<PAGE> 1
As filed with the Securities and Exchange Commission on February 12, 1999
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PRELIMINARY COPY
SCHEDULE 14A
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE
SECURITIES EXCHANGE ACT OF 1934
------------------------------
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
<TABLE>
<S> <C>
[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
</TABLE>
UNIVERSAL AMERICAN FINANCIAL CORP.
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(Name of Registrant as Specified in Its Charter)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies:
------------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
------------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:
------------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
------------------------------------------------------------------------
(5) Total fee paid:
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form, Schedule or Registration Statement No.:
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(3) Filing Party:
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(4) Date Filed:
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<PAGE> 2
PRELIMINARY COPY
U N I V E R S A L A M E R I C A N
F I N A N C I A L C O R P .
--, 1999
TO OUR SHAREHOLDERS:
We invite you to attend the special meeting of shareholders of Universal
American Financial Corp. to be held on --, 1999, at 10:00 a.m., local time, at
The Penn Club, 30 West 44th Street, New York, New York 10036. THIS IS A VERY
IMPORTANT MEETING THAT AFFECTS YOUR INVESTMENT IN UNIVERSAL AMERICAN. At the
special meeting, among other things, you will be asked to consider and vote on
two proposals: one proposal to approve the issuance and sale of Universal
American common stock to Capital Z Financial Services Fund II, L.P. ("Capital
Z") and some agents and members of management of the Penn Union Companies and a
second proposal containing six proposed amendments to Universal American's
certificate of incorporation, including an amendment to increase the number of
authorized shares of common stock and other corporate governance amendments. The
proposals are being made in connection with an acquisition by Universal American
of a number of insurance company subsidiaries and other assets (the "Penn Union
Companies") from PennCorp Financial Group, Inc. ("PFG"), an insurance holding
company listed on the New York Stock Exchange.
The details of all proposals to be considered and voted upon by you at the
special meeting are described in the enclosed proxy materials. To assist you in
understanding the proposals, a question and answer section appears on page 1.
Your vote is important. EVEN IF YOU PLAN ON ATTENDING THE SPECIAL MEETING
IN PERSON, PLEASE READ THE PROXY STATEMENT AND FILL OUT YOUR PROXY CARD IN FULL
AND RETURN IT TO UNIVERSAL AMERICAN IN THE ENVELOPE PROVIDED. PLEASE DO NOT
DELAY IN REGISTERING YOUR VOTE. You may revoke your proxy at any time, or you
may appear at the special meeting and cast your vote, in which case your proxy
would be ignored.
Before you review the body of the proxy statement and the accompanying
annexes, please take a few moments to read the summary that begins on page 4.
Please do not hesitate to call the Senior Vice President and Chief
Financial Officer of Universal American, Robert A. Waegelein, with any
questions. Mr. Waegelein may be reached at (914) 934-5200, generally between 9
a.m. and 5 p.m. Eastern Time on weekdays.
Sincerely,
------------------------------------------
Richard A. Barasch
Chairman and Chief Executive Officer
of Universal American Financial Corp.
YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, SIGN, DATE AND
PROMPTLY RETURN THE ENCLOSED PROXY IN THE ENVELOPE PROVIDED.
<PAGE> 3
UNIVERSAL AMERICAN FINANCIAL CORP.
SIX INTERNATIONAL DRIVE
RYE BROOK, NEW YORK 10573-1068
-------------------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON --, 1999
TO THE SHAREHOLDERS OF
UNIVERSAL AMERICAN FINANCIAL CORP.:
The special meeting of shareholders of Universal American Financial Corp.
will be held at 10:00 a.m., local time, on --, 1999 at The Penn Club, 30 West
44th Street, New York, New York 10036 to consider and vote on the following
proposals:
1. To approve the issuance and sale to Capital Z and some agents and
members of the management of the Penn Union Companies of up to 26,031,746 shares
of common stock for $3.15 per share and the payment of part of a transaction fee
to an affiliate of Capital Z in Universal American common stock. The number of
shares issued and purchased and the price paid for the shares may be adjusted
under the terms of the share purchase agreement between Universal American and
Capital Z.
2. To amend Universal American's certificate of incorporation to:
(a) Increase the number of authorized shares of common stock from 20
million shares to 80 million shares.
(b) Provide for shareholder action by written consent instead of a
meeting of shareholders. Written consent would only need to be given
by shareholders holding the number of shares required to approve the
action being taken by written consent.
(c) Eliminate the requirement that holders of 66 2/3% of Universal
American's outstanding voting capital stock approve amendments to
some provisions of the certificate of incorporation, which means
only majority approval will be necessary for those amendments.
(d) Remove the provision in the certificate of incorporation which
requires the vote by holders of 66 2/3% of the outstanding voting
capital stock to call a special meeting of the shareholders. The
board will amend the by-laws to allow special meetings of the
shareholders to be called at the request of holders of 50% of the
outstanding voting capital stock.
(e) Replace the present method of electing directors and the length of
the term each director serves with a system in which all directors
are elected at one time for a term expiring at the next annual
meeting. Directors are currently elected to three-year staggered
terms.
(f) Require 66 2/3% of Universal American's board of directors to
approve some important corporate actions.
3. To conduct other business that properly comes before the special
meeting or any adjournment or postponement of the special meeting.
<PAGE> 4
Additional information relating to the matters described above and the
business to be considered at the special meeting is described in the
accompanying proxy materials, which you should read carefully and in their
entirety.
By order of the board of directors,
------------------------------------------
Joan M. Ferrarone
Secretary
- --, 1999
Rye Brook, New York
YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN THE
ENCLOSED PROXY IN THE ENVELOPE PROVIDED.
-------------------------
YOU MAY REQUEST ADDITIONAL COPIES OF PROXY MATERIALS OR UNIVERSAL
AMERICAN'S ANNUAL REPORT TO SHAREHOLDERS BY WRITING TO ROBERT A. WAEGELEIN,
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, AT THE PRINCIPAL EXECUTIVE
OFFICES OF UNIVERSAL AMERICAN, SIX INTERNATIONAL DRIVE, RYE BROOK, NEW YORK
10573.
<PAGE> 5
UNIVERSAL AMERICAN FINANCIAL CORP.
PROXY STATEMENT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
QUESTIONS AND ANSWERS ABOUT THE
PROPOSALS............................... 1
SUMMARY................................... 3
Universal American...................... 3
Capital Z............................... 3
The Capital Z Issuance.................. 3
The Penn Union Companies................ 3
Financing of the Acquisition of the Penn
Union Companies...................... 3
Reasons for the Acquisition and the
Capital Z Issuance................... 4
Board of Directors' Approval............ 4
Interests of Persons Involved in the
Capital Z Issuance and the
Acquisition That May Be Different
from Yours........................... 5
Material Terms of the Share Purchase
Agreement............................ 5
Material Terms of the Acquisition
Agreement Relating to the Penn Union
Companies............................ 6
Regulatory Approvals.................... 7
Other Information....................... 7
Forward-Looking Statements.............. 7
Proposal No. 1 -- The Capital Z
Issuance............................. 8
Proposal No. 2 -- Amendments to the
Certificate of Incorporation......... 9
Summary Historical and Pro Forma
Financial Information................ 11
THE CAPITAL Z ISSUANCE AND THE ACQUISITION
OF THE PENN UNION COMPANIES............. 21
Background.............................. 21
Universal American Financial Corp....... 23
Capital Z Financial Services Fund II,
L.P.................................. 23
The Penn Union Companies................ 23
Financing of the Acquisition of the Penn
Union Companies...................... 24
Reasons for the Acquisition and the
Capital Z Issuance................... 25
Capital Z Issuance...................... 28
Material Terms of the Share Purchase
Agreement............................ 28
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Material Terms of the Acquisition
Agreement and Related Transactions... 35
The Voting Agreement.................... 40
UNAUDITED PRO FORMA FINANCIAL
INFORMATION............................. 42
SPECIAL MEETING OF SHAREHOLDERS OF
UNIVERSAL AMERICAN...................... 50
Time, Date, Place and Purpose........... 50
Record Date, Shareholders Entitled to
Vote and Quorum Requirements......... 50
Effect of Broker Non-Votes.............. 50
Nasdaq Listing and Accountants.......... 51
PROPOSAL NO. 1 -- THE CAPITAL Z
ISSUANCE................................ 52
PROPOSAL NO. 2 -- AMENDMENTS TO THE
CERTIFICATE OF INCORPORATION............ 54
INTERESTS OF PERSONS INVOLVED IN THE
CAPITAL Z ISSUANCE AND THE ACQUISITION
THAT MAY BE DIFFERENT FROM YOURS........ 58
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT................... 61
UNIVERSAL AMERICAN FINANCIAL CORP.
SELECTED CONSOLIDATED FINANCIAL
INFORMATION............................. 65
UNIVERSAL AMERICAN FINANCIAL CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.............................. 67
PENN UNION COMPANIES SELECTED COMBINED
FINANCIAL INFORMATION................... 80
PENN UNION COMPANIES MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..... 82
WHERE YOU CAN FIND MORE INFORMATION....... 97
PROXIES AND SOLICITATION.................. 97
ANNEXES................................... 98
</TABLE>
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QUESTIONS AND ANSWERS ABOUT THE PROPOSALS
Q. WHAT IS THE PURPOSE OF THE SPECIAL MEETING?
A. The special meeting is being held for you to consider and vote on proposals
that relate to the acquisition by Universal American of the Penn Union
Companies for $175 million from PFG.
We are asking you to approve the issuance and sale of shares of common stock
to Capital Z and some agents and members of management of the Penn Union
Companies and the payment in shares of common stock of part of a transaction
fee to an affiliate of Capital Z. The proceeds from the issuance and sale are
expected to be approximately $82 million. The proceeds will be used to
partially finance the acquisition of the Penn Union Companies.
We are also asking you to approve the increase in the number of authorized
shares Universal American can issue under its certificate of incorporation
together with some other amendments to the certificate of incorporation.
Without the approval to increase the authorized shares, Universal American
will not be able to issue the shares to Capital Z.
For your ease of reading, we will refer to the issuance of Universal American
common stock to Capital Z and some agents and members of management of the
Penn Union Companies together with part of the transaction fee paid to an
affiliate of Capital Z in common stock, as the "Capital Z Issuance" in this
proxy statement.
Because the shares of common stock to be issued in the Capital Z Issuance
will have voting power equal to or greater than 20% of the voting power
outstanding before the Capital Z Issuance, shareholders must approve the
Capital Z Issuance before it can occur. YOU ARE NOT BEING ASKED TO APPROVE
THE ACQUISITION OF THE PENN UNION COMPANIES; you are being asked to approve
the Capital Z Issuance and amendments to the certificate of incorporation.
Q. WHAT HAPPENS IF THE CAPITAL Z ISSUANCE IS NOT APPROVED OR IS NOT COMPLETED?
A. If the Capital Z Issuance is not approved or completed, then Universal
American will not acquire the Penn Union Companies. Similarly, if the
acquisition of the Penn Union Companies is not consummated, then Universal
American will not complete the Capital Z Issuance.
Q. WHEN DO YOU EXPECT THE CAPITAL Z ISSUANCE AND THE ACQUISITION OF THE PENN
UNION COMPANIES TO BE COMPLETED?
A. Universal American hopes to complete the Capital Z Issuance and the
acquisition of the Penn Union Companies in May 1999.
Q. DO I NEED TO VOTE ON EACH PROPOSAL, INCLUDING EACH ITEM OF PROPOSAL NO. 2?
A. Universal American has entered into a voting agreement under which holders of
more than 50% of Universal American's voting stock have already agreed to
vote in favor of Proposal No. 1, which contains the Capital Z Issuance, and
item (a) of Proposal No. 2 which would increase the number of authorized
shares permitted under Universal American's certificate of incorporation.
Even though shareholders owning over 50% of the outstanding voting stock have
agreed to vote in favor of Proposal No. 1 and item (a) of Proposal No. 2, WE
ASK THAT YOU VOTE ON ALL OF THE PROPOSALS, INCLUDING EACH ITEM OF PROPOSAL
NO. 2, INCLUDED IN THIS PROXY STATEMENT. You must vote separately on each
item of Proposal No. 2, but you do not have to vote the same way on each
item.
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<PAGE> 7
THE VOTING AGREEMENT DOES NOT COVER ITEMS (b) THROUGH (f). THEREFORE, YOUR
VOTE IS PARTICULARLY IMPORTANT TO THE APPROVAL OF THOSE ITEMS AND YOU ARE
REQUESTED TO COMPLETE AND RETURN YOUR BALLOT. IF YOU DO NOT RETURN YOUR
BALLOT, IT WILL BE CONSIDERED A VOTE AGAINST ALL OF THE ITEMS IN PROPOSAL NO.
2.
Q. WHAT IS REQUIRED FOR THE PROPOSALS TO PASS?
A. Proposal No. 1 requires the vote by holders of 50% of the outstanding voting
shares represented and voting at a meeting where a quorum is present; items
(b) through (e) of Proposal No. 2 require the vote by holders of 66 2/3% of
the outstanding voting shares entitled to vote on these proposals; items (a)
and (f) of Proposal No. 2 requires the vote by holders of 50% of the
outstanding shares entitled to vote on these proposals.
Q. WHAT DO I NEED TO DO NOW?
A. After carefully reading and considering the information contained in this
proxy statement, please indicate on your proxy card how you want to vote and
mail your signed and dated form in the enclosed return envelope as soon as
possible.
Q. WHAT DO I DO IF I WANT TO CHANGE MY VOTE?
A. Just send in a later-dated, signed proxy card to the Secretary of Universal
American before the special meeting or attend the meeting in person and vote.
Q. IF MY SHARES ARE HELD IN "STREET NAME" BY MY BROKER, WILL MY BROKER VOTE MY
SHARES FOR ME WITHOUT MY INSTRUCTIONS?
A. No. Your broker will not be able to vote your Universal American shares
without instructions from you. You should instruct your broker to vote your
shares, following the directions provided by your broker. Your failure to
instruct your broker to vote your shares will in some cases be the equivalent
of voting against a proposal.
Q. WHAT IF I PLAN TO ATTEND THE SPECIAL MEETING IN PERSON?
A. We recommend that you send in your proxy card whether or not you intend to
attend the special meeting in person.
WHO CAN HELP ANSWER YOUR QUESTIONS?
If you have more questions about the proposals, you should contact:
Robert A. Waegelein
Universal American Financial Corp.
Six International Drive
Rye Brook, New York 10573-1068
Telephone: (914) 934-5200
2
<PAGE> 8
SUMMARY
This summary highlights selected information from this proxy statement and
may not contain all of the information that is important to you. To understand
the proposals fully and for a more complete description of the terms of the
Capital Z Issuance and the acquisition of the Penn Union Companies, you should
carefully read this entire document, including the annexes. See "Where You Can
Find More Information" (page 97). We have included page references
parenthetically to direct you to more complete descriptions of the topics
presented in this summary.
UNIVERSAL AMERICAN (PAGE 23)
Universal American was incorporated in New York in 1981. Universal American
is an insurance holding company that operates through its subsidiaries. Through
its subsidiaries, Universal American markets and underwrites accident and health
insurance products aimed at the senior market, including Medicare supplement,
long term care and home health care, as well as life insurance and annuities.
CAPITAL Z (PAGE 23)
Capital Z is a $1.8 billion fund that was formed to make investments in
securities of a diversified global portfolio of insurance, financial services
and healthcare services companies and other related businesses.
THE CAPITAL Z ISSUANCE (PAGE 28)
Under the terms of the share purchase agreement between Universal American
and Capital Z, Capital Z and some agents and members of management of the Penn
Union Companies will purchase up to 26,031,746 shares of Universal American
common stock for $3.15 per share for a total of approximately $82 million. If an
adjustment is required under the share purchase agreement, more than 26,031,746
shares may be sold at a price less than $3.15 per share. In any case, the
aggregate purchase price to be paid by Capital Z is expected to be approximately
$76.5 million. Universal American may also issue common stock to an affiliate of
Capital Z as partial payment of a transaction fee. The Capital Z Issuance is
conditioned on shareholder approval. After the Capital Z Issuance, Capital Z or
its affiliates will hold between 61.0% and 65.3% of the outstanding voting
shares.
The share purchase agreement is attached as Annex A to this proxy
statement. We encourage you to read the share purchase agreement because it, and
not the proxy statement, is the legal document that governs the Capital Z
Issuance.
THE PENN UNION COMPANIES (PAGE 23)
The Penn Union Companies consist of Pennsylvania Life Insurance Company
("Pennsylvania Life"), Penncorp Life Insurance Company, Union Bankers Insurance
Company ("Union Bankers"), Constitution Life Insurance Company, Marquette
National Life Insurance Company, Peninsular Life Insurance Company, PennCorp
Financial, Inc. and selected assets of PennCorp Financial Services, Inc. The
Penn Union Companies underwrite and market, through a distribution system of
approximately 1,000 career agents and a network of producers throughout the
United States and Canada, fixed-benefit accident and health insurance policies
and life insurance and asset accumulation products.
FINANCING OF THE ACQUISITION OF THE
PENN UNION COMPANIES (PAGE 24)
Universal American has entered into an acquisition agreement with PFG and
some of PFG's subsidiaries to purchase the Penn Union Companies for a total
purchase price equal to $175 million, $136 million of which will be in cash and
$39 million of which will be in the form of subordinated notes issued by
Universal American to PFG or its subsidiaries. The $175 million purchase price
may
3
<PAGE> 9
be increased or decreased under
circumstances specified in the acquisition agreement between Universal American
and PFG.
The acquisition agreement is attached as Annex B to this proxy statement.
We encourage you to read the acquisition agreement because it, and not this
proxy statement, is the legal document that governs the acquisition of the Penn
Union Companies. In order to obtain the proceeds to complete this acquisition,
Universal American proposes to raise both equity and debt funding. SHAREHOLDERS
ARE NOT BEING ASKED TO APPROVE THE ACQUISITION OF THE PENN UNION COMPANIES.
SUBORDINATED NOTES
Universal American intends to obtain part of its financing for the
acquisition by issuing subordinated notes in the principal amount of $39 million
to PFG or its subsidiaries. The subordinated notes will have a ten-year term and
will bear interest at 8% per year. The terms of the subordinated notes are more
fully described on page 24 of this proxy statement.
SENIOR DEBT FINANCING
Universal American also intends to obtain senior debt financing of
approximately $80 million through a bank credit facility provided by a syndicate
of banks led by The Chase Manhattan Bank ("Chase Bank") and Chase Securities
Inc. ("CSI"). Seventy million dollars of the senior debt financing will be in
the form of a term loan and $10 million will be in the form of a revolving
credit facility. The amounts obtained from the term loan, the issuance of the
subordinated notes and the Capital Z Issuance in excess of $175 million will be
used to finance transaction-related costs and to repay $4.75 million of existing
Universal American debt. The senior debt financing is more fully described on
page 24 of this proxy statement.
REASONS FOR THE ACQUISITION AND
THE CAPITAL Z ISSUANCE (PAGE 25)
Through its acquisition of the Penn Union Companies, Universal American
expects to expand its policyholder, product and capital base and to achieve
long-term economies of scale and cost savings. By financing part of the
acquisition through an equity investment rather than through additional debt,
Universal American will be able to incur less debt, while simultaneously
developing a relationship with Capital Z that we expect to bring a number of
benefits.
There are drawbacks related to the acquisition and the Capital Z Issuance,
including the concentration of ownership by Capital Z and the additional debt
Universal American will have to service. However, after considering these and
other factors, the board determined that the Capital Z Issuance and the
acquisition will be beneficial to Universal American's shareholders.
BOARD OF DIRECTORS' APPROVAL (PAGE 21)
CSI prepared an analysis of the Capital Z Issuance and the potential
acquisition of the Penn Union Companies by Universal American.
In addition, Advest, Inc. ("Advest"), a financial advisor to Universal
American's board, delivered a written opinion to the board stating that the
financial terms and effects of (i) the $175 million Universal American agreed to
pay to purchase the Penn Union Companies and (ii) the controlling-interest
investment in Universal American by Capital Z, together with the additional
investment by UAFC, L.P., ("AAM") and some agents and members of the management
of the Penn Union Companies, both individually and in the aggregate, are fair,
from a financial point of view to Universal American and its shareholders.
The full text of Advest's written opinion is attached as Annex C to this
proxy statement. WE URGE YOU TO CAREFULLY READ THE ENTIRE ADVEST OPINION for a
description
4
<PAGE> 10
of the procedures followed, assumptions
made, matters considered and qualifications and limitations on Advest's review
in connection with the delivery of its written opinion. Advest's opinion is not
a recommendation as to how any Universal American shareholder should vote.
After considering the results of CSI's analysis and the potential benefits
and risks of the acquisition and the Capital Z Issuance, the board approved the
Capital Z Issuance and the acquisition of the Penn Union Companies. The board
approval was subject to the receipt by a designated committee of the board of
Advest's opinion. The board committee has received and approved Advest's opinion
and forwarded it to the full board.
INTERESTS OF PERSONS INVOLVED IN THE
CAPITAL Z ISSUANCE AND THE ACQUISITION
THAT MAY BE DIFFERENT FROM YOURS
(PAGE 58)
Some directors or executive officers or their affiliates may have interests
in the share purchase agreement, the acquisition agreement and the related
agreements that may be different from, or in addition to, your interests. For
example, following the transactions, some of the present executive officers will
have employment agreements with Universal American under which their
compensation will be increased. The board of directors of Universal American was
aware of these interests and took them into account in approving the share
purchase agreement, the acquisition agreement and the related agreements.
MATERIAL TERMS OF THE SHARE PURCHASE
AGREEMENT (PAGE 28)
CONDITIONS TO THE CAPITAL Z ISSUANCE
Universal American and Capital Z will not complete the Capital Z Issuance
unless they satisfy or waive a number of conditions. The material conditions
are:
- - a majority of the holders of the Series C-1 preferred stock must approve the
senior debt and the issuance of the subordinated notes, which approval is
expected to be obtained;
- - a majority of Universal American's shareholders must approve the Capital Z
Issuance and the amendment to Universal American's certificate of
incorporation to increase the number of authorized shares;
- - the closing of the acquisition of the Penn Union Companies must occur at the
same time as the closing of the Capital Z Issuance;
- - Universal American must obtain insurance and other regulatory approvals
relating to the Capital Z Issuance and the acquisition of the Penn Union
Companies;
- - Richard A. Barasch, Chief Executive Officer and Chairman of the Board of
Universal American, must enter into an employment agreement with Universal
American, the terms of which already have been agreed to; and
- - Universal American must enter into a shareholders' agreement and a
registration rights agreement with some shareholders of Universal American,
the terms of which already have been agreed to.
TERMINATION OF THE SHARE PURCHASE
AGREEMENT
Universal American and Capital Z, at any time after May 31, 1999, can agree
to terminate the share purchase agreement without completing the Capital Z
Issuance. Either Universal American or Capital Z can terminate the share
purchase agreement under some circumstances, including:
- - if the acquisition of the Penn Union Companies has not occurred by March 31,
1999, or, under some circumstances, by May 31, 1999; or
- - if the shareholders of Universal American fail to approve the Capital Z
Issuance or the amendment to the certificate of incor-
5
<PAGE> 11
poration to increase the authorized shares of common stock.
To review the terms of the share purchase agreement in greater detail, see
page 28.
MATERIAL TERMS OF THE ACQUISITION
AGREEMENT RELATING TO THE
PENN UNION COMPANIES (PAGE 35)
CONDITIONS TO THE ACQUISITION OF THE
PENN UNION COMPANIES
Universal American and PFG will not complete the acquisition and sale of
the Penn Union Companies unless they satisfy or waive a number of conditions.
The material conditions are:
- - Universal American's shareholders must approve the Capital Z Issuance and the
amendment to the certificate of incorporation to increase the number of
authorized shares of common stock that Universal American is permitted to
issue;
- - Universal American and PFG must obtain insurance and other regulatory
approvals relating to the acquisition of the Penn Union Companies and, in the
case of Universal American, relating to the Capital Z Issuance;
- - Universal American must be satisfied with a report being prepared based upon a
review of Pennsylvania Life's insurance reserves;
- - Universal American must receive a review report from PFG's independent
auditors, satisfactory to Universal American, indicating that there are no
material modifications that should be made to the unaudited financial
statements of the Penn Union Companies as of September 30, 1998 which were
previously provided to Universal American;
- - PFG must complete specified restructuring and other transactions; and
- - Universal American must enter into agreements with selected agents and members
of management of the Penn Union Companies regarding compensation and equity
investments.
In negotiating the acquisition agreement, Universal American recognized
that additional claims reserves in Pennsylvania Life may be required.
Accordingly, Universal American included provisions in the agreement to ensure
adequate claims reserves. First, Universal American is required to receive
reports from independent reserve consultants prior to the closing of the
acquisition as to the adequacy of Pennsylvania Life's claims reserves. The
results of these reports must be reasonably satisfactory to Universal American.
If Universal American is not satisfied with the reserve consultants' reports, it
is not required to close the acquisition. Second, selected Penn Union Companies,
including Pennsylvania Life, must each meet minimum capital and surplus
requirements. For example, Pennsylvania Life must have capital and surplus equal
to at least $36 million. In addition, the aggregate capital and surplus amounts
of selected Penn Union Companies must equal at least $72.3 million plus the
earnings, as described in the acquisition agreement, of those companies from
January 1, 1999 to the closing. If the estimated capital and surplus amounts do
not equal or exceed the minimum capital and surplus requirements at closing,
Universal American is not obligated to close the acquisition. Finally, the
acquisition agreement requires a post-closing purchase price adjustment based on
the actual capital and surplus of the selected Penn Union Companies. PFG will
pay Universal American the difference between the actual capital and surplus
amounts and the required capital and surplus amounts. See "The Capital Z
Issuance and the Acquisition of the Penn Union Companies--Material Terms of the
Acquisition Agreement and the Related Transactions--Purchase Price Adjustment."
Pennsylvania Life is currently involved in discussions with the Commonwealth of
Pennsylvania Insurance Department as to the calculation methods for some of its
6
<PAGE> 12
claim reserves to be recorded in its December 31, 1998 statutory financial
statements. See "Penn Union Companies Management's Discussion and Analysis of
Financial Condition and Results of Operations--Regulatory Matters."
TERMINATION OF THE ACQUISITION AGREEMENT
Universal American and PFG can together agree to terminate the acquisition
agreement before completing the acquisition of the Penn Union Companies. Either
Universal American or PFG can terminate the share purchase agreement under some
circumstances, including the failure of the acquisition of the Penn Union
Companies to close by March 31, 1999, or, under certain circumstances, by May
31, 1999.
To review the terms of the acquisition agreement of the Penn Union
Companies in greater detail, see page 35.
REGULATORY APPROVALS (PAGE 28)
The regulatory authorities in New York, Florida, Texas, Pennsylvania and
North Carolina must approve the Capital Z Issuance and the acquisition. The
transactions also require approval under some Canadian federal and provincial
laws. In addition, both the Capital Z Issuance and the acquisition are subject
to compliance with applicable state and federal securities laws and approvals
from or notices to various states.
The Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act")
applies to both the Capital Z Issuance and the acquisition of the Penn Union
Companies. The HSR Act prohibits Universal American and PFG from completing the
acquisition of the Penn Union Companies until Universal American, Capital Z and
PFG have furnished the required information and materials to the Antitrust
Division of the Department of Justice and the Federal Trade Commission and the
required waiting period has ended or been terminated.
OTHER INFORMATION
Unless otherwise indicated, all financial information and operating
statistics applicable to Universal American and the Penn Union Companies in this
proxy statement are based on generally accepted accounting principles ("GAAP")
and not statutory accounting practices ("SAP"). In conformity with industry
practice, information derived from A.M. Best Company, Inc. ("A.M. Best") and the
National Association of Insurance Commissioners ("NAIC") and used in this proxy
statement for industry comparisons is based on SAP.
PFG has furnished the financial and other information set forth in this
proxy statement concerning PFG and the Penn Union Companies. We have no reason
to believe that the information provided by PFG is incorrect. However, in the
event that this information is materially inaccurate, Universal American's
recourse may be limited in some respects by the terms of the acquisition
agreement. Based on information obtained from PFG, Universal American prepared
descriptions of PFG and the Penn Union Companies.
FORWARD-LOOKING STATEMENTS (PAGE 21)
Statements in this proxy statement are or may be forward-looking statements
that involve risks and uncertainties. Actual results may differ materially from
those expressed in such statements depending on a variety of factors discussed
more fully in this proxy statement. You should carefully review all information,
including the financial statements and the notes to the financial statements,
included in this proxy statement.
7
<PAGE> 13
PROPOSALS
PROPOSAL NO. 1 -- THE CAPITAL Z
ISSUANCE (PAGE 52)
THE CAPITAL Z ISSUANCE. Proposal No. 1 asks you to approve the Capital Z
Issuance. Capital Z does not currently own any capital stock of Universal
American.
EFFECT OF THE CAPITAL Z ISSUANCE. After the Capital Z Issuance, Capital Z
will hold approximately 63.0% of Universal American's outstanding common stock.
If all of the securities of Universal American that could be converted into
common stock were converted or exercised, Capital Z would own 56.8% of the
outstanding common stock.
If the acquisition of the Penn Union Companies and the Capital Z Issuance
had been completed on January 1, 1998, pro forma earnings per share of Universal
American for the nine months ended September 30, 1998 would have been $.10 per
share, assuming that all of Universal American's securities that could be
converted or exercised into common stock had been converted or exercised. See
"-- Universal American Financial Corp. Unaudited Pro Forma Condensed
Consolidated Statement of Operations -- Nine Months Ended September 30, 1998."
ADVANTAGES AND DISADVANTAGES OF THE CAPITAL Z ISSUANCE. The board of
directors approved the Capital Z Issuance to ensure that Universal American has
the opportunity to complete the acquisition of the Penn Union Companies. The
board of directors considered the extent of Capital Z's ownership following the
Capital Z Issuance. The board of directors, however, views the relationship with
Capital Z as beneficial to Universal American's ability to continue its growth
and take advantage of opportunities to complete acquisitions as they arise. The
relationship may also provide Universal American with greater access to capital
markets and enhance shareholder value. In addition, funding the acquisition of
the Penn Union Companies in part through the issuance of equity will allow
Universal American to maintain a more conservative debt-to-equity ratio and
satisfy rating agency considerations. The board decided these advantages
outweighed the concerns raised by Capital Z's ability to control elections of
Universal American's directors, the potential depressive effect on the trading
market for Universal American's common stock by the concentration of Capital Z's
ownership, and the fact that Capital Z's ownership could delay or prevent an
advantageous change in control.
CORPORATE GOVERNANCE. As a condition to the Capital Z Issuance, Universal
American, Capital Z, Richard A. Barasch, and AAM, and some other shareholders of
Universal American will enter into a shareholders' agreement. The shareholders'
agreement provides that initially after the closing, Capital Z may nominate four
directors, Richard A. Barasch may nominate two directors, AAM may nominate one
director, and Universal American will nominate the remaining two directors of
Universal American. Capital Z, Richard Barasch and AAM are each required to vote
for the director(s) nominated by the others. The number of directors each
shareholder can nominate may change, depending on future share ownership. As
long as Capital Z owns over 50% of the outstanding voting stock after the
Capital Z Issuance, it will have the ability to select Universal American's two
designated directors. As a consequence, Capital Z will effectively be able to
select 6 of the 9 directors on Universal American's board. See "The Capital Z
Issuance and the Acquisition of the Penn Union Companies -- Terms of the Share
Purchase Agreement -- Shareholders' Agreement."
CONSEQUENCES IF THE CAPITAL Z ISSUANCE IS NOT APPROVED. Under the terms of
the share purchase agreement, if the shareholders do not approve the Capital Z
Issuance, Universal American will not be able to complete the acquisition of the
Penn Union
8
<PAGE> 14
Companies or otherwise purchase or acquire any of the businesses or assets of
PFG for a period of two years after the termination of the share purchase
agreement.
EVEN THOUGH SHAREHOLDERS OWNING OVER 50% OF THE OUTSTANDING VOTING STOCK
HAVE AGREED TO VOTE IN FAVOR OF PROPOSAL NO. 1, WE ASK THAT YOU COMPLETE AND
RETURN YOUR BALLOT.
ADVANTAGES AND DISADVANTAGES OF THE ACQUISITION OF THE PENN UNION
COMPANIES. Through the acquisition of the Penn Union Companies, Universal
American will be able to expand its product and policyholder base. Universal
American expects that the growth that will result from the acquisition will
allow it to achieve long-term economies of scale and to cut costs and increase
profits.
There is no guarantee that these benefits will materialize. It is possible
that Universal American may have difficulty consolidating the operations of the
Penn Union Companies with its own business. However, after considering all the
advantages and disadvantages, the board determined that the acquisition will
ultimately increase shareholder value. See "The Capital Z Issuance and the
Acquisition of the Penn Union Companies -- Reasons for the Acquisition and the
Capital Z Issuance."
THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE CAPITAL Z ISSUANCE AND
RECOMMENDS A VOTE FOR PROPOSAL NO. 1.
PROPOSAL NO. 2 -- AMENDMENTS TO THE
CERTIFICATE OF INCORPORATION (PAGE 54)
Each of the following amendments to Universal American's certificate of
incorporation are proposed:
a. Increase the number of authorized shares of Universal American common stock
from 20 million to 80 million shares in order to effect the Capital Z
Issuance.
b. Provide for shareholder action by written consent instead of a meeting of
shareholders. Written consent would only need to be given by shareholders
holding the number of shares required to approve the action being taken by
written consent.
c. Eliminate the requirement that holders of 66 2/3% of Universal American's
outstanding voting capital stock approve amendments to some provisions of the
certificate of incorporation, which means only majority approval will be
necessary for those amendments.
d. Remove the provision in the certificate of incorporation which requires the
vote of holders of 66 2/3% of the outstanding voting capital stock to call a
special meeting of the shareholders. The board will amend the by-laws to
allow special meetings of the shareholders to be called at the request of
holders of 50% of the outstanding voting capital stock.
e. Replace the present method of electing directors and the length of their
terms with a system in which all directors are elected at one time for a term
expiring at the next annual meeting. Directors are currently elected to three
year staggered terms.
f. Require 66 2/3% of Universal American's board of directors to approve some
important corporate actions.
YOU MUST VOTE ON EACH ITEM OF PROPOSAL NO. 2 SEPARATELY, BUT YOU DO NOT
HAVE TO VOTE THE SAME WAY ON EACH ITEM.
