred tax assets 10,078,040 9,237,544
Less valuation allowance (1,641,538) (1,342,838)
--------------- ----------------
Net deferred tax assets 8,436,502 7,894,706
--------------- ----------------
Deferred policy acquisition costs (5,226,080) (5,796,879)
Unrealized gains on investments - (436,830)
Goodwill (1,140,546) (1,102,528)
Present value of future profits - (435,814)
Other - (17,242)
--------------- ----------------
Total gross deferred tax liabilities (6,366,626) (7,789,293)
--------------- ----------------
Net deferred tax asset $2,069,876 $ 105,413
=============== ================
</TABLE>
At December 31, 1996 and 1997, the Company has established valuation
allowances of $1,342,838 and $1,134,555, respectively, with respect to its
deferred tax assets. Based on the Company's future expectation of adjusted
taxable income and through its ability to change its investment strategy and use
of prudent and feasible tax planning strategies, management believes it is more
likely than not that the Company will realize the recorded net deferred tax
assets.
A reconciliation of the "expected" tax expense at 34% with the
Company's actual tax expense applicable to operating income before taxes
reported in the Consolidated Statements of Operations is as follows:
<TABLE>
1995 1996 1997
-------------------- -------------------- -----------------
<S> <C> <C> <C>
Expected tax expense $ 901,294 $ 126,783 $ 1,091,818
Change in the beginning of the
year balance of the valuation
allowance for deferred tax assets
allocated to income tax expense (903,878) 187,414 -
Tax exempt interest income (1,415) - -
Other 13,031 (45,180) -
-------------------- -------------------- -----------------
Actual tax expense $ 9,032 $ 269,017 $ 1,091,818
==================== ==================== =================
</TABLE>
F-21
<PAGE>
At December 31, 1997 the Company (exclusive of American Pioneer and
American Exchange) had a net operating tax loss carry forwards of approximately
$11,300,000 which expire in the years 1999 to 2011. At December 31, 1997
American Pioneer and American Exchange had net operating tax loss carry
forwards, most of them incurred prior to its acquisition by the Company, of
approximately $1,100,000 which expire in the years 2000 to 2011. As a result of
changes in ownership of American Pioneer in May 1993, use of most of the loss
carry forwards of American Pioneer are subject to annual limitations.
6. SERIES C PREFERRED STOCK
During the second and third quarters of 1997, the Company issued 43,750
shares (par value $100) of Series C Preferred Stock for $4,375,000, of which
$2.4 million was purchased by UAFC L.P. ("AAM") an unaffiliated investment firm,
$600,000 by Chase Equity Partners, L.P., and $1,375,000 by Richard A. Barasch
(the Chairman and Chief Executive Officer of the Company), members of his
family, and members and associates of the Company's management. This transaction
received the approval of the Florida Insurance Department.
During the third quarter of 1997, the Company issued an additional
7,930 shares of Series C Preferred Stock for $793,000, which shares were
purchased by owners and employees of Ameri-Life & Health Services, a general
agency that sells the Company's senior market products.
The total Series C Preferred Stock issued by the Company amounted to
$5,168,000 and the Company incurred $329,644 of issue expenses, which were
charged to paid in capital.
The Series C Preferred Stock contains the following
provisions:
The Series C Preferred Stock is convertible by the holders at any time at
a conversion price of $2.375 per common share (subject to anti-dilution
adjustment).
The Company can require conversion if it executes a public offering of
common stock at over $3.45 per common share (or equivalent equity), with
gross proceeds in excess of $10 million, or if the average bid price of its
common stock, for any 60 day period, exceeds $3.45, $4.25 and $5.15 per
common share in 1999, 2000 and 2001, respectively.
In the event that the Company takes certain action without the consent of
the holders of a majority of the Series C Preferred Stock, those holders
who voted against such action have the right to require its redemption at
the Redemption Price or the Call Price, (which Prices are defined below)
depending on the nature of the action taken.
The Company has the right to call all of the Series C Preferred Stock at
any time between January 1, 2000 and December 31, 2002, at a per share call
price (the "Call Price") of $150 in the year 2000 or $175 in the years 2001
and 2002, in each case increased by the redemption accrual at the rate of
8% of the par value.
Unless converted or called earlier, the Series C Preferred Stock will be
redeemed on December 31, 2002, at a per share redemption price (the
"Redemption Price") equal to par, increased by a redemption accrual at the
rate of 8% per annum. The redemption price will be payable in two equal
installments on December 31, 2002 and December 31, 2003. The redemption
accrual is not payable upon any conversion.
No dividends will be paid on the Series C Preferred Stock, unless
dividends are paid on the common stock, in which case the Series C
F-22
<PAGE>
Preferred Stock will participate as if converted. As of December 31, 1997,
$249,790 of redemption accruals were accumulated on the Series C preferred
stock for the period April 25, 1997 to December 31, 1997.
The holders of the Series C Preferred Stock (excluding a portion of such
series which may be issued without voting rights) will have the right to
elect one director of the Company.
The Company, AAM, the holders of the Series C Preferred Stock, Barasch
Associates Limited Partnership ("BALP") and Richard A. Barasch entered into a
stockholders' agreement at the closing of the transaction which contained the
following conditions:
The holders of the Series C Preferred Stock were given registration rights
and informational rights.
The Series C Preferred Stockholders agreed to vote their shares for the
election of a person designated by AAM as the director elected by that
Series.