EVEN THOUGH SHAREHOLDERS OWNING OVER 50% OF THE OUTSTANDING VOTING STOCK
HAVE AGREED TO VOTE IN FAVOR OF ITEM (a) OF PROPOSAL NO. 2, THE VOTING AGREEMENT
DOES NOT COVER THE APPROVAL OF ITEMS (b) THROUGH (f) OF PROPOSAL NO. 2. IN
ADDITION, ITEMS (b) THROUGH (e) REQUIRE APPROVAL BY HOLDERS OF 66 2/3% OF THE
TOTAL OUTSTANDING VOTING SHARES ENTITLED TO VOTE ON THOSE ITEMS. ACCORDINGLY,
YOUR VOTE IS VERY IMPORTANT TO THE APPROVAL OF THE AMEND-
9
<PAGE> 15
MENTS TO THE CERTIFICATION OF INCORPORATION AND YOU ARE REQUESTED TO COMPLETE
AND RETURN YOUR BALLOT. Failure to return your ballot will be considered a vote
against each item of Proposal No. 2.
THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THESE AMENDMENTS TO THE
CERTIFICATE OF INCORPORATION AND RECOMMENDS A VOTE FOR EACH ITEM OF PROPOSAL NO.
2.
YOU ARE URGED TO REVIEW CAREFULLY THE MORE DETAILED INFORMATION INCLUDED IN
THIS PROXY STATEMENT AND THE ACCOMPANYING ANNEXES.
10
<PAGE> 16
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
We are providing the following historical financial information to aid you
in your analysis of the financial aspects of the Capital Z Issuance and the
acquisition of the Penn Union Companies. This information is only a summary and
you should read it in conjunction with the historical financial statements and
other financial information contained in Universal American's most recent annual
and quarterly reports filed with the SEC, the historical financial information
and more detailed financial information provided in Annex E to this proxy
statement, and the historical financial information in the other documents to
which we refer. See "Where You Can Find More Information" on page 97.
The summary historical financial information for Universal American is
derived from consolidated financial statements of Universal American and was
prepared in accordance with GAAP. The financial statements for Universal
American as of December 31, 1996 and 1997 and each of the two years in the
period ended December 31, 1997 have been audited by Ernst & Young LLP,
independent auditors. The financial statements for Universal American for the
year ended December 31, 1995 have been audited by KPMG LLP, independent
auditors. The summary financial information for Universal American as of
September 30, 1998 and for the nine month periods ended September 30, 1997 and
1998 was derived from unaudited consolidated financial statements of Universal
American that include all adjustments, including normally occurring accruals,
that we consider necessary for a fair presentation of the results of operations
for the periods presented.
The combined financial statements for the Penn Union Companies for the
years ended December 31, 1995, 1996 and 1997 have been audited by KPMG LLP,
independent auditors. The summary financial information for the Penn Union
Companies as of September 30, 1998 and for the nine months ended September 30,
1997 and 1998 was derived from unaudited combined financial statements of the
Penn Union Companies, that include all adjustments, including normally occurring
accruals, that the Penn Union Companies consider necessary for fair presentation
of the results of operations for the periods presented.
The results of operations for the nine months ended September 30, 1998 for
Universal American and the Penn Union Companies are not necessarily indicative
of the results for the full year.
The Universal American Financial Corp. Unaudited Pro Forma Condensed
Consolidated Statement of Operations for the nine month period ended September
30, 1998 and the year ended December 31, 1997 and the Universal American
Financial Corp. Unaudited Pro Forma Condensed Consolidated Balance Sheet as of
September 30, 1998 present results for Universal American as if the acquisition
and the financing of the acquisition had been consummated as of the beginning of
each period presented. The unaudited pro forma financial information has been
derived from and should be read in conjunction with the Notes to Unaudited Pro
Forma Financial Information that follow on page 18, as well as the historical
Consolidated Financial Statements and Notes of Universal American for the nine
months ended September 30, 1998 (unaudited) and the year ended December 31, 1997
and the historical Combined Financial Statements and Notes of the Penn Union
Companies of PFG for the nine months ended September 30, 1998 (unaudited) and
the year ended December 31, 1997 set forth in Annex E to this proxy statement.
The pro forma adjustments and combined amounts are provided for
informational purposes only, and if the acquisition of the Penn Union Companies
is consummated, Universal American's consolidated financial statements will
reflect the effects of the acquisition only from the date the transaction
occurs. The pro forma adjustments are applied
11
<PAGE> 17
to the historical financial statements of Universal American and the Penn Union
Companies to account for the acquisition of the Penn Union Companies by
Universal American under the purchase method of accounting in accordance with
APB Opinion No. 16. Under this method of accounting, the total purchase cost
will be allocated to the Penn Union Companies' assets and liabilities based on
their relative fair values. These allocations are subject to valuations as of
the date of the acquisition based upon appraisals and other information
available at that time. Accordingly, the final purchase price adjustments will
be different from the amounts reflected in this proxy statement. The unaudited
pro forma combined financial information, however, reflects management's best
estimate based upon currently available information.
The pro forma information is presented for illustrative purposes only and
is not necessarily indicative of the results of operations or financial position
that would have occurred had the acquisition been consummated on the dates
assumed, nor is the pro forma information intended to be indicative of Universal
American's future results of operations.
12
<PAGE> 18
UNIVERSAL AMERICAN FINANCIAL CORP.
INCOME STATEMENT INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------------- ---------------------------
1997 1998 1995 1996 1997
----------- ----------- ------- ------- -------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Direct premium and policyholder
fees.............................. $73,773 $95,945 $46,145 $55,287 $99,339
Reinsurance premium assumed......... 267 658 8,866 10,522 998
Reinsurance premium ceded........... (44,196) (64,763) (18,200) (25,664) (62,623)
------- ------- ------- ------- -------
Net premium and other policyholder
fees........................... 29,844 31,840 36,811 40,145 37,714
------- ------- ------- ------- -------
Net investment income............... 7,511 8,056 8,945 9,850 10,023
Realized gains on investments....... 915 281 674 240 1,133
Fee income.......................... 1,850 1,990 3,137 2,872 2,368
Other income........................ 70 47 244 280 93
------- ------- ------- ------- -------
Total revenues.................... 40,190 42,214 49,811 53,387 51,331
------- ------- ------- ------- -------
Total benefits, claims and other
deductions........................ 37,683 39,161 47,161 53,014 48,120
------- ------- ------- ------- -------
Operating income before taxes....... 2,507 3,053 2,650 373 3,211
Net income after taxes.............. 1,654 2,015 2,642 104 2,119
Redemption accrual on Series C
preferred stock................... 146 325 -- -- 250
------- ------- ------- ------- -------
Net income applicable to common
shareholders(1)................... 1,508 1,690 2,642 104 1,869
======= ======= ======= ======= =======
Diluted income per share............ $ 0.14 $ 0.15 $ 0.25 $ 0.01 $ 0.18
======= ======= ======= ======= =======
</TABLE>
BALANCE SHEET INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, AS OF DECEMBER 31,
------------- -------------------
1998 1996 1997
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Total investments.................................... $159,219 $144,681 $159,429
Total assets......................................... 288,982 242,237 272,575
Policyholder account balances........................ 156,915 134,539 145,085
Series C preferred stock............................. 5,168 -- 5,168
Series B preferred stock............................. 4,000 4,000 4,000
Stockholders' equity................................. 29,210 22,079 25,706
Stockholders' equity per share of common stock(2).... 3.30 2.53 2.96
</TABLE>
- -------------------------
(1) After provision for Series C preferred stock dividends of $146 and $325 for
the nine months ended September 30, 1997 and 1998, respectively and $250 for
the year ended December 31, 1997.
(2) Stockholders' equity per share of common stock represents shareholders'
equity less the stated value of Series B preferred stock divided by
outstanding shares of common stock.
13
<PAGE> 19
THE PENN UNION COMPANIES
INCOME STATEMENT INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------------- ------------------------------
1997 1998 1995 1996 1997
----------- ----------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Direct premium and policyholder
fees............................. $243,851 $224,826 $161,188 $329,871 $326,096
Reinsurance premiums assumed....... 4,319 3,357 9,156 22,514 5,029
Reinsurance premiums ceded......... (78,431) (68,034) (4,058) (56,123) (106,121)
-------- -------- -------- -------- --------
Net premium and policyholder fees
earned........................ 169,739 160,149 166,286 296,262 225,004
Net investment income.............. 36,209 36,720 30,572 48,113 47,405
Realized gains (losses) on
investments...................... 5,342 2,568 (278) (616) 4,795
Other income....................... 12,250 7,690 3,717 9,252 17,550
-------- -------- -------- -------- --------
Total revenues................... 223,540 207,127 200,297 353,011 294,754
Total benefits, claims and other
deductions....................... 203,332 295,375 153,397 298,937 262,860
-------- -------- -------- -------- --------
Operating income (loss) before
taxes............................ 20,208 (88,248) 46,900 54,074 31,894
Net income (loss) after taxes...... $ 15,955 $(57,392) $ 27,432 $ 36,468 $ 24,305
</TABLE>
BALANCE SHEET INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, AS OF DECEMBER 31,
------------- -----------------------
1998 1996 1997
------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Total investments................................ $ 707,652 $ 651,061 $ 674,749
Total assets..................................... 1,143,232 1,226,372 1,266,182
Policy liabilities and accruals.................. 636,950 638,991 666,598
Business equity.................................. 441,895 483,179 498,840
</TABLE>
14
<PAGE> 20
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
----------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
---------- ---------- ---------------- ------------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Net premium and policyholder
fees earned.................. $31,840 $160,149 $(41,919) $ -- $150,070
Net investment income.......... 8,056 36,720 (5,644) -- 39,132
Realized gains on investments.. 281 2,568 (25) -- 2,824
Other income................... 2,037 7,690 6 -- 9,733
------- -------- -------- -------- --------
Total revenues................. 42,214 207,127 (47,582) -- 201,759
------- -------- -------- -------- --------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.......... 28,152 138,380 (36,268) -- 130,264
Change in deferred acquisition
costs........................ (2,814) 54,464 (1,195) (77,128)(2) (26,673)
Amortization of present value
of future profits............ 131 9,542 (2,426) (7,116)(3) 131
Amortization of goodwill....... 116 4,167 -- (4,167)(3) 116
Amortization of negative
goodwill..................... -- -- -- (2,032)(4) (2,032)
Interest expense on the senior
secured note................. -- -- -- 4,996(5) 4,996
Interest expense on the
subordinated note............ -- -- -- 2,340(5) 2,340
Other operating costs and
expenses..................... 13,576 88,822 (14,000) (1,545)(6) 86,853
------- -------- -------- -------- --------
Total benefits, claims and
other deductions............. 39,161 295,375 (53,889) (84,652) 195,995
------- -------- -------- -------- --------
Operating income (loss) before
taxes........................ 3,053 (88,248) 6,307 84,652 5,764
Federal income tax expense
(benefit).................... 1,038 (30,856) 2,225 29,417(7) 1,824
------- -------- -------- -------- --------
Net income (loss).............. 2,015 (57,392) 4,082 55,235 3,940
Redemption accrual on Series C
preferred stock.............. 325 -- -- (325)(8) --
------- -------- -------- -------- --------
Net income (loss) applicable to
common shareholders.......... $ 1,690 $(57,392) $ 4,082 $ 55,560 $ 3,940
======= ======== ======== ======== ========
EARNINGS PER COMMON SHARE:
Basic.......................... $ 0.23 $ 0.11
======= ========
Diluted........................ $ 0.15 $ 0.10
======= ========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING:
Basic.......................... 7,498 27,857 35,355
Diluted........................ 13,070 27,857 40,927
</TABLE>
15
<PAGE> 21
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
----------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
---------- ---------- ---------------- ------------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Net premium and policyholder
fees earned.................. $37,714 $225,004 $(64,780) $ -- $197,938
Net investment income.......... 10,023 47,405 (8,457) -- 48,971
Realized gains on
investments.................. 1,133 4,795 (885) -- 5,043
Other income................... 2,461 17,550 35 -- 20,046
------- -------- -------- -------- --------
Total revenues................. 51,331 294,754 (74,087) -- 271,998
------- -------- -------- -------- --------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.......... 30,806 144,451 (52,673) -- 122,584
Change in deferred acquisition
costs........................ (2,946) (27,177) 4,597 (11,844)(2) (37,370)
Amortization of present value
of future profits............ -- 17,352 (4,421) (12,931)(3) --
Amortization of goodwill....... 112 5,594 -- (5,594)(3) 112
Amortization of negative
goodwill..................... -- -- -- (2,710)(4) (2,710)
Interest expense on the senior
secured note................. -- -- -- 6,889(5) 6,889
Interest expense on the
subordinated note............ -- -- -- 3,120(5) 3,120
Other operating costs and
expenses..................... 20,148 122,640 (25,574) (2,209)(6) 115,005
------- -------- -------- -------- --------
Total benefits, claims and
other deductions............. 48,120 262,860 (78,071) (25,279) 207,630
------- -------- -------- -------- --------
Operating income before taxes.. 3,211 31,894 3,984 25,279 64,368
Federal income tax expense..... 1,092 7,589 1,410 8,849(7) 18,940
------- -------- -------- -------- --------
Net income..................... 2,119 24,305 2,574 16,430 45,428
Redemption accrual on Series C
preferred stock.............. 250 -- -- (250)(8) --
------- -------- -------- -------- --------
Net income applicable to common
shareholders................. $ 1,869 $ 24,305 $ 2,574 $ 16,680 $ 45,428
======= ======== ======== ======== ========
EARNINGS PER COMMON SHARE:
Basic.......................... $ 0.26 $ 1.29
======= ========
Diluted........................ $ 0.18 $ 1.14
======= ========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING:
Basic.......................... 7,242 27,857 35,099
Diluted........................ 12,041 27,857 39,898
</TABLE>
16
<PAGE> 22
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
FINANCING PURCHASE
UNIVERSAL ACCOUNTING PENN UNION ACCOUNTING PRO FORMA
AMERICAN ADJUSTMENTS(9) COMPANIES ADJUSTMENT(10) CONSOLIDATED
---------- -------------- ---------- --------------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Total investments.............. $159,219 $ -- $ 707,652 $ -- $ 866,871
Deferred policy acquisition
costs........................ 21,927 -- 114,746 (114,746) 21,927
Goodwill....................... 4,393 -- 104,873 (104,873) 4,393
Present value of future
profits...................... 1,613 -- 92,829 (92,829) 1,613
Other assets................... 101,830 6,187 123,132 -- 231,149
-------- -------- ---------- --------- ----------
Total assets................... 288,982 6,187 1,143,232 (312,448) 1,125,953
======== ======== ========== ========= ==========
LIABILITIES, SERIES C
PREFERRED STOCK AND
STOCKHOLDERS' EQUITY:
Reserves for future policy
benefits..................... 220,643 -- 636,950 -- 857,593
Loan payable................... 5,000 (5,000) -- -- --
Senior secured note payable.... -- 70,000 -- -- 70,000
Subordinated note payable...... -- 39,000 -- -- 39,000
Deferred income tax
liability.................... 1,583 -- 11,957 (72,652) (59,112)
Negative goodwill.............. -- -- -- 27,099 27,099
Other liabilities.............. 26,804 -- 52,430 -- 79,234
-------- -------- ---------- --------- ----------
Total liabilities............ 254,030 104,000 701,337 (45,553) 1,013,814
-------- -------- ---------- --------- ----------
Series C preferred stock
(including redemption accrual
thereon)..................... 5,742 (5,742) -- -- --
-------- -------- ---------- --------- ----------
Total stockholders' equity..... 29,210 82,929 441,895 (441,895) 112,139
-------- -------- ---------- --------- ----------
Total liabilities, Series C
preferred stock and
stockholders' equity......... $288,982 $181,187 $1,143,232 $(487,448) $1,125,953
======== ======== ========== ========= ==========
</TABLE>
17
<PAGE> 23
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION
(IN THOUSANDS)
Certain one-time events occurring during the nine months ended September
30, 1998 and for the year ended December 31, 1997 are not presented as pro forma
adjustments. However, they impact the pro forma financial statements results.
Due to the non-recurring nature of these events, management believes they will
have no meaningful bearing on the results of operations after this transaction
is completed.
Therefore, below is a reconciliation of pro forma net income applicable to
common shareholders considering these one-time events for December 31, 1997 and
September 30, 1998, respectively:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Pro forma net income applicable to common
shareholders....................................... $45,428 $ 3,940
Long term care reserve adjustment(a)................. -- 7,551
Disability income reserve adjustment(a).............. -- 23,000
Step purchase GAAP accounting adjustments(b)......... (3,087) --
One-time reserve changes(c).......................... (8,269) --
Commission accruals(d)............................... -- 1,039
Reduction of deferrable expenses(d).................. (4,000) --
Restructuring charge(e).............................. -- 1,834
Tax effects of above adjustments..................... 5,375 (11,698)
------- --------
Pro forma adjusted net income applicable to common
shareholders....................................... $35,447 $ 25,666
======= ========
Annualized pro forma adjusted net income applicable
to common shareholders............................. $35,447 $ 34,221
======= ========
</TABLE>
(a) During 1998, the Penn Union Companies refined their calculation of policy
benefit reserves for long-term care products, which resulted in a one-time
increase of approximately $7,551. Additionally, the Penn Union Companies
have been closely monitoring the development of claims reserve experiences.
The methodology previously utilized has experienced what appears to be a
deterioration of the adequacy of its claim reserves associated with its
disability income products at Pennsylvania Life. As a result of the trends,
Pennsylvania Life increased its claims reserve estimate by $23,000 during
the nine-month period ended September 30, 1998. If this adjustment was
pushed back to January 1, 1997, the amortization for 1997 would have been
reduced by $3,087.
(b) The Union Bankers deferred ceding gain was reduced by $7,310 due to the
step purchase accounting as of January 2, 1998 when PFG acquired the
remaining interest of Southwestern Financial Corporation. As a result of
the step purchase treatment, 22% of the assets and liabilities of the
acquired entities, including Union bankers, were marked to fair value at
the date of acquisition. The effect of adjusting Union Bankers assets and
liabilities was an increase in the business equity of Union Bankers of
$830, however this included a reduction of the ceding gain and effectively
reduced the amortization for the period ended September 30, 1998. If this
adjustment was pushed back to January 1, 1997, the amortization for 1997
would have been reduced by $3,087.
(c) During 1997, reserves on the Union Bankers comprehensive block of business
were strengthened by $5,900. Additionally, in 1997, the scheduled reserve
release relating to
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<PAGE> 24
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
the conversion to the new valuation system was $2,369. These one-time
events impacted the expected results for the Penn Union Companies.
(d) Effective in 1998, Pennsylvania Life modified the commission structure and
related participation in agency profitability. As a result, certain agency
field expenses are no longer paid directly by Pennsylvania Life. Instead,
they are factored into the agency commissions. $4,000 is the pre-tax impact
to expenses for 1997 had this change in structure been affected in 1997.
Also, related to this change, one-time commission payments of $1,039 were
accrued in 1998.
(e) As a result of the Penn Union Companies' initiative to transfer
administration of their comprehensive and Medicare supplement blocks to
third party administrators, the Penn Union Companies recognized a pre-tax
restructuring charge of $1,834 during 1998.
Adjustments to the unaudited pro forma condensed consolidated statements of
operations to give effect to the acquisition of the Penn Union Companies as of
January 1, 1997 and 1998 are summarized as follows:
(1) The share purchase agreement contains certain pre-closing restructuring
provisions, including the termination of the reinsurance agreements between
Peninsular Life Insurance Company and Occidental Life Insurance Company of
North Carolina (both are subsidiaries of PFG) and the reinsurance of 100%
of the comprehensive major medical and unreinsured Medicare supplement
business of Union Bankers. The premiums earned, policyholder benefits and
expenses incurred, net investment income earned on the reserves held,
change in deferred acquisition costs, amortization of present value of
future profits, and the related taxes on these items, recorded by the Penn
Union Companies prior to the acquisition have been eliminated.
(2) The deferred acquisition costs recorded by the Penn Union Companies prior
to the acquisition was eliminated. However, the change in deferred
acquisition costs which occurred during the period presented were recorded.
(3) The amortization of the present value of future profits and goodwill
recorded by the Penn Union Companies prior to the acquisition was
eliminated.
(4) Amortization of the excess of estimated fair values of net assets acquired
over the purchase price (negative goodwill) is recognized over a ten-year
period on a straight-line basis.
(5) Interest expense was recorded to reflect the issuance of $70,000 of senior
bank debt with an annual interest rate of 8.69% and the subordinated note
of $39,000 with an annual interest rate of 8.00%.
(6) Management fees charged to the Penn Union Companies by its current parent,
PFG, prior to the acquisition were eliminated.
(7) Income taxes were adjusted at a rate of 35% to reflect the effect on taxes
of notes (2) through (6).
(8) The redemption accrual on the Series C preferred stock of Universal
American accumulated prior to the acquisition was eliminated since these
securities will be converted into common stock of Universal American at the
time of the Capital Z Issuance.
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<PAGE> 25
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
Adjustments to the unaudited pro forma condensed consolidated balance sheet
to give effect to the purchase of the Penn Union Companies as of September 30,
1998 are summarized as follows:
(9) The financing of this acquisition consists of the following:
<TABLE>
<S> <C>
Issuance of common stock.............................. $ 82,000
Senior secured term note.............................. 70,000
Issuance of subordinated notes........................ 39,000
--------
Total sources of financing......................... $191,000
========
The uses of the financing consists of the following:
Acquisition of the Penn Union Companies............... $175,000
Refinancing of Universal American's outstanding
loan................................................. 4,750
Expenses incurred in issuance of equity............... 5,063
Expenses incurred on the senior debt financing........ 6,187
--------
Total uses of the financing........................ $191,000
========
</TABLE>
In addition to the financing described above, the Series C preferred stock
will be converted into the common stock of Universal American at the time
of the Capital Z Issuance. As of September 30, 1998, Universal American had
$5,168 of Series C preferred stock outstanding and $575 of redemption
accruals on the Series C preferred stock. The Series C preferred stock will
be converted into common stock at a price of $2.375 per common share (2,176
shares) and the elimination of the redemption accrual will be reflected in
the retained earnings account of Universal American.
(10) The purchase price for the Penn Union Companies is $175,000, including
$136,000 in cash and $39,000 in subordinated notes issued to PFG or its
subsidiaries. The following table reflects the adjustments made to the
acquired business equity of the Penn Union Companies:
<TABLE>
<S> <C>
Net asset value acquired.................................... $441,895
--------
Increase (decrease) in the Penn Union net asset value to
reflect estimated fair value:
Elimination of the historical deferred policy acquisition
costs.................................................. (114,746)
Elimination of the historical present value of future
profits................................................ (104,873)
Elimination of the historical goodwill.................... (92,829)
Elimination of the deferred tax liability related to the
historical adjustments................................. 72,652
--------
Total estimated fair value adjustments............. 239,796
--------
Estimated fair value of net assets acquired................. 202,099
Purchase price.............................................. 175,000
--------
Excess of estimated fair value of net assets acquired over
purchase price (negative goodwill)........................ $ 27,099
========
</TABLE>
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<PAGE> 26
THE CAPITAL Z ISSUANCE AND THE
ACQUISITION OF THE PENN UNION COMPANIES
Some statements in this proxy statement are forward-looking and are
identified by the use of forward-looking words or phrases such as "intended,"
"will be positioned," "expects," is or are "expected," "anticipates," and
"anticipated." These forward-looking statements are based on Universal
American's current expectations. To the extent any of the information contained
in this proxy statement is a "forward-looking statement" as defined in Section
27A(i)(1) of the Securities Act of 1933, the considerations set forth below are
cautionary statements identifying important factors that could cause results to
differ materially from those in the forward-looking statement. Realization of
management's beliefs and projections will depend on a number of factors,
including management's successful execution of its business plan for integrating
the Penn Union Companies into Universal American; the insurance market's
reception to the acquisition; Universal American's success in obtaining,
retaining and selling additional services to clients; the pricing of products
and services; overall economic trends, including interest rate trends; impact of
the Year 2000; stock market activity; employment levels; changes in technology;
changes in insurance laws and regulations; and other factors beyond Universal
American's control.
BACKGROUND
On February 18, 1998, PFG announced that it had engaged Salomon Smith
Barney and Fox-Pitt Kelton Inc. to review strategic alternatives for maximizing
value for shareholders of PFG, including the sale of the Penn Union Companies.
In the spring of 1998, management of PFG and Salomon Smith Barney approached
Capital Z to discuss a possible acquisition of the Penn Union Companies by
Capital Z. On May 29, 1998, Capital Z and PFG executed a confidentiality
agreement to facilitate the sharing of confidential information for the purpose
of evaluating a potential acquisition.
On March 26, 1998, CSI approached Universal American and suggested that
Universal American consider bidding for the Penn Union Companies. CSI indicated
that it would help raise the equity and debt financing necessary for any
acquisition. On May 29, 1998, Universal American engaged CSI as a financial
advisor in connection with the possible acquisition of the Penn Union Companies.
The terms of CSI's engagement were later revised. In May of 1998, Universal
American and PFG executed a confidentiality agreement to facilitate the sharing
of confidential information for the purpose of evaluating a potential
acquisition.
Universal American began limited due diligence on the Penn Union Companies
after receiving informational materials from Salomon Smith Barney in June 1998.
Thereafter, Universal American, through CSI, held a series of meetings with PFG
executives to discuss the possibility of working with members of a
management-led buyout group. These discussions terminated in June 1998.
While Capital Z and Universal American were each independently engaging in
discussions about the possibility of acquiring the Penn Union Companies, in July
of 1998, CSI, some affiliates of which have a variety of business relationships
with Capital Z, introduced management of Universal American to Capital Z.
Capital Z and Universal American then began discussions about the
possibility of working together to acquire the Penn Union Companies. On August
13, 1998, Richard Barasch informed the board of Universal American that
Universal American had begun to consider a transaction with Capital Z to
purchase the Penn Union Companies.
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<PAGE> 27
On August 21, 1998, Capital Z and PFG executed a preliminary, non-binding
indication of interest setting forth the preliminary proposed terms of a
possible acquisition by Capital Z of the Penn Union Companies. The indication of
interest included an exclusivity agreement in which PFG agreed that for 45 days
it would not entertain offers from any other person to purchase the Penn Union
Companies. This exclusivity period was eventually extended to December 21, 1998.
The indication of interest also stated that Capital Z was considering including
Universal American in the transaction to acquire the Penn Union Companies.
On September 14, 1998, an initial draft of the acquisition agreement was
delivered to Capital Z and its legal advisors, and Capital Z and PFG began to
negotiate the terms of the definitive agreement in connection with the potential
acquisition, including the purchase price, which PFG and Capital Z agreed would
be in the form of cash and debt securities. Universal American and its advisors
later joined in the negotiations of the terms of the acquisition agreement and
Universal American intensified its due diligence.
During the following weeks, representatives of the parties, through
face-to-face meetings and telephonic conference calls, discussed various issues
raised by the draft acquisition agreement and related documentation. On October
29, 1998 and November 9, 1998, the board of directors of Universal American met
to discuss the potential transactions and authorized Universal American to
continue to proceed with discussions on the proposed acquisition and the Capital
Z Issuance.
In November 1998, representatives of Capital Z and Universal American and
their legal advisors began negotiations of the terms of the agreements relating
to the Capital Z Issuance. Through face-to-face meetings and telephonic
conference calls, representatives of Capital Z and Universal American and their
respective legal advisors discussed various issues raised by the draft share
purchase agreement and related documentation, including the per share purchase
price and, in particular, indemnification issues related to the acquisition of
the Penn Union Companies. Negotiations of the acquisition agreement and the
share purchase agreement continued until December 31, 1998, at which time both
agreements were executed.
During the period when the acquisition agreement and the share purchase
agreement were being negotiated, the board of directors of Universal American
held meetings to discuss the potential acquisition of the Penn Union Companies
and the potential investment by Capital Z. At a meeting held on December 8,
1998, CSI and one of Universal American's legal advisors, Simpson Thacher &
Bartlett, made presentations to the board about the acquisition and the
investment. On December 8, 1998, Universal American hired Advest to analyze the
transaction and provide a fairness opinion as to both the acquisition and the
Capital Z Issuance. Over several weeks the board of directors, in consultation
with CSI, and subsequently Advest, analyzed the proposed acquisition and the
effect on Universal American of the Capital Z Issuance, the senior debt
financing and the issuance of the subordinated notes. At a meeting held on
December 17, 1998, the terms of the acquisition agreement and the share purchase
agreement were described in detail to the board. At a meeting held on December
23, 1998, the board approved, subject to the receipt of a favorable fairness
opinion of Advest by a designated committee of the board, the execution and
delivery of the share purchase agreement and the acquisition agreement. For a
discussion of the reasons for the board's decision to approve the transactions
contemplated by the acquisition agreement and the share purchase agreement and
the factors considered by the board, see "-- Reasons for the Acquisition and the
Capital Z Issuance" on page 25. Finally, at a meeting held on December 24, 1998,
a designated committee of the board met to discuss Advest's fairness opinion. At
that time, the committee accepted Advest's
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<PAGE> 28
affirmative opinion that (i) the $175 million Universal American agreed to pay
to purchase the Penn Union Companies and (ii) the controlling-interest
investment in Universal American by Capital Z, together with the additional
investment by AAM and some agents and members of the management of the Penn
Union Companies, both individually and in the aggregate, are fair from a
financial point of view to Universal American and its shareholders. The Advest
opinion was subsequently delivered to the full board.
UNIVERSAL AMERICAN FINANCIAL CORP.
Universal American was incorporated in New York in 1981. Universal American
is a life and accident and 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"), American Exchange Life Insurance Company ("American Exchange"),
and WorldNet Services Corp. ("WorldNet"), a third party administrator that
provides communication, managed care and claims adjudication services to its
subsidiaries and non-affiliated insurance companies and affinity groups.
American Pioneer, American Progressive and American Exchange are referred to in
this proxy statement as the "Insurance Subsidiaries." Through its insurance
subsidiaries, Universal American markets and underwrites accident and health
insurance products aimed at the senior market, including Medicare supplement,
long-term care and home health care. Universal American also underwrites life
insurance and annuities.
CAPITAL Z FINANCIAL SERVICES FUND II, L.P.
Capital Z is a $1.8 billion fund that was formed to make investments in
securities of a diversified global portfolio of insurance, financial services
and healthcare services companies and other related businesses. Capital Z
focuses primarily on opportunities within the United States and Western Europe
and, to a lesser extent, the emerging markets of Asia, Latin America and Eastern
Europe.
Capital Z is managed by Capital Z Partners, L.P., a global alternative
asset investment management firm headquartered in New York with offices or
affiliates in London and Hong Kong. The investment professionals of Capital Z
Partners, L.P. were formerly with three organizations: International Insurance
Investors, L.P., Insurance Partners, L.P. and Zurich Centre Investments, Inc.
Between 1990 and 1997, these three organizations have invested in such companies
as: National Reinsurance Corporation, Superior National Insurance Group, Inc.,
Provident Companies, Inc., Kemper Corporation, Transport Holdings, Inc., USI
Insurance Services Corp., and CAT Limited, as well as many others.
THE PENN UNION COMPANIES
PFG, incorporated in Delaware in 1989, is a holding company. The principal
subsidiaries of PFG are insurance companies. During 1997, PFG restructured its
operating units into three primary business units: the Penn Union Companies, the
Payroll Sales Division, and the Financial Services Division.
The Penn Union Companies include the operations of Pennsylvania Life,
Penncorp Life Insurance Company, a Canadian company ("Penncorp Life"),
Peninsular Life Insurance Company ("Peninsular"), Union Bankers, Constitution
Life Insurance Company ("Constitution"), Marquette National Life Insurance
Company ("Marquette"), PennCorp Financial, Inc. and selected assets of PennCorp
Financial Services, Inc. Pennsylvania Life, Penncorp Life and Peninsular are
referred to in this proxy statement as the "PennLife Companies." Union Bankers,
Constitution and Marquette are referred to as the "ConLife Companies."
23
<PAGE> 29
The Penn Union Companies, through a distribution system of approximately
1,000 career agents and a network of producers, market fixed benefit accident
and health insurance policies and life insurance and asset accumulation
products. Pennsylvania Life, together with its wholly owned subsidiary, Penncorp
Life, operates through a career agency system with over 100 sales offices
located in rural and suburban areas throughout the United States and Canada.
Historically, Pennsylvania Life sold small face amount disability and
hospitalization products on a home service basis. Union Bankers primarily sells
senior-related supplemental health products such as major medical, Medicare
supplement, long term care and home health care through a network of managing
general agents.
FINANCING OF THE ACQUISITION OF THE PENN UNION COMPANIES
Universal American will acquire the Penn Union Companies for total
consideration equal to $175 million, consisting of $136 million in cash and $39
million in original principal amount of subordinated notes of Universal American
to be issued to PFG.
Capital Z Issuance. If completed, the Capital Z Issuance will provide up
to approximately $82 million to Universal American to finance a portion of the
acquisition price of the Penn Union Companies.
Subordinated Notes. Universal American will raise a portion of the
purchase price it will pay to PFG to acquire the Penn Union Companies by issuing
to PFG or its subsidiaries $39 million in original principal amount of
subordinated notes. The subordinated notes will have a ten-year term and will
bear interest at a rate of 8% per year which will accumulate and compound or be
paid in cash, at Universal American's option, quarterly. The subordinated notes
are junior in right of payment to the senior debt financing and to all other
existing and future indebtedness of Universal American. In some circumstances,
the subordinated notes are subject to downward and upward adjustment either
through reduction of the principal amount by Universal American to settle
obligations owed to it by PFG or the issuance by Universal American to PFG of up
to $10 million in principal amount plus interest thereon of additional
subordinated notes. See "-- Material Terms of the Acquisition Agreement and
Related Transactions -- Reserve Adjustment" and "-- Material Terms of the
Acquisition Agreement and Related Transactions -- Set-Off Right" on page 40.
Senior Debt Financing. Universal American also intends to incur senior
debt financing with estimated proceeds of approximately $80 million, $70 million
in the form of a term loan and $10 million in the form of a revolving credit
facility. The interest rate, due date, and other terms of the senior debt
financing have been determined in arm's length negotiations between Universal
American and Chase Bank and CSI, as agents to the lenders under the credit
facility.
24
<PAGE> 30
Sources and Uses of Funds. The sources and uses of funds in the acquisition
are summarized as follows:
<TABLE>
<S> <C>
SOURCES OF FUNDS:
Equity investment...................................... $82.00 million
Term loan.............................................. 70.00 million
Subordinated notes..................................... 39.00 million
----------------
Total................................................ $191.00 million
================
USES OF FUNDS:
Acquisition of the Penn Union Companies................ $175.00 million
Refinancing existing debt.............................. 4.75 million
Expenses incurred in equity issuance................... 5.06 million
Expenses incurred in the senior debt financing......... 6.19 million
----------------
Total................................................ $191.00 million
================
</TABLE>
REASONS FOR THE ACQUISITION AND THE CAPITAL Z ISSUANCE
After considering all the benefits and potential risks of the proposed
transactions, the board of directors approved the acquisition and the Capital Z
Issuance, reflecting its belief that the various risks and mitigating factors it
considered were outweighed by the substantial benefits it expected Universal
American to receive from these transactions, including, that:
- Universal American wanted to finance a substantial portion of the
acquisition through the issuance of equity, as opposed to additional debt
financing, to allow Universal American to maintain a more conservative
debt-to-equity ratio and satisfy rating agency considerations;
- The per share consideration to be received by Universal American for its
common stock will be at a premium to the average daily market closing
price for 1998;
- Universal American will have the opportunity to improve the financial
performance of the Penn Union Companies through a lower corporate cost
structure and the introduction of new products;
- Universal American will have the opportunity to market senior-related
insurance products to the policyholder base of the Penn Union Companies
through the career sales force of the Penn Union Companies;
- Universal American will be able to diversify its products and increase
geographic distribution;
- Universal American will benefit from economies of scale over a period of
years, potentially realizing cost savings as a result; and
- Universal American will benefit from a higher profile in the insurance
industry as a result of its relationship with Capital Z, and, in
addition, that relationship may provide opportunities for additional
acquisitions and continued growth, greater access to capital markets and
enhanced shareholder value.
Before approving the acquisition and the Capital Z Issuance, the board of
directors also considered a number of mitigating factors that could prevent
Universal American from
25
<PAGE> 31
realizing these benefits and could possibly materially and adversely affect
Universal American's financial condition and results of operation, including
that:
- Universal American may not be successful in coordinating and integrating
the operations and business enterprises of Universal American and the
Penn Union Companies and, consequently, Universal American may not
realize the expected benefits of the acquisition;
- Universal American will have to service a greater amount of debt after
the acquisition which will require dividend payments from its insurance
subsidiaries and the ability of its subsidiaries to make such dividend
payments is subject to certain legal restrictions; greater leverage
presents a greater degree of financial risk and the failure of Universal
American to meet its debt obligations would likely have a significant
adverse financial impact on Universal American;
- The change in Universal American's operating strategy caused by the
utilization of the career sales force of the Penn Union Companies may not
be successful;
- The anticipated long-term economies of scale may fail to materialize,
adversely affecting Universal American's cash flow and earnings before
taxes; and
- The concentration of ownership of Universal American by Capital Z could
delay or prevent an advantageous change in control of Universal American,
or have a depressive effect on the trading market for Universal
American's common stock.
In evaluating the above factors, the board of directors found particularly
important the prospect of increased sales through an enhanced field force and
increased geographic scope. While the board of directors was particularly
sensitive to change of control issues and other risks associated with the
ownership by Capital Z, the board determined that the opportunities for future
acquisitions and continued growth, together with the potential for greater
access to the capital markets and increased shareholder value, sufficiently
mitigated this concern.
The board also gave significant weight to its view that size and financial
strength are critical to success in the insurance industry. On a pro forma
basis, after the acquisition, Universal American would have had net premiums and
policyholder fees earned of $202 million for the nine months ended September 30,
1998 and $272 million for the year ending December 31, 1997, and total assets of
$1,126 million on a pro forma combined basis as of September 30, 1998. If the
acquisition of the Penn Union Companies and the Capital Z Issuance had been
completed on January 1, 1998, pro forma earnings per share of Universal American
for the nine months ended September 30, 1998 would have been $.10 per share
assuming that all of Universal American's securities that could be converted or
exercised into common stock had been converted or exercised. See "Unaudited Pro
Forma Financial Information -- Universal American Financial Corp. Unaudited Pro
Forma Condensed Consolidated Statement of Operations -- Nine Months Ended
September 30, 1998."
Universal American received an opinion dated December 31, 1998 from
Advest -- the full text of which, including the assumptions made, matters
considered, and limits on the reviews undertaken, is attached to the proxy
statement as Annex C -- that as of the date of the opinion the financial terms
and effects of the Capital Z Issuance, together with an additional investment by
AAM, and the acquisition of the Penn Union Companies by Universal American, both
individually and in the aggregate, are fair, from a financial point of view, to
Universal American and its shareholders. Advest's Opinion will not be updated
prior
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<PAGE> 32
to the closing of the Capital Z Issuance and the acquisition of the Penn Union
Companies. In addition, CSI made a presentation to the board of Universal
American in which it analyzed the Capital Z Issuance and the acquisition of the
Penn Union Companies by Universal American. Both Advest and CSI received fees
for their work and will be reimbursed for their expenses and indemnified from
and against certain liabilities in connection with their engagements. For a
description of the investment by AAM see "Interests of Persons Involved in the
Capital Z Issuance and the Acquisition That May Be Different From Yours --
Investment by AAM in Universal American."
Ultimately, after weighing the various risks and concerns against the
expected benefits and after evaluating the information provided by its financial
advisors, including Advest's fairness opinion, the board of directors determined
that completing the acquisition and the Capital Z Issuance are in the best
interests of Universal American and its shareholders.
The Chase Manhattan Corporation and its affiliates, including CSI
(collectively, "Chase"), in the ordinary course of business, have from time to
time provided commercial and investment banking services to Universal American
and to PFG and its subsidiaries, for which Chase received usual and customary
compensation, and in the future may continue to provide commercial and
investment banking services. In the ordinary course of business, Chase may trade
in the debt and equity securities of Universal American and/or PFG and their
subsidiaries for Chase's own accounts and for the accounts of their customers
and, accordingly, may at any time hold a long or short position in such
securities. In addition, CSI advised the board of directors of Universal
American of the following additional relationships among Chase, Universal
American, Capital Z and PFG: (a) Chase owns the second largest limited
partnership interest in Capital Z; (b) Chase is an investor in a fund managed by
AAM, which is a shareholder of Universal American, and a representative of AAM
is a member of the board of directors of Universal American; (c) Universal
American requested that Chase consider arranging a financing in connection with
the transactions described in this proxy statement and Chase arranged this
financing and is a lender under the proposed senior debt financing; (d) Chase is
a minority shareholder in Universal American; (e) Chase is a minority
shareholder of PFG; (f) Chase has made a loan to PFG, which will be repaid, in
part, from the proceeds of the acquisition; (g) Chase is a lender to Universal
American under its current credit facility in an amount equal to $4.75 million,
which amount will be paid in full with a portion of the proceeds of the proposed
transactions; and (h) Chase is a lender to other companies affiliated with
Capital Z.
The foregoing discussion of the information and factors considered by the
board of directors is not intended to be exhaustive, but we believe it includes
the material factors considered by the board. In light of the number and variety
of information and factors the board considered in connection with its
evaluation of the Capital Z Issuance and the acquisition of the Penn Union
Companies, the board did not find it practicable to, and did not, assign any
specific or relative weights to the foregoing factors, and individual directors
may have attached differing weights to different factors. For a discussion of
the interests of certain persons in the transactions, see "Interests of Persons
in the Acquisition Agreement and the Share Purchase Agreement That May Be
Different From Yours." The board recognized such interests and determined that
such interests neither supported nor detracted from its determination that the
Capital Z Issuance and the acquisition of the Penn Union Companies is in the
best interests of Universal American and its shareholders.
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<PAGE> 33
CAPITAL Z ISSUANCE
Upon approval of the shareholders of Universal American and the
satisfaction or waiver of the other conditions to the Capital Z Issuance,
Capital Z and some agents and members of management of the Penn Union Companies
will purchase up to 26,031,746 shares of common stock of Universal American for
$3.15 per share, for a total purchase price of up to approximately $82 million.
The investment by those agents and members of management is expected to equal
approximately $5.5 million. The aggregate investment by Capital Z is expected to
be approximately $76.5 million and the total aggregate equity investment of
Capital Z, together with those agents and members of management, will be
approximately $82 million. At Capital Z's option, Universal American may also
pay a portion of a transaction fee in shares of common stock to an affiliate of
Capital Z.
The statements made in this proxy statement with respect to the terms of
the Capital Z Issuance and related transactions governed by the share purchase
agreement are qualified in their entirety by reference to the more complete
information set forth in Annex A.
Governmental and Regulatory Approvals. The Capital Z Issuance is subject
to: approval of the insurance regulatory authorities in New York, Florida,
Texas, Pennsylvania and North Carolina; approvals under Canadian federal and
provincial laws; compliance with applicable state and federal securities laws;
approvals from or notices to various states; and the expiration of the waiting
period under the HSR Act. Universal American and Capital Z are in the process of
making the required filings. In addition, the shareholders must approve the
Capital Z Issuance and item (a) of Proposal No. 2. In addition, a majority of
the holders of the Series C-1 preferred stock must approve the senior debt
financing and the issuance of the subordinated notes to PFG. We expect to obtain
approvals from the Series C-1 holders.
Effect of Capital Z Issuance. Following the Capital Z Issuance and the
conversion into shares of common stock of the Series B preferred stock, some of
the Series C-1 preferred stock, the Series C-2 preferred stock, the Series D-1
preferred stock and the Series D-2 preferred stock (collectively the
"Convertible Preferred Stock"), Capital Z will own in the aggregate
approximately 24,722,222 shares, representing approximately 63.0% of Universal
American's then-outstanding common stock. If all of the securities of Universal
American that could be converted or exchanged into common stock were converted
or exchanged, Capital Z would own approximately 56.8% of the outstanding common
stock. After the Capital Z Issuance, Capital Z, pursuant to a shareholders'
agreement, will have the ability to nominate 4 of Universal American's 9
directors and Universal American will have the ability to nominate two
directors. However, since Capital Z will own over 50% of Universal American's
outstanding stock after the Capital Z Issuance, it will effectively be able to
select 6 of the 9 directors on the board of Universal American.
MATERIAL TERMS OF THE SHARE PURCHASE AGREEMENT
Per Share Purchase Price Adjustment
There will be a per share purchase price adjustment if Universal American
is subject to an MAE Event before the closing. An "MAE Event" occurs if there is
one or a series of related event(s), condition(s), or circumstance(s) occurring
after the date of signing and before the closing that has had, or is reasonably
likely to have, an adverse impact on the business, results of operations or
financial condition of Universal American and its subsidiaries, taken as a
whole, that would reduce the value of Universal American and its subsidiaries,
taken as a whole, by an amount in excess of $3 million. If an MAE Event causes
the purchase price per share payable by Capital Z to be $2.25 per share or less,
calculated pursuant to a formula specified in the share purchase agreement,
(i.e., if the per
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<PAGE> 34
share purchase price adjustment would be $0.90 or more), Capital Z will have the
absolute right, but not the obligation, (i) to cause Universal American to
assign to another person all of Universal American's rights and obligations
under the acquisition agreement and (ii) upon such assignment and assumption,
the parties' obligations under the share purchase agreement, except for
specified indemnification obligations, will terminate. If the substitute buyer
consummates the closing, Universal American will not be liable for, and Capital
Z will indemnify Universal American from, liabilities relating to the
acquisition agreement.
Representations and Warranties of Universal American
Except as otherwise specified or disclosed, Universal American makes
representations and warranties about: (i) the due organization and good standing
of Universal American and its subsidiaries, (ii) Universal American's
capitalization, (iii) the authorization of the share purchase agreement, (iv)
the valid issuance of the common stock to be issued under the share purchase
agreement, (v) pending or threatened litigation, (vi) that the share purchase
agreement does not violate any agreement, law, charter or by-law provision and
no governmental or third-party consents are required to execute, deliver, and
perform the share purchase agreement, (vii) specified tax matters, (viii) the
accuracy of financial statements and filings with the SEC, (ix) the conduct of
business in the ordinary course and the absence of any material adverse change
in the financial condition, results of operations of Universal American since
December 31, 1997, (x) Universal American's and its subsidiaries' compliance
with the applicable laws, (xi) the existence and identity of brokers and finders
and (xii) potential conflicts of interest.
Representations and Warranties of Capital Z
Capital Z makes representations and warranties about: (i) its organization
and good standing and authorization of the share purchase agreement, (ii) the
share purchase agreement's non-contravention of any agreement, law or charter
provision, except to the extent contravention would not have a materially
adverse impact on Capital Z's ability to consummate the transactions or perform
its obligations, and, except as specified, the ability of Capital Z to execute,
deliver, and perform the share purchase agreement without obtaining any
additional governmental or third-party consents, (iii) the existence and
identity of brokers and finders, (iv) the availability of funds to meet such
entity's obligation to purchase the shares of common stock, and (v) state and
federal securities laws matters.
Material Covenants
The share purchase agreement contains the following material covenants:
Conduct of Business Prior to Closing; Management of Universal
American. During the period from the date of the share purchase agreement to
the closing, except as otherwise contemplated by the share purchase agreement,
by the acquisition agreement, or as Capital Z otherwise agrees in writing in
advance, Universal American has agreed not to:
- except in the ordinary course of business, incur or issue any
indebtedness or assume, guarantee or endorse the obligations of any other
person;
- except in the ordinary course of business, including the managing by
Universal American of its investment assets, (a) sell, transfer or
otherwise dispose of any of its property or assets, (b) mortgage or
encumber any of its property or assets or (c) enter into any material
contracts;
- repurchase any of its capital stock or any capital stock of any of its
subsidiaries;
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- declare, set aside or pay any dividend or other distribution on its
capital stock;
- amend its certificate of incorporation or by-laws or merge with or into
or be consolidated with any other person;
- split, combine or reclassify its capital stock;
- other than in connection with ordinary course exercises of outstanding
options or grants under existing stock option plans, issue or sell any of
its equity securities or any options, warrants, conversion or other
rights to purchase any such securities or agree to grant any such rights;
- increase the rates of compensation, including bonuses, payable to any of
its officers, employees, agents, independent contractors or consultants
other than increases made in the ordinary course of business consistent
with past practice;
- enter into or amend existing employment contracts, severance agreements
or consulting contracts; or, other than in the ordinary course of
business, institute any increase in benefits or alter its employment
practices or the terms and conditions of employment;
- except as may be required by applicable laws, change in any material way
its underwriting, actuarial or tax or financial accounting methods,
principles or practices;
- enter into, amend or terminate any transaction or contract the result of
which is reasonably likely to have a material adverse effect; or
- enter into any joint ventures or partnerships of any kind.
Proxy Statement/Board of Directors Recommendation. Universal American has
agreed to take actions to cause the due preparation and timely mailing of this
proxy statement to its shareholders.
Further Assurances. Universal American and Capital Z have agreed to use
their reasonable efforts to obtain all necessary waivers, consents and approvals
of all third parties and governmental authorities necessary to complete the
transactions contemplated by the share purchase agreement and all related
agreements. The Capital Z Issuance cannot be effected until (i) the applicable
waiting periods under the HSR Act have terminated and (ii) Form A filings have
been made by each party with the department of each state as required. Universal
American and Capital Z are in the process of making the required filings.
Universal American Actions Relating to the Acquisition Agreement.
Universal American may not amend or terminate the acquisition agreement without
the prior written consent of Capital Z. In addition, Universal American cannot,
without Capital Z's consent, (i) acknowledge fulfillment of or waive any of the
closing conditions in the acquisition agreement or (ii) with respect to any
conditions in the acquisition agreement that require that an event, action or
circumstance occur or be performed to the satisfaction of Universal American,
indicate or acknowledge Universal American's satisfaction to such occurrence or
performance. Capital Z may give or withhold its consent in its sole discretion.
Indemnification Generally. Universal American and Capital Z have agreed
that if the closing occurs, each will indemnify the other and each of the
other's affiliates and their directors, officers, partners, members, employees,
agents and representatives against all claims, obligations, costs and expenses
arising out of a breach of any representation, warranty, covenant or agreement
by the other party in the share purchase agreement. Neither party is obligated
to make any indemnification payment until the amount of any claim
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exceeds $500,000, and then only for the amount in excess of $500,000.
Indemnification for breaches of representations and warranties cannot be in
excess of the purchase price.
Additional Indemnification Obligations for Potential Liabilities to PFG for
Failure to Close Under the Acquisition Agreement. If the acquisition fails to
close other than because the senior debt financing is not available, Universal
American and Capital Z have agreed that:
- Capital Z will indemnify Universal American 100% if Universal American
cannot close under the acquisition agreement because Universal American
is unable to take action because of the failure or refusal by Capital Z
to give consent as described above under the heading "-- Universal
American Actions Relating to the Acquisition Agreement."
- Capital Z will be responsible for 60% and Universal American will be
responsible for 40% of any liabilities under the acquisition agreement
resulting from action as described above under the heading "-- Universal
American Actions Relating to the Acquisition Agreement" taken or not
taken by Universal American upon mutual agreement with Capital Z.
- Universal American will indemnify Capital Z 100% for liabilities arising
from action taken by Universal American in violation of the provisions
described above under the heading "-- Universal American Actions Relating
to the Acquisition Agreement," including Universal American's failure to
close the acquisition after Capital Z has demanded in writing that
Universal American close the transaction.
If the acquisition fails to close because the senior debt financing is not
available, Universal American and Capital Z have agreed as follows:
- Universal American will indemnify Capital Z 100% for liabilities to PFG
if the senior debt financing is unavailable solely because of (i)
Universal American's failure to satisfy specified fundamental
representations, warranties or covenants, (ii) a breach or violation of a
representation or warranty under the share purchase agreement that
involves or results from intentional false statements or omissions by
Universal American or (iii) a willful breach by Universal American of any
covenant under the share purchase agreement.
- Universal American will be responsible for 6% of its liabilities to PFG
and Capital Z will be responsible for 94% of Universal American's
liabilities to PFG if the senior debt financing is unavailable because of
breaches or violations of any representation, warranty, covenant or
agreement of Universal American under the share purchase agreement other
than those discussed in the previous bullet point or because of breaches
of representations or warranties that did not exist as of the date of the
share purchase agreement but arise before the closing because of events
outside of Universal American's control.
- Capital Z will indemnify Universal American for 100% of the liability if
the senior debt financing is unavailable for any other reason not
specified in the two immediately preceding bullet points.
Required Additional Investment. If Chase Bank and/or the lenders under the
senior debt financing have notified Universal American that the senior debt
financing will not be available to Universal American unless an additional
amount of equity is invested in Universal American, then Capital Z will have the
right, but not the obligation, together with certain other shareholders of
Universal American, to purchase additional shares of common stock in order to
fund the additional equity. If Capital Z and any shareholder of Universal
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American, as of the date of the share purchase agreement, opt to purchase
additional shares, the purchase price per share will be (x) if Capital Z and
Universal American prior to the closing agree on the price to be paid for the
additional shares of common stock, the agreed price, and (y) if Capital Z and
Universal American cannot agree on the price to be paid for the additional
shares of common stock, a price per share equal to 60% of the per share purchase
price determined according to the per share purchase price adjustment mechanism
described above under the heading "-- Per Share Purchase Price Adjustment."
Exclusivity. Universal American has agreed that it will not, directly or
indirectly, at any time prior to the closing, solicit, entertain or accept
offers from persons (other than Capital Z) for the investment contemplated by
the share purchase agreement. Universal American has further agreed that during
the term of the share purchase agreement and for two additional years, it will
not consummate any other purchase of the Penn Union Companies or any other
purchase of any of PFG's assets without first consummating the acquisition
contemplated by the acquisition agreement unless (i) the share purchase
agreement is terminated due to a breach by Capital Z; (ii) Universal American
and Capital Z mutually agree not to complete the acquisition, or (iii) Universal
American is unable to complete the acquisition because of Capital Z's failure to
give its consent to Universal American to waive or acknowledge the satisfaction
of conditions to the closing of the acquisition agreement.
Conditions to Closing
The share purchase agreement contains the following material conditions:
Conditions to Each Party's Obligations. The parties do not have to
complete the Capital Z Issuance unless the following conditions are met or
waived by Universal American or Capital Z on or before the Closing:
- no United States or state authority or other agency or commission or
federal or state court of competent jurisdiction shall have enacted,
issued, promulgated, enforced or entered any statute, rule, regulation,
injunction or other order, whether temporary, preliminary, or permanent,
which is in effect and has the effect of prohibiting the consummation of
the transactions contemplated by the share purchase agreement or
restricting the operation of the business of Universal American and the
subsidiaries in a manner that would have a material adverse effect on
Universal American;
- any waiting period applicable to the transactions contemplated by the
share purchase agreement, including, without limitation, those applicable
to any HSR filing, any Form A required to be filed, or any further
approval required by any department of insurance of any state or any
other regulatory filing, or any filing in connection with or in
compliance with the provisions of each of the Securities Act of 1933, the
Exchange Act of 1934, and any applicable state securities laws shall have
expired or been terminated;
- the closing provided for in the share purchase agreement shall occur
simultaneously with the closing of the transactions contemplated by the
acquisition agreement; and
- the shareholders of Universal American shall have duly approved at the
special meeting Proposal No. 1 and item (a) of Proposal No. 2 contained
in this proxy statement and the holders of the Series C-1 preferred stock
shall have approved the incurrence of the senior debt and the issuance of
the subordinated notes. We expect to obtain approvals from the Series C-1
holders.
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Conditions to Universal American's Obligation. Universal American does not
have to complete the Capital Z Issuance unless the following conditions are met
or waived on by it on or before the closing:
- the accuracy of specified representations and warranties of Capital Z
when given and at the closing and material performance of its obligations
required to be performed under the share purchase agreement;
- the execution of the documents containing the terms of the senior debt
financing; and
- the receipt of all necessary waivers, consents or approvals.
Conditions to Capital Z's Obligation. Capital Z does not have to complete
the Capital Z Issuance unless the following conditions are met or waived by it
on or before the closing:
- Universal American will not have violated specified covenants including
those relating to incurrence of debt, repurchase of stock, payment of
dividends, amendment to its certificate of incorporation or by-laws,
stock issuance or sale of equity securities, Capital Z's exclusivity,
amendment or termination of the share purchase agreement, or other
actions relating to the acquisition agreement;
- Universal American's representations and warranties, relating to
corporate organization, its subsidiaries, capital stock, newly issued
shares, and authority shall be true and correct as of the closing;
- Universal American will have obtained all necessary waivers or consents
to, approvals of, and notices or filings have been made with respect to
the transactions contemplated by the share purchase agreement;
- neither Universal American nor its designated principal executive
officers shall have committed criminal fraud or otherwise engaged in
felonious, criminal conduct with respect to, or in the operation of, the
business or the affairs of Universal American or any of its subsidiaries;
and
- all of the closing conditions for Universal American and PFG under the
acquisition agreement shall have been satisfied or waived.
Termination/Amendment
The share purchase agreement may be terminated:
- by either party simultaneously with, or at any time following, the
termination of the acquisition agreement;
- by Universal American, on the one hand, or Capital Z, on the other hand,
upon notice to the other, five business days after the failure of the
shareholders of Universal American to approve Proposal No. 1 or item (a)
of Proposal No. 2 and failure of a majority of the holders of the Series
C-1 preferred stock to approve the senior debt financing and the issuance
of the subordinated notes;
- by either party if the transactions contemplated in the acquisition
agreement fail to close by March 31, 1999, subject to two 30-day
extensions under some circumstances;
- by either party at any time on or after May 31, 1999; or
- upon substitution of a new buyer in place of Universal American as
described above under the heading "-- Per Share Purchase Price
Adjustment."
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Survival
The representations and warranties set forth in the share purchase
agreement will survive the closing for 18 months. However, (i) the
representations and warranties relating to corporate organization, subsidiaries,
capital stock, newly issued shares, and authority will survive without
limitation and (ii) the representations and warranties relating to taxes and
employee benefit plans will survive until 30 days after the date upon which all
relevant claims are barred by all applicable statutes of limitation.
Costs/Expenses/Transaction Fee
If the transactions contemplated by the share purchase agreement are
consummated, Universal American will pay all costs and expenses incurred by
Capital Z, including any sales or transfer taxes. If the transactions
contemplated in the share purchase agreement are not consummated because the
senior debt financing is unavailable under circumstances that obligate Universal
American to indemnify Capital Z 100% for amounts owed to PFG, then Universal
American will pay all of the costs and expenses of Capital Z.
Upon consummation of the purchase of the shares, Universal American will
pay a transaction fee of $5 million to Capital Z Management, Inc., an affiliate
of Capital Z. Of the $5 million fee, at Capital Z's option, $1.375 million may
be in the form of shares of Universal American common stock valued at the same
price per share as the price paid by Capital Z in the Capital Z Issuance.
Registration Rights Agreement
Universal American, Capital Z, AAM, Richard Barasch and WAND/Universal
Investments I, L.P. and WAND/Universal Investments II, L.P. (collectively,
"WAND") and several other shareholders of Universal American (collectively,
"Selling Shareholders") will enter into a registration rights agreement as a
condition to the Capital Z Issuance. The registration rights agreement provides
that each of WAND, AAM and Capital Z (including some of its affiliates) may, at
any time after the closing, require Universal American to prepare and file with
the Securities and Exchange Commission (the "SEC") a registration statement
under the Securities Act of 1933 covering the public offer and sale of shares of
common stock they hold, including shares issued in the Capital Z Issuance.
Universal American must use its reasonable best efforts to cause the
registration statement to be declared effective and remain effective for up to
the lesser of 180 days or the period during which all of the shares requested to
be so registered have been sold (a "Demand Registration"). WAND may require two
Demand Registrations, both at Universal American's expense. AAM may require one
Demand Registration at Universal American's expense. Capital Z and any affiliate
to whom shares of common stock have been transferred by Capital Z may request
unlimited Demand Registrations, but no more than four registrations will be paid
by Universal American.
Notwithstanding the terms described above, Universal American is not
required to file a registration statement in response to a Demand Registration
if specified conditions are not met, including the anticipated failure of a
Demand Registration to have an aggregate net market value of at least $15
million.
The parties to the registration rights agreement have customary "piggyback"
registration rights allowing them to register shares in the event Universal
American proposes to sell any of its common stock to the public in a transaction
registered under the Securities Act of 1933. In addition, the parties may
include shares held by them in any Demand Registration of another party.
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Shareholders' Agreement
Universal American, AAM, Richard Barasch and several other shareholders of
Universal American will enter into a shareholders' agreement as a condition to
the Capital Z Issuance. The shareholders' agreement requires that all proposed
sales/transfers by the other shareholders who are party to the shareholders'
agreement must first be offered to Richard A. Barasch and Capital Z, including
its affiliates. However, pledges and some other transfers by any party to the
shareholders' agreement of less than 1% of Universal American's outstanding
common stock at any one time, or 2.5% when aggregated with other transfers by
the shareholder and his, her or its permitted transferees of Universal
American's outstanding common stock, are permitted. In addition, the
shareholders' agreement subjects the parties to tag-along and drag-along rights
under some circumstances. "Tag-along rights" allow the holder of stock to
include his, her or its stock in a sale of common stock initiated by another
party to the shareholders' agreement. "Drag-along rights" permit a selling party
to the shareholders' agreement to force the other parties to the shareholders
agreement to sell a proportion of the other holder's shares in a sale arranged
by the selling shareholder.
Under the terms of the shareholders' agreement, of the nine members of
Universal American's board, the shareholders are permitted to nominate directors
as follows: Capital Z -- four, Richard Barasch -- two, AAM -- one and Universal
American -- two. Because of Capital Z's majority stock ownership, Capital Z also
effectively controls the election of the two directors that Universal American
is entitled to nominate. Capital Z, Richard Barasch and AAM are each required to
vote for the director(s) nominated by the others. The ability to nominate
directors may be adjusted based upon the amount of common stock owned by each
such shareholder. The ability of Richard Barasch to nominate directors is also
affected by his continued employment with Universal American. In addition, the
ability to nominate directors is not transferable, except that Capital Z may
transfer its right to a third-party buyer who acquires 10% or more of the
outstanding common stock of Universal American from Capital Z.
Pursuant to the terms of the shareholders' agreement, Capital Z is entitled
to representation on each of the audit committee and the compensation committee
of the board of directors provided that it continues to hold at least 10% of the
outstanding common stock of Universal American.
Each party to the shareholders' agreement has agreed for two years
following the closing not to vote his or its shares in favor of a merger where
Universal American's shareholders would receive consideration other than in the
form of shares of the surviving entity.
MATERIAL TERMS OF THE ACQUISITION AGREEMENT AND RELATED TRANSACTIONS
The acquisition agreement among Universal American, PFG and several of
PFG's subsidiaries provides that Universal American, under conditions described
more fully below, will purchase the Penn Union Companies for a purchase price of
$175 million. Richard A. Barasch and representatives of Capital Z principally
negotiated the terms of the acquisition, the Capital Z Issuance and the senior
debt financing.
The statements made in this proxy statement with respect to the terms of
the acquisition and related transactions are qualified in their entirety by
reference to the acquisition agreement, a copy of which accompanies this proxy
statement as Annex B.
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Purchase Price Adjustment
Universal American and PFG have agreed to a purchase price adjustment based
upon the capital and surplus amounts of the PennLife Companies and the ConLife
Companies derived by Universal American and set forth in a closing statement to
be prepared by Universal American after the closing. If PFG and Universal
American cannot agree on the capital and surplus amounts listed in the closing
statement, an independent accounting firm of national reputation will resolve
the dispute. The closing statement will be adjusted to reflect the independent
accounting firm's resolution of the dispute. For each of the PennLife Companies
and the ConLife Companies, PFG has agreed to pay Universal American the amount
by which the capital and surplus or, in the case of Penncorp Life, total
shareholders' equity, listed on the final closing statement is less than target
capital and surplus amounts specified in the acquisition agreement. In addition,
PFG has agreed to pay Universal American an amount by which the aggregate
capital and surplus for all of the PennLife Companies and the ConLife Companies
set forth on the final closing statement is less than the aggregate target
capital and surplus amount specified in the acquisition agreement.
Reserve Adjustment
In connection with the acquisition, PFG has agreed to provide an adjustment
to the purchase price paid for the Penn Union Companies based on actual loss
payments and loss adjustment expenses of Pennsylvania Life relating to
disability income reserves. On the fifth anniversary of the closing, Universal
American will cause an actuary to compare the disability insurance claims
reserves of Pennsylvania Life as of the closing to the actual loss payments and
loss adjustment expense payments and actual losses and loss adjustment expenses
of Pennsylvania Life during the five-year period. In the event of a deficiency
in the disability insurance claim reserves of Pennsylvania Life, PFG will, at
its option, either pay Universal American the after-tax amount of the deficiency
in cash or reduce the original principal amount of the subordinated notes by the
amount of the deficiency. In either case, the amount of the set-off or cash
payment will not be greater than the value of the subordinated notes, plus
accrued interest. In the event of a positive development in the disability
insurance claim reserves, Universal American will issue additional subordinated
notes to PFG up to a maximum of $10 million principal amount plus interest. An
agreed upon discount rate will be applied to the actual loss experience used in
determining the amount of any deficiency or positive development in the
disability insurance claim reserves.
Closing of the Acquisition
Unless Universal American and PFG otherwise agree, the closing will occur
as soon as possible following the satisfaction or waiver of all of the
conditions specified in the acquisition agreement. Universal American
anticipates that, if the Capital Z Issuance is approved by Universal American's
shareholders, and the other closing conditions to the Capital Z issuance and the
acquisition are satisfied or waived, the acquisition will occur in May 1999.
Conditions to the Acquisition
The obligations of Universal American to complete the acquisition are
subject to, among other conditions:
- receipt of necessary consents, authorizations and approvals by the
appropriate regulatory authorities, including: (i) approvals to
restructure the capital of, and to reset to not less than zero, the
unassigned surplus of the PennLife Companies and
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the ConLife Companies and (ii) the approval of Proposal No. 1 and item
(a) of Proposal No. 2 of this proxy statement and the approval of the
holders of the Series C-1 preferred stock of the senior debt financing
and the issuance of the subordinated notes. We expect to obtain the
approvals of the Series C-1 holders;
- the companies comprising the PennLife Companies and the ConLife Companies
must each meet specified minimum capital and surplus requirements and all
of those companies as a whole must meet an aggregate capital and surplus
requirement equal to the sum of $72.3 million plus the earnings of the
PennLife Companies and the ConLife Companies from January 1, 1999 to the
closing of the acquisition;
- completion of the reserve consultants' review of the amount and
composition of the Pennsylvania Life insurance reserves which must be
satisfactory to Universal American;
- completion, to the reasonable satisfaction of Universal American, of
specified restructuring transactions;
- each of the companies constituting the Penn Union Companies has received
either (i) a rating of B+ or better from A.M. Best or (ii) assurances
from A.M. Best satisfactory to Universal American that, on or immediately
after the closing, each of the companies constituting the Penn Union
Companies will be assigned at least a B+ rating; and
- the review report from PFG's independent auditors is satisfactory to
Universal American and indicates that there are no material modifications
that should be made to the unaudited financial statements of the Penn
Union Companies as of September 30, 1998 that was previously provided to
Universal American.
The obligations of PFG to complete the acquisition are subject to, among
other conditions:
- receipt of necessary consents, authorizations and approvals, including
shareholder approval of Proposal No. 1 and item (a) of Proposal No. 2 and
the approval of the holders of the Series C-1 preferred stock of the
senior debt financing and the issuance of the subordinated notes. We
expect to obtain the approvals from the Series C-1 holders;
- Universal American shall have entered into services agreements with
Security Life and Trust Insurance Company, Occidental Life Insurance
Company of North Carolina and Professional Insurance Company, all
subsidiaries of PFG, to provide data processing services to them.
Representations and Warranties
The acquisition agreement contains representations and warranties by PFG,
Penn Union Companies and Universal American to the effect that, except as
specified or disclosed and, in some cases, subject to some materiality
exceptions, including the following material representations and warranties: (a)
all parties are duly organized and in good standing, and have the requisite
corporate power to own their properties and carry on their business as it is now
being conducted; (b) all parties have all requisite corporate power and
authority to enter into the acquisition agreement and all agreements
contemplated by the acquisition agreement and to consummate the acquisition, and
the acquisition agreement has been duly authorized by and constitutes the valid
and binding obligation of each party; and (c) the execution, delivery and
performance of the acquisition agreement by all parties will not conflict with
any party's articles or certificates of incorporation or by-laws, violate any
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agreement or law to which such party or its assets are bound, or violate any
order, writ, judgment, injunction, decree, statute, rule or regulation of any
court, regulatory or governmental agency.