BALP and Mr. Barasch granted the Series C holders a co-sale right should
they sell any shares of the Company's common stock held by them, except to
certain "permitted transferees".
7. STOCKHOLDERS' EQUITY:
Preferred Stock
The Company has 2,000,000 authorized shares of preferred stock to be
issued in series with 52,080 shares issued and outstanding at December 31, 1996
and 1997, respectively (see Note 6 for a discussion of Series C Preferred
Stock).
Series B Preferred Stock
The Company has 400 shares of Series B Preferred Stock issued and outstanding,
with a par value of $10,000 per share, which are held by Wand/Universal
Investments L.P. ("Wand"). The Series B Preferred Stock is convertible into
Common Stock at $2.25 per share (subject to adjustment) and is entitled to
dividends as if already converted, only when and if dividends are declared on
the Common Stock. The holder of the Series B Preferred Stock may not require the
Company to redeem it unless the Company engages in certain defined transactions.
The Company has the right to require a conversion if it raises additional equity
from the public on pricing terms that meet certain criteria.
The holders of the Series B Preferred Stock have the right to elect one
Director of the Company, and have the right to vote on all other matters
submitted to the vote of the holders of the Common Stock, as if their Series B
Preferred Stock had been converted to Common Stock. In addition, under the New
York Business Corporation Law, any amendment to the Certificate of Incorporation
which would make certain changes affecting the Series B Preferred Stock must be
approved by the holders of a majority of the outstanding Series B Preferred
Stock, voting separately as a class.
Pursuant to the stock subscription agreement, Wand, the Company and
certain shareholders of the Company, including Barasch Associates Limited
Partnership ("BALP"), entered into a shareholders' agreement contemporaneously
with the issuance of the Series B Preferred Stock to Wand. Under the
shareholders' agreement, the holder of the Series B Preferred Stock agreed to
vote such shares, and the Common Stock issued upon their conversion, for the
nominees of BALP for election as directors of the Company and, after the
conversion of the Series B Preferred Stock to Common Stock, all parties agreed
to vote their shares for the election of one director designated by Wand. The
shareholders' agreement also contained "stand still," "tag along" and
registration rights provisions. The stand still provision will prohibit Wand
from acquiring more than an additional 5% of the Company's outstanding Common
Stock without the Company's consent, as long as BALP and certain partners in
BALP continue to hold at least certain percentages of the Company's Common
F-23
<PAGE>
Stock, on an outstanding and fully diluted basis. The tag along provision will
prohibit BALP and certain of its partners from making private sales of their
shares of Common Stock unless Wand is given the opportunity to sell a
proportionate part of its holding on the same terms.
The Company and Wand Partners L.P., an affiliate of Wand, have also
entered into a financial advisory agreement, under which the Wand affiliate is
to render advisory services to the Company and is to be paid a fee of $100,000
per year for such services as long as Wand owns 500,000 shares of Common Stock,
or its common stock equivalent, reduced by any directors' fee paid to the
director designated by Wand.
In connection with the determination by the New York Superintendent of
Insurance (the "Superintendent") that Wand is not a controlling shareholder of
Company, within the meaning of the New York Insurance Law, certain commitments
were made to the Superintendent. These commitments included a commitment by
Wand, Wand's general partner and Wand's general partner's shareholders that, as
long as Wand owns 10% or more of the voting power of Universal's outstanding
stock, Wand will not acquire any additional shares of Universal, except by
exercise of its conversion rights, and will not attempt to obtain or exercise
control of Universal, without the consent of the Superintendent. Universal,
American Progressive, BALP, BALP's general partner and certain limited partners,
and the shareholders of BALP's general partner also entered into commitments,
including commitments that, as long as Wand owns 10% or more of the voting power
of Universal's outstanding shares, the size of Universal's Board would not be
reduced below ten directors and that no transaction between Universal or
American Progressive, on the one hand, and Wand or its partners of controlling
parties, on the other hand, would be entered without the approval of the
Superintendent, except for the shareholders agreement and the financial advisory
agreement referred to herein.
Common Stock
The par value of common stock is $.01 per share with 20,000,000 shares
authorized for issuance. The shares issued and outstanding at December 31, 1996
and 1997 were 7,149,221, and 7,325,860, respectively. During the years ended
December 31, 1995, 1996 and 1997, the Company issued 781,242 191,689 and 176,639
shares, respectively, of its common stock.
Common Stock Warrants
The Company had 668,481 common stock warrants issued and outstanding at
December 31, 1996 and 1997, which are registered under the Securities Exchange
Act of 1934. During the year ended December 31, 1996, 11,140 warrants were
exercised to purchase common shares at $1.00 per share. At December 31, 1996 and
1997, the Company had 2,015,760 warrants outstanding which are not registered
under the Securities Exchange Act of 1934. The warrants have no par value, have
an exercise price to purchase common stock on a one to one basis at $1.00 and
expire on December 31, 1999.