Material Covenants
The acquisition agreement contains covenants, including but not limited to
the following:
Conduct of Business Prior to the Closing. Prior to the closing, PFG must
conduct the business and operations of the Penn Union Companies in the ordinary
and usual course. PFG will not permit any of the companies constituting the Penn
Union Companies to:
- amend its certificate of incorporation or by-laws;
- incur any indebtedness except in the ordinary course of business;
- adopt any new benefit plan or materially change any existing benefit
plans;
- sell any asset or assets worth more than $500,000 other than in the usual
course, or encumber any of its assets;
- sell any securities except consistent with past practice;
- enter into or terminate any material contracts except in the ordinary
course;
- split its shares, pay a dividend, other than as specifically permitted in
the acquisition agreement, issue any additional shares, or purchase any
of its capital stock;
- enter into a capital expenditure or expenditures that exceed $100,000
except in the ordinary course;
- intentionally breach any of its representations and warranties in the
acquisition agreement;
- restructure or reorganize;
- materially change its accounting practices;
- settle any claim or claims in excess of $250,000; or
- make any loan to or engage in any transaction with any affiliated
company.
Transaction Bonuses; Payments to Field Force Managers. Except for
obligations reserved for on the unaudited financial statements and the audited
financial statements and except for obligations otherwise scheduled, PFG will
pay, prior to or at the closing, all bonuses payable to certain specified
officers, directors, employees and agents in connection with the proposed
transaction. Prior to or at the closing, PFG will pay to all field force
managers amounts agreed to under compensation arrangements made in connection
with or relating to the sale of the Penn Union Companies and Universal American
will adopt commission schedules and stock-based and other compensation plans.
Nonsolicitation. PFG and its signatory affiliates agree not to solicit or
hire any current officers, general sales agents, or sales agents (to the level
of district manager) of the Penn Union Companies for a period of two years after
the closing other than as specifically permitted in the acquisition agreement.
PFG and its affiliates, however, may make general solicitations or hire
terminated employees under conditions specifically described in the acquisition
agreement.
Acquisition Proposals. PFG may not make, entertain, solicit, encourage,
accept, negotiate or hold substantive discussions regarding any competing offer.
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Financial Matters. Prior to the closing, PFG will cause Pennsylvania Life
to record additional reserves relating to the disability income claim reserves
of Pennsylvania Life to the extent indicated in the reserves report to be
prepared prior to the closing. During the quarter period ended September 30,
1998, PFG recorded a $20 million reserve increase. Under the terms of the
acquisition agreement, PFG will not be required to cause Pennsylvania Life to
record additional reserves in excess of $5 million.
Survival/Indemnification
Survival. All representations and warranties of PFG survive the closing.
All of the representations and warranties of Universal American survive the
closing, except those representations and warranties regarding SEC reports; the
absence of undisclosed liabilities; the absence of certain changes; and
compliance with applicable law, permits, and licenses, all of which do not
survive the closing.
With the exceptions listed in this paragraph, the representations and
warranties that survive the closing expire 18 months after the closing. Any
claim based on a tax representation or warranty will terminate 30 days after the
expiration of the applicable statute of limitations. Any claim based on an
environmental representation or warranty will terminate three years after the
closing. Any claim based on a representation or warranty related to the employee
benefit plans will terminate on the expiration of the applicable statute of
limitations. Any claim based on specific fundamental representations and
warranties will survive indefinitely.
Indemnification by PFG. PFG agrees to indemnify Universal American for,
among other things:
- any breach of any representation or warranty that survives the closing
and any covenant or agreement;
- any derivative lawsuits or lawsuits based on violations by PFG of federal
or state securities laws;
- any liability for taxes of any affiliates of the Penn Union Companies;
- any Phase III Taxes up to the closing date and 75% of certain Phase III
taxes for five years after the closing. Phase III Taxes relate to
insurance income that has been earned but, under prior tax law, was not
subject to tax at such time. Instead, a tax liability is incurred if, and
when, such income is distributed to Universal American's shareholders;
- any reductions in or limitations on the net operating losses including
any increased liability or taxes with respect to periods after the
closing, and a portion of Universal American's tax liability if the net
operating losses available for carryover are less than $20 million;
- any liabilities of PennCorp Financial Services, Inc. that Universal
American has not expressly assumed;
- any taxes relating to the transactions contemplated by the acquisition
agreement; and
- any transaction bonuses and pre-sale obligations to any field force
managers.
Universal American may set off indemnification amounts against the
subordinated notes as more fully described under "-- Set-Off Rights."
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Indemnification by Universal American. Universal American has agreed to
indemnify PFG for any breach of any representation, warranty, covenant or
agreement by Universal American. Universal American will also indemnify PFG for
Universal American's failure to enter into investment agreements with some
agents of Pennsylvania Life, to adopt certain commission schedules and
stock-based compensation plans, and to carry out certain other post-closing
compensation obligations to certain agents and persons of Pennsylvania Life. In
each case, Universal American's indemnification obligations are limited to the
extent described in the next paragraph.
Limitations on Indemnification. PFG will not be obligated to indemnify
Universal American for losses arising from any inaccuracy in or any breach of
any representation or warranty, until the aggregate amounts for indemnification
equal $2.5 million, at which time PFG must pay only the amount of losses in
excess of $2.5 million. The limitation in the previous sentence does not apply
to losses based on several fundamental representations, nor does it apply to the
representations and warranties that relate to employee benefit plans or taxes.
Except for some fundamental representations, PFG is not obligated to indemnify
Universal American for breaches of any representations or warranties in excess
of the purchase price. In any event, Universal American is not obligated to make
any payment to PFG for indemnification in excess of $50 million.
Set-Off Rights. Universal American has the right to set off against the
subordinated notes any amounts owed to it by PFG under the indemnification
provisions of the acquisition agreement or as a result of a reserve adjustment.
This set-off right terminates on the fifth anniversary of the closing, provided
that such right will continue with respect to any claim that is pending on the
fifth anniversary of the closing.
Termination. The acquisition agreement may be terminated (i) by the mutual
consent of Universal American and PFG, or (ii) by either party: (a) if a
governmental authority enters an order restraining, enjoining or prohibiting any
of the transactions contemplated by the acquisition agreement; (b) if the
closing does not occur by March 31, 1999, subject to two 30-day extensions under
some circumstances; or (c) upon a material default or breach by the other, that
is not remedied or waived within 30 days, of the performance of any obligations,
covenants, and agreements or in their representations and warranties under the
acquisition agreement.
THE VOTING AGREEMENT
In connection with the acquisition of the Penn Union Companies, Richard
Barasch, AAM, certain limited partners of Barasch Associates Limited Partnership
(the "Shareholders") and Universal American, PFG and Capital Z have executed a
voting agreement. The Shareholders together control more than 50% of Universal
American's outstanding voting stock.
Under the voting agreement, the Shareholders have agreed to vote in favor
of the Capital Z Issuance and the amendment to Universal American's certificate
of incorporation to increase the number of authorized shares of common stock
from 20 million to 80 million (Item (a) of Proposal No. 2).
In addition, the Shareholders agreed that until the voting agreement
terminates, they will vote against (i) any proposal opposed to or in competition
with the acquisition of the Penn Union Companies, (ii) any change in Universal
American's capital structure other than under the share purchase agreement and
the conversion of the Convertible Preferred Stock, and (iii) any action or
agreement that could impede, interfere with, delay, postpone or attempt to
40
<PAGE> 46
discourage the Capital Z Issuance or the acquisition of the Penn Union Companies
or result in a breach by Universal American which is likely to result in the
failure of a condition to the share purchase agreement or the acquisition
agreement.
The Shareholders have also agreed that for two years after the share
purchase agreement is terminated, they will not vote in favor of any transaction
contemplating or proposing the acquisition by Universal American of any business
or assets of PFG. This obligation does not apply if (i) the share purchase
agreement is terminated due to a breach by Capital Z of that agreement, (ii)
Universal American and Capital Z mutually agree not to complete the acquisition,
or (iii) Universal American is unable to complete the acquisition as a result of
Capital Z's failure to give its consent to Universal American to waive or
acknowledge the satisfaction of conditions to the closing of the acquisition
agreement.
Except for the two-year agreement described in the preceding paragraph, the
voting agreement will terminate upon the earlier of (i) the consummation of the
Capital Z Issuance and the acquisition, (ii) the termination of the share
purchase agreement, or (iii) the termination of the acquisition agreement. If
the voting agreement is terminated under clause (ii) or (iii) of this paragraph
because of the failure to vote in favor of Proposal No. 1 and item (a) of
Proposal No. 2, Universal American will be solely responsible for, and will
indemnify Capital Z for all liabilities arising under the acquisition agreement.
41
<PAGE> 47
UNAUDITED PRO FORMA FINANCIAL INFORMATION
We are providing the pro forma financial information reflecting Universal
American after the Capital Z Issuance and the acquisition of the Penn Union
Companies (which we refer to as "pro forma" information) to give you a better
picture of what the results of operations and the financial position of the
consolidated businesses of Universal American and the Penn Union Companies might
have looked like had the Capital Z Issuance and the acquisition of the Penn
Union Companies occurred on an earlier date.
The Universal American Financial Corp. Unaudited Pro Forma Condensed
Consolidated Statement of Operations for the nine month period ended September
30, 1998 and the year ended December 31, 1997 and the Universal American
Financial Corp. Unaudited Pro Forma Condensed Consolidated Balance Sheet as of
September 30, 1998 present results for Universal American as if the acquisition
and the financing of the acquisition had been consummated as of the beginning of
each period presented. The unaudited pro forma financial information has been
derived from and should be read in conjunction with the Notes to Unaudited Pro
Forma Financial Information that follow on page 46, as well as historical
Consolidated Financial Statements and Notes of Universal American for the nine
months ended September 30, 1998 (unaudited) and the year ended December 31, 1997
and the historical Combined Financial Statements and Notes of the Penn Union
Companies of PFG for the nine months ended September 30, 1998 (unaudited) and
the year ended December 31, 1997 set forth in Annex E to this proxy statement.
The pro forma adjustments and combined amounts are provided for
informational purposes only, and if the acquisition of the Penn Union Companies
is consummated, Universal American's consolidated financial statements will
reflect the effects of the acquisition only from the date such transaction
occurs. The pro forma adjustments are applied to the historical financial
statements of Universal American and the Penn Union Companies to account for the
acquisition of the Penn Union Companies by Universal American under the purchase
method of accounting in accordance with APB Opinion No. 16. Under this method of
accounting, the total purchase cost will be allocated to the Penn Union
Companies' assets and liabilities based on their relative fair values. These
allocations are subject to valuations as of the date of the acquisition based
upon appraisals and other information at that time. Accordingly, the final
purchase price adjustments will be different from the amounts reflected herein.
The unaudited pro forma combined financial information, however, reflects
management's best estimate based upon currently available information.
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the results of operations or financial
position that would have occurred had the acquisition been consummated on the
dates assumed, nor is the pro forma information intended to be indicative of
Universal American's future results of operations.
42
<PAGE> 48
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
---------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
--------- ---------- ---------------- ------------------ ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
Net premium and policyholder fees
earned............................... $31,840 $160,149 $(41,919) $ -- $150,070
Net investment income.................. 8,056 36,720 (5,644) -- 39,132
Realized gains on investments.......... 281 2,568 (25) -- 2,824
Other income........................... 2,037 7,690 6 -- 9,733
------- -------- -------- ----------- --------
Total revenues......................... 42,214 207,127 (47,582) -- 201,759
------- -------- -------- ----------- --------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.................. 28,152 138,380 (36,268) -- 130,264
Change in deferred acquisition costs... (2,814) 54,464 (1,195) (77,128)(2) (26,673)
Amortization of present value of future
profits.............................. 131 9,542 (2,426) (7,116)(3) 131
Amortization of goodwill............... 116 4,167 -- (4,167)(3) 116
Amortization of negative goodwill...... -- -- -- (2,032)(4) (2,032)
Interest expense on the senior secured
note................................. -- -- -- 4,996(5) 4,996
Interest expense on the subordinated
note................................. -- -- -- 2,340(5) 2,340
Other operating costs and expenses..... 13,576 88,822 (14,000) (1,545)(6) 86,853
------- -------- -------- ----------- --------
Total benefits, claims and other
deductions........................... 39,161 295,375 (53,889) (84,652) 195,995
------- -------- -------- ----------- --------
Operating income (loss) before taxes... 3,053 (88,248) 6,307 84,652 5,764
Federal income tax expense (benefit)... 1,038 (30,856) 2,225 29,417(7) 1,824
------- -------- -------- ----------- --------
Net income (loss)...................... 2,015 (57,392) 4,082 55,235 3,940
Redemption accrual on Series C
preferred stock...................... 325 -- -- (325)(8) --
------- -------- -------- ----------- --------
Net income (loss) applicable to common
shareholders......................... $ 1,690 $(57,392) $ 4,082 $ 55,560 $ 3,940
======= ======== ======== =========== ========
EARNINGS PER COMMON SHARE:
Basic................................ $ 0.23 $ 0.11
======= ========
Diluted.............................. $ 0.15 $ 0.10
======= ========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic................................ 7,498 27,857 35,355
Diluted.............................. 13,070 27,857 40,927
</TABLE>
43
<PAGE> 49
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
---------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
--------- ---------- ---------------- ------------------ ------------
<S> <C> <C> <C> <C> <C>
REVENUE:
Net premium and policyholder fees
earned............................... $37,714 $225,004 $(64,780) $ -- $197,938
Net investment income.................. 10,023 47,405 (8,457) -- 48,971
Realized gains on investments.......... 1,133 4,795 (885) -- 5,043
Other income........................... 2,461 17,550 35 -- 20,046
------- -------- -------- ----------- --------
Total revenues......................... 51,331 294,754 (74,087) -- 271,998
------- -------- -------- ----------- --------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.................. 30,806 144,451 (52,673) -- 122,584
Change in deferred acquisition costs... (2,946) (27,177) 4,597 (11,844)(2) (37,370)
Amortization of present value of future
profits.............................. -- 17,352 (4,421) (12,931)(3) --
Amortization of goodwill............... 112 5,594 -- (5,594)(3) 112
Amortization of negative goodwill...... -- -- -- (2,710)(4) (2,710)
Interest expense on the senior secured
note................................. -- -- -- 6,889(5) 6,889
Interest expense on the subordinated
note................................. -- -- -- 3,120(5) 3,120
Other operating costs and expenses..... 20,148 122,640 (25,574) (2,209)(6) 115,005
------- -------- -------- ----------- --------
Total benefits, claims and other
deductions........................... 48,120 262,860 (78,071) (25,279) 207,630
------- -------- -------- ----------- --------
Operating income before taxes.......... 3,211 31,894 3,984 25,279 64,368
Federal income tax expense............. 1,092 7,589 1,410 8,849(7) 18,940
------- -------- -------- ----------- --------
Net income............................. 2,119 24,305 2,574 16,430 45,428
Redemption accrual on Series C
preferred stock...................... 250 -- -- (250)(8) --
------- -------- -------- ----------- --------
Net income applicable to common
shareholders......................... $ 1,869 $ 24,305 $ 2,574 $ 16,680 $ 45,428
======= ======== ======== =========== ========
EARNINGS PER COMMON SHARE:
Basic.............................. $ 0.26 $ 1.29
======= ========
Diluted............................ $ 0.18 $ 1.14
======= ========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic.............................. 7,242 27,857 35,099
Diluted............................ 12,041 27,857 39,898
</TABLE>
44
<PAGE> 50
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
FINANCING PURCHASE
UNIVERSAL ACCOUNTING PENN UNION ACCOUNTING PRO FORMA
AMERICAN ADJUSTMENTS(9) COMPANIES ADJUSTMENTS(10) CONSOLIDATED
--------- -------------- ---------- --------------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Total investments..................... $159,219 $ -- $ 707,652 $ -- $ 866,871
Deferred policy acquisition costs..... 21,927 -- 114,746 (114,746) 21,927
Goodwill.............................. 4,393 -- 104,873 (104,873) 4,393
Present value of
future profits...................... 1,613 -- 92,829 (92,829) 1,613
Other assets.......................... 101,830 6,187 123,132 -- 231,149
-------- -------- ---------- --------- ----------
Total assets........................ 288,982 6,187 1,143,232 (312,448) 1,125,953
======== ======== ========== ========= ==========
LIABILITIES, SERIES C PREFERRED STOCK
AND STOCKHOLDERS' EQUITY:
Reserves for future policy benefits... 220,643 -- 636,950 -- 857,593
Loan payable.......................... 5,000 (5,000) -- -- --
Senior secured note payable........... -- 70,000 -- -- 70,000
Subordinated note payable............. -- 39,000 -- -- 39,000
Deferred income tax liability......... 1,583 -- 11,957 (72,652) (59,112)
Negative goodwill..................... -- -- -- 27,099 27,099
Other liabilities..................... 26,804 -- 52,430 -- 79,234
-------- -------- ---------- --------- ----------
Total liabilities................... 254,030 104,000 701,337 (45,553) 1,013,814
-------- -------- ---------- --------- ----------
Series C preferred stock (including
redemption accrual thereon)......... 5,742 (5,742) -- -- --
-------- -------- ---------- --------- ----------
Total stockholders' equity............ 29,210 82,929 441,895 (441,895) 112,139
-------- -------- ---------- --------- ----------
Total liabilities, Series C preferred
stock and stockholders' equity...... $288,982 $181,187 $1,143,232 $(487,448) $1,125,953
======== ======== ========== ========= ==========
</TABLE>
45
<PAGE> 51
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION
(IN THOUSANDS)
Certain one-time events occurring during the nine months ended September
30, 1998 and for the year ended December 31, 1997 are not presented as pro forma
adjustments. However, they impact the pro forma financial statements results.
Due to the non-recurring nature of these events, management believes they will
have no meaningful bearing on the results of operations after this transaction
is completed.
Therefore, below is a reconciliation of pro forma net income applicable to
common shareholders considering these one-time events for December 31, 1997 and
September 30, 1998, respectively:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Pro forma net income applicable to common
shareholders.................................... $45,428 $ 3,940
Long term care reserve adjustment(a).............. -- 7,551
Disability income reserve adjustment(a)........... -- 23,000
Step purchase GAAP accounting adjustments(b)...... (3,087) --
One-time reserve changes(c)....................... (8,269) --
Commission accruals(d)............................ -- 1,039
Reduction of deferrable expenses(d)............... (4,000) --
Restructuring charge(e)........................... -- 1,834
Tax effects of above adjustments.................. 5,375 (11,698)
------- --------
Pro forma adjusted net income applicable to common
shareholders.................................... $35,447 $ 25,666
======= ========
Annualized pro forma adjusted net income
applicable to common shareholders............... $35,447 $ 34,221
======= ========
</TABLE>
(a) During 1998, the Penn Union Companies refined their calculation of policy
benefit reserves for long-term care products, which resulted in a one-time
increase of approximately $7,551. Additionally, the Penn Union Companies
have been closely monitoring the development of claims reserve experiences.
The methodology previously utilized has experienced what appears to be a
deterioration of the adequacy of its claim reserves associated with its
disability income products at Pennsylvania Life. As a result of the trends,
Pennsylvania Life increased its claims reserve estimate by $23,000 during
the nine-month period ended September 30, 1998.
(b) The Union Bankers deferred ceding gain was reduced by $7,310 due to the
step purchase accounting as of January 2, 1998 when PFG acquired the
remaining interest of Southwestern Financial Corporation. As a result of
the step purchase treatment, 22% of the assets and liabilities of the
acquired entities, including Union bankers, were marked to fair value at
the date of acquisition. The effect of adjusting Union Bankers assets and
liabilities was an increase in the business equity of Union Bankers of
$830, however this included a reduction of the ceding gain and effectively
reduced the amortization for the period ended September 30, 1998. If this
adjustment was pushed back to January 1, 1997, the amortization for 1997
would have been reduced by $3,087.
46
<PAGE> 52
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(c) During 1997, reserves on the Union Bankers comprehensive block of business
were strengthened by $5,900. Additionally, in 1997, the scheduled reserve
release relating to the conversion to the new valuation system was $2,369.
These one-time events impacted the expected results for the Penn Union
Companies.
(d) Effective in 1998, Pennsylvania Life modified the commission structure and
related participation in agency profitability. As a result, certain agency
field expenses are no longer paid directly by Pennsylvania Life. Instead,
they are factored into the agency commissions. $4,000 is the pre-tax impact
to expenses for 1997 had this change in structure been affected in 1997.
Also, related to this change, one-time commission payments were accrued in
1998 of $1,039.
(e) As a result of the Penn Union Companies' initiative to transfer
administration of their comprehensive and Medicare supplement blocks to
third party administrators, the Penn Union Companies recognized a pre-tax
restructuring charge of $1,834 during 1998.
Adjustments to the unaudited pro forma condensed consolidated statements of
operations to give effect to the acquisition of the Penn Union Companies as of
January 1, 1997 and 1998 are summarized as follows:
(1) The share purchase agreement contains certain pre-closing restructuring
provisions, including the termination of the reinsurance agreements between
Peninsular Life Insurance Company and Occidental Life Insurance Company of
North Carolina (both are subsidiaries of PFG) and the reinsurance of 100%
of the comprehensive major medical and unreinsured Medicare supplement
business of Union Bankers. The premiums earned, policyholder benefits and
expenses incurred, net investment income earned on the reserves held,
change in deferred acquisition costs, amortization of present value of
future profits, and the related taxes on these items, recorded by the Penn
Union Companies prior to the acquisition have been eliminated.
(2) The deferred acquisition costs recorded by the Penn Union Companies prior
to the acquisition was eliminated. However, the change in deferred
acquisition costs which occurred during the period presented were recorded.
(3) The amortization of the present value of future profits and goodwill
recorded by the Penn Union Companies prior to the acquisition was
eliminated.
(4) Amortization of the excess of estimated fair values of net assets acquired
over the purchase price (negative goodwill) is recognized over a ten-year
period on a straight-line basis.
(5) Interest expense was recorded to reflect the issuance of $70,000 of senior
bank debt with an annual interest rate of 8.69% and the subordinated note
of $39,000 with an annual interest rate of 8.00%.
(6) Management fees charged to the Penn Union Companies by its current parent,
PFG, prior to the acquisition were eliminated.
(7) Income taxes were adjusted at a rate of 35% to reflect the effect on taxes
of notes (2) through (6).
47
<PAGE> 53
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(8) The redemption accrual on the Series C preferred stock of Universal
American accumulated prior to the acquisition was eliminated since these
securities will be converted into common stock of Universal American at the
time of the Capital Z Issuance.
Adjustments to the unaudited pro forma condensed consolidated balance sheet
to give effect to the purchase of the Penn Union Companies as of September 30,
1998 are summarized as follows:
(9) The financing of this acquisition consists of the following:
<TABLE>
<S> <C>
Issuance of common stock............................... $ 82,000
Senior secured term note............................... 70,000
Issuance of subordinated notes......................... 39,000
--------
Total sources of financing........................ $191,000
========
The uses of the financing consists of the following:
Acquisition of the Penn Union Companies................ $175,000
Refinancing of Universal American's outstanding loan... 4,750
Expenses incurred in issuance of equity................ 5,063
Expenses incurred on the senior debt financing......... 6,187
--------
Total uses of the financing....................... $191,000
========
</TABLE>
In addition to the financing described above, the Series C preferred stock
will be converted into the common stock of Universal American at the time
of the Capital Z Issuance. As of September 30, 1998, Universal American
had $5,168 of Series C preferred stock outstanding and $575 of redemption
accruals on the Series C preferred stock. The Series C preferred stock
will be converted into common stock at a price of $2.375 per common share
(2,176 shares) and the elimination of the redemption accrual will be
reflected in the retained earnings account of Universal American.
48
<PAGE> 54
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(10) The purchase price for the Penn Union Companies is $175,000, including
$136,000 in cash and $39,000 in subordinated notes issued to PFG or its
subsidiaries. The following table reflects the adjustments made to the
acquired business equity of the Penn Union Companies:
<TABLE>
<S> <C>
Net asset value acquired.................................... $ 441,895
---------
Increase (decrease) in the Penn Union net asset value to
reflect estimated fair value:
Elimination of the historical deferred policy acquisition
costs.................................................. (114,746)
Elimination of the historical present value of future
profits................................................ (104,873)
Elimination of the historical goodwill.................... ( 92,829)
Elimination of the deferred tax liability related to the
historical adjustments................................. 72,652
---------
Total estimated fair value adjustments................. 239,796
---------
Estimated fair value of net assets acquired................. 202,099
Purchase price.............................................. 175,000
---------
Excess of estimated fair value of net assets acquired over
purchase price (negative goodwill)........................ $ 27,099
=========
</TABLE>
49
<PAGE> 55
SPECIAL MEETING OF SHAREHOLDERS OF UNIVERSAL AMERICAN
TIME, DATE, PLACE AND PURPOSE
The special meeting of shareholders of Universal American will be held on
- --, 1999 at 10:00 a.m., local time, at The Penn Club, 30 West 44th Street, New
York, New York 10036.
At the special meeting, Universal American's shareholders will be asked to
consider and vote upon the two proposals described in this proxy statement and
to conduct other business that properly comes before the special meeting or any
adjournment or postponement of the special meeting. This proxy statement and the
proxy card used at the special meeting were mailed or delivered to the
shareholders of Universal American on or about --, 1999.
RECORD DATE, SHAREHOLDERS ENTITLED TO VOTE AND QUORUM REQUIREMENTS
The record date for determining the shareholders of Universal American
entitled to vote upon the matters set forth in this proxy statement is the close
of business on --, 1999.
As of December 31, 1998, Universal American had three classes of voting
securities outstanding, namely 7,761,192 shares of common stock, 400 shares of
Series B preferred stock and 45,680 shares of the Series C-1 preferred stock.
Holders of the common stock are entitled to one vote for each share registered
in their names at the close of business on the record date. As to all matters,
each shareholder is entitled to one vote for each share of common stock held or
each share of common stock into which voting preferred stock is convertible.
Holders of the Series B preferred stock and the Series C-1 preferred stock are
each entitled to vote together with the holders of the common stock on all
matters, other than the election of directors, as if the 400 shares of the
Series B preferred stock had been converted into 1,777,777 shares of common
stock and as if the 45,680 shares of the Series C-1 preferred stock had been
converted into 1,923,368 shares of common stock. The holders of record of a
majority of the combined voting power of the outstanding shares of capital stock
will constitute a quorum for the transaction of business at the special meeting
requiring a vote of all the outstanding voting stock of Universal American.
All proxies that are properly completed, signed, and returned before the
special meeting will be voted. If a shareholder specifies how the proxy is to be
voted with respect to any of the proposals for which a choice is provided, the
proxy will be voted in accordance with such specifications. For Proposal No. 1,
if a shareholder fails to specify or fails to clearly indicate how the proxy is
to be voted, the signed proxy will be treated as a vote in favor. For each item
of Proposal No. 2, if a shareholder fails to specify or fails to clearly
indicate how the proxy is to be voted, the signed proxy will be treated as a
vote in favor. Any proxy given by a shareholder may be revoked at any time
before it is exercised by filing with the Secretary of Universal American an
instrument revoking it, by a duly executed proxy bearing a later date, or by the
shareholder attending the special meeting and expressing a desire to vote his or
her shares in person.
EFFECT OF BROKER NON-VOTES
"Broker Non-Votes" occur when a broker holding shares of common stock in
street name withholds its vote on some "non-routine" matters because the broker
has not received instructions from the beneficial owner of those shares and does
not have discretionary authority to vote on non-routine matters without specific
instructions. Brokers holding shares in street name must receive specific
instructions from the beneficial owners
50
<PAGE> 56
in order to have the authority to vote, in person or by proxy, on non-routine
matters. When a beneficial owner does not give specific instructions to the
broker, the broker, as the holder of record, is entitled to vote only on
"routine" matters and must withhold its votes as to all non-routine matters.
Where a proxy solicitation includes a non-routine proposal and the broker does
not receive specific instructions from the beneficial owner, the resulting proxy
is considered a "limited proxy." Shares represented by limited proxies are
considered present for quorum purposes, but are not considered present for
purposes of determining the total number of shares with voting power present
with regard to a non-routine proposal. The resulting Broker Non-Vote of a
limited proxy will be treated as an abstention on each non-routine proposal.
All of the proposals are non-routine. For Proposal No. 1, a limited proxy
will have no effect. For each item of Proposal No. 2, the effect of a limited
proxy will be that Broker Non-Votes will be treated as votes against any item of
such Proposal.
NASDAQ LISTING AND ACCOUNTANTS
The common stock is listed for trading under the symbol "UHCO" on The
Nasdaq National Market, which is operated by The Nasdaq Stock Market, Inc. On
January 29, 1999 the last reported trading price for a share of common stock on
Nasdaq was $3 7/8.
A member of Ernst & Young LLP, Universal American's independent auditor, is
expected to be present at the special meeting, will have an opportunity to make
a statement, and will be available to respond to appropriate questions.
51
<PAGE> 57
PROPOSAL NO. 1 --THE CAPITAL Z ISSUANCE
INTRODUCTION
The board of directors believes that the best interests of Universal
American and its shareholders will be served by the issuance and sale of up to
26,031,746 shares of common stock to Capital Z and some agents and members of
management of the Penn Union Companies for $3.15 per share, for a total purchase
price of approximately $82 million. If an adjustment is required under the share
purchase agreement, the number of shares of common stock to be purchased by
Capital Z and those agents and members of management may exceed 26,031,746. In
that case, the shares would be sold at a price less than $3.15 per share.
Universal American may also pay a part of a transaction fee to an affiliate of
Capital Z in Universal American common stock.
The amount invested by the agents and members of management of the Penn
Union Companies is expected to be approximately $5.5 million. In any case, the
total purchase price to be paid by Capital Z is expected to be approximately
$76.5 million. Notwithstanding any purchase price adjustment or investment by
other parties, the aggregate proceeds from the issuance of the common stock to
Capital Z and the agents and members of management will be approximately $82
million.
Following the Capital Z Issuance and the conversion of the Convertible
Preferred Stock in conjunction with the transaction, Capital Z will own a total
of approximately 24,722,222 shares or approximately 63.0% of Universal
American's then-outstanding common stock. If all of the securities of Universal
American that could be converted or exchanged into common stock were converted
or exchanged, Capital Z would own 56.8% of the outstanding common stock.
The board of directors has agreed to the Capital Z Issuance for the reasons
set forth in this proxy statement, and its consummation is subject to some
conditions. See "The Capital Z Issuance and the Acquisition of the Penn Union
Companies --Reasons for the Acquisition and the Capital Z Issuance" and "The
Capital Z Issuance and the Acquisition of the Penn Union Companies --Material
Terms of the Share Purchase Agreement." The simultaneous closing of the
acquisition and the senior debt financing are conditions to the closing of the
Capital Z Issuance. Shareholders are urged to read carefully all sections of
this proxy statement, including the related annexes, before voting on this
proposal.
The affirmative vote of the holders of a majority of the outstanding voting
shares of common stock on the record date voting at a meeting at which a quorum
is present must approve the Capital Z Issuance. The board of directors has
unanimously approved the Capital Z Issuance and has determined that it is fair
and in the best interests of Universal American and its shareholders.
CONSEQUENCES IF PROPOSAL NO. 1 IS NOT APPROVED
IF THE SHAREHOLDERS DO NOT APPROVE THE CAPITAL Z ISSUANCE, THEN UNIVERSAL
AMERICAN CANNOT COMPLETE THE ACQUISITION OF THE PENN UNION COMPANIES or
otherwise purchase or acquire, by merger or otherwise, any of the businesses or
assets of PFG for a period of two years after the termination of the share
purchase agreement. However, you should note that Universal American has entered
into a voting agreement which provides the holders of more than 50% of Universal
American's voting stock have agreed to vote in favor of this Proposal No. 1. IF
PROPOSAL NO. 1 IS NOT APPROVED, NONE OF THE ITEMS OF PROPOSAL NO. 2 WILL BE
IMPLEMENTED EVEN IF THEY ARE APPROVED.
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VOTE REQUIRED TO APPROVE PROPOSAL NO. 1
Approval of "Proposal No. 1 --The Capital Z Issuance" requires the
affirmative vote of the holders of a majority of the issued and outstanding
voting shares of common stock represented and voting at a meeting at which a
quorum is present. Abstentions will have no effect.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE
FOR THIS PROPOSAL NO. 1.
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PROPOSAL NO. 2 -- AMENDMENTS TO THE CERTIFICATE OF INCORPORATION
THE AMENDMENTS
EACH OF ITEMS (A) THROUGH (F) MUST BE VOTED ON SEPARATELY AND INDEPENDENTLY
OF THE OTHERS, BUT YOU DO NOT HAVE TO VOTE THE SAME WAY ON EACH ITEM. THE
FAILURE TO RETURN YOUR PROXY CARD WILL BE COUNTED AS A VOTE AGAINST EACH ITEM OF
PROPOSAL NO. 2.
The board of directors has approved and adopted, subject to shareholder
approval, a resolution providing for amendments to Universal American's
certificate of incorporation to:
Increase in Authorized Shares (Item (a))
(a) Increase the authorized number of shares of common stock from 20 million to
80 million shares.
Shareholder Matters (Items (b)-(e))
(b) Permit shareholders to act by written consent instead of a meeting. Written
consent would only need to be given by the number of shareholders required
to approve the action being taken by written consent.
(c) Revise Article Fourteen of Universal American's current certificate of
incorporation, the result of which is to no longer require approval by
holders of 66 2/3% of the outstanding voting stock of Universal American to
amend certain provisions of the certificate of incorporation, which means
only majority approval will be necessary for those amendments.
(d) Remove the provision in the certificate of incorporation which requires the
vote of holders of 66 2/3% of the outstanding voting capital stock to call
a special meeting of the shareholders. The board will amend the by-laws to
allow special meetings of the shareholders to be called at the request of
holders of 50% of the outstanding voting capital stock.
(e) Replace the way in which directors are elected and the length of their
terms with a system in which all directors are elected at one time each for
a term expiring at the next annual meeting. Directors are currently elected
to three-year staggered terms.