F-24
<PAGE>
Incentive Stock Option Plan
In 1983, the Company adopted an incentive stock option plan, which, as
amended, reserves 1,000,000 shares of common stock. Since its adoption, 351,500
shares have been exercised, leaving 648,500 shares reserved as of December 31,
1997. Stock options totaling 168,000 and 452,500 expire five years and ten
years, respectively, after the date granted or upon the earlier termination of
employment. Options are exercisable one year after grant, and at December 31,
1997, 464,000 options are exercisable. Additional information with respect to
the Company's stock option plan is as follows:
Shares Under
Options Exercise
Outstanding Price
------------------ ----------------------
Balance, January 1, 1995 607,500
Granted 65,000 $2.25 - $2.48
Exercised (34,500) $0.50 - $0.80
Terminated (27,000) $0.80 - $3.12
------------------
Balance, December 31, 1995 611,000
Granted 141,000 $2.00 - $2.20
Exercised (135,000) $0.50 - $1.35
Terminated (47,000) $2.87 - $3.25
------------------
Balance, December 31, 1996 570,000
Granted 166,500 $2.00 - $3.03
Exercised (95,000) $1.25 - $1.44
Terminated (21,000) $1.25 - $3.33
------------------
Balance, December 31, 1997 620,500 $1.44 - $3.33
==================
Stock Option Plan for Directors
At the 1992 Annual Shareholders' Meeting, the Universal American
Financial Corp. non-employee Directors Plan ("Stock Option Plan for Directors")
was approved. The Stock Option Plan for Directors reserves 75,000 shares of
common stock and provides that options shall be granted on June 30 of each year
to each eligible Director, then in office, at the rate of 1,000 options for each
additional year of service completed since the last grant. Options are
exercisable one year after grant.
Options Exercise
Outstanding Price
------------------ ----------------------
Balance, January 1, 1995 15,000
Granted 6,000 $3.12
------------------
Balance, December 31, 1995 21,000
Granted 7,000 $2.50
------------------
Balance, December 31, 1996 28,000
Granted 8,000 $1.88
------------------
Balance, December 31, 1997 36,000 $0.56 - $3.50
==================
F-25
<PAGE>
Other Stock Options
On December 15, 1995, the Board of Directors approved a plan under
which up to 200,000 options may be granted to agents of the Company's
subsidiaries (subject to insurance law restrictions) and to other persons as to
whom the Board of Directors believes the grant of such options will serve the
best interests of the Corporation, provided that no options may be granted under
this plan to officers, directors or employees of the Company or of any
subsidiary, while they are serving as such. On December 15, 1995, the Board of
Directors granted options to three individuals, two of whom are members of the
Company's law firm and the other of whom is a consultant to the Company, to
purchase a total of 40,000 shares of the Company's common stock, at a price of
$2.50 per share, which was the quoted market price for such shares at the time
of the grant. Such options will expire 10 years from the date of the grant.
Accounting for Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under
FASB Statement No. 123, "Accounting for Stock-Based Compensation",
("Statement No. 123") requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB No. 25, because
the exercise price of the Company's employee stock options equals the market
price of the underlyingstock on the date of grant, no compensation expense is
recognized.
The Company's Incentive Stock Option Plan has authorized the grant of
options for up to 1,000,000 shares of the Company's common stock. Under the
Company's Stock Option Plan for Directors 75,000 shares of the Company's common
stock have been reserved. The Company has also reserved 200,000 shares of the
Company's stock under the Stock Option Plan for Agents and Others. All options
expire five years or ten years from the date of grant and have a vesting period
of one year from the date of grant.
Pro forma information regarding net income and earnings per share is required by
Statement No. 123, and has been determined as if the Company had accounted for
its employee stock option under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1995, 1996 and 1997, respectively: risk-free interest rates of
6.21% - 6.27%, 6.32% - 6.38% and 6.13% - 6.63%; dividend yields of 0%, 0% and
0%; volatility factors of the expected market price of the Company's common
stock of 51.58% - 51.75%, 52.20% - 52.74% and 49.97 - 53.11%; and a
weighted-average expected life of the option of 4.5 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock option.
F-26
<PAGE>
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
<TABLE>
1995 1996 1997
---------------- ----------------- -------------------
<S> <C> <C> <C>
Net Income $ 2,641,822 $ 103,875 $2,119,409
Less: Pro forma estimated fair value
options granted 10,756 133,208 183,057
---------------- ----------------- -------------------
Pro forma net income (loss) $ 2,631,066 $ (29,333) $ 1,936,352
================ ================= ===================
Pro forma diluted earnings per share $ 0.25 $ 0.00 $ 0.16
================ ================= ===================
</TABLE>
A summary of the status of the Company's three stock option plans as of
December 31, 1996 and 1997, and changes during the years ending on those dates
is presented below:
<TABLE>
1996 1997
------------------------------------- --------------------------------------
Weighted-Average Weighted-Average
Fixed Options Options Exercise Price Options Exercise Price
- -------------------------------------- ------------- --------------------- ------------ ---------------------
<S> <C> <C> <C> <C>
Outstanding-beginning of year 672,000 $1.83 638,000 $2.03
Granted 148,000 2.08 174,500 2.48
Exercised (135,000) 0.66 (95,000) 1.33
Terminated (47,000) 3.03 (21,000) 2.83
------------- --------------------- ------------ ---------------------
Outstanding-end of year 638,000 $2.03 696,500 $2.22
============= ===================== ============ =====================
Options exercisable at end
of year 490,000 522,000
============= ============
Weighted-average fair value of
options granted during the year $ 1.01 $ 1.19
============= ============
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1997:
<TABLE>
Number Weighted-Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/97 Contractual Life Exercise Price at 12/31/97 Exercise Price
- ------------------ --------------- ---------------------- ------------------- ------------------- ------------------
<S> <C> <C> <C> <C> <C>
$0.56 to 0.72 4,000 1.0 years $0.64 4,000 $0.64
1.25 to 1.88 181,000 4.0 years 1.51 173,000 1.49
2.00 to 2.75 386,500 9.0 years 2.26 245,000 2.17
3.03 to 3.50 125,000 7.2 years 3.16 100,000 3.20
--------------- -------------------
$0.56 to 3.50 696,500 6.6 years 2.22 522,000 2.13
=============== ===================
</TABLE>
F-27
<PAGE>
8. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS:
American Pioneer, American Progressive and American Exchange are
required to meet minimum statutory capital requirements imposed by the Insurance
Departments of the states in which they are licensed in order to operate as an
insurance company without restrictions. The minimum statutory capital and
surplus requirements of American Pioneer, American Progressive and American
Exchange for the maintenance of authority to do business at December 31, 1997
was $2,423,698, $2,500,000 and $770,000, respectively.