Board Matters (Item (f))
(f) Require 66 2/3% of the total number of the board of directors to approve
(i) (x) entering into any merger or consolidation in which either Universal
American or a material subsidiary is a constituent corporation or its
securities are being issued and the shareholders following such transaction
do not own, directly or indirectly, in the aggregate a majority of the
shares or equity securities of the surviving corporation of any such merger
or consolidation entitled to elect members of the board of directors, (y)
the sale of all or substantially all of the corporation's assets or
properties in a single transaction or in a series of related transactions,
or (z) the sale, lease, exchange or other disposition of any shares of a
material subsidiary or all or substantially all assets of any material
subsidiary; (ii) changing the authorized number of directors; (iii)
amending or modifying the certificate of incorporation or by-laws; (iv)
electing or removing any of the President, Chief Financial Officer or other
executive officers and amending or modifying the employment agreement to be
entered
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<PAGE> 60
into with the Chief Executive Officer on the closing of the acquisition;
(v) voluntarily dissolving or winding-up the corporation or any material
subsidiary or filing with respect to the corporation or any material
subsidiary a voluntary petition in bankruptcy or for reorganization or for
the adoption of any plan or arrangement with creditors or an admission
seeking the relief therein provided under any existing or future law of any
jurisdiction relating to bankruptcy, insolvency, reorganization or relief
of debtors; and (vi) approving any dividend or other distribution in
respect of the common stock.
The proposed amended and restated certificate of incorporation, which
incorporates the amendments set forth in this Proposal No. 2, is attached as
Annex D to this proxy statement.
REASONS FOR THE AMENDMENTS AND THE PRINCIPAL EFFECTS
Item (a) is a condition to the closing of the Capital Z Issuance. In
addition, Capital Z insisted that the proposals set forth in items (b) through
(f) be presented to the shareholders.
Increase in Authorized Shares (Item (a))
At the close of business on the record date, there were 20 million shares
of common stock authorized and -- shares of common stock outstanding and
entitled to vote. There are currently not enough authorized and unissued shares
of common stock to complete the Capital Z Issuance. In order to consummate the
Capital Z Issuance, Universal American needs to authorize at least 25 million
additional shares of common stock and to issue at least 31. 375 million
additional shares of common stock.
This amount includes sufficient additional shares in case an event occurs
that gives rise to a per share purchase price adjustment that requires the
issuance of additional shares in excess of the 26,031,726 shares contemplated
for the Capital Z Issuance. The proposed amount also includes shares that need
to be issued upon conversion of the Convertible Preferred Stock, the exercise of
any options or warrants issued or permitted to be issued under current
compensation plans and the payment of a transaction fee to an affiliate of
Capital Z in shares of common stock. Any shares authorized but not issued in
connection with the Capital Z Issuance and the conversion of the Convertible
Preferred Stock would be available for issuance in the future for purposes that
the board of directors may determine to be in the best interests of Universal
American and its shareholders. These purposes could include the issuance of
shares for cash, for acquisitions, through employee benefit programs, and for
other general corporate purposes. In many situations, prompt action may be
required that would not permit seeking shareholder approval to authorize
additional shares for a specific transaction on a timely basis. The board of
directors believes it is important that it maintain the flexibility to act
promptly in the best interests of shareholders. The terms of any future issuance
of shares of stock will depend largely on market and financial conditions and
other factors existing at the time of issuance.
Shareholder Matters (Items (b)-(e))
In negotiating the share purchase agreement and the other documents related
to the Capital Z Issuance and the acquisition of the Penn Union Companies with
Capital Z, Universal American agreed, at Capital Z's insistence, to seek
shareholder approval of the amendments to its certificate of incorporation
described in items (b) through (e).
Generally, these amendments will make it easier for Universal American's
shareholders, including Capital Z, to govern the company. By allowing
shareholders to take action by written consent, the amendment contemplated by
item (b) would give shareholders the
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ability to act without the necessity of holding a meeting of shareholders. Until
recently, New York State did not allow corporate action by the written consent
of shareholders. Now that this restriction no longer applies, Universal American
believes that it would be advantageous to amend its charter to facilitate
shareholder governance of the corporation while simultaneously making such
governance more efficient and less expensive. Shareholder action by written
consent will allow, in most cases, the majority shareholder to effect corporate
action, without having a meeting at which the other shareholders could be
present to express their views.
Item (c) would substitute a simple majority (50%) for the existing
requirement that holders of 66 2/3% of Universal American's outstanding voting
stock approve certain amendments to the certificate of incorporation. Lowering
the number of votes required to approve such amendments provides more
flexibility to Universal American and its shareholders, including Capital Z, to
change the certificate of incorporation. The amendment contemplated by item (c)
would maintain the requirement that holders of 66 2/3% of the outstanding voting
stock approve any amendment of the provision of the certificate of incorporation
which relates to transactions with interested parties.
Item (d) permits holders of 50% of the outstanding voting stock of
Universal American, instead of the current 66 2/3%, to call a special meeting.
The ability of a lower percentage of shareholders to call a special meeting may
facilitate and accelerate the shareholder approval process. Universal American's
current certificate of incorporation and by-laws both require the vote by
holders of 66 2/3% of the outstanding voting stock to call a special meeting of
the shareholders. If item (b) is approved and the 66 2/3% requirement is removed
from the certificate of incorporation, the board of directors will amend the
by-laws to allow shareholder meetings to be called by a vote of 50% of the
outstanding voting stock.
Item (e) would eliminate Universal American's staggered board of directors.
A staggered board is a common way to resist undesirable takeovers. Under the
terms of the shareholders' agreement, Universal American plans to restructure
the board to accurately represent the principal investing parties who are
involved in the Capital Z Issuance.
Board Matters (Item (f))
In its negotiations with Capital Z about the terms of the share purchase
agreement and the related documents, Universal American also agreed, at Capital
Z's insistence, to seek shareholder approval of the amendment to its certificate
of incorporation described in item (f). This amendment would make those
corporate actions identified in clauses (i) through (vi) of item (f) more
difficult to effect because such action will require 66 2/3% of the total number
of the directors instead of a simple majority of directors. As a result, two
directors that are not nominees of Capital Z would have to approve the actions
set forth in clauses (i) through (vi). However, because Capital Z will
effectively be able to select Universal American's two nominees, Capital Z will
effectively control 66 2/3% of the board. For the actions specified in clauses
(i) through (vi), a quorum of the board shall be 7 of the 9 directors on the
board.
CONSEQUENCES IF THE ITEMS OF PROPOSAL NO. 2 ARE NOT APPROVED
The additional shares of common stock authorized by the approval of item
(a) would have rights identical to those of the currently outstanding common
stock. Adoption of item (a) would not affect the rights of the holders of
currently outstanding stock, except for effects that are incidental to
increasing the number of shares of stock outstanding upon any future issuance of
newly authorized shares of stock. If Universal American's shareholders
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<PAGE> 62
approve item (a), then it will become effective upon the filing of the amended
and restated certificate of incorporation of Universal American with the
Secretary of State of the State of New York. The amended and restated
certificate of incorporation will be filed immediately prior to completion of
the acquisition.
IF ITEM (A) IS NOT APPROVED, THEN THE CAPITAL Z ISSUANCE WILL NOT OCCUR AND
THE ACQUISITION OF THE PENN UNION COMPANIES WILL NOT BE CONSUMMATED. You should
note that Universal American has entered into a voting agreement under which the
holders of more than 50% of Universal American's voting stock have agreed to
vote in favor of item (a). EVEN THOUGH SHAREHOLDERS OWNING OVER 50% OF THE
OUTSTANDING VOTING STOCK OF UNIVERSAL AMERICAN HAVE AGREED TO VOTE IN FAVOR OF
ITEM (A), THE VOTING AGREEMENT DOES NOT COVER THE APPROVAL OF ITEMS (B) THROUGH
(F) WHICH ALSO RELATE TO THE CAPITAL Z ISSUANCE AND THE ACQUISITION OF THE PENN
UNION COMPANIES. IN ADDITION, ITEMS (B) THROUGH (E) REQUIRE APPROVAL BY HOLDERS
OF 66 2/3% OF THE TOTAL OUTSTANDING VOTING SHARES ENTITLED TO VOTE ON THOSE
ITEMS. ACCORDINGLY, YOUR VOTE IS PARTICULARLY IMPORTANT TO THE APPROVAL OF ITEMS
(B) THROUGH (F) AND YOU ARE REQUESTED TO VOTE ON ALL PROPOSALS IN THIS PROXY
STATEMENT, INCLUDING EACH ITEM OF PROPOSAL NO. 2, BY COMPLETING AND RETURNING
YOUR PROXY CARD.
If any of items (b) through (f) are not approved, then Universal American
will still amend the certificate of incorporation to give effect to Proposal No.
1 and those items of Proposal No. 2 that are approved. HOWEVER, IF THE
ACQUISITION OR THE CAPITAL Z ISSUANCE DO NOT CLOSE, THEN NONE OF THE AMENDMENTS
TO THE CERTIFICATE OF INCORPORATION DESCRIBED IN ITEMS (B) THROUGH (F) WILL BE
MADE, EVEN IF THEY ARE APPROVED BY THE SHAREHOLDERS.
VOTE REQUIRED TO APPROVE THE AMENDMENTS
Increase in Authorized Shares (Item (a))
Approval of Item (a) of Proposal No. 2 -- Increase in Authorized
Shares -- requires the affirmative vote of holders of 50% of the outstanding
voting shares of Universal American entitled to vote thereon. Abstentions will
have the effect of a negative vote.
Shareholder Matters (Items (b)-(e))
Approval of items (b), (c), (d) and (e) of Proposal No. 2 -- Governance
Matters -- requires the affirmative vote of holders of 66 2/3% of the total
outstanding shares entitled to vote thereon. Abstentions will have the effect of
a negative vote.
Board Matters (Item (f))
Approval of item (f) of Proposal No. 2 -- Supermajority Board
Approvals -- requires the affirmative vote of holders of 50% of the outstanding
voting shares of Universal American entitled to vote thereon. Abstentions will
have the effect of a negative vote.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE
FOR EACH ITEM OF THIS PROPOSAL NO. 2.
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INTERESTS OF PERSONS INVOLVED IN THE CAPITAL Z ISSUANCE AND
THE ACQUISITION THAT MAY BE DIFFERENT FROM YOURS
General. In connection with its approval of the acquisition agreement and
the share purchase agreement and the transactions contemplated thereby, the
board concluded that it was in the best interests of Universal American's
shareholders to ensure that Universal American continues to have the dedication
of its Chief Executive Officer, Richard A. Barasch, following the Capital Z
Issuance. The board of directors also considered the interests of its officers
and directors who have existing employment agreements and severance and benefit
plans. In addition, the acquisition agreement and the share purchase agreement
contain provisions relating to the indemnification of Universal American's
directors and officers and directors' and officers' liability insurance.
Employment Agreement with Richard A. Barasch. In connection with the
acquisition, Universal American agreed in the share purchase agreement that, as
a condition to closing, an employment agreement will be entered into with
Richard A. Barasch (the "Employment Agreement"). The Employment Agreement
provides that Mr. Barasch will continue to serve as the Chairman of the Board
and Chief Executive Officer of Universal American starting after the closing of
the Capital Z Issuance for a period of three years. The Employment Agreement
also provides for an automatic one-year extension unless Universal American or
Mr. Barasch provides the other party six months' prior written notice before the
expiration of the original three-year term.
Under the Employment Agreement, Mr. Barasch is entitled to receive an
annual base salary of $475,000 and any annual increases that may be determined
in the sole discretion of the board (the "Salary"). In 1999, Mr. Barasch is
entitled to receive an annual bonus equal to: (i) for the period prior to the
closing of the Capital Z Issuance, a pro rated bonus based on Universal
American's existing executive bonus plan plus (ii) the product of the Salary
times a fraction, the numerator of which is the number of days from the closing
of the Capital Z Issuance through the end of the fiscal year and the denominator
of which is 365 and shall be based upon the achievement of goals established by
the board in good faith consultation with Mr. Barasch. If goals are not
established, the amount will be determined by reference to Universal American's
existing executive bonus plan. Commencing in the year 2000, and for each fiscal
year during the remaining employment term under the Employment Agreement, Mr.
Barasch will be eligible to earn a bonus based on criteria set by the
compensation committee of the board giving him an opportunity to earn a maximum
bonus of up to 200% of his Salary.
Mr. Barasch is entitled to an initial grant of stock options to purchase
600,000 shares under Universal American Financial Corp.'s 1998 Incentive
Compensation Plan (the "1998 Incentive Plan") on the date of the closing of the
Capital Z Issuance. The options will be granted to Mr. Barasch at the same price
per share at which Capital Z purchases shares of common stock in the Capital Z
Issuance and shall have a ten-year term. Options representing the right to
purchase 400,000 shares vest ratably over a five-year period and the remainder
will vest on the seventh anniversary of the grant date. The remainder, however,
will become immediately exercisable if Capital Z has achieved an internal rate
of return on its equity interest in Universal American of 30% by dates set forth
in the Employment Agreement.
Other Employment Agreements and Arrangements. It is anticipated that
Universal American will enter into employment agreements with some of its other
executive officers simultaneously with the consummation of the acquisition and
the Capital Z Issuance. The terms of those agreements have not been determined
as of the date of the mailing of this
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proxy statement. Universal American expects that on or after the closing certain
other senior members of management of Universal American and the Penn Union
Companies will be granted options to purchase Universal American's common stock
at the same purchase price per share paid by Capital Z in the Capital Z
Issuance.
1998 Stock Incentive Plan. Certain officers, directors and employees were
granted options under the 1998 Incentive Plan. The Capital Z Issuance will
constitute a change of control under the 1998 Incentive Plan and any option
outstanding, except for the options granted on or after December 8, 1998 through
the closing, will vest upon the change of control. Therefore, approximately
583,750 options will vest upon the Capital Z Issuance.
Registration Rights Agreement. Under the registration rights agreement to
be executed in connection with closing of the Capital Z Issuance, WAND, AAM and
some other shareholders of Universal American will have registration rights not
held by all shareholders of Universal American. Some parties are entitled to a
number of Demand Registrations, at the expense of Universal American, as
follows: WAND -- two, AAM -- one and Capital Z and its affiliates -- four. In
addition, Capital Z and some of its affiliates may make an unlimited number of
Demand Registrations if the related expenses are paid by Capital Z or its
affiliates. Each of WAND and AAM and the other parties to the registration
rights agreement will be allowed to register securities when either Universal
American registers securities for its own account or when it registers
securities in connection with a Demand Registration. See "The Capital Z Issuance
and the Acquisition of the Penn Union Companies -- Material Terms of the Share
Purchase Agreement -- Registration Rights Agreement."
Shareholders' Agreement. Under the shareholders' agreement to be executed
in connection with the closing of the Capital Z Issuance, Richard A. Barasch,
Capital Z, AAM and several other parties to the shareholders' agreement will be
subject to limitations on the transfer of their shares. Those parties may be
forced to sell a portion of their shares to a third-party buyer under some
circumstances. In addition, the parties to the shareholders' agreement are
permitted to include a proportion of the shares they own in a sale to a third
party by another party to the shareholders' agreement. See "The Capital Z
Issuance and the Acquisition of the Penn Union Companies -- Material Terms of
the Share Purchase Agreement -- Shareholders' Agreement."
Investment by AAM in Universal American. On December 31, 1998, AAM
executed an agreement pursuant to which it invested (i) $2.25 million in
Universal American on that date in exchange for 22,500 shares of preferred stock
designated "Series D-1 preferred stock" and (ii) an additional $1.75 million in
Universal American as of February 2, 1999 in exchange for 17,500 shares of
preferred stock designated "Series D-2 preferred stock." The Series D-1
preferred stock and the Series D-2 preferred stock are referred to as the
"Series D Preferred Stock" in this proxy statement. Each share of Series D
Preferred Stock was sold at a price of $100 per share.
The terms of the Series D Preferred Stock are identical to the terms of the
Series C-1 preferred stock, except that: (a) the Series D Preferred Stock does
not have any voting rights, except to the extent required by law, (b) Universal
American's obligation to issue common stock upon the conversion of the Series D
Preferred Stock is subject to compliance with any applicable requirements of the
insurance laws relating to the acquisition of voting securities of an insurance
company of each state in which a subsidiary of Universal American is domiciled,
and (c) the conversion price of the Series D-1 preferred stock and the Series
D-2 preferred stock is $2.70 rather than $2.375 per share. If the Capital Z
Issuance is consummated, or if the conversion takes place in connection with
another sale
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contracted in 1999 by Universal American of common stock or securities
convertible into common stock having at least 30% of the voting power after the
sale, the Series D-2 preferred stock will be mandatorily converted into common
stock at a conversion price equal to the price per share at which such stock or
securities are sold by Universal American.
Other Arrangements with Interested Parties. The current consulting
arrangement between Universal American and Barco Associates, Inc. will be
extended to December 31, 2000. Barco Associates is a company wholly-owned by
Marvin Barasch who is a director of Universal American. In addition, upon the
consummation of the Capital Z Issuance, Marvin Barasch will step down as a
director and become a non-voting observer of the board of directors. The
Employment Agreement, dated December 9, 1997 between American Progressive Life
and Health Insurance Company of New York and Marvin Barasch will be extended
through December 31, 2000.
The financial advisory contract between Universal American and WAND
Partners, Inc., an affiliate of WAND, will be terminated. Pursuant to such
agreement, WAND Partners, Inc. will continue to receive its agreed-upon fee
through December 31, 1999.
Universal American has a variety of relationships with Chase which are
described in this proxy statement. See "The Capital Z Issuance and the
Acquisition of the Penn Union Companies -- Reasons for the Acquisition and the
Capital Z Issuance."
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SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of December 31, 1998
as to the number of shares of common stock beneficially owned by (i) each person
known by Universal American to own beneficially more than 5% of Universal
American's common stock ("5% Holder"), (ii) each person who is a director of
Universal American or a nominee for election as a director, and (iii) all
persons as a group who are directors and officers of Universal American, and as
to the percentage of outstanding shares held by them on that date. Unless
otherwise indicated, each such beneficial owner holds the sole voting and
investment power with respect to shares of common stock outstanding. Universal
American's common stock, Series B preferred stock and Series C-1 preferred stock
are the only classes of voting securities outstanding. WAND owns all of the
issued and outstanding Series B preferred stock. The shares of Series C-1
preferred stock are owned as follows: UAFC, L.P.--52.5%; Richard A. Barasch, his
wife and children--17.2%; other directors, officers and consultants of Universal
American and its subsidiaries--12.9%; and principals and employees of AmeriLife
& Health Services, Inc. (a general agency of Universal American)--17.4%.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP(A)
-------------------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER STATUS SHARES OF CLASS
- ------------------------------------ --------- ------------------ ---------
<S> <C> <C> <C> <C>
Barasch Associates Limited
Partnership (BALP).............................. 5% Holder 3,476,828 (b)(c) 35.4%
c/o Richard Barasch
Six International Drive
Rye Brook, NY 10573
Wand/Universal American Investments I L.P. and
Wand/Universal American
Investments II L.P.............................. 5% Holder 1,777,777 (c)(d) 18.6%
630 Fifth Avenue
New York, NY 10111
UAFC, L.P....................................... 5% Holder 1,843,859 (e) 21.02%
30 North LaSalle Street
Chicago, IL 60602
Midland National Life Insurance Company......... 5% Holder 671,807 8.7%
One Midland Plaza
Sioux Falls, SD 57193
Marvin Barasch.................................. Director 218,432 (f) 2.8%
Six International Drive
Rye Brook, NY 10573
Michael Barasch................................. Director 73,553 (g) *
11 Park Place
New York, NY 10007
</TABLE>
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<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP(A)
-------------------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER STATUS SHARES OF CLASS
- ------------------------------------ --------- ------------------ ---------
<S> <C> <C> <C> <C>
Richard A. Barasch.............................. Executive 6,582,695 (h) 58.6%
Six International Drive Officer/
Rye Brook, NY 10573 Director
David F. Bolger................................. Director 508,500 (i) 6.5%
79 Chestnut Street
Ridgewood, NJ 07450
Gary W. Bryant.................................. Executive 374,572 (j) 4.7%
600 Courtland Street Officer
Orlando, FL 32084
Bertram Harnett................................. Director 6,679,091 (k) 59.0%
150 East Palmetto Park Road
Boca Raton, FL 33432
Mark M. Harmeling............................... Director 16,500 (i) *
108 Chestnut Street
North Reading, MA 01864
Walter L. Harris................................ Director 18,500 (l) *
320 West 57th Street
New York, NY 10019
Harry B. Henshel................................ Director 102,000 (i) 1.3%
One Bulova Avenue
Woodside, NY 11377
Patrick J. McLaughlin........................... Director 40,500 (m) *
100 Chetwynd Drive
Rosemont, PA 19010
Richard Veed.................................... Director 4,500 (n) *
30 North LaSalle Street
Chicago, IL 60602
Robert A. Waegelein............................. Executive 261,030 (o) 3.3%
Six International Drive Officer
Rye Brook, NY 10573
William E. Wehner............................... Executive 573,030 (p) 7.1%
600 Courtland Street Officer/
Orlando, FL 32804 5% Holder
</TABLE>
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<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP(A)
-------------------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER STATUS SHARES OF CLASS
- ------------------------------------ --------- ------------------ ---------
<S> <C> <C> <C> <C>
Robert F. Wright................................ Director 206,946 (q) 2.7%
57 West 57th Street
New York, NY 10019
Directors and Officers as a Group (17
persons)........................................ 7,400,317 (r) 63.9%
</TABLE>
- -------------------------
* Percent of class is less than 1%.
(a) The SEC has defined "beneficial owner" of a security to include any person
who has or shares voting power or investment power with respect to any such
security or who has the right to acquire beneficial ownership of any
security within 60 days. The percentages shown for each person or persons
are therefore based on the 7,761,192 shares of common stock outstanding as
of December 31, 1998 plus common stock issuable with respect to options and
warrants presently exercisable and convertible preferred stock presently
convertible held by such person or persons.
(b) Includes 2,065,419 shares that would be received upon the exercise of
340,036 warrants registered under the Exchange Act of 1934 and 1,725,383
warrants not registered under the Exchange Act of 1934. Richard Barasch
serves as trustee of the Harnett Family Trust which holds shares of the
general partner of BALP. Richard Barasch, through his direct ownership in
the general partner of BALP, together with his control of the Harnett Family
Trust, which also has an ownership interest in BALP's general partner, has
voting power with respect to the shares of Universal American held by BALP.
(c) BALP and Wand have entered into an agreement, which provides that as long as
Wand holds common stock issued from conversion of its Series B preferred
stock, BALP will vote its shares for the election of one director nominated
by Wand and Wand will vote its shares for BALP's nominees for the balance of
the board positions.
(d) Represents the amount of common stock issuable upon conversion of the Series
B preferred stock held by Wand.
(e) Represents the amount of common stock issuable upon conversion of the Series
C-1 preferred stock and the Series D-1 preferred stock held by UAFC, L.P.
(f) Includes 38,235 shares of common stock that would be received upon the
exercise of 20,000 stock options and 5,600 warrants and the conversion of
the Series C-1 preferred stock held by Marvin Barasch. Excludes any
indirect ownership through BALP of which Marvin Barasch is a limited
partner.
(g) Includes 29,553 shares of common stock that would be received upon the
exercise of 8,500 stock options and the conversion of the Series C-1
preferred stock held by Michael Barasch. Excludes any indirect ownership
through BALP of which Michael Barasch is a limited partner.
(h) Includes 524,522 shares of common stock that would be received upon the
exercise of 273,000 stock options and 3,100 warrants and the conversion of
Series C-1 preferred stock held by Richard Barasch. Includes 5,741,666
shares of voting stock beneficially owned pursuant to an irrevocable limited
proxy given by some shareholders of Universal American to Richard Barasch
and Bertram Harnett to vote in favor of some matters set forth in this proxy
statement. Richard Barasch and Bertram Harnett share voting power with each
shareholder who granted the irrevocable proxy. Excludes any indirect
ownership through BALP. Richard Barasch serves as trustee of the Harnett
Family Trust which holds shares of the general partner of BALP. Richard
Barasch, through his direct ownership in the general partner of BALP,
together with his control of the Harnett Family Trust, which also has an
ownership interest in BALP's general partner, has voting power with respect
to the shares of Universal American held by BALP.
(i) Includes 8,500 shares of common stock that would be received upon the
exercise of 8,500 stock options.
(j) Includes 211,053 shares of common stock that would be received upon the
exercise of 190,000 stock options and the conversion of the Series C-1
preferred stock held by Mr. Bryant.
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<PAGE> 69
(k) Includes 74,700 shares of common stock that would be received upon the
exercise of 12,095 warrants and 20,500 stock options and the conversion of
the Series C-1 preferred stock held by Bertram Harnett. Includes 6,222,291
shares of voting stock beneficially owned pursuant to an irrevocable limited
proxy given by some shareholders of Universal American to Richard Barasch
and Bertram Harnett to vote in favor of some matters set forth in this proxy
statement. Richard Barasch and Bertram Harnett share voting power with each
shareholder who granted the irrevocable proxy. Includes 339,901 shares of
common stock that would be received upon the exercise of 339,901 warrants
and 50,000 shares of common stock. The 339,901 warrants and the 50,000
shares are held in an irrevocable trust (the "Harnett Family Trust") of
which Richard Barasch is trustee. Bertram Harnett disclaims beneficial
ownership of such warrants and shares.
(l) Excludes any indirect ownership through BALP of which Mr. Harris is a
limited partner.
(m) Includes 6,500 shares of common stock that would be received upon the
exercise of 6,500 stock options.
(n) Includes 4,500 shares of common stock that would be received upon the
exercise of 4,500 warrants. Does not include any indirect ownership through
UAFC, L.P. by Mr. Veed who is a partner of AAM Capital Partners, L.P., in a
partnership that owns an interest in UAFC, L.P.
(o) Includes 152,632 shares of common stock that would be received upon the
exercise of 140,000 stock options and the conversion of the Series C-1
preferred stock held by Mr. Waegelein.
(p) Includes 255,053 shares of common stock that would be received upon the
exercise of 140,000 stock options and 94,000 warrants and the conversion of
the Series C-1 preferred stock held by Mr. Wehner.
(q) Includes 36,052 shares of common stock that would be received upon the
exercise of 15,000 stock options and the conversion of the Series C-1
preferred stock held by Mr. Wright. Excludes any indirect ownership through
BALP of which Mr. Wright is a limited partner.
(r) Includes the 3,476,828 shares of common stock beneficially owned by BALP
and the shares of common stock beneficially owned by Richard Barasch and
Bertram Harnett pursuant to the irrevocable limited proxy.
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<PAGE> 70
UNIVERSAL AMERICAN FINANCIAL CORP.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following selected consolidated financial information is derived from
consolidated financial statements of Universal American. The financial
statements for the two years ended December 31, 1996 and December 31, 1997 have
been audited by Ernst & Young LLP, independent auditors. The financial
statements for the year ended December 31, 1995 have been audited by KPMG LLP,
independent auditors. The selected financial information as of September 30,
1998 and for the nine months in the periods ended September 30, 1997 and
September 30, 1998 has been derived from unaudited consolidated financial
statements of Universal American, but includes all adjustments, including
normally occurring accruals, that Universal American considers necessary for
fair presentation of the results of operations for the periods presented. The
results of operations for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for Universal
American's fiscal year ended December 31, 1998. The information should be read
in conjunction with the consolidated financial statements, related notes, and
other financial information included in the most recent annual and quarterly
reports filed with the SEC, and the more comprehensive historical financial
information included as Annex E to this proxy statement. See "Universal American
Financial Corp. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
65
<PAGE> 71
UNIVERSAL AMERICAN FINANCIAL CORP.
INCOME STATEMENT INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------------- ---------------------------
1997 1998 1995 1996 1997
----------- ----------- ------- ------- -------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Direct premium and policyholder fees.... $73,773 $95,945 $46,145 $55,287 $99,339
Reinsurance premium assumed............. 267 658 8,866 10,522 998
Reinsurance premium ceded............... (44,196) (64,763) (18,200) (25,664) (62,623)
------- ------- ------- ------- -------
Net premium and other policyholder
fees............................... 29,844 31,840 36,811 40,145 37,714
------- ------- ------- ------- -------
Net investment income................... 7,511 8,056 8,945 9,850 10,023
Realized gains on investments........... 915 281 674 240 1,133
Fee income.............................. 1,850 1,990 3,137 2,872 2,368
Other income............................ 70 47 244 280 93
------- ------- ------- ------- -------
Total revenues..................... 40,190 42,214 49,811 53,387 51,331
------- ------- ------- ------- -------
Total benefits, claims and other
deductions............................ 37,683 39,161 47,161 53,014 48,120
------- ------- ------- ------- -------
Operating income before taxes........... 2,507 3,053 2,650 373 3,211
Net income after taxes.................. 1,654 2,015 2,642 104 2,119
Redemption accrual on Series C preferred
stock................................. 146 325 -- -- 250
------- ------- ------- ------- -------
Net income applicable to common
shareholders(1)....................... 1,508 1,690 2,642 104 1,869
======= ======= ======= ======= =======
Diluted income per share................ $ 0.14 $ 0.15 $ 0.25 $ 0.01 $ 0.18
======= ======= ======= ======= =======
</TABLE>
BALANCE SHEET INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, AS OF DECEMBER 31,
------------- -------------------
1998 1996 1997
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
Total investments.................................... $159,219 $144,681 $159,429
Total assets......................................... 288,982 242,237 272,575
Policyholder account balances........................ 156,915 134,539 145,085
Series C preferred stock............................. 5,168 -- 5,168
Series B preferred stock............................. 4,000 4,000 4,000
Stockholders' equity................................. 29,210 22,079 25,706
Stockholders' equity per share of common stock(2).... 3.30 2.53 2.96
</TABLE>
- -------------------------
(1) After provision for Series C preferred stock dividends of $146 and $325 for
the nine months ended September 30, 1997 and 1998, respectively and $250 for
the year ended December 31, 1997.
(2) Stockholders' equity per share of common stock represents shareholders'
equity less the stated value of Series B preferred stock divided by
outstanding shares of common stock.
66
<PAGE> 72
UNIVERSAL AMERICAN FINANCIAL CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Universal American is an insurance holding company representing the
strategic combination of three life insurance companies, American Progressive,
American Pioneer and American Exchange, and a non-insurance subsidiary,
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 external, 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. Amounts presented below are in thousands except for
per share information or unless otherwise stated.
The Insurance Subsidiaries had consolidated revenues of approximately
$40,300 million for the nine months ended September 30, 1998 and $46,600,
$51,100 and $49,300 for the years ended December 31, 1995, 1996, and 1997,
respectively, representing 95%, 93%, 95% and 96% of Universal American's total
revenues for each period, respectively. 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. American Exchange, domiciled in
Texas, exclusively sells its products in Texas. However, one or more of the
Insurance Subsidiaries is licensed in 45 states and in the District of Columbia.
Universal American cautions readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this proxy
statement and in any other oral or written statements, either made by, or on
behalf of Universal American, whether or not in future filings with the 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
Universal American's products, investment spreads or yields, or the earnings or
profitability of Universal American'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 Universal American'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, Universal American. 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 American specifically, such as credit, volatility and other
risks associated with Universal American's investment portfolio, and other
factors. Universal American disclaims any obligation to update forward-looking
information.
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<PAGE> 73
LIQUIDITY AND CAPITAL RESOURCES
Universal American
In December, 1997, Universal American entered into an agreement with the
Chase Bank for a $3,500 five-year, secured term loan (the "Credit Agreement")
and during the nine months ended September 30, 1998, Universal American began
the repayment of the loan by making principal payments totaling $350. The loan
agreement called for interest at the London Interbank Offered Rate ("LIBOR")
plus 200 basis points. However, Universal American entered into a three-year
interest rate swap agreement (the "Swap Agreement") with CSI, effective January
1, 1998, to lock in a fixed rate of 8.19% for a three-year period. During the
nine months ended September 30, 1998, Universal American paid $207 in interest
for the period December 4, 1997 to September 30, 1998.
On September 30, 1998, Universal American executed the first amendment to
its Credit Agreement with Chase Bank, which refinanced the current loan
agreement with the bank (the "First Amendment"). Under the First Amendment,
Universal American executed a new $5,000 five-year secured term loan. The
principal amount outstanding on the prior loan was $3,150 and was paid off with
the proceeds of the new loan. The new loan agreement calls for interest at LIBOR
plus 200 basis points. The Swap Agreement with Chase Bank remains in effect. The
effective interest rate as of September 30, 1998 on the refinanced loan is
7.865%. The loan remains secured by a first priority interest in all the assets
of WorldNet and Quincy Coverage Corp. (an immaterial non-operating subsidiary),
a pledge of 9.9% of the outstanding common shares of American Progressive and
100% of the shares of Quincy Coverage Corp. Universal American believes that the
cash flow from WorldNet will be able to sufficiently service the installment
payments required by the loan agreement.
Insurance Subsidiaries
The Insurance Subsidiaries are required to maintain minimum amounts of
capital and surplus as determined by SAP. The minimum statutory capital and
surplus requirements as of September 30, 1998 for American Progressive, American
Pioneer and American Exchange in New York, Florida and Texas, were $2,500,
$2,710 and $770, respectively. However, in these states substantially more than
those minimum amounts are needed to meet statutory and administrative
requirements of adequate capital and surplus to support the current level of the
Insurance Subsidiaries' operations. At September 30, 1998 the adjusted statutory
capital and surplus, including asset valuation reserve, of American Progressive,
American Pioneer and American Exchange was $9,698, $11,162 and $4,025,
respectively.
On September 30, 1998, Universal American made a $1,000 capital
contribution to American Pioneer from the proceeds of the First Amendment. The
capital contribution was made to support the growth in new business production
at American Pioneer.
At September 30, 1998, the investment portfolios of the Insurance
Subsidiaries included cash and short-term investments totaling $10,249, as well
as fixed maturity securities carried at their fair values which amounted to
$134,607 and equity securities carried at their fair values which amounted to
$1,096, all of which readily could be converted to cash. The fair value of these
liquid investments totaled more than $145,952 and constituted approximately 93%
of the Insurance Subsidiaries' investments at September 30, 1998.