As of December 31, 1996 and 1997, the statutory capital and surplus
amounts of American Pioneer, American Progressive and American Exchange (which
was acquired by the Company on December 4, 1997, see Note 3) were as follows:
1996 1997
---------------- -----------------
American Pioneer $12,733,151 $10,490,353
American Progressive $ 7,464,004 $ 9,345,050
American Exchange $ 4,218,871
The insurance companies statutory gain (loss) for the years ended
December 31, 1995, 1996 and 1997 were as follows:
1995 1996 1997
----------- ------------- -------------
American Pioneer $ 1,694,711 $ 955,714 $ 439,330
American Progressive $ (262,049) $(672,127) $1,810,710
American Exchange $ (538,120)
The insurance companies have calculated their risk-based capital
("RBC") levels and, as of December 31, 1997, American Pioneer, American
Progressive and American Exchange's ratios of total adjusted capital to RBC are
in excess of the authorized control levels.
Dividend payments from American Progressive to the Company would
require regulatory approval which, in all likelihood, would not be obtained
until American Progressive generated enough statutory profits to offset its
entire negative unassigned surplus, which was approximately $8,412,233 at
December 31, 1997. American Progressive made no dividends or distributions
during 1995, 1996 or 1997.
American Pioneer may pay a dividend or make a distribution without the
prior written approval of the Florida Insurance Department when (a) the dividend
is equal to or less than the greater of (1) 10% of the insurer's surplus as to
policyholders derived from net operating profits on its business and net
realized capital gains ("policyholder surplus from operations"); or (2) the
insurer's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year but not more than its
policyholder surplus from operations; (b) the insurer will have surplus as to
policyholders equal to or exceeding 115% of the minimum required statutory
surplus as to policyholders after the dividend or distribution is made; and (c)
the insurer has filed notice with the department at least 10 business days prior
to the dividend payment or distribution. American Pioneer paid American
Progressive $500,000, $500,000 and $185,455 in dividends during 1995, 1996 and
1997, respectively and paid Universal $425,000 in dividends in 1997.
F-28
<PAGE>
Under current Texas insurance law, a life insurer may pay dividends or
make distributions without the prior approval of the Insurance Department as
long as the dividend distributions do not exceed the greater of (i) 10% of the
insurer's surplus as to policyholders as of the preceding December 31st; or (ii)
the insurer's net gain from operations for the immediately preceding calendar
year. American Exchange made no dividends or distributions in 1997.
9. REINSURANCE:
The Company is party to several reinsurance agreements on its life and
accident and health insurance risks. The Company's senior market accident and
health insurance products are reinsured under coinsurance treaties with
unaffiliated insurers, while the life insurance risks are reinsured under either
coinsurance or yearly-renewable term treaties with unaffiliated insurers. Under
coinsurance treaties, the reinsurer receives an agreed upon percentage of all
premiums and reimburses the Company that same percentage of any losses. In
addition, the Company receives certain allowances from the reinsurers to cover
commissions, expenses and premium taxes. Under yearly-renewable term treaties,
the reinsuring company receives premiums at an agreed upon rate and holds the
required reserves for its share of the risk on a yearly-renewable term basis. A
contingent liability exists with respect to reinsurance which may become a
liability of the Company in the event that the reinsurers should be unable to
meet the obligations which they assumed. The Company evaluates the financial
condition of its reinsurers and monitors concentrations of credit risk to
minimize its exposure to significant losses from reinsurer insolvencies. At
December 31, 1997, amounts due from reinsurers with a total carrying value of
$44,030,178 were associated with three reinsurers, which reinsurers were rated
A, or better, by A.M. Best.