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<PAGE> 74
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1997 and 1998
For the nine months ended September 30, 1998, Universal American earned net
income after federal income taxes of $2,015 ($0.15 per share) compared to $1,654
($0.14 per share) in the year ago period. Operating income before federal income
taxes amounted to $3,052 for the nine months ended September 30, 1998 compared
to $2,507 in the year ago period. All references to per share amounts are on a
diluted basis which means that calculations are made as if all securities that
are convertible or exchangeable into shares of common stock had been converted
or exchanged.
During September 1997, Universal American sold Amerifirst Insurance
Company, an inactive insurance company, for $3,379 and realized a pretax gain of
$569 ($376 after tax or $0.03 per share).
REVENUES. Total revenues increased approximately $2,025 to approximately
$42,214 for the nine months ended September 30, 1998 compared to total revenues
of approximately $40,189 in the year ago period. In the nine months ended
September 30, 1998, Universal American's gross premium and policyholder fees
earned (including reinsurance premiums assumed) amounted to $96,603, a $22,564
increase over the $74,039 amount in 1997. This gross premium increase is
primarily related to Universal American's acquisitions of the stock of American
Exchange in December 1997 and a Medicare supplement block of business from
Dallas General Life Insurance Company ("Dallas General") effective January 1,
1998, which premiums, in total, amounted to $23,377. In addition, the gross
premiums on the programs currently marketed by Universal American increased as
follows:
<TABLE>
<CAPTION>
PREMIUM 1998 TOTAL
PRODUCT INCREASE PREMIUM EARNED
- ------- -------- --------------
<S> <C> <C>
Senior market accident and health.................... $ 6,614 $14,381
Senior market life insurance......................... 743 2,421
Specialty life insurance............................. 421 1,111
Specialty medical.................................... 2,296 4,514
Group life insurance................................. 12 2,554
------- -------
Totals............................................. $10,086 $24,981
======= =======
</TABLE>
These increases totaled $33,463 and were offset by the decrease in premiums
on the products terminated and not currently marketed by Universal American as
follows:
<TABLE>
<CAPTION>
PREMIUM 1998 TOTAL
PRODUCT DECREASE PREMIUM EARNED
- ------- -------- --------------
<S> <C> <C>
First National assumed business..................... $ 4,146 $35,090
Non-marketed life insurance......................... 1,096 5,009
Non-marketed accident & health...................... 616 8,146
Group dental insurance.............................. 5,041 --
------- -------
Totals............................................ $10,899 $48,245
======= =======
</TABLE>
In continuation of its restructuring activity, Universal American executed
an agreement with an unaffiliated insurer to reinsure 100% of its group dental
block of business effective
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<PAGE> 75
September 1, 1997. Universal American will continue to perform the
administration of the business for a fee.
While Universal American 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 nine months ended
September 30, 1998 amounted to $64,763, a $20,567 increase from the 1997 amount
of $44,196. Details of the changes in reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM
INCREASE 1998 TOTAL
PRODUCT (DECREASE) PREMIUM CEDED
- ------- ------------- -------------
<S> <C> <C>
Business acquired
American Exchange............................ $12,009 $12,009
Dallas General............................... 6,191 6,191
Senior market accident and health.............. 3,701 6,982
Senior market life insurance................... (241) 698
Specialty life insurance....................... 251 793
Specialty medical.............................. 2,040 4,045
First National assumed business................ (3,364) 28,331
Other lines.................................... (20) 5,714
------- -------
Totals....................................... $20,567 $64,763
======= =======
</TABLE>
Net investment income of Universal American increased $545 to $8,056 for
the nine months ended September 30, 1998, compared to $7,511 in the year ago
period. This increase is attributable to the increase in invested assets
outstanding during the nine-month period in 1998 compared to the same period in
1997. Realized gains on investments amounted to $281 for the nine months ended
September 30, 1998 compared to $915 in the year ago period. Included in the 1997
amount is the $569 realized gain on the sale of Amerifirst Insurance Company to
an unaffiliated third party.
Fee income amounted to $1,990 for the nine months ended September 30, 1998,
an increase of $140 from the $1,850 amount for the year ago period. The
amortization of deferred revenue amounted to $48 for the nine months ended
September 30, 1998 compared to $70 in the year ago period.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions increased approximately $1,478 to $39,161 for the nine months ended
September 30, 1998, compared to $37,683 in the year ago period.
Claims and other benefits increased $1,513 to $20,657 for the nine months
ended September 30, 1998 compared to $19,144 in the year ago period. The change
in reserves for the nine months ended September 30, 1998 amounted to an increase
of $2,069 compared to an increase of $439 in the year ago period generating a
variance of $1,630. These increases in claims and change in reserves are the
result of the $1,997 increase in net premiums earned for the nine months ended
September 30, 1998 discussed above.
Interest credited to policyholders increased $898 to $5,426, which increase
is the result of more policyholder account values in force, primarily from the
sale of the Asset Enhancer product (an interest sensitive whole life product).
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<PAGE> 76
The change in deferred acquisition costs increased by $708 for the nine
months ended September 30, 1998 compared to 1997. The amount of acquisition
costs that were capitalized increased $1,036 from $4,945 in 1997 to $5,982 in
1998. The overall increase in capitalized costs is the result of the increase in
new premium production in the nine months ended September 30, 1998 compared to
the year ago period. The amortization of deferred acquisition costs increased
$329 from $2,839 in 1997 to $3,168 in 1998. This increase is the result of the
increase in Universal American's asset balance. In the nine months ended
September 30, 1998, Universal American amortized $116 of goodwill generated in
the acquisitions of First National Life Insurance Company ("First National")
($84) and American Exchange ($32) and $131 of present value of future profits
generated in the acquisitions of American Exchange ($96) and Dallas General
($35).
Commissions increased $5,374 in the nine months ended September 30, 1998 to
$19,531, compared to $14,157 in the year ago period. This increase is the direct
result of the $22,564 increase in total premium discussed above. Commissions and
expense allowances on reinsurance ceded increased $8,249 in the nine months
ended September 30, 1998 to $21,490, compared to $13,241 in the year ago period.
This increase is the direct result of the $20,567 increase in reinsurance
premium ceded discussed above.
Other operating costs and expenses increased $858 in the nine months ended
September 30, 1998 to $15,536 compared to $14,678 in the year ago period. The
Insurance Subsidiaries' expenses amounted to $13,249 for the nine months ended
September 30, 1998 compared to $12,668 in the year ago period, an increase of
$581. This increase is the result of an increase of expenses incurred in
generating new business ($781) and the result of expenses incurred at American
Exchange ($482), which was not owned by Universal American in the 1997 period.
These increases were offset by decreases in the general overhead incurred at the
Insurance Subsidiaries ($572) and expenses incurred on exited businesses ($110).
The non-Insurance Subsidiaries expenses increased $276 to $2,287 for the nine
months ended September 30, 1998. This increase is the result of additional
expenses incurred by Universal American of $458, which is primarily the interest
expense on the new loan outstanding and increased activity of the public company
operations in 1998 relative to 1997. This increase was offset by a decrease of
$148 in expenses incurred at WorldNet.
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, Universal American earned net income
after federal income taxes of $2,119 ($0.18 per share) compared to $104 ($0.01
per share) in the prior year. Operating income before federal income taxes
amounted to $3,211 for the year ended December 31, 1997 compared to $373 in the
prior year. In September, 1997, Universal American sold Amerifirst Insurance
Company, an inactive insurance company, to an unaffiliated third party, for
$3,379 and realized a pretax gain of $569 ($376 after tax or $0.03 per share).
REVENUES. Total revenues decreased approximately $2,057 to approximately
$51,330 for the year ended December 31, 1997, compared to total revenues of
approximately
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<PAGE> 77
$53,387 in the prior year, which decrease is primarily attributable to Universal
American's decision to restructure its operations and exit certain product
lines.
In the year ended December 31, 1997, Universal American's gross premium and
policyholder fees earned, including reinsurance assumed, amounted to $100,337, a
$34,528 increase over the $65,809 amount in 1996. This gross premium increase is
significantly attributable to the increase of $37,084 of premiums received on
the policies assumed in the fourth quarter of 1996 from First National, which
premiums amounted to $51,266 in 1997 compared to $14,182 in 1996. In addition,
the gross premiums on Universal American's currently marketed programs increased
as follows:
<TABLE>
<CAPTION>
PREMIUM PREMIUM
PRODUCT INCOME EARNED
- ------- ------- -------
<S> <C> <C>
Senior market supplemental health.......................... $4,391 $11,366
Senior market life insurance............................... 773 2,380
Group life insurance....................................... 116 3,407
------ -------
Totals................................................... $5,280 $17,153
====== =======
</TABLE>
In addition, other life insurance premiums increased $2,134 to $8,352 in
1997.
These increases totaled $44,498 and were offset by the net decrease in
premiums on the products terminated and not currently marketed by Universal
American. Effective December 1, 1996, Universal American withdrew its
participation in the National Association of Insurance Underwriters ("NAIU")
specialty accident and health insurance pool and also sold its New York State
Disability Insurance business ("New York State DBL") in force. The decrease in
premium from the exit from these lines amounted to $11,239 for the year ended
December 31, 1997.
Effective September 1, 1997, Universal American 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
in 1997.
Other accident and health insurance premiums increased $124 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 in 1997, while the premiums on the non-marketed
accident and health products decreased $1,140 in 1997.
While Universal American 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, a $36,960 increase from the 1996 amount of
$25,663. Of this increase, $30,991 relates to the business acquired from First
National, while $1,912 relates to senior market accident and health and $174
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.
Effective January 1, 1997, Universal American entered into a new
reinsurance agreement on American Pioneer's major medical/major hospital
business. Under the new treaty, Universal American retains 50% of the first $60
in claims risk compared to 25% under the prior agreement. As a result, premiums
ceded on this product decreased $1,719 in 1997.
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<PAGE> 78
Accident and health premiums ceded on the policies not currently marketed also
decreased $1,004.
In connection with the restructuring activity previously discussed,
reinsurance on the NAIU pool business amounted to $1,119 and reinsurance on the
group dental business amounted to $2,198.
Net investment income of Universal American increased $173 to $10,023 for
the year ended December 31, 1997, compared to $9,850 in the prior year. Realized
gains on investments amounted to $1,133 for the year ended December 31, 1997
compared to $240 in the prior year. Included in the 1997 amount is the $569 gain
realized on the sale of Amerifirst Insurance Company to an unaffiliated third
party.
Fee income amounted to $2,368 for the year ended December 31, 1997, a
decrease of $503 from the $2,871 amount for the prior year. 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 for the year ended December
31, 1997, compared to $280 in the prior year. This $187 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.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions decreased approximately $4,895 to $48,119 for the year ended December
31, 1997, compared to $53,014 in the prior year.
Claims and other benefits decreased $324 to $23,719 for the year ended
December 31, 1997 compared to $24,043 in the prior year. The increase in net
claims on the business assumed from First National amounted to $6,454, while net
claims on the senior market accident and health business increased $775. As
discussed above, Universal American is retaining a higher amount of major
medical/major hospital business under a new reinsurance agreement and, as a
result, Universal American's claims on this product increased $1,067 to $2,169.
This increase corresponds to the $1,137 increase in retained premiums. In
addition, claims on the non-marketed accident and health products increased $367
in 1997.
These increases of $8,663 were offset by decreases in the claims incurred
on the terminated businesses (NAIU -- $4,219, New York State DBL -- $3,712;
group dental -- $903). The remaining decrease of $154 represents a decrease in
life insurance claims.
The change in reserves for the year ended December 31, 1997 amounted to an
increase of $441 compared to an increase of $1,855 in the prior year generating
a decrease of $1,414. Included in the 1996 change in reserves is $256 generated
by the NAIU accident pool business that Universal American has exited. Interest
credited to policyholders increased $32 to $6,646.
The change in deferred acquisition costs increased $688 for the year ended
December 31, 1997 compared to 1996. The amount of acquisition costs capitalized
increased $1,670 from $5,042 in 1996 to $6,712 in 1997. This increase is the
result of the increase in new premium production in the year ended December 31,
1997 compared to the prior year. The amortization of deferred acquisition costs
increased $982 from $2,784 in 1996 to $3,766 in 1997. This increase is the
result of the increase in the asset balance. In the year ended December 31,
1997, Universal American amortized $112 of the goodwill generated in the First
National acquisition.
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<PAGE> 79
Commissions increased $5,009 in the year ended December 31, 1997 to
$21,089, compared to $16,080 in the prior year. This increase is the direct
result of the $34,528 increase in gross premium earned discussed above.
Commissions and expense allowances on reinsurance ceded increased $9,296 for the
year ended December 31, 1997 to $20,300, compared to $11,004 in the prior year.
This increase is the direct result of the $36,960 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 in the year ended
December 31, 1997 to $19,358, compared to $17,684 in the prior year. The
non-Insurance Subsidiaries' expenses decreased $280 to $2,594 for the year ended
December 31, 1997 as a result of the decrease in expenses incurred at
WorldNet -- Miami.
The Insurance Subsidiaries' expenses amounted to $16,764 for the year ended
December 31, 1997 compared to $14,810 in the prior year, an increase of $1,954.
Expenses incurred administrating the recently acquired business from First
National amounted to $4,258, while premium taxes increased $768. These increases
totaled $5,026 and were offset by the decrease in new business expenses of $318,
general overhead of the insurance companies of $1,145 and expenses incurred by
the NAIU pool in 1996 of $1,609.
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.
For the year ended December 31, 1996, Universal American earned net income
of approximately $104 resulting in an earnings per share applicable to common
shareholders of $0.01. For the year ended December 31, 1995, Universal American
earned net income of approximately $2,642, resulting in an earnings per share of
$0.25.
Operating income before income taxes decreased $2,278 from $2,651 in 1995
to $373, 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, (ii) a decrease in realized gains on investment of $434 and (iii)
the $250 expense accrual made at December 31, 1996 for the restructuring
activity of Universal American. These three items represent $1,784 of the $2,278
decrease.
REVENUES. Total revenues increased approximately $3,576 from total
revenues of approximately $49,811 for the years ended December 31, 1995 to
approximately $53,387 for the year ended December 31, 1996. Net premiums and
policyholder fees earned increased approximately $3,334. Supplemental health
insurance premiums at American Progressive increased approximately $1,258
(primarily Medicare supplement, hospital indemnity and home health care) and its
life premiums grew approximately $30, while American Pioneer's life premiums
grew approximately $374 and its group dental premiums grew approximately $919.
The increase in these life and supplemental health premiums of $2,581 was offset
by the decrease of approximately $547 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 Universal American (approximately $754). Universal American had an
increase in premiums from the NAIU pool of $1,798 and the New York State DBL
business of $256. Realized gains on investments decreased approximately $434,000
to approximately $240, compared to a gain of approxi-
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mately $674 for the prior year. Net investment income increased approximately
$905 from $8,945 in 1995 to $9,850 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 deposit received by American Progressive in
connection with the sale of the New York State DBL business. WorldNet's fee
income decreased by $716 which reduction primarily results from Universal
American's termination of its service agreement with Liberty Mutual Insurance
Company in February, 1996. For the year ended December 31, 1996, Universal
American amortized approximately $280 of deferred revenue compared to $244
amortized in the same period in 1995.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions increased approximately $5,754 to $53,014 for the year ended December
31, 1996. The change in future policy benefits amounted to an increase of
approximately $3,192. The increase in reserves for the year ended December 31,
1996 was $1,855 and primarily relates to the increase in life reserves at
American Pioneer of $971, the increase in the unearned premium reserve at NAIU
of $256 and the increase in the senior market supplemental health insurance
unearned premium reserves of $628. This increase compares to a decrease in 1995
of approximately $1,337, which decrease in 1995 primarily relates to the
reduction in the 1995 NAIU premium ($491), the accident and health business of
American Progressive ($827), which is not actively marketed, and the major
hospital and major medical of American Pioneer ($430) offset by an increase in
the senior market supplemental health insurance reserves ($559). Claims and
other benefits increased approximately $1,676. This increase is a result of
increased mortality of approximately $516, an increase in American Progressive's
senior market supplemental health benefits of approximately $1,062, and the
claims incurred on the First National business acquired of $1,077, and increased
morbidity of $388 on the group dental business. The runoff health business at
both insurance companies had a reduction in benefits totaling $3,145 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
and New York State DBL benefits increased $695. The increase in deferred
acquisition costs decreased approximately $1,106 and was due to the decrease in
capitalized expenses of $228 and the increase in amortization of $878.
Commissions decreased $265 to $5,076 for the year ended December 31, 1996.
The increase in gross commissions of $4,967 was due to the increase in gross
premiums noted above, offset by a corresponding increase in reinsurance
allowances of $5,231. Other operating costs and expenses decreased approximately
$175. Expenses incurred by the Insurance Subsidiaries during 1996 exceeded the
1995 amount by approximately $1,405. New business expenses and premium taxes
increased approximately $166. The expenses incurred on the administration of the
acquired First National business amounted to $550, while the expense incurred by
the NAIU accident pool decreased $397. The general overhead expenses of the
insurance companies increased approximately $1,086, which increase directly
relates to the increase in business being administered by Universal American.
These administrative general expense increases are partially recovered from the
increase in the reinsurance allowances noted above. The remaining decrease of
$1,580 results from a decrease of continuing operation expenses incurred by
WorldNet of approximately $1,292 and a decrease in the parent company's expenses
of $288,000. Amortization of the present value of future profits was
approximately $205 for 1995, which amount fully amortized the asset.
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IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs being 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
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
Universal American's plan to resolve the Year 2000 issue involves the
following phases: (1) the assessment phase, which determines the impact of the
Year 2000 issue, (2) the remediation phase, which is the updating or modifying
of affected systems, (3) the testing phase, which determines the effectiveness
of the remediation phase, (4) the implementation phase, which applies all proven
systems to the operating environment and (5) the contingency planning phase,
which develops plans in the event that the Year 2000 issue was not appropriately
addressed.
Universal American has completed its assessment of the systems that could
be significantly affected by the Year 2000 issue. The completed assessment
indicated that Universal American's main policy administration system utilizes
programs that were written using four digit codes to define the applicable year.
This main policy administration system was tested to determine the system's
ability to operate after January 1, 2000. Test results indicated that the system
should continue to process transactions without disruption. Some of Universal
American's computer programs used to process portions of Universal American's
business outside of the main policy administration system were written using two
digits rather than four to define the applicable year and therefore have to be
modified or replaced. As a result, Universal American began a conversion process
to bring all of Universal American's products onto its main policy
administration system. All of Universal American's products were placed on this
system by January 1, 1999.
In addition to its policy administration system, Universal American
performed assessments of other processing systems and determined that a claims
paying system for a small block of business was not Year 2000 compliant.
Universal American obtained the vendor upgrade for this system. It is
anticipated that the installation, testing and implementation of this upgrade
will be completed by March 31, 1999.
Universal American recently acquired blocks of business (the First National
and Dallas General blocks) and American Exchange. In connection with those
acquisitions, Universal American has converted all of the acquired businesses
into the Year 2000 compliant systems currently in place.
In addition to resolving the internal Year 2000 issue, Universal American
is working with all external organizations, business partners and vendors to
assess Year 2000 issues associated with the exchange of electronic data.
Universal American is in the process of testing the interfaces with these
business partners. Universal American has also begun the process of obtaining
Year 2000 readiness statements from all its external business partners to
determine the extent to which Universal American might be 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 Universal American's
systems rely will be timely converted and will not have an adverse effect on
Universal American's systems.
Universal American estimates that its plan to resolve the Year 2000 issue
will be completed by March 31, 1999, which is prior to any anticipated impact on
its operating systems, and that the Year 2000 issue should not pose significant
operational problems for
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its computer systems. However, if Universal American's plan is not successfully
implemented, the Year 2000 issue could have a material impact on the operations
of Universal American.
Universal American's plan includes the development of contingency plans for
any significant risks that might result from the Year 2000 issue. As discussed
above, Universal American is not presently aware of any specific significant
business risk that it believes it is exposed to regarding the Year 2000 issue.
Therefore, Universal American has not developed a contingency plan for the Year
2000 issue. Universal American will continue to monitor and assess risks for
which contingency plans will be required.
Currently, Universal American 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 costs of the project and the date on
which Universal American 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. There can be no guarantee that these estimates 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.
INVESTMENTS
Universal American's investment policy is to balance the portfolio between
long-term and short-term investments so as to achieve investment returns
consistent with the preservation of capital and maintenance of liquidity
adequate to meet the payment of policy benefits and claims. Universal American
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 that may be made. Universal
American currently engages the services of an investment advisor, Asset
Allocation and Management Company, to manage Universal American's fixed maturity
portfolio, under the direction and management of the Insurance Subsidiaries and
in accordance with guidelines adopted by their respective boards of directors.
Universal American has invested in a limited number of non-investment grade
securities that provide higher yields than investment grade securities. As of
September 30, 1998 and December 31, 1997, Universal American held unrated or
less-than-investment grade corporate debt securities of approximately $2,047 and
$2,616, respectively. These holdings amounted to 1.3% of total investments and
0.7% of total assets at September 30, 1998 compared to 1.6% of total investments
and 1.0% of total assets at December 31, 1997.
At September 30, 1998, all of Universal American's investments were income
producing and current in interest and principal payments. In addition, Universal
American has no investment in any derivative instruments or other hybrid
securities that contain any off-balance sheet risk.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 1999. Because of Universal American's minimal
use of derivatives, management does not
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anticipate that the adoption of the new statement will have a significant effect
on earnings or the financial position of Universal American.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("Statement 131"), effective for years
beginning after December 15, 1997. Statement 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-makers in deciding how to allocate resources and in
assessing performance and will be implemented by Universal American starting
with December, 1998 financial statements. 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 131 also requires information about
revenues from products or services, countries where Universal American has
operations or assets, and major customers. The adoption of Statement 131 will
not affect results of operations or financial position.
As of January 1, 1998, Universal American adopted Statement 130, "Reporting
Comprehensive Income." Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on Universal American's net income or shareholders'
equity. Statement 130 requires unrealized gains or losses on Universal
American's available-for-sale securities, which prior to adoption were reported
separately in shareholders' equity, to be included in other comprehensive
income. Prior year financial statements have been reclassified to conform to the
requirements of Statement 130.
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UNIVERSAL AMERICAN FINANCIAL CORP.
SUPPLEMENTARY UNAUDITED FINANCIAL INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
Summarized unaudited quarterly financial information for 1998, 1997, 1996
and 1995 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- -------
<S> <C> <C> <C> <C>
1998
Total revenue............................... $13,815 $14,331 $14,068
Operating income before income taxes........ 774 1,260 1,018
Net income applicable to common
shareholders.............................. 425 701 564
Diluted earnings per share.................. .04 .06 .05
1997
Total revenue............................... $12,885 $13,275 $14,030 $11,141
Operating income before income taxes........ 560 709 1,238 705
Net income applicable to common
shareholders.............................. 370 413 726 362
Diluted earnings per share.................. .03 .04 .07 .04
1996
Total revenue............................... $12,258 $11,737 $14,200 $15,192
Operating income (loss) before income
taxes..................................... 328 187 150 (292)
Net income (loss) applicable to common
shareholders.............................. 282 123 101 (402)
Diluted earnings (loss) per share........... .03 .01 .01 (.04)
1995
Total revenue............................... $12,264 $12,519 $12,891 $12,138
Operating income before income taxes........ 592 1,058 486 515
Net income applicable to common
shareholders.............................. 391 698 320 1,232
Diluted earnings per share.................. .03 .07 .03 .12
</TABLE>
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PENN UNION COMPANIES
SELECTED COMBINED FINANCIAL INFORMATION
The following selected combined financial information is derived from
combined financial statements of the Penn Union Companies. The financial
statements for the three years ended December 31, 1995, 1996 and 1997 have been
audited by KPMG LLP, independent auditors. The selected financial information as
of September 30, 1998 and for the nine month periods ended September 30, 1997
and September 30, 1998 has been derived from unaudited combined financial
statements of the Penn Union Companies, but includes all adjustments, including
normally occurring accruals, that the Penn Union Companies consider necessary
for fair presentation of the results of operations for the periods presented.
The results of operations for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the Penn Union
Companies' fiscal year ended December 31, 1998. The information should be read
in conjunction with the combined financial statements, related notes, and the
more comprehensive historical financial information included as Annex E to this
proxy statement. See "Penn Union Companies Management's Discussion and Analysis
of Financial Condition and Results of Operations."
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THE PENN UNION COMPANIES
SELECTED COMBINED FINANCIAL INFORMATION
INCOME STATEMENT INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------------- -------------------------------
1997 1998 1995 1996 1997
----------- ----------- -------- -------- ---------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Direct premium and policyholder fees... $243,851 $224,826 $161,188 $329,871 $ 326,096
Reinsurance premiums assumed........... 4,319 3,357 9,156 22,514 5,029
Reinsurance premiums ceded............. (78,431) (68,034) (4,058) (56,123) (106,121)
-------- -------- -------- -------- ---------
Net premium and policyholder fees
earned............................... 169,739 160,149 166,286 296,262 225,004
Net investment income.................. 36,209 36,720 30,572 48,113 47,405
Realized gains (losses) on
investments.......................... 5,342 2,568 (278) (616) 4,795
Other income........................... 12,250 7,690 3,717 9,252 17,550
-------- -------- -------- -------- ---------
Total revenues....................... 223,540 207,127 200,297 353,011 294,754
-------- -------- -------- -------- ---------
Total benefits, claims and other
deductions........................... 203,332 295,375 153,397 298,937 262,860
-------- -------- -------- -------- ---------
Operating income (loss) before taxes... 20,208 (88,248) 46,900 54,074 31,894
Net income (loss) after taxes.......... $ 15,955 $(57,392) $ 27,432 $ 36,468 $ 24,305
</TABLE>
BALANCE SHEET INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, AS OF DECEMBER 31,
------------- ------------------------
1998 1996 1997
------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Total investments.............................. $ 707,652 $ 651,061 $ 674,749
Total assets................................... 1,143,232 1,226,372 1,266,182
Policy liabilities and accruals................ 636,950 638,991 666,598
Business equity................................ 441,895 483,179 498,840
</TABLE>
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PENN UNION COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For purposes of this management's discussion and analysis, the Penn Union
Companies include the insurance operations of Pennsylvania Life, Penncorp Life,
Union Bankers, Marquette, Peninsular and PennCorp Financial, Inc. The Penn Union
Companies market and underwrite limited fixed-benefit accident and sickness
products and, to a lesser extent, life and accumulation products through a sales
force exclusive to the Penn Union Companies throughout the United States and
Canada. All dollar amounts presented below are in thousands unless otherwise
stated.
CAUTIONARY STATEMENTS
The Penn Union Companies caution readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this proxy
statement and in any other oral or written statements, either made by, or on
behalf of the Penn Union Companies, whether or not in future filings with the
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
Penn Union Companies' products, investment spreads or yields, or the earnings or
profitability of the Penn Union Companies' activities.
These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results to be materially
different from those contemplated by the forward looking statements. Such
factors include, among other things: (1) general economic conditions and other
factors, including prevailing interest rate levels and stock market performance,
which may affect the ability of the Penn Union Companies to sell their products,
the market value of the Penn Union Companies' investments and the lapse rate and
profitability of policies; (2) the Penn Union Companies' ability to achieve
anticipated levels of operational efficiencies and cost-saving initiatives and
to meet cash requirements based upon projected liquidity sources; (3) customer
response to new products, distribution channels and marketing initiatives; (4)
mortality, morbidity, and other factors which may affect the profitability of
the Penn Union Companies' insurance products; (5) changes in the federal income
tax laws and regulations which may affect the relative tax advantages of some of
the Penn Union Companies' products; (6) increasing competition in the sale of
insurance and annuities; (7) regulatory changes or actions, including those
relating to regulation of insurance products and of insurance companies; (8)
ratings assigned to the Penn Union Companies' insurance companies by independent
rating organizations such as A.M. Best; (9) the Penn Union Companies' ability to
successfully complete their Year 2000 remediation efforts; (10) the completion,
including obtaining required regulatory approvals, of the sale of the Penn Union
Companies to Universal American; and (11) unanticipated litigation. There can be
no assurance that other factors not currently anticipated by management will not
also materially and adversely affect Penn Union Companies' results of
operations.
RECENT DEVELOPMENTS
On December 31, 1998, PFG, the ultimate parent of the Penn Union Companies,
and several of PFG's subsidiaries entered into an acquisition agreement to sell
the Penn Union
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Companies to Universal American, in conjunction with Capital Z's simultaneous
equity investment in Universal American. The purchase price is $175,000,
consisting of $136,000 of cash and $39,000 original principal amount of
subordinated notes. The purchase price may be increased or decreased under the
terms of the acquisition agreement.
To finance part of the transaction, Universal American will issue
approximately $82,000 of new equity in the form of common stock to Capital Z and
some agents and members of management of the Penn Union Companies at a price of
$3.15 per share. In addition, Universal American may pay a portion of a
transaction fee in its common stock to an affiliate of Capital Z.
Universal American also intends to fund the transaction by borrowing
$70,000, which has been committed by a syndicate of lenders arranged by CSI. The
lenders will make an additional $10,000 available to Universal American on a
revolving credit basis. In addition, Universal American will issue $39,000
original principal amount of subordinated notes to PFG or its subsidiaries. The
subordinated notes will have an 8% coupon and a maturity of ten years. Interest
on the subordinated notes may be paid in additional subordinated notes or in
cash, at Universal American's option. The unpaid principal balance of and any
accreted interest on the subordinated notes will be subject to offset in the
event of adverse development in Pennsylvania Life's disability income claim
reserve and for other indemnification claims, subject to specified limitations.
The closing of the acquisition and the Capital Z Issuance is subject to
certain closing conditions, including receipt of all required regulatory
approvals. The Capital Z Issuance and the increase in the authorized shares of
Universal American, which are conditions to closing the acquisition, require the
approval of Universal American's shareholders. The parties expect the closing of
the acquisition and the Capital Z Issuance to occur in May of 1999.
The acquisition agreement contains other pre-closing restructuring
provisions, including the termination of the current reinsurance agreements
between Peninsular and Occidental Life Insurance Company of North Carolina
("Occidental"), an affiliate, relating to the assumption by Peninsular of
Occidental's reserves and the establishment of a new reinsurance agreement,
whereby Peninsular will cede 100% of its existing direct business to Occidental.
In December 1998, Union Bankers signed a letter of intent to cede the
remaining 20% of its Medicare supplement business to Cologne Life Reinsurance
Company. The letter of intent also amends certain provisions of the existing
contract. Universal American, at its option, has the ability to require Union
Bankers to recapture the additional 20%. Management of the Penn Union Companies
does not expect this transaction to have a material effect on the financial
position of the Penn Union Companies.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1998 and 1997
For the nine months ended September 30, 1998, the Penn Union Companies
incurred a net loss after federal income taxes of $57,392, compared to net
income of $15,955 for the same period of the prior year. The operating loss
before federal taxes amounted to $88,248 for the nine months ended September 30,
1998 compared to operating income of $20,208 in the same period in the prior
year.
REVENUES. Total revenues decreased by $16,413, or 7.3%, to $207,127 for
the nine months ended September 30, 1998, compared to total revenues of $223,540
for the same period of the prior year.
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PREMIUMS AND POLICY AND PRODUCT CHARGES. Net premiums decreased by
approximately $9,457, or 5.6%, to $158,995 for the nine months ended September
30, 1998, compared to $168,452 for the same period of the prior year. Premiums
at Union Bankers decreased by $8,530. This decrease reflects the continued
run-off of the Medicare and comprehensive blocks of business, due to the
decision to not actively market these blocks of business at Union Bankers.
Interest sensitive policy product charges decreased by $133 or 10.3% to
$1,154 for the nine months ended September 30, 1998. This decrease reflects the
continued run-off of this closed block of business. During 1997, the Penn Union
Companies (primarily Constitution) ceased writing interest-sensitive life and
annuity business.
INVESTMENT INCOME AND NET REALIZED GAINS. Net investment income increased
by $511, or 1.4%, to $36,720 for the nine months ended September 30, 1998
compared to $36,209 for the same period of the prior year.
Realized gains on investments amounted to $2,568 for the nine months ended
September 30, 1998 compared to realized gains of $5,342 for the same period of
the prior year. Included in the 1997 amount are gains resulting from the
liquidation of a significant portion of the equity securities held by
Pennsylvania Life.
OTHER INCOME. Other income decreased by $4,560, or 37.2%, to $7,690 for
the nine months ended September 30, 1998 compared to $12,250 for the same period
of the prior year. The amortization of the deferred revenue associated with the
reinsurance of the Medicare supplement line of business amounted to $6,681 for
the nine months ended September 30, 1998 compared to $11,204 for the same period
of the prior year. The amortization is anticipated to continue to decrease as
the block of business runs out.
BENEFITS AND EXPENSES. Total benefits and expenses increased by $92,043,
or 45.3% to $295,375 for the nine months ended September 30, 1998, compared to
$203,332 for the same period of the prior year.
Policyholder benefits incurred decreased by $8,972, or 8.0%, to $103,754
for the nine months ended September 30, 1998, compared to $112,726 in the prior
year. The decrease relates primarily to the run-off of the Medicare supplement
block of business. It is anticipated that the claims relating to this block will
continue to decline. Also contributing to the decrease is a change in the mix of
business at Pennsylvania Life, including less disability income written with
lifetime benefits. Additionally, at Pennsylvania Life, the instant issue line
has been discontinued and a home office underwritten product is being sold,
reducing loss ratios.
The change in liability for future policy benefits and other policy
benefits for the nine months ended September 30, 1998 amounted to an increase of
$34,626 compared to an increase of $3,557 for the same period of the prior year,
generating an increase of $31,096. The Penn Union Companies have been closely
monitoring the development of claims reserve experience. The methodology
previously utilized has experienced what appears to be a deterioration of the
adequacy of its claims reserves associated with its disability income products
underwritten prior to PFG's ownership of Pennsylvania Life. During the first
quarter of 1998, Pennsylvania Life recognized this trend and strengthened the
reserves by approximately $3,000. During the three-month period ended June 30,
1998, Pennsylvania Life began a process to change its methodology in determining
these reserves. As a result of the trends, Pennsylvania Life increased its
claims reserve estimate by $20,000. The effect of the change in methodology is
inseparable from the effect of the change in accounting estimate and is
accordingly reflected in operations for the nine-month period ended
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September 30, 1998. During 1998 the Penn Union Companies also refined their
calculation of policy benefit reserves for long term care products which
resulted in an increase of approximately $7,551.
The amortization of present value of insurance in force and deferred policy
acquisition costs increased by $66,426, or 228.0%, to $95,565 for the nine
months ended September 30, 1998 compared to $29,139 for the same period of the
prior year. The period ended September 30, 1998 includes an impairment loss
related to deferred policy acquisition costs. During 1998, the Penn Union
Companies' assumptions as to future morbidity have increased primarily as a
result of adverse trends identified by the Penn Union Companies with respect to
disability income claim reserves. Additionally, effective in 1998, Pennsylvania
Life modified the commission structure and related participation in agency
profitability. Based on a recoverability analysis, comparing future discounted
cash flows from these blocks of business to the unamortized deferred policy
acquisition costs, it was determined that the unamortized deferred policy
acquisition costs for these blocks of business were not fully recoverable. This
resulted in a charge to income and a reduction of unamortized deferred policy
acquisition costs of $65,376.
The amortization of costs in excess of net assets acquired was $4,167 for
the nine months ended September 30, 1998 compared to $4,204 for the same period
of the prior year, representing a decrease of 0.9%.
Interest expense was $120 for the nine months ended September 30, 1998
compared to $151 for the same period of the prior year, representing a decrease
of 20.5%. The interest expense relates to the imputed interest on a capitalized
lease obligation. The lease agreement pertains to certain office furniture.
Underwriting and other administrative expenses increased by $3,588, or
6.7%, to $57,143 for the nine months ended September 30, 1998 compared to
$53,555 for the same period of the prior year. As a result of the Penn Union
Companies' initiative to transfer administration of their comprehensive and
Medicare supplement blocks of business to third party administrators, the Penn
Union Companies recorded a pre-tax restructuring charge of $1,834 during 1998.
The restructuring charge recognized primarily severance and related benefits
incurred due to staff reductions. Through September 30, 1998, the Penn Union
Companies have charged $1,308 against the accrual. As of September 30, 1998, the
Penn Union Companies re-evaluated such charge and reduced accruals by $269. The
Penn Union Companies also incurred additional period costs related to the
transition to the third party administrators as well as the move of the
financial operations of Constitution, Union Bankers and Marquette from Dallas to
Raleigh. In addition, as a result of the above-mentioned modification to the
compensation structure for Pennsylvania Life agents, certain agency field
expenses are no longer paid directly by Pennsylvania Life. Instead, they are
factored into the agency commissions. The impact of this change is a reduction
in the level of deferrable acquisition costs, thus increasing expenses.
Years Ended December 31, 1997 and 1996
For the year ended December 31, 1997, the Penn Union Companies earned net
income after federal income taxes of $24,305 compared to $36,468 in the prior
year. Operating income before federal taxes amounted to $31,894 for the year
ended December 31, 1997 compared to $54,074 in the prior year.
REVENUES. Total revenues decreased by $58,257, or 16.5%, to $294,754 for
the year ended December 31, 1997, compared to total revenues of $353,011 in the
prior year.
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PREMIUMS AND POLICY AND PRODUCT CHARGES. Net premiums decreased by
$70,226, or 23.9%, to $223,283 for the year ended December 31, 1997 compared to
$293,509 in the prior year. Gross premiums of $324,375 for the year ended
December 31, 1997 were consistent with the prior year. Assumed premiums
decreased by $17,485 to $5,029 in 1997. This decrease relates primarily to a
decrease in a block of life business assumed by Peninsular from an affiliate,
Occidental. Ceded premiums increased $49,998 to $106,121 in 1997. This increase
is primarily attributable to the Penn Union Companies' decision to reinsure 80%
of their Medicare supplement line of business at Union Bankers with an
unaffiliated reinsurer in July 1996. Premiums ceded under this treaty were
$97,851 in 1997 compared to $49,726 in 1996.
Interest sensitive policy product charges decreased by $1,032, or 37.5%,
primarily due to the run-off of this block of business. During 1997, the Penn
Union Companies (primarily Constitution) ceased writing interest sensitive life
and annuity business.
INVESTMENT INCOME AND NET REALIZED GAINS. Net investment income decreased
by $708, or 1.5%, to $47,405 for the year ended December 31, 1997 compared to
$48,113 in the prior year. Realized gains on investments amounted to $4,795 for
the year ended December 31, 1997 compared to a realized loss of $616 in the
prior year. Included in the 1997 amount are gains resulting from the liquidation
of a significant portion of the equity securities held by Pennsylvania Life of
$4,400.
OTHER INCOME. Other income increased by $8,298, or 89.7%, to $17,550 for
the year ended December 31, 1997 compared to $9,252 in the prior year. The
amortization of the deferred revenue associated with the reinsurance of the
Medicare supplement line of business amounted to $15,370 for the year ended
December 31, 1997, compared to $6,880 in the prior year. This increase is the
result of a full year of amortization of the deferred gain in 1997 compared to a
half year of amortization in 1996, as the reinsurance was effective on July 1,
1996.
BENEFITS AND EXPENSES. Total benefits and expenses decreased by $36,077,
or 12.1%, to $262,280 for the year ended December 31, 1997, compared to $298,937
in the prior year.
Policyholder benefits incurred decreased by $28,118, or 16.1%, to $147,055
for the year ended December 31, 1997, compared to $175,173 in the prior year.
The increase in net Medicare supplement claims ceded at Union Bankers was
approximately $32,766. This is the result of a full year of claims ceded under
the treaty in 1997 compared to six months in the prior year. In addition, due to
the run-off of this block of business, there was a decrease in the net claims
and benefits retained of approximately $1,900. These decreases were offset by an
increase of approximately $5,500 at Pennsylvania Life as a result of adverse
experience on its accident and health line of business.
The change in liability for future policy benefits and other policy
benefits for the year ended December 31, 1997 amounted to a decrease of $2,604
compared to a decrease of $15,137 in the prior year generating an increase of
$12,533. At Union Bankers, the change in reserves increased by $20,336. This is
due to the decrease in reserves of approximately $11,933 as a result of the
cession of the Medicare block of business in 1996, as well as other increases in
reserves during 1997 of $8,403, including the strengthening of reserves relating
to the comprehensive block of business of $5,900. In addition, the decrease of
$14,424 from the prior year at Peninsular is due primarily to the 1996
assumption of a block of life business by Peninsular from Occidental, which
increased reserves for that period. Lastly, at Pennsylvania Life, the change in
the liability increased by $7,375. In 1997, the scheduled reserve releases
relating to the conversion to the new valuation system were
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lower than the amount released in 1996 by $3,596. The remaining increase is due
primarily to a reduction in the run-off of accident and health claims reserves
during 1997.
The amortization of present value of insurance in force and deferred policy
acquisition costs increased by $1,169, or 3.0%, to $39,666 for the year ended
December 31, 1997 compared to $39,487 in the prior year. In 1997, the
amortization of deferred acquisition costs increased by $7,784 over 1996. The
amortization in 1996 reflects the effects of purchase GAAP accounting in the
prior year, which reduced the deferred acquisition cost asset for both Union
Bankers and Constitution to zero. Continued growth in the deferred acquisition
cost asset through current year capitalization accounts for the remaining
increase. Offsetting the increase in deferred acquisition cost amortization was
a decrease in the amortization of the present value of business acquired of
$6,615. This decrease was due primarily to the reduction in the present value of
in force in 1996 related to the 80% coinsurance of the Medicare supplement block
of business at Union Bankers.
The amortization of costs in excess of net assets acquired was $5,594 for
the year ended December 31,1997 compared to $5,613 in the prior year,
representing a decrease of 0.3%.
Interest expense was $201 for the year ended December 31, 1997 compared to
$179 in the prior year, representing an increase of 12.3%. The interest expense
relates to the imputed interest on a capitalized lease obligation. The lease
agreement pertains to certain office furniture.
Underwriting and other administrative expenses decreased by $21,664, or
22.9%, to $72,948 for the year ended December 31, 1997 compared to $94,612 in
the prior year. Commissions decreased by $13,683 related primarily to the
cession of premium on the medicare block of business. In addition, expenses
recovered under this reinsurance contract in 1997 were $4,600 greater than in
the prior year. General expenses at Pennsylvania Life also declined by
approximately $4,600 in 1997. This is due primarily to the non-recurring expense
relating to the write-down of unrecoverable agent balances of approximately
$3,300 in 1996.
Years Ended December 31, 1996 and 1995
For the year ended December 31, 1996, the Penn Union Companies earned net
income after federal income taxes of $36,468, compared to $27,432 in the prior
year. Operating income before federal taxes amounted to $54,074 for the year
ended December 31, 1996 compared to $46,900 in the prior year.
Pursuant to a stock acquisition agreement effective December 14, 1995,
Constitution, and its affiliates, Union Bankers, Marquette and Southwestern Life
Insurance Company ("Southwestern Life") were acquired by Southwestern Financial
Corporation, a corporation organized by PFG and KB Investment Fund I, LP. Prior
to December 14, 1995, Constitution, Union Bankers and Marquette were
wholly-owned subsidiaries of Southwestern Life, whose ultimate parent was I.C.H.
Corporation. Subsequently, on December 14, 1995, Constitution issued a surplus
debenture in the amount of $80,000 to its former immediate parent, in exchange
for all of the outstanding common stock of Union Bankers, including its wholly-
owned subsidiary, Marquette. The fair value of the net assets of Constitution,
Union Bankers and Marquette amounted to $25,967, resulting in $76,673 of costs
in excess of net assets acquired which is being amortized over 30 years. The
acquisition was accounted for as a purchase in accordance with generally
accepted accounting principles and accordingly the
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purchase price was allocated to the assets and liabilities acquired based on
estimates of their fair value as of the acquisition date, which became the new
cost basis.
The following unaudited pro forma financial information represents the Penn
Union Companies' combined results of operations as if the acquisition of
Constitution, Union Bankers and Marquette occurred as of January 1, 1995. This
unaudited pro forma information has been prepared for comparative purposes only
and does not purport to be indicative of what would have occurred had the
acquisition been made as of January 1, 1995, or results which may occur in the
future.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1995
------------
(UNAUDITED)
<S> <C>
Total revenues.................................. $455,141
Income before taxes............................. 62,025
Net income...................................... 36,427
</TABLE>
REVENUES. Total revenues increased by $152,714, or 76.2%, to $353,011 for
the year ended December 31, 1996, compared to total revenues of $200,297 in the
prior year.
PREMIUMS AND POLICY AND PRODUCT CHARGES. Net premiums increased by
$127,469, or 76.8%, to $293,509 for the year ended December 31, 1996, compared
to $166,040 in the prior year. Net premiums earned by Constitution, Union
Bankers and Marquette during 1996 added $127,092 to the Penn Union Companies.
Interest sensitive policy product charges increased by $2,507, due to the
acquisition of Constitution. The interest sensitive policy product charges
earned by Constitution during 1996 added $2,307 to the Penn Union Companies.
INVESTMENT INCOME AND NET REALIZED GAINS. Net investment income increased
by $17,541, or 57.4%, to $48,113 for the year ended December 31, 1996 compared
to $30,572 in the prior year. The net investment income earned by Constitution,
Union Bankers and Marquette during 1996 added $18,486 to the Penn Union
Companies. Realized losses on investments amounted to $616 for the year ended
December 31, 1996 compared to realized losses of $278 in the prior year. The net
realized gains earned by Constitution, Union Bankers and Marquette during 1996
was $692.
OTHER INCOME. Other income increased by $5,535, or 148.9%, to $9,252 for
the year ended December 31, 1996 compared to $3,717 in the prior year. The other
revenue earned by Constitution, Union Bankers and Marquette during 1996 added
$7,770 to the Penn Union Companies. The amortization of the deferred revenue
associated with the reinsurance of the Medicare supplement line of business at
Union Bankers amounted to $6,633 for the year ended December 31, 1996. This was
offset by a reduction in other income at Pennsylvania Life of $1,600 due to a
decrease in gains on trading securities of $2,303.
BENEFITS AND EXPENSES. Total benefits and expenses increased by $145,540,
or 94.9%, to $298,937 for the year ended December 31, 1996, compared to $153,397
in the prior year.
Policyholder benefits incurred increased by $95,892, or 121.0%, to $175,173
for the year ended December 31, 1996, compared to $79,281 in the prior year. The
policyholder benefits incurred by Constitution, Union Bankers and Marquette
during 1996 added $99,181 to the Penn Union Companies. During 1996, Union
Bankers entered into an 80% coinsurance contract to reinsure its Medicare block
of business. This resulted in ceded claims of $22,062.
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The change in liability for future policy benefits and other policy
benefits for the year ended December 31, 1996 amounted to a decrease of $15,137
compared to a decrease of $12,729 in the prior year generating a decrease of
$2,408. The change in future policy benefits at Peninsular increased by $14,282,
due primarily to an increase in the block of business assumed from Occidental.
At Pennsylvania Life, the change in reserves increased over the prior year by
$2,709, due primarily to the growth in the Canadian blocks of business. The
decrease in the liability for Constitution, Union Bankers and Marquette during
1996 was $18,695.
The amortization of present value of insurance in force and deferred policy
acquisition costs increased by $14,105, or 57.8%, to $38,497 for the year ended
December 31, 1996 compared to $24,392 in the prior year. Amortization of present
value of insurance in force incurred by Constitution, Union Bankers and
Marquette during 1996 added $13,203 to the Penn Union Companies.
The amortization of costs in excess of net assets acquired increased by
$2,561, or 83.9%, to $5,613 for the year ended December 31, 1996 compared to
$3,052 in the prior year. This increase is due primarily to the amortization of
the goodwill associated with the acquisition of Constitution, Union Bankers and
Marquette on December 14, 1995.
Interest expense was $179 for the year ended December 31, 1996. This
reflects the imputed interest relating to the capitalized lease obligation. The
lease agreement pertains to certain office furniture, which commenced in March
1996.
Underwriting and other administrative expenses increased by $35,211, or
59.3%, to $94,612 for the year ended December 31, 1996 compared to $59,401 in
the prior year. Underwriting and other administrative expenses incurred by
Constitution, Union Bankers and Marquette during 1996 added $39,893 to the Penn
Union Companies.
INCOME TAXES
The effective tax rates for the nine months ended September 30, 1998 and
1997 and the years ended December 31, 1997, 1996 and 1995 were 35.0%, 21.0%,
23.8%, 32.6% and 41.5%, respectively. The permanent differences relate primarily
to the deduction for tax purposes of the interest expense on the surplus notes
of Constitution which are treated as deemed distributions and the change in the
valuation allowance on the deferred tax assets.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997. The increase in the
effective tax rate to 35.0% for the nine months ended September 30, 1998 from
21.0% for the same period in the prior year is due primarily the effect of the
reduction of the deferred acquisition cost asset at September 30, 1998 as well
as the reserve adjustments. Those items significantly increased the net loss
before taxes in relation to the permanent differences, therefore minimizing the
effects of the permanent differences. However, the valuation allowance was
increased during the period ended September 30, 1998 by $1,056 compared to a
reduction of $448 for the same period in the prior year. This was due to an
increase in foreign tax credits relating to the foreign operations of
Pennsylvania Life that management believes may not be utilized in future
periods.
YEARS ENDED DECEMBER 31, 1997 AND 1996. During 1997, net income before
taxes decreased by $22,180, amplifying the effects of the permanent differences.
In addition, the valuation allowance was decreased by $525 during the year ended
December 31, 1997 compared to an increase of $1,052 in the prior year. This
decrease in the valuation allowance was based on management's belief that a
greater portion of net operating losses and other credits would be utilized in
future periods.
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YEARS ENDED DECEMBER 31, 1996 AND 1995. The decrease in the effective rate
for the period ended December 31, 1996 is due primarily to addition of the
permanent difference for the interest on the surplus notes at Constitution. This
item was not included prior to the acquisition of Constitution, Union Bankers
and Marquette at December 14, 1995. This decrease was offset, in part, by an
increase in the net income before taxes.
INFLATION
The Penn Union Companies sell fixed benefit insurance products, and to a
lesser extent life and accumulation products. The fixed benefit products
typically provide a predetermined fixed payment that will be paid under
specified conditions. Fixed benefit products are not designed to provide
reimbursement for medical and related costs incurred as a result of accident and
sickness. Accordingly, payment amounts are not affected by the insured's actual
cost of health care services. Because of the characteristics of their fixed
benefit products, the Penn Union Companies believe that inflation does not have
a material effect on their operations.
LIQUIDITY AND CAPITAL RESOURCES
The Penn Union Companies that are insurance subsidiaries prepare their
statutory financial statements in accordance with accounting practices
prescribed or permitted by their respective state insurance departments.
Prescribed SAP includes state laws, regulations, and general administrative
rules, as well as a variety of publications of the NAIC. Permitted SAP encompass
all accounting practices that are approved by insurance regulatory authorities;
such practices differ from state to state, and may differ from company to
company within a state, and may change in the future. The NAIC has a project to
codify SAP, the result of which is expected to constitute the only source of
prescribed SAP. Accordingly, that project will likely change to some extent
prescribed SAP and may result in changes to the accounting practices that
insurance enterprises use to prepare their statutory financial statements.
Pennsylvania Life, Peninsular, Constitution, Union Bankers and Marquette
are required to maintain minimum amounts of capital and surplus as determined by
state regulatory authorities.
Statutory capital and surplus of the insurance companies as reported to
regulatory authorities at September 30, 1998 and December 31, 1997 and 1996
totaled $183,736, $226,312 and $220,653, respectively. Statutory net (loss)
income of the insurance companies as reported to regulatory authorities totaled
$(22,045) for the nine months ended September 30, 1998 and $9,469, $21,473 and
$(25,171) for the years ended December 31, 1997 and 1996 and 1995, respectively.
Pennsylvania Life's Canadian branch and Canadian subsidiary report to
Canadian regulatory authorities based upon Canadian SAP that vary in some
respects from U.S. SAP. Canadian net assets based upon Canadian SAP were
$50,379, $51,428 and $51,567 as of September 30, 1998, December 31, 1997 and
December 31, 1996, respectively.
Cash generated by the insurance companies included in the Penn Union
Companies is made available to PFG, the ultimate parent, principally through
periodic payments of principal and interest on surplus debentures, funded
primarily by dividends from the insurance companies included in or owned by the
Penn Union Companies.
Dividend payments by insurance companies are limited by, or subject to, the
approval of the insurance regulatory authority of each insurance company's state
of domicile. Such
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dividend requirements and approval processes vary significantly from state to
state. Currently, the insurance companies included in the Penn Union Companies
are not able to pay dividends without prior approval from their respective
insurance regulatory authorities.
The surplus debentures in the amount of $105,750, $113,000, and $119,000 as
of September 30, 1998 and December 31, 1997 and 1996, respectively, are excluded
from net assets in the combined statements (see Note 1 on the basis of
presentation). However, pursuant to the terms of the surplus debenture issued by
Constitution to the benefit of Southwestern Life Companies, Inc., Constitution
may make principal and interest payments to the extent that Constitution's
surplus, plus liabilities relating to the surplus debentures, less the statutory
carrying value of Southwestern Life and Union Bankers, exceeds $1,200.
Constitution's surplus at September 30, 1998 was $154,799, of which $158,215 was
attributable to its ownership of Southwestern Life and Union Bankers.
Liabilities relating to the surplus debentures at September 30, 1998 were
$6,059, representing accrued principal and interest. At September 30, 1998,
Constitution was restricted from making the full payment on the surplus note and
was in arrears with respect to principal in the amount of $3,625 and interest in
the amount of $990. At December 31, 1997, Constitution's surplus was $174,715 of
which $161,098 was attributable to its ownership of Southwestern Life and Union
Bankers.
Beginning in 1993, the NAIC imposed regulatory risk-based capital ("RBC")
requirements on life insurance enterprises, including the insurance companies.
The RBC model serves as a benchmark for the regulation of life insurance
companies by state insurance regulators. RBC provides for targeted surplus
levels based on formulas which specify various weighting factors that are
applied to financial balances or various levels of activity based on the
perceived degree of risk, and are set forth in the RBC requirements. Such
formulas focus on four general types of risk: (a) the risk with respect to a
company's assets (asset or default risk); (b) the risk of adverse insurance
experience with respect to a company's liabilities and obligations (insurance or
underwriting risk); (c) the interest rate risk with respect to a company's
business (asset/liability matching); and (d) all other business risk
(management, regulatory action, and contingencies). The amount determined under
such formulas is called the authorized control level RBC ("ACLC").
The RBC guidelines define specific capital levels based on a company's ACLC
that are determined by the ratio of a company's total adjusted capital ("TAC")
to its ACLC. TAC is equal to statutory capital, plus AVR and certain other
specified adjustments. The specified capital levels, in declining order, and
applicable ratios are generally as follows: "Company Action Level" where TAC is
less than or equal to 2.0 times ACLC or the TAC is less than or equal to 2.5
times ACLC with a negative trend; "Regulatory Action Level" where TAC is less
than or equal to 1.5 times ACLC; "Authorized Control Level" where TAC is less
than or equal to 1.0 times ACLC; and "Mandatory Control Level" where TAC is less
than or equal to 0.7 times ACLC. Companies at the Company Action Level are
required to submit a comprehensive financial plan to the insurance commissioner
of the state of domicile. Companies at the Regulatory Action Level are subject
to mandatory examination or analysis by the commissioner and possible required
corrective actions. At the Authorized Control Level, companies are subject to,
among other things, the commissioner placing them under regulatory control. At
the Mandatory Control Level, the insurance commissioner is required to place a
company under regulatory control.
At December 31, 1997 Pennsylvania Life's TAC was $44,224, with a negative
trend, placing it within the Company Action Level. Should Pennsylvania Life need
to substantially increase its claims reserves further, it is likely that
Pennsylvania Life's risk-based capital
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ratio would materially decline, without further management action, to a level
which could require certain actions be taken by the Commonwealth of Pennsylvania
Insurance Department. See "-- Regulatory Matters" on page 95.
On September 30, 1998, Pennsylvania Life entered into a reinsurance
agreement with an unaffiliated reinsurer to coinsure certain in force individual
life and health business written or acquired by Pennsylvania Life prior to
January 1, 1998. In addition, as part of the acquisition agreement, PFG is
required to deliver each of the PennLife Companies and the ConLife Companies to
Universal American with minimum target capital and surplus amounts to ensure
that each of the companies are above the Company Action Level. The aggregate
capital and surplus requirements for the PennLife Companies and the ConLife
Companies must equal the sum of $72.3 million plus the earnings of the PennLife
Companies and the ConLife Companies from January 1, 1999 to the closing of the
acquisition. To achieve this, several actions are planned. These actions include
the sale of Penncorp Life by Pennsylvania Life to PFG for fair value; the
replacement, by PFG, of certain non-performing assets held by the Penn Union
Companies with investment grade bonds assigned an NAIC rating of 1 or 2; and the
reallocation of capital.
Attaining and maintaining the required RBC levels depends on future events
and circumstances, the outcome of which cannot be assured and the ultimate
outcome cannot be presently determined. Accordingly, no adjustments that may
result from the ultimate resolution of this uncertainty have been made in the
accompanying financial statements. Management presently believes that it will
implement its plan and meet and maintain RBC requirements.
At December 31, 1997, Union Bankers, Constitution, Peninsular, and
Marquette's total adjusted capital place them above the Company Action Level.
INVESTMENTS
The Penn Union Companies' investment policy is to balance the portfolio
between long-term and short-term investments so as to achieve investment returns
consistent with the preservation of capital and maintenance of liquidity
adequate to meet the payment of policy benefits and claims. The Penn Union
Companies invest in assets permitted under the insurance laws of the various
states in which they operate; such laws generally prescribe the nature, quality
of and limitations on various types of investments that may be made. The Penn
Union Companies currently engage the services of an investment advisor to manage
their investment portfolio, under the direction and management of the Penn Union
Companies and in accordance with guidelines adopted by their respective boards
of directors.
The Penn Union Companies have invested in a limited number of
non-investment grade securities that provide higher yields than investment grade
securities. As of September 30, 1998 and December 31, 1997, the Penn Union
Companies held unrated or less-than investment grade securities with fair values
of $21,557 and $25,668, respectively. These holdings amounted to 3.2% of total
investments and 1.9% of total assets at September 30, 1998 compared to 3.9% of
total investments and 2.0% of total assets at December 31, 1997. The Penn Union
Companies had non-income producing securities with fair values of $1,929 and
$1,948 at September 30, 1998 and December 31, 1997, respectively.
The Penn Union Companies have no investments in any derivative instruments
or other hybrid securities that contain any off balance sheet risk.
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IMPACT OF YEAR 2000
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g., "98" represents 1998). It is
highly likely that such systems will not be able to accurately process data
containing date information for the year 2000 and beyond. The Penn Union
Companies are highly reliant upon computer systems and software as are many of
the businesses with which the Penn Union Companies interact. The Penn Union
Companies' ability to service their policyholders and agents is dependent upon
accurate and timely transaction reporting. Transaction reporting in turn is
dependent upon the Penn Union Companies' highly complex interdependent computer
hardware, software, telecommunications and desktop applications. The inability
of the Penn Union Companies or any of their integral business partners to
complete Year 2000 remediation efforts associated with these highly complex and
interdependent systems could lead to a significant business interruption. Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.
The Penn Union Companies' plan to resolve the Year 2000 issue involves the
following phases: (1) the assessment phase, (2) the remediation phase which is
the upgrading or modifying of affected systems, (3) the testing phase which
determines effectiveness of the remediation phase, (4) the implementation phase
which applies all proven systems to the operating environment and (5) the
contingency planning phase which develops plans in the event that the Year 2000
issue was not appropriately addressed.
The Penn Union Companies believe that they have substantially completed
their Year 2000 assessment and remediation efforts, which will be subject to
ongoing tests for the remainder of 1999.
In addition to addressing the internal Year 2000 issue, the Penn Union
Companies are working with critical external organizations, business partners
and vendors to assess Year 2000 issues associated with the exchange of
electronic data. The Penn Union Companies are in the process of testing the
interfaces with these business partners. The Penn Union Companies have obtained
Year 2000 readiness statements from their critical external business partners to
determine the extent to which the Penn Union Companies might be 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 Penn Union
Companies' systems rely will be timely converted and will not have an adverse
effect on the Penn Union Companies' systems.
The Penn Union Companies, based upon internal assessment, believe that they
were 92.5% complete with respect to their Year 2000 remediation efforts of
critical business systems as of September 30, 1998. As of December 31, 1998, the
Penn Union Companies believe that their critical business systems are Year 2000
compliant. However, if the Penn Union Companies' plan is not successfully
implemented, the Year 2000 issue could have a material impact on the operations
of the Penn Union Companies.
The Penn Union Companies' plan includes the development of contingency
plans for any significant risks that might result from the Year 2000 issue. As
discussed above, the Penn Union Companies are not presently aware of any
specific significant business risk that they believe they are exposed to
regarding the Year 2000 issue. Although the Penn Union Companies believe that
the Year 2000 issues should not cause a material disruption to their business,
they have developed various contingency plans and proposed action steps
associated with remediation tasks which the Penn Union Companies believe are at
a higher
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risk for potential failure. However, the Penn Union Companies will continue to
monitor and assess risks which may require modification to the current
contingency plans.
The Penn Union Companies have engaged certain outside vendors and focused
certain employees' full time efforts to help in their Year 2000 initiative. This
includes systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Penn Union Companies are projecting to
incur internal and external costs associated with such expertise of
approximately $2,606, to be incurred primarily during 1998 and early 1999. The
Penn Union Companies estimate that they have incurred internal and external
costs aggregating $1,858 through September 30, 1998.
Although the Penn Union Companies believe that their operating companies,
outside vendors and most critical business partners will be sufficiently
compliant that the Year 2000 issue should not cause a material disruption in the
Penn Union Companies' business, there can be no assurance that there will not be
material disruptions to the Penn Union Companies' business or an increase in the
cost of doing business.
OTHER COMMITMENTS AND CONTINGENCIES
PFG, the parent of the Penn Union Companies, and two current or former PFG
directors and officers have been named as defendants in ten class-action
securities complaints (collectively, the "Complaints") filed in the United
States District Court for the Southern District of New York. The Complaints are
brought on behalf of certain purchasers of PFG's common stock and subordinated
notes. The Complaints charge PFG and such officers and directors with violations
of federal securities laws. Plaintiffs seek to recover damages in unspecified
amounts on behalf of themselves and all other purchasers of PFG's common stock
and subordinated notes during various periods. All parties have agreed to the
consolidation of all of the above actions and the court appointed lead
plaintiffs on behalf of the shareholders and noteholders. Additional information
with respect to the Complaints is included in PFG's Form 10-Q, for the period
ended September 30, 1998, on file with the SEC.
Presently, none of the Penn Union Companies have been specifically named in
the above Complaints. In addition, PFG has agreed to indemnify Universal
American in specified circumstances for liabilities of the Penn Union Companies,
if any, in connection with the Complaints.
While it is not feasible to predict or determine the final outcome of these
proceedings or to estimate the amount or potential range of loss with respect to
these matters, management believes that an adverse outcome with respect to such
proceedings would not have a material adverse impact on the financial condition,
results of operations or cash flows of the Penn Union Companies.
On July 30, 1998, the SEC notified PFG that it had commenced a formal
investigation into possible violations of the federal securities laws including
matters relating to PFG's restatement of its financial statements for the first
nine months of 1997, and for the years ended December 31, 1996, 1995, and 1994.
PFG and its management are fully cooperating with the SEC in its investigation.
Certain lawsuits have been brought against the Penn Union Companies in the
normal course of the insurance business involving the settlement of various
matters and seeking compensatory and in some cases punitive damages. Management
of the Penn Union Companies believes that the ultimate settlement of all such
litigations will not have a
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materially adverse effect on the Penn Union Companies' combined financial
position or results of operations. PFG has also agreed to indemnify Universal
American for any liabilities of the Penn Union Companies, if any, in connection
with these lawsuits or the SEC investigation.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
Those associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered through a reduction in future premium taxes. The insurance
subsidiaries paid assessments of $292 through September 30, 1998, and $787, $541
and $435 for the years ended December 31, 1997, 1996 and 1995, respectively.
Based on information currently available, the insurance subsidiaries have
determined that no accrual is necessary at September 30, 1998 for future
assessments, net of future premium tax reductions.
REGULATORY MATTERS
The Texas Department of Insurance is conducting its regularly scheduled
triennial examinations of Constitution, Union Bankers, and Marquette.
The Commonwealth of Pennsylvania Insurance Department is in the process of
completing its examination of Pennsylvania Life as of December 31, 1996. The
Department has indicated that Pennsylvania Life's historical method of
calculating statutory claims reserves may not have provided the most accurate
determination of claims reserve estimates. Pennsylvania Life is completing the
process of establishing the methodology for its claims reserves on a statutory
basis. The new methodology will likely produce materially different claims
reserve estimates. Based upon preliminary findings, Pennsylvania Life increased
its statutory claims reserve estimates above historical levels by approximately
$20,000 during the three month period ended September 30, 1998. On February 5,
1999, management met with the Commonwealth of Pennsylvania Insurance Department
to discuss establishing the methodology to determine claim reserves as of
December 31, 1998. Management has requested permission to use Pennsylvania
Life's own termination rate experience and other assumptions. Depending on the
level of Pennsylvania Life's experience considered as compared to reserves
calculated with a strict interpretation of certain model regulations, an
additional reserve increase in the range of zero to $25,000 would be recorded.
Should the Commonwealth of Pennsylvania Insurance Department grant the permitted
practices as of December 31, 1998, there is no guarantee that the permitted
practices would be reapproved in future periods. Pennsylvania Life is awaiting
the results of the Commonwealth of Pennsylvania Insurance Department's review
and conclusion as to the permitted practices with respect to establishing the
methodology for claim reserves. Should Pennsylvania Life need to substantially
increase its claims reserves, it is likely that Pennsylvania Life's risk-based
capital ratio would materially decline, without further management action, to a
level which could require certain actions be taken by the Commonwealth of
Pennsylvania Insurance Department.
Additionally, on September 30, 1998, Pennsylvania Life entered into a
reinsurance agreement with an unaffiliated reinsurer which allows Pennsylvania
Life to maintain sufficient statutory capital and surplus. Should Pennsylvania
Life need to substantially increase its claims reserves estimates further it is
likely that Pennsylvania Life's RBC ratios would decline, without further
management action, to a level which could require certain actions be
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taken by the Commonwealth of Pennsylvania Insurance Department. The Penn Union
Companies continue to closely monitor Pennsylvania Life's RBC ratios.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 defines derivative instruments
and provides comprehensive accounting and reporting standards for the
recognition and measurement of derivative and hedging activities, including
certain instruments embedded in other contracts. It requires derivatives to be
recorded in the balance sheet at fair value and establishes criteria for hedges
of changes in the fair value of assets, liabilities or firm commitments, hedges
of variable cash flows of forecasted transactions, and hedges of foreign
currency exposures of net investments in foreign operations. Changes in the fair
value of derivatives not meeting specific hedge accounting criteria would be
recognized in the Combined Statement of Income. SFAS No. 133 is effective for
all fiscal quarters of all years beginning after June 15, 1999. The Penn Union
Companies are evaluating SFAS No. 133 and have not determined its effect on the
combined financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." This SOP provides
guidance for determining whether cost of software developed or obtained for
internal use should be capitalized or expensed as incurred. In the past, the
Penn Union Companies have expensed such costs as they were incurred. This SOP is
effective for fiscal years beginning after December 15, 1998. The Penn Union
Companies are currently evaluating the financial impact as well as the changes
to their related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures
about Pensions and other Postretirement Benefits." SFAS No. 132 is effective for
fiscal years beginning after December 31, 1997. Earlier application is
encouraged. Restatement of disclosures for earlier periods provided for
comparative purposes is required. SFAS No. 132 standardizes employers'
disclosures about pension and other post-retirement benefits, requires
additional information on changes in the benefit obligations and fair values of
plan assets to facilitate financial analysis, and eliminates certain irrelevant
disclosures. The Penn Union Companies are currently evaluating the necessary
changes to their related disclosures.
In December 1997, the AICPA issued SOP 97-3. SOP 97-3 provides: (1)
guidance for determining when an entity should recognize a liability for
guaranty-fund and other insurance-related assessments, (2) guidance on how to
measure the liability, (3) guidance on when an asset may be recognized for a
portion or all of the assessment liability or paid assessment that can be
recovered through premium tax offsets or policy surcharges, and (4) requirements
for disclosure of certain information. This SOP is effective for financial
statements for fiscal years beginning after December 15, 1998. Early adoption is
encouraged. Previously issued annual financial statements are not restated. The
Penn Union Companies will report the effect of initially adopting this SOP in a
manner similar to the reporting of a cumulative effect of a change in accounting
principle. The Penn Union Companies are currently evaluating the financial
impact, which is expected to be immaterial, as well as the changes to their
related disclosures which the Penn Union Companies anticipate will be included
in the annual financial statements as of and for the twelve month period ended
December 31, 1998.