A summary of reinsurance activity for the three years ended December
31, 1997 is presented below:
<TABLE>
As of December 31,
---------------------------------------------------------
1995 1996 1997
------------------ ----------------- -----------------
<S> <C> <C> <C>
Life insurance in force
(amounts in thousands)
Gross amount $ 1,955,809 $ 2,118,265 $ 2,118,492
Ceded to other companies (944,697) (889,132) (842,624)
Assumed from other companies 27,294 25,484 42,237
------------------ ----------------- -----------------
Net Amount $ 1,038,406 $ 1,254,617 $ 1,318,105
================== ================= =================
Percentage of assumed to net 3% 2% 3%
================== ================= =================
</TABLE>
<TABLE>
Year Ended December 31,
---------------------------------------------------------
Premiums 1995 1996 1997
------------------ ----------------- -----------------
<S> <C> <C> <C>
Life insurance $ 17,231,562 $ 9,923,021 $12,660,147
Accident and health 28,290,413 44,853,225 86,177,075
------------------ ----------------- -----------------
Total gross premiums 45,521,975 54,776,246 98,837,222
------------------ ----------------- -----------------
Ceded to other companies
Life insurance (10,703,350)
(2,870,540) (5,585,289)
Accident and health (7,497,083) (22,792,684) (57,037,432)
------------------ ----------------- -----------------
Total ceded premiums (18,200,433) (25,663,224) (62,622,721)
------------------ ----------------- -----------------
Assumed from other companies
Life insurance 997,836
386,254 391,456
Accident and health 8,479,756 10,130,531
-
------------------ ----------------- -----------------
Total assumed premium 8,866,010 10,521,987 997,836
------------------ ----------------- -----------------
Net amount
Life insurance 6,914,466 8,072,694
7,443,937
Accident and health 29,273,086 32,191,072 29,139,643
------------------ ----------------- -----------------
Total net premium $ 36,187,552 $ 39,635,009 $37,212,337
================== ================= =================
Percentage of assumed to net
Life insurance 6% 5% 12%
================== ================= =================
Accident and health 29% 31% 0%
================== ================= =================
Total assumed to total net 25% 27% 3%
================== ================= =================
</TABLE>
F-29
<PAGE>
10. LOAN PAYABLE AND SHORT-TERM DEBT:
On December 10, 1997, the Company entered into an agreement with Chase
Manhattan Bank for a $3,500,000 five-year secured term loan. The loan proceeds
were used to finance a segment of the intercompany sale of American Pioneer from
American Progressive to Universal and to retire the $800,000 amount outstanding
on the term loan agreement with a commercial bank. The loan agreement calls for
interest at the London Interbank Offered Rate (LIBOR) plus 200 basis points. In
connection with this loan agreement, the Company entered into a three-year
interest rate swap agreement, (the "Swap Agreement") with Chase Securities
Corp., effective January 1, 1998, to lock in a fixed rate of 8.19% for the three
year period. Upon expiration of the Swap Agreement, the Company's interest rate
reverts to the LIBOR plus 200 basis points. The loan will be secured by a first
priority interest in all the assets of WorldNet Services Corp. and Quincy Corp.,
a pledge of 9.9% of the outstanding common shares of American Progressive and
100% of the shares of Quincy Coverage Corp.
The following table sets forth summary information with respect to
total borrowings of the Company for the three years ended December 31, 1997:
<TABLE>
As of December 31, Year Ended December 31,
------------------------------- ---------------------------------------------------
Weighted
Maximum Average(a) Average
Amount Interest Amount Amount Interest
Outstanding Rate Outstanding Outstanding Rate (b)
--------------- -------------- ---------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
1995 $ 800,000 10.50% $ 800,000 $800,000 10.94%
=============== ============== ================ ============== ===============
1996 $ 800,000 9.50% $ 800,000 $800,000 10.48%
=============== ============== ================ ============== ===============
1997 $3,500,000 8.19% $3,500,000 $952,419 9.76%
=============== ============== ================ ============== ===============
- --------------------------------------------------------------
(a) The average amounts of borrowings outstanding were computed by
determining the arithmetic average of the months' average
outstanding in borrowings.
(b) The weighted-average interest rates were determined by dividing
interest expense related to total borrowings by the average amounts
outstanding of such borrowings.
</TABLE>
11. COMMITMENTS:
The Company is obligated under certain lease arrangements for its executive and
administrative offices in New York, Orlando, Florida and Texas. Rent expense for
the three years ended December 31, 1995, 1996 and 1997 was $721,848, $640,524
and $843,961, respectively. The minimum rental commitments, subject to
escalation clauses, at December 31, 1997 under non-cancelable operating leases
are as follows:
Total
---------------
1998 $ 715,000
1999 702,000
2000 675,000
2001 687,000
2002 433,000
2003 237,000
2004 160,000
---------------
Totals $3,609,000
===============
F-30
<PAGE>
12. UNIVERSAL AMERICAN FINANCIAL CORP. 401(K) SAVINGS PLAN:
Effective April 1, 1992, the Company adopted the Universal American Financial
Corp. 401(k) Savings Plan ("Savings Plan"). The Savings Plan is a voluntary
contributory plan under which employees may elect to defer compensation for
federal income tax purposes under Section 401(k) of the Internal Revenue Code of
1986. The employee is entitled to participate in the Savings Plan by
contributing through payroll deductions up to 20% of the employee's
compensation. In the three year period ended December 31, 1997, the Company
matched the employee's contribution up to 1% of the employee's compensation,
which contribution will be made with Company common stock. Beginning in 1998,
the Company will match the employee's contribution up to 2% of the employee's
compensation, which contribution will be made with Company common stock. As of
December 31, 1997, 215,654 shares of the Company's common stock were held by the
Savings Plan.
The participating employee is not taxed on these contributions until
they are distributed. Moreover, the employer's contributions vest at the rate of
25% per plan year. Amounts credited to employee's accounts under the Savings
Plan are invested by the employer-appointed investment committee. Generally, a
participating employee is entitled to distributions from the Savings Plan upon
termination of employment, retirement, death or disability. Savings Plan
participants who qualify for distributions may receive a single lump sum, have
the assets transferred to another qualified plan or individual retirement
account, or receive a series of specified installment payments. Total matching
contributions by the Company under the Savings Plan were $42,325, $38,478 and
$40,546 in 1995, 1996 and 1997, respectively.
13. FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK:
For the years ended December 31, 1996 and 1997, the Company held
unrated or less-than-investment grade corporate debt securities with carrying
and estimated fair values as follows:
1996 1997
--------------- ---------------
Carrying value $3,850,510 $2,616,470
=============== ===============
Estimated fair value $3,850,510 $2,616,470
=============== ===============
Percentage of total assets 1.6% 1.0%
=============== ===============
The holdings of less-than-investment grade securities are widely
diversified and the investment in any one such security is currently less than
$1,000,000, which is approximately 0.4% of total assets.
F-31
<PAGE>
14. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
a. Fixed maturities available for sale: For those securities
available for sale, fair value equals quoted market price, if
available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar
securities.
b. Equity securities: For equity securities carried at fair
value, fair value equals quoted market price.
c. Cash and cash equivalents: For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value.
d. Investment contract liabilities: For annuity and universal
life type contracts, the carrying amount is the policyholder
account value (see Note 2e); estimated fair value equals the
policyholder account value less surrender charges.
e. Short term debt and loan payable: For short-term borrowings
and loan payable, the carrying value is a reasonable estimate
of fair value due to their short-term nature.
f. Accounts receivable and uncollected premiums: Accounts
receivable and uncollected premiums are primarily insurance
contract related receivables, which are determined based upon
the underlying insurance liabilities and added reinsurance
amounts.
F-32
<PAGE>
The estimated fair values of the Company's financial
instruments as of December 31, 1996 and 1997 are as follows:
1996
------------------------------------------
Carrying
Amount Fair Value
--------------------- ------------------
Financial assets:
Fixed maturities available for sale $ 121,492,167 $ 121,492,167
Equity securities 33,562 33,562
Policy loans (a) 6,421,251
Property tax liens (b) 131,729
Mortgage loans (c) 1,199,110
Cash and cash equivalents 15,403,450 15,403,450
Financial liabilities:
Investment contract liabilities 134,538,954 121,649,219
Short-term debt 800,000 800,000
1997
------------------------------------------
Carrying
Amount Fair Value
--------------------- ------------------
Financial assets:
Fixed maturities available for sale $ 123,585,708 $ 123,585,708
Equity securities 945,116 945,116
Policy loans (a) 7,185,014
Property tax liens (b) 136,713
Mortgage loans (c) 2,562,008
Cash and cash equivalents 25,014,019 25,014,019
Financial liabilities:
Investment contract liabilities 145,085,687 132,208,242
Loan payable 3,500,000 3,500,000
- --------------------------------------------------------------
(a) It is not practicable to estimate the fair value of policy loans as they
have no stated maturity and their rates are set at a fixed spread to related
policy liability rates. Policy loans are carried at the aggregate unpaid
principal balances in the consolidated balance sheets, and earn interest at
rates between 6% to 8%. Individual policy liabilities, in all cases, equal or
exceed outstanding policy loan balances.
(b) Property tax liens are carried at cost. The determination of fair value for
these invested assets is not practical because there is no active trading market
for such invested assets. Individual liens in all cases are first priority liens
with collateral in excess of 300% of the carrying value of the lien.
(c) Mortgage loans are carried at the aggregate unpaid balances and the fair
market value was not determined as the amount involved was considered to be
immaterial.
F-33
<PAGE>
15. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The quarterly results of operations for the three years ended December
31, 1997 are presented below:
<TABLE>
1995 Three Months Ended
- -------------------------------------------- ------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
------------------ --------------- ---------------- -------------------
<S> <C> <C> <C> <C>
Total revenue $12,264,057 $12,518,785 $12,891,128 $12,137,611
Total benefits, claims & other expenses 11,671,626 11,461,004 12,405,619 11,622,478
---------------- --------------- ---------------- -------------------
Operating income before income taxes 592,431 1,057,781 485,509 515,133
Federal income tax expense (benefit) 201,426 359,646 165,073 (717,113)
---------------- --------------- ---------------- -------------------
Net income applicable to common
shareholders $ 391,005 $ 698,135 $ 320,436 $ 1,232,246
================ =============== ================ ===================
Diluted earnings per share $ 0.03 $ 0.07 $ 0.03 $ 0.12
================ =============== ================ ===================
</TABLE>
<TABLE>
1996 Three Months Ended
- -------------------------------------------- ------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------- --------------- ---------------- -------------------
<S> <C> <C> <C> <C>
Total revenue $12,257,842 $11,737,328 $14,199,901 $15,192,114
Total benefits, claims & other expenses 11,930,299 11,550,317 14,049,636 15,484,041
---------------- --------------- ---------------- -------------------
Operating income (loss) before income taxes 327,543 187,011 150,265 (291,927)
Federal income tax expense 45,948 63,584 49,011 110,474
---------------- --------------- ---------------- -------------------
Net income (loss) applicable to common
shareholders $ 281,595 $ 123,427 $ 101,254 $ (402,401)
================ =============== ================ ===================
Diluted earnings (loss) per share $ 0.03 $ 0.01 $ 0.01 $ (0.04)
================ =============== ================ ===================
</TABLE>
<TABLE>
1997 Three Months Ended
- -------------------------------------------- ------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
---------------- --------------- ---------------- -------------------
<S> <C> <C> <C> <C>
Total revenue $12,884,699 $13,274,793 $14,029,877 $11,141,151
Total benefits, claims & other expenses 12,325,071 12,565,533 12,792,167 10,436,522
---------------- --------------- ---------------- -------------------
Operating income before income taxes 559,628 709,260 1,237,710 704,629
Federal income tax expense 190,013 241,410 420,820 239,575
---------------- --------------- ---------------- -------------------
Net Income 369,615 467,850 816,890 465,054
Redemption accrual on Series C
preferred stock
- 55,200 91,230 103,360
---------------- --------------- ---------------- -------------------
Net income applicable to common
shareholders $ 369,615 $ 412,650 $ 725,660 $ 361,694
================ =============== ================ ===================
Diluted earnings per share $ 0.03 $ 0.04 $ 0.07 $ 0.04
================ =============== ================ ===================
</TABLE>
During the fourth quarter of 1996, the Company accrued $250,000 for its
restructuring (see Note 3) and $500,000 for its withdrawal from its
participation in the National Accident Insurance Underwriters accident pool as
of December 31, 1996. Offsetting these amounts was the amount received by the
F-34
<PAGE>
Company on the sale of its New York State DBL business, which amounted to
$200,000, net of additional reserves established.
16. INTERCOMPANY SALE OF AMERICAN PIONEER:
When American Pioneer was acquired in 1993, it became a wholly-owned
subsidiary of American Progressive. This ownership structure (the "stacking")
significantly reduced the Risk-Based Capital ratio of American Progressive as
computed by the regulators and the rating agencies and adversely affected the
ratings of both companies and their ability to write new business.
Pursuant to an agreement between Universal and American Progressive,
entered into with the consent of the New York Insurance Department on June 27,
1996 (the "Unstacking Agreement"), Universal is obligated to purchase all of the
outstanding stock of American Pioneer from American Progressive over a five-year
period for a total purchase price of $15,800,000. Under the terms of the
Unstacking Agreement, the purchase is to be implemented in segments with the
purchase price of the shares included in each segment being paid one half in
cash and one half in five-year debentures, paying interest at 8.5%. The
debentures are payable by Universal to American Progressive.
The Unstacking Agreement is intended to make American Pioneer a direct
subsidiary of Universal, rather than an indirect subsidiary, owned through
American Progressive. This unstacking is expected to have a beneficial effect on
the ratings of both insurers. In addition, the unstacking increases the surplus
of American Progressive, improves its Risk Based Capital Ratio and, when and to
the extent that American Pioneer is able to pay dividends, permits the payment
of such dividends directly to Universal.
The first segments of the unstacking were consummated in September and
December of 1997. In the aggregate, Universal acquired 75% of American Pioneer
from American Progressive for $11,850,000 consisting of $5,925,000 in cash and
$5,925,000 in debentures payable to American Progressive. The cash portion of
the unstacking was obtained by Universal from the proceeds of the Series C
Preferred Stock transaction with AAM, a dividend from American Pioneer, and from
the proceeds of a loan from Chase Manhattan Bank. It is expected that Universal
will acquire the balance of American Pioneer in 1998.
17. SUBSEQUENT EVENT:
On March 19, 1998, the Company acquired a $12.6 million block of annual
premiums in force of Medicare Supplement business from Dallas General. The
business was assumed by American Pioneer, which assumption was approved by the
Texas and Florida Departments of Insurance. The Dallas General block has
approximately 10,000 policies in force produced by approximately 400 agents, all
in Texas. In addition, the principals of Dallas General have entered into a
contract to continue to produce business for American Pioneer through an agency
relationship.
F-35
<PAGE>
Schedule II - Condensed Financial Information of Registrant
UNIVERSAL AMERICAN FINANCIAL CORP.
(Parent Company)
CONDENSED BALANCE SHEETS
December 31, 1996 and 1997
<TABLE>
1996 1997
-------------- --------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 76,844 $ 969,878
Investments in subsidiaries at equity 22,382,683 38,069,090
Note receivable from American Pioneer 1,000,000
-
Due from subsidiary 290,974 259,848
Deferred tax asset 883,077 983,540
Other assets 77,597 304,965
---------------- ----------------
Total assets 23,711,175 41,587,321
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt 800,000 -
Loan Payable - 3,500,000
Note Payable to American Progressive - 5,925,000
Due to subsidiary 794,690 949,099
Amounts payable and other liabilities 37,959 89,054
---------------- ----------------
Total liabilities 1,632,649 10,463,153
---------------- ----------------
Series C Preferred Stock - 5,168,000
---------------- ----------------
Redemption accrual on Series C Preferred Stock - 249,790
---------------- ----------------
Total stockholders' equity 22,078,526 25,706,378
---------------- ----------------
Total liabilities and stockholders' equity $23,711,175 $41,587,321
================ ================
</TABLE>
See notes to consolidated financial statements.
Schedule II, Continued
F-36
<PAGE>
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(Parent Company)
CONDENSED STATEMENTS OF OPERATIONS
For the Three Years Ended December 31, 1997
<TABLE>
1995 1996 1997
--------------- --------------- ---------------
<S> <C> <C> <C>
REVENUES:
Net investment income $ 165 $ 75 $ 73,397
Dividends received from American Pioneer - - 425,000
--------------- --------------- ---------------
Total revenues 165 75 498,397
--------------- --------------- ---------------
EXPENSES:
Selling, general and administrative expenses 640,632 301,235 501,998
--------------- --------------- ---------------
Total expenses 640,632 301,235 501,998
--------------- --------------- ---------------
Operating loss before provision for federal
income taxes and equity income (640,467) (301,160) (3,601)
Federal income taxes - - (119,099)
--------------- --------------- ---------------
Net loss before equity income (640,467) (301,160) 115,498
Equity in undistributed income 3,282,289 405,035 2,633,003
--------------- --------------- ---------------
Net income 2,641,822 103,875 2,748,501
Redemption accrual on Series C Preferred Stock - - 249,790
--------------- --------------- ---------------
Net income applicable to common shareholders $2,641,822 $103,875 $2,498,711
=============== =============== ===============
</TABLE>
See notes to consolidated financial statements.
Schedule II, Continued
F-37
<PAGE>
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(Parent Company)
CONDENSED STATEMENTS OF CASH FLOWS
For the Three Years Ended December 31, 1997
<TABLE>
1995 1996 1997
---------------- ---------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities: $ 2,641,822 $ 103,875 $ 2,748,501
Adjustments to reconcile net income to
net cash used by operating activities:
Amortization and depreciation, net 4,147 - -
Increase in investment in subsidiaries (5,476,975) (392,557) (2,358,983)
Change in amounts due to/from subsidiaries 2,904,984 176,160 185,535
Change in other assets and liabilities 200,050 (32,860) (295,375)
---------------- ---------------- -----------------
Net cash (used by) provided from operating activities 274,028 (145,382) 279,678
---------------- ---------------- -----------------
Cash flows from investing activities:
Cost of note receivable from American Pioneer - - (1,000,000)
Purchase of 75% of American Pioneer - - (11,850,000)
---------------- ---------------- -----------------
Net cash used by investing activities - - (12,850,000)
---------------- ---------------- -----------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 1,355,465 202,263 274,020
Redemption of the Series A preferred stock (1,618,062) - -
Proceeds from the issuance of Series C preferred stock - - 4,838,356
Increase in note payable to American Progressive - - 5,925,000
Increase in payable - - 3,500,000
Change in short-term debt - - (800,000)
---------------- ---------------- -----------------
Net cash provided from (used by) financing activities (262,597) 202,263 13,463,356
---------------- ---------------- -----------------
Net increase in cash and cash equivalents 11,431 56,881 893,034
Cash and cash equivalents:
At beginning of year 8,532 19,963 76,844
---------------- ---------------- -----------------
At end of year $ 19,963 $ 76,844 $ 969,878
================ ================ =================
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 96,289 $ 83,852 $ 77,389
================ ================ =================
Income taxes
$ - $ - $ -
================ ================ =================
</TABLE>
See notes to consolidated financial statements
F-38
<PAGE>
Schedule III - Supplementary Insurance Information
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
<TABLE>
1995 1996 1997
------------------ ------------------- -------------------
<S> <C> <C> <C>
Deferred policy acquisition costs $ 16,564,450 $ 19,091,514 $ 20,832,060
================== =================== ===================
Policyholder account balances $118,608,836 $ 134,538,954 $ 145,085,687
================== =================== ===================
Policy and contract claims $ 9,374,815 $ 25,814,721 $ 23,759,654
================== =================== ===================
Premiums and policyholders fees earned $ 36,810,937 $ 40,145,373 $ 37,714,366
================== =================== ===================
Net investment income $ 8,945,280 $ 9,850,083 $ 10,022,658
================== =================== ===================
Interest credited to policyholders $ 6,089,860 $ 6,614,176 $ 6,645,716
================== =================== ===================
Claims and other benefits and
change in future policy benefits $ 21,029,905 $ 25,897,415 $ 24,160,144
================== =================== ===================
Increase in deferred acquisition costs $ 3,317,523 $ 2,257,617 $ 2,945,672
================== =================== ===================
Commissions and other operating costs and expenses $ 23,153,921 $ 22,760,319 $ 20,147,286
================== =================== ===================
</TABLE>
F-39
Exhibit 23(a)
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 11-258016) pertaining to the Universal American Financial Corp. 401(k)
Plan of our report dated March 25, 1998, with respect to the consolidated
financial statements and financial statement schedules of Universal American
Financial Corp. and subsidiaries included in the Annual Report (Form 10-K) for
the year ended December 31, 1997.
New York, New York Ernst & Young LLP
March 25, 1998
F-40
<PAGE>
Exhibit 23(b)
Consent of Independent Auditors
The Board of Directors and Stockholders
Universal American Financial Corp.:
We consent to the incorporation by reference in the Registration Statement No.
11-258016 on Form S-8 of our report dated March 26, 1996, with respect to the
consolidated financial statements and financial statement schedules included in
the Annual Report (Form 10-K) of Universal American Financial Corp. (formerly
Universal Holding Corp.) for the year ended December 31, 1995.
New York, New York KPMG Peat Marwick LLP
March 30, 1998
F-41
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 123585708
<DEBT-MARKET-VALUE> 123585708
<EQUITIES> 945116
<MORTGAGE> 2562008
<REAL-ESTATE> 0
<TOTAL-INVEST> 159428578
<CASH> 25014019
<RECOVER-REINSURE> 76576040
<DEFERRED-ACQUISITION> 20832060
<TOTAL-ASSETS> 272575336
<POLICY-LOSSES> 38327612
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 145085687
<POLICY-HOLDER-FUNDS> 23759654
<NOTES-PAYABLE> 3500000
0
9168000
<COMMON> 73259
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 272575336
37714336
<INVESTMENT-INCOME> 10022658
<INVESTMENT-GAINS> 1132521
<OTHER-INCOME> 2460975
<BENEFITS> 23719208
<UNDERWRITING-AMORTIZATION> (2945672)
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 3211227
<INCOME-TAX> 1091818
<INCOME-CONTINUING> 2119409
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2119409
<EPS-PRIMARY> 0.26
<EPS-DILUTED> 0.18
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