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SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was issued in June 1997 by the FASB. This statement requires that
companies disclose segment data on the basis that is used internally by
management for evaluating segment performance and allocating resources to
segments. This statement requires that a company report a measure of segment
profit or loss, certain specific revenue and expense items, and segment assets.
It also requires various reconciliations of total segment information to amounts
in the combined financial statements. The Penn Union Companies currently operate
under one segment. The footnote disclosure requirements of SFAS No. 131 are
effective for fiscal years beginning after December 15, 1997.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's web site at http://www.sec.gov. You may also read and copy
any document we file at the SEC's public reference rooms in Washington, D.C.,
New York, New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330
for further information on the public reference rooms.
You should rely only on the information provided in this proxy statement.
We have not authorized anyone else to provide you with any information that
differs from or adds to the information in this proxy statement or in the
documents we publicly file with the SEC. Therefore, if anyone does give you
different or additional information, you should not rely on it. You should not
assume that the information in this proxy statement is accurate as of any date
other than the date on the front of this document.
A copy of the 1997 Annual Report to shareholders is available from
Universal American. Universal American has also filed with the Commission its
Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Each
Annual Report contains information concerning Universal American and its
operations. A COPY OF EITHER REPORT WILL BE FURNISHED TO SHAREHOLDERS WITHOUT
CHARGE UPON REQUEST IN WRITING TO: Robert A. Waegelein, Senior Vice President
and Chief Financial Officer, at the offices of Universal American, Six
International Drive, Rye Brook, New York 10573. Such reports are not a part of
this proxy statement.
PROXIES AND SOLICITATION
Proxies for the special meeting are being solicited by mail directly and
through brokerage and banking institutions. Universal American will pay all
expenses in connection with the solicitation of proxies. In addition to the use
of the mails, proxies may be solicited by directors, officers and regular
employees of Universal American personally or by telephone. Universal American
may reimburse brokers and other persons holding stock in their names, or in the
names of nominees, for their expenses in sending proxy materials to principals
and obtaining their proxies.
Shareholder proposals with respect to Universal American's next annual
meeting should have been received by Universal American no later than February
1, 1999 to be considered for inclusion in Universal American's next proxy
statement.
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ANNEXES
Annex A -- The Share Purchase Agreement -- Share Purchase Agreement dated
as of December 31, 1998 between Universal American and Capital Z
Annex B -- The Acquisition Agreement -- Purchase Agreement dated December
31, 1998 between Universal American, PFG and several of PFG's
subsidiaries
Annex C -- Opinion of Advest, Inc.
Annex D -- Proposed Amended and Restated Certificate of Incorporation of
Universal American
Annex E -- Financial Information
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ANNEX A
SHARE PURCHASE AGREEMENT
BETWEEN
UNIVERSAL AMERICAN FINANCIAL CORP.
AND
CAPITAL Z FINANCIAL SERVICES FUND II, L.P.
------------------------
DATED AS OF DECEMBER 31, 1998
------------------------
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
ARTICLE I
THE TRANSACTIONS.................................................. A-1
1.1 Purchase and Sale........................................... A-1
1.2 Closing Matters............................................. A-2
1.3 The Closing................................................. A-2
1.4 Fee......................................................... A-2
1.5 PennCorp Purchase Agreement................................. A-2
1.6 Per Share Purchase Price Adjustment......................... A-3
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF THE PURCHASER................... A-5
2.1 Organization................................................ A-5
2.2 Authority................................................... A-5
2.3 No Violation................................................ A-5
2.4 Brokers..................................................... A-6
2.5 Funds Available............................................. A-6
2.6 Securities Act Representation............................... A-6
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE COMPANY..................... A-6
3.1 Corporate Organization...................................... A-6
3.2 Subsidiaries................................................ A-6
3.3 Capital Stock............................................... A-7
3.4 Books and Records........................................... A-7
3.5 Newly Issued Shares......................................... A-7
3.6 Authority for and Title to Properties....................... A-8
3.7 Authority................................................... A-8
3.8 No Violation................................................ A-8
3.9 SEC Filings................................................. A-9
3.10 SAP Financial Statements; Reserves.......................... A-10
3.11 Litigation.................................................. A-11
3.12 Compliance with Laws........................................ A-11
3.13 No Material Adverse Change.................................. A-11
3.14 Private Offering............................................ A-11
3.15 Taxes....................................................... A-12
3.16 Brokers..................................................... A-12
3.17 Certain Agreements.......................................... A-12
3.18 Year 2000 Compliance........................................ A-13
3.19 Insurance and Reinsurance................................... A-13
3.20 Employee Benefit Plans...................................... A-13
3.21 Labor Relations............................................. A-14
3.22 Potential Conflicts of Interest............................. A-15
3.23 Representations and Warranties on Closing Date.............. A-15
</TABLE>
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<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
ARTICLE IV
COVENANTS AND AGREEMENTS.......................................... A-15
4.1 Conduct of Business Prior to the Closing; Management of the
Company..................................................... A-15
4.2 Proxy Statement and Meeting of Company's Shareholders....... A-16
4.3 Further Assurances.......................................... A-17
4.4 Indemnification by the Company.............................. A-17
4.5 Indemnification by the Purchaser............................ A-18
4.6 Limitations on Indemnification.............................. A-18
4.7 Disclosure Supplements...................................... A-19
4.8 Additional Indemnification Obligation....................... A-19
4.9 Consents.................................................... A-20
4.10 Use of Proceeds............................................. A-20
4.11 HSR Reports................................................. A-21
4.12 Exclusivity................................................. A-21
4.13 SEC Filings and Annual Statements........................... A-21
4.14 Amendment or Termination of Purchase Agreement.............. A-21
4.15 Actions Relating to the PennCorp Purchase Agreement......... A-21
4.16 Registration Rights Agreement............................... A-21
4.17 Shareholders Agreement...................................... A-21
4.18 Employment Agreement........................................ A-22
ARTICLE V
CONDITIONS PRECEDENT.............................................. A-22
5.1 Conditions to Each Party's Obligations...................... A-22
5.2 Conditions to the Obligations of the Company................ A-22
5.3 Conditions to the Obligations of the Purchaser.............. A-23
ARTICLE VI
MISCELLANEOUS..................................................... A-24
6.1 Termination................................................. A-24
6.2 Amendment................................................... A-24
6.3 Waiver...................................................... A-24
6.4 Survival.................................................... A-24
6.5 Notices..................................................... A-24
6.6 Headings; Agreement......................................... A-25
6.7 Publicity................................................... A-25
6.8 Entire Agreement............................................ A-26
6.9 Assignment.................................................. A-26
6.10 Counterparts................................................ A-26
6.11 Governing Law............................................... A-26
6.12 Third Party Beneficiaries................................... A-26
6.13 Costs and Expenses.......................................... A-26
6.14 Specific Performance........................................ A-26
</TABLE>
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<TABLE>
<S> <C> <C>
EXHIBITS
Exhibit
A PennCorp Purchase Agreement
Exhibit
B Chase Commitment Letter
Exhibit
C Form of Registration Rights Agreement
Exhibit
D Form of Shareholders Agreement
Exhibit
E Form of Opinion of Simpson Thatcher & Bartlett
</TABLE>
[Exhibits have been intentionally omitted for purposes of this proxy
statement]
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SHARE PURCHASE AGREEMENT
SHARE PURCHASE AGREEMENT ("Agreement"), dated as of December 31, 1998,
between Universal American Financial Corp., a New York corporation (the
"Company"), and Capital Z Financial Services Fund II, L.P., a Bermuda limited
partnership (the "Purchaser").
R E C I T A L S:
WHEREAS, the Purchaser wishes to purchase from the Company, and the Company
wishes to issue and sell to the Purchaser, the number of shares of common stock,
par value $.01 per share (the "Common Stock"), of the Company set forth in
Section 1.1 below, on the terms and subject to the conditions set forth herein;
WHEREAS, the Purchaser, together with the Company, has participated in the
negotiation of a Stock Purchase Agreement (the "PennCorp Purchase Agreement") to
be entered into between the Company and PennCorp Financial Group, Inc.
("PennCorp"), pursuant to which the Company will acquire (the "Acquisition")
certain subsidiaries and assets of PennCorp (the "PennCorp Subsidiaries");
WHEREAS, concurrently with the execution of this Agreement, the Company and
PennCorp are entering into the PennCorp Purchase Agreement, a copy of which is
attached hereto as Exhibit A;
WHEREAS, concurrently with the execution of this Agreement, the Company,
Chase Manhattan Bank, N.A. ("Chase") and Chase Securities Inc. ("CSI") are
entering into a Commitment Letter (the "Chase Commitment Letter"), a copy of
which is attached hereto as Exhibit B, for a term loan facility and a revolving
credit facility (the "Chase Facility");
WHEREAS, the proceeds of the Chase Facility, together with the proceeds of
the issuance and sale of the Shares to the Purchaser are intended to be used to
consummate the Acquisition.
WHEREAS, the Board of Directors of the Company (the "Board of Directors")
has approved this Agreement and the transactions contemplated hereby, upon the
terms and subject to the conditions set forth herein.
A G R E E M E N T:
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants, agreements and conditions contained
herein, the sufficiency of which is hereby acknowledged, and in order to set
forth the terms and conditions of the transactions described herein and the mode
of carrying the same into effect, the parties hereby agree as follows:
ARTICLE I
THE TRANSACTIONS
1.1 Purchase and Sale. Subject to the terms and conditions of this
Agreement, the Purchaser agrees to purchase from the Company and the Company
agrees to issue and sell to the Purchaser (the "Purchase") at the Closing (as
defined below) an aggregate of Twenty Six Million Thirty One Thousand Seven
Hundred Forty Six (26,031,746) shares of Common Stock at a purchase price per
share equal to Three Dollars and Fifteen Cents ($3.15), for an aggregate
purchase price equal to Eighty Two Million Dollars ($82,000,000), in each case
subject to adjustment as provided in Section 1.6 below. The number of shares of
Common Stock to be purchased at $3.15 per share by the Purchaser and the
aggregate purchase price to be paid by the Purchaser will be reduced by the
aggregate number of shares of Common Stock purchased
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at or prior to the Closing (defined below) by certain members of management of
the Company and certain agents of the Company (the "Management Investors") and
the aggregate purchase price paid for such shares by such Management Investors
pursuant to subscription agreements entered into between the Company and such
Management Investors (which will be in form and substance reasonably
satisfactory to the Purchaser). Notwithstanding the foregoing, the aggregate
purchase price paid by the Purchaser will be at least Sixty Two Million Five
Hundred Thousand Dollars ($62,500,000) for which the Purchaser will receive
Nineteen Million Eight Hundred Forty One Thousand Two Hundred Seventy
(19,841,270) shares of Common Stock at a purchase price per share equal to
$3.15, subject to adjustment as provided in Section 1.6. The shares of Common
Stock to be purchased by the Purchaser under this Agreement, after the
adjustments, if any, made as described above and in Section 1.6, are referred to
as the "Shares," and the aggregate purchase price actually paid by the Purchaser
as reduced by the purchase price paid by the Management Investors as
contemplated above is referred to as the "Purchase Price."
1.2 Closing Matters. At the Closing, the Purchaser shall wire transfer or
otherwise make available in same day funds to the Company the Purchase Price and
the Company shall deliver to the Purchaser certificates representing the Shares.
1.3 The Closing. Subject to the fulfillment of the conditions precedent
specified in Article V hereof (any or all of which may be waived in writing by
the respective parties whose performance is conditioned upon satisfaction of
such conditions precedent), the purchase and sale of the Shares shall be
consummated (the "Closing") simultaneously with the closing of the Acquisition
in accordance with Section 7.1 of the PennCorp Purchase Agreement (the "Closing
Date").
1.4 Fee. If the transactions contemplated by this Agreement are
consummated and the Purchase occurs, the Company shall pay to Capital Z
Management, Inc. at the Closing by wire transfer of immediately available funds
to an account or accounts designated by Capital Z Management, Inc. a transaction
fee (the "Fee") equal to Five Million Dollars ($5,000,000); provided, that the
Purchaser may elect to receive up to One Million Three Hundred Seventy Five
Thousand Dollars ($1,375,000) of such Fee in a number of shares of Common Stock
equal to the amount elected by the Purchaser divided by the per Share purchase
price (as adjusted pursuant to Section 1.6); provided, further, however, that no
Fee is payable if the transactions contemplated by this Agreement are not
consummated.
1.5 PennCorp Purchase Agreement.
(a) The parties hereto understand that the purpose of this Agreement is to
enable the Company to have funds necessary for the Acquisition.
(b) Notwithstanding anything in this Agreement to the contrary, neither
party hereto makes any representation or warranty of any type with respect to
PennCorp or any PennCorp Subsidiary. Neither party hereto has made any
inducements to the other with respect to the PennCorp Purchase Agreement or to
the status, prospects or profitability of the PennCorp Subsidiaries.
(c) The Purchaser and the Company agree that, in the event that (i) the
PennCorp Purchase Agreement is terminated under Section 9.1 thereof and (ii) the
Purchaser and the Company supply to PennCorp an invoice or invoices identifying
their costs and expenses pursuant to Section 9.2 thereof, the Purchaser and the
Company will cooperate with each other to prepare such invoice or invoices (and
collect all supporting information), which invoice or invoices will clearly (i)
distinguish between amounts owed by PennCorp to the Purchaser and amounts owed
by PennCorp to the Company and (ii) identify the account or accounts of the
Purchaser into which payment by PennCorp should be made to the Purchaser and the
account or accounts of the Company into which payment by PennCorp should be made
to the Company.
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The Purchaser and the Company agree to work together to ensure that payment by
PennCorp is made in accordance with the invoice or invoices provided to it by
the Purchaser and the Company, including, to the extent necessary, transferring
money to each other in the amount of any overpayment by PennCorp to one party
and underpayment by PennCorp to the other so as either (i) to cause each of the
Purchaser and the Company to be reimbursed for all of such party's reimbursable
costs and expenses or (ii) if the amount paid or payable by PennCorp is
insufficient fully to reimburse all of the Purchaser's and the Company's
reimbursable costs and expenses, ratably in proportion to each party's total
expenses.
1.6 Per Share Purchase Price Adjustment.
(a) If between the date hereof and the Closing the Purchaser believes that
an MAE Event (defined below) has occurred, the Purchaser shall promptly deliver
to the Company, before the Closing, a written notice (the "MAE Notice") setting
forth in reasonable detail the grounds for its belief that an MAE Event has
occurred and the diminution in the value of the Company the Purchaser believes
has or will occur as a result of such MAE Event. "MAE Event" means any one (or a
series of related) event(s), condition(s) or circumstance(s) occurring after the
date hereof and before the Closing Date that has had, or is reasonably likely to
have, an adverse impact on the business, results of operations or financial
condition of the Company and its Subsidiaries (taken as a whole) that would
reduce the value of the Company and its Subsidiaries (taken as a whole) by an
amount in excess of $3 million (assuming the Benchmark Value set forth on
Schedule 1.6).
(b) Promptly following the delivery of the MAE Notice (if any) by the
Purchaser, the Purchaser and the Company will begin good faith negotiations to
agree on a mutually acceptable adjustment to the per share purchase price to be
paid by Purchaser (it being understood by both parties that any such adjustment
will be determined in accordance with paragraph (d) below). If within 10
business days following the inception of negotiations the parties have not
agreed on a mutually acceptable adjustment to the per share purchase price, such
disagreement will be submitted for resolution to, and the amount of the
adjustment, if any, will be determined by PricewaterhouseCoopers (the
"Settlement Valuator") (or if PricewaterhouseCoopers is not available, such
other independent accounting firm of national reputation selected by the mutual
agreement of the Purchaser and the Company or, if the Purchaser and the Company
cannot agree, a nationally recognized accounting firm or investment bank
selected by PricewaterhouseCoopers. The Purchaser and the Company will cooperate
with the Settlement Valuator and will proceed in good faith to cooperate with
the Settlement Valuator to resolve any such disagreement within 45 days after
such disagreement is submitted to the Settlement Valuator (the "Settlement
Date"). The Purchaser and the Company will each pay one-half of the fees and
expenses of the Settlement Valuator.
(c) Promptly (but in any event within 10 business days) following the
submission of any dispute to the Settlement Valuator, the Purchaser and the
Company shall each deliver to the Settlement Valuator and the other party a
statement setting forth in reasonable detail (with such supporting data as such
party deems appropriate), its determination of the adjustment to the per share
purchase price to be paid by Purchaser (the "Per Share Purchase Price
Adjustment"). The Settlement Valuator, in its reasonable discretion, will
determine (i) the nature and extent of the participation by the Purchaser and
the Company and their respective agents in connection with any disagreement
submitted to the Settlement Valuator for resolution and (ii) the nature and
extent of information, whether documentary or by live witness, that the
Purchaser and the Company may submit to the Settlement Valuator for
consideration in connection with such resolution. The Settlement Valuator's
resolution of any such disagreement, with respect to dollar amounts, must fall
within the range of the disputed amounts stated by the Purchaser and the Company
in the statements supplied by them to the Settlement Valuator pursuant to this
Section 1.6(c) and will be reflected in a written report which will be delivered
on or before the Settlement Date to, and will be final and binding upon, the
Purchaser and the Company. The
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report of the Settlement Valuator will contain the Settlement Valuator's
determination of the Per Share Purchase Price Adjustment in accordance with
paragraph (d) below.
(d) The parties agree that the diminution of value that has resulted or is
reasonably likely to result from a MAE Event will be determined in accordance
with the principles set forth on Schedule 1.6, and without regard to the trading
price of the Common Stock as listed on Nasdaq (or such other stock exchange on
which the Common Stock is then listed). The Per Share Purchase Price Adjustment
will be determined in accordance with the following formula:
Per Share Purchase
Price Adjustment = the after-tax amount of the diminution in value resulting
from the MAE Event minus the product of (x) all
out-of-the-money options, warrants or other securities
convertible into or exchangeable or exercisable for shares
of Common Stock existing on the date of this Agreement times
(y) $3.15 less the applicable conversion, exchange or
exercise price of each such option
divided by
the aggregate number of shares of Common Stock outstanding
on the date of this Agreement plus all in-the-money
options, warrants or other securities convertible into or
exchangeable or exercisable for shares of Common Stock
existing on the date of this Agreement.
For purposes of determining whether options, warrants or other securities
convertible into or exchangeable or exercisable for shares of Common Stock are
"in-the-money" or "out-of-the-money," the applicable conversion, exchange or
exercise price will be compared to the post-adjustment per Share purchase price.
In addition, all shares of Series D-1 and Series D-2 Preferred Stock, par value
$1.00 per share, of the Company outstanding on the date hereof (and all shares
of Common Stock issuable upon conversion or exchange thereof) are expressly
excluded from the foregoing formula.
(e) If there is to be an adjustment pursuant to the foregoing provisions,
upon the earlier to occur of (i) the parties' agreement with respect to the
amount of the Per Share Purchase Price Adjustment or (ii) the delivery of the
report of the Settlement Valuator as provided in Section 1.6(c) hereof with
respect to a dispute submitted to the Settlement Valuator pursuant to Section
1.6(b), either:
(i) if the Closing has not yet occurred, then, at the Closing, the
Company shall issue to the Purchaser, and the Purchaser will acquire from
the Company, instead of the number of Shares described in Section 1.1, that
number of Shares determined by dividing the Purchaser's money commitment
under Section 1.1 by the adjusted purchase price per Share which shall be
$3.15 less the Per Share Purchase Price Adjustment; or
(ii) if the Closing has already occurred, the Company promptly (but in
any event no later than 10 days thereafter) will issue to the Purchaser,
for no additional consideration, certificates representing such number of
additional Shares necessary to cause the Purchaser's purchase price per
share to equal $3.15 less the Per Share Purchase Price Adjustment.
(f) The parties hereby agree that, so long as all conditions precedent set
forth in Article V have been satisfied or waived, neither the delivery of an MAE
Notice nor the pendency of proceedings before the Settlement Valuator will in
any way prevent or delay the Closing, regardless of whether an adjustment is
requested or may be made pursuant to the foregoing provisions.
(g) Notwithstanding the foregoing or any other provision of this Agreement,
if an MAE Event causes (or would be reasonably likely to cause) the purchase
price per share payable by the
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Purchaser (determined in accordance with the formula set forth in paragraph (d)
above) to be $2.25 per share or less (i.e., if the Per Share Purchase Price
Adjustment would be $0.90 or more), the Purchaser shall have the absolute right
(i) to cause the Company to assign to another person (the "Substituted Buyer")
all of the Company's rights and obligations under the PennCorp Purchase
Agreement pursuant to Section 10.12 of the PennCorp Purchase Agreement and (ii)
upon such assignment to and assumption by the Substituted Buyer, the parties'
obligations under this Agreement, except for the indemnification obligations set
forth in Section 4.8(b) and 6.13 (to the extent set forth therein), shall
terminate; provided, however, that if the PennCorp Purchase Agreement is
assigned to a Substituted Buyer and the Acquisition is consummated by such
Substituted Buyer, the Company shall not be liable for, and the Purchaser shall
indemnify and hold harmless the Company from, any and all liabilities, including
without limitation, defense costs, relating to PennCorp or the PennCorp Purchase
Agreement. It is further understood that the right of substitution hereunder
will terminate and have no further force or effect upon the consummation of the
Acquisition.
ARTICLE II
REPRESENTATIONS AND WARRANTIES
OF THE PURCHASER
The Purchaser represents and warrants to the Company as follows:
2.1 Organization. The Purchaser is a limited partnership duly organized,
validly existing and in good standing under the laws of its jurisdiction of
formation.
2.2 Authority. (i) The Purchaser has full partnership power and authority
to execute and deliver this Agreement and each other agreement contemplated
hereby to which it is a party, to carry out its obligations hereunder and
thereunder and to consummate the transactions contemplated on its part hereby
and thereby, (ii) the execution, delivery and performance by the Purchaser of
this Agreement and each other agreement contemplated hereby to which it is a
party have been duly authorized by all necessary partnership action on the part
of the Purchaser, (iii) no other action on the part of the Purchaser is
necessary to authorize the execution and delivery of this Agreement and each
other agreement contemplated hereby by the Purchaser or the performance by the
Purchaser of its obligations hereunder and (iv) this Agreement has been duly
executed and delivered by the Purchaser and (assuming due execution and delivery
by the other parties hereto) constitutes a legal, valid and binding agreement of
the Purchaser, enforceable against it in accordance with its terms, subject to
applicable bankruptcy, insolvency, moratorium, reorganization or similar laws
affecting creditors' rights generally and subject to general equitable
principles (regardless of whether such enforceability is considered in a
proceeding in equity or at law). Each other agreement to be executed by the
Purchaser in connection with this Agreement on or prior to the Closing Date will
be duly executed and delivered by the Purchaser, and (assuming due execution and
delivery by the other party or parties thereto) will constitute a legal, valid
and binding obligation of the Purchaser, enforceable against it in accordance
with its terms, subject to applicable bankruptcy, insolvency, moratorium,
reorganization or similar laws affecting creditors' rights generally and subject
to general equitable principles (regardless of whether such enforceability is
considered in a proceeding in equity or at law).
2.3 No Violation. The execution and delivery by the Purchaser of this
Agreement and each other agreement contemplated hereby to which it is a party,
the performance by the Purchaser of its obligations hereunder and thereunder and
the consummation by it of the transactions contemplated hereby and thereby will
not (a) violate any provision of law, rule or regulation or final order,
judgment, injunction, decree, determination or award found against it
(collectively, "Requirements of Law") applicable to the Purchaser, (b) require
the Purchaser to obtain the consent, waiver, approval, license or authorization
of or make any filing with any person or
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governmental authority except for (i) filings to be made in connection with or
in compliance with the provisions of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), Regulation D as promulgated under the Securities
Act of 1933, as amended (the "Securities Act"), and applicable state securities
laws, (ii) if required, the filing by the Company or the Purchaser of a
pre-merger notification report under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (an "HSR Report"), and (iii) the filing of
a Form A Information Statement ("Form A") by the Purchaser with the insurance
departments of such states as may be required in connection with the
transactions contemplated by this Agreement or (c) violate, result (with or
without notice or the passage of time, or both) in a breach of or give rise to
the right to accelerate, terminate or cancel any obligation under or constitute
(with or without notice or the passage of time, or both) a default under, any of
the terms or provisions of any charter or bylaw, partnership agreement,
indenture, mortgage, agreement, contract, order, judgment, ordinance, regulation
or decree to which the Purchaser is subject or by which the Purchaser is bound,
except for any of the foregoing matters which would not reasonably be expected
to have, individually or in the aggregate, a materially adverse impact upon the
ability of the Purchaser to consummate the transactions contemplated hereby or
to perform its obligations hereunder.
2.4 Brokers. Neither the Purchaser nor any of its affiliates has
committed on behalf of itself or a third party to pay any fee or commission to
any broker, finder, investment banker or other intermediary in connection with
this Agreement.
2.5 Funds Available. The Purchaser has funds available, or firm
commitments from third parties to provide funds, sufficient to pay the Purchase
Price as evidenced by Schedule 2.5.
2.6 Securities Act Representation. As of the Closing hereunder, the
Purchaser will be an "accredited investor" as defined in Rule 501 promulgated as
part of Regulation D under the Securities Act. The Purchaser is not purchasing
the Shares with a view to a distribution or resale of any of such securities in
violation of any applicable securities laws.
ARTICLE III
REPRESENTATIONS AND WARRANTIES
OF THE COMPANY
The Company represents and warrants to the Purchaser as follows:
3.1 Corporate Organization. Each of the Company and its Subsidiaries (as
defined below) is a corporation duly organized, validly existing and in good
standing under the laws of the jurisdiction of its incorporation, with all
requisite corporate power and authority to carry on its business as it is now
being conducted in any such jurisdiction as described in the SEC Filings (as
defined herein), and is duly qualified or licensed to do business and is in good
standing in each jurisdiction in which it currently carries on its business,
except where the failure to be so qualified or licensed or be in good standing
would not reasonably be expected to have, individually or in the aggregate, a
materially adverse impact on the business, results of operations or financial
condition (a "Material Adverse Effect") of the Company. With respect to the
Company, a "Material Adverse Effect" as that term is used throughout this
Agreement, shall mean and refer to the Company and its Subsidiaries on a
consolidated basis. True and complete copies of the Certificate of Incorporation
and the Bylaws of the Company and respective charter documents of the
Subsidiaries, each as amended to date, heretofore have been delivered to the
Purchaser. "Subsidiaries" means, with respect to the Company, a corporation or
other entity of which 50% or more of the voting power of the outstanding voting
securities or 50% or more of the outstanding equity interests is held, directly
or indirectly, by the Company.
3.2 Subsidiaries. Schedule 3.2 sets forth a complete and accurate list of
all of the Subsidiaries of the Company, together with their respective
jurisdictions of incorporation or organization. Unless otherwise indicated on
Schedule 3.2, each such Subsidiary is directly wholly
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owned by the Company. All of the outstanding shares of capital stock of the
Subsidiaries are validly issued, fully paid and, except as provided under
Section 630 of the Business Corporation Law of New York (relating to employee
wages), non-assessable. Except as indicated on Schedule 3.2, all of the
outstanding shares of capital stock of, or other ownership interests in, each of
the Subsidiaries are owned by the Company or by a wholly owned Subsidiary free
and clear of any and all liens, encumbrances, security interests, preemptive
rights, adverse claims or rights in favor of another ("Liens"). Except as
indicated on Schedule 3.2, no Subsidiary has outstanding options, warrants,
subscriptions, calls, rights convertible securities or other agreements or
commitments obligating the Subsidiary to issue, transfer or sell any securities
of the Subsidiary.
3.3 Capital Stock. The authorized capital stock of the Company consists
of: (a) 20,000,000 shares of Common Stock, of which, as of the date hereof,
7,638,057 shares are issued and outstanding; (b) 500 shares of Series B
Convertible Preferred Stock, par value $1.00 per share (the "Series B Preferred
Stock"), of which, as of the date hereof, 400 are issued and outstanding; (c)
100,000 shares of Series C Convertible Preferred Stock, par value $1.00 per
share (the "Series C Preferred Stock"), of which, as of the date hereof, 45,680
shares designated as Series C-1 (the "Series C-1 Shares") are issued and
outstanding and 6,000 shares designated as Series C-2 are issued and
outstanding; (d) 22,500 shares of Series D-1 Convertible Preferred Stock, par
value $1.00 per share (the "Series D-1 Preferred Stock"), of which, as of the
date hereof, 22,500 shares are issued and outstanding; and (e) 17,500 shares of
Series D-2 Convertible Preferred Stock, par value $1.00 per share (collectively
with the Series B Preferred Stock, the Series C Preferred Stock and the Series
D-1 Preferred Stock, the "Preferred Stock"), of which, as of the date hereof, no
shares are issued and outstanding. In addition, as of the date hereof, there are
2,673,991 warrants to purchase shares of Common Stock (the "Common Stock
Warrants") issued and outstanding. All of the outstanding shares of Common Stock
and Preferred Stock have been duly and validly authorized and issued, are fully
paid and, except as provided under Section 630 of the Business Corporation Law
of New York (relating to employee wages), nonassessable, and were issued in
compliance with all applicable federal and state securities laws. Upon exercise
of the Common Stock Warrants, the shares of Common Stock issued pursuant to such
warrants will be validly issued, fully paid and, except as provided under
Section 630 of the Business Corporation Law of New York (relating to employee
wages) nonassessable, and issued in compliance with all applicable federal and
state securities laws. Except for the Common Stock Warrants, for options and
other stock rights authorized for issuance pursuant to the Company's stock plans
and director, employee and agent stock option and purchase plans described in
the SEC Filings and except as set forth on Schedule 3.3, there are no preemptive
rights, options, warrants, conversion privileges or other rights presently
outstanding to purchase or otherwise acquire any authorized but unissued shares
of capital stock or other securities of the Company or any of the Subsidiaries.
3.4 Books and Records. Copies of all the minute books and stock record
books of the Company and the Subsidiaries have been delivered to the Purchaser
for inspection and contain records of all meetings of, and written consents by,
the boards of directors (and any committees thereof) and shareholders of the
Company and each Subsidiary since, in the case of the Company, the date of its
incorporation and, in the case of the Subsidiaries, the date on which the
Company acquired such Subsidiary, in each case through the date hereof.
3.5 Newly Issued Shares. The Shares to be issued and sold by the Company
to the Purchaser in accordance with the terms of this Agreement have been or
will be, when approved by the shareholders of the Company as provided in Section
4.2, duly authorized and, when issued as contemplated hereby, will be validly
issued, fully paid and, except as provided under Section 630 of the Business
Corporation Law of New York (relating to employee wages) non-assessable and the
issuance of the Shares by the Company will not be subject to preemptive or other
similar rights. At the Closing, the Purchaser will acquire good and marketable
title to the
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Shares free and clear of any and all Liens, except for such Liens as may be
created pursuant to this Agreement or imposed by applicable federal and state
securities laws.
3.6 Authority for and Title to Properties. The Company and each
Subsidiary have all requisite corporate power and authority to lease the
properties it operates as lessee. The Company and each Subsidiary have good
record and marketable title in fee simple to, or hold interests as lessee under
leases in full force and effect in, all of their respective real properties,
except for such defects in title as would not be reasonably expected to have,
individually or in the aggregate, a Material Adverse Effect on the Company.
3.7 Authority. The Company has full corporate power and authority to
execute and deliver this Agreement and each other agreement contemplated hereby
to which it is a party, to carry out its obligations hereunder and thereunder
and to consummate the transactions contemplated on its part hereby and thereby.
The execution, delivery and performance by the Company of this Agreement and
each other agreement contemplated hereby to which it is a party and the
consummation of the transactions contemplated on its part hereby have been duly
authorized by the Board of Directors, and no other corporate proceedings on the
part of the Company, except for the shareholder approval specified in Section
4.2 hereof, are necessary to authorize the execution and delivery of this
Agreement and each other agreement contemplated hereby by the Company or the
performance by the Company of its obligations hereunder or thereunder. This
Agreement has been duly executed and delivered by the Company and (assuming due
execution and delivery by the other parties hereto) constitutes the legal, valid
and binding obligation of the Company, enforceable against the Company in
accordance with its terms, subject to applicable bankruptcy, insolvency,
moratorium, reorganization or similar laws affecting creditors' rights generally
and subject to general equitable principles (regardless of whether such
enforceability is considered in a proceeding in equity or at law). Each other
agreement to be executed by the Company in connection with this Agreement on or
prior to the Closing Date will be duly executed and delivered by the Company,
and (assuming due execution and delivery by the other party or parties thereto)
will constitute a legal, valid and binding obligation of the Company,
enforceable against the Company in accordance with their respective terms,
subject to applicable bankruptcy, insolvency, moratorium, reorganization, or
similar laws affecting creditors' rights generally and subject to general
equitable principles (regardless of whether such enforceability is considered in
a proceeding in equity or at law).
3.8 No Violation. The execution, delivery and performance of this
Agreement and each other agreement contemplated hereby by the Company and the
consummation by it of the transactions contemplated hereby and thereby do not
(a) violate any Requirements of Law applicable to the Company or any of the
Subsidiaries, (b) require the consent, waiver, approval, license or
authorization of or any notice or filing by the Company or any of the
Subsidiaries with any person or governmental authority except for (i) filings to
be made in connection with or in compliance with the provisions of the
Securities Act, the Exchange Act and applicable state securities laws and
Canadian federal and provisional laws, (ii) the filing of (A) HSR Reports by the
Company or the Purchaser, if required, in connection with this Agreement and (B)
the filing and approval of Forms A by the Purchaser and, where required, the
Company, with the insurance departments as may be required by the insurance
departments in order for the Company to implement this Agreement and (iii) the
shareholder approval specified in Article V or (c) violate, result (with or
without notice or the passage of time, or both) in a breach of or give rise to
the right to accelerate, terminate or cancel any obligation under, constitute
(with or without notice or the passage of time, or both) a default under, any of
the terms or provisions of any charter or bylaw, indenture, mortgage, agreement,
contract, order, judgment, ordinance, regulation or decree to which the Company
or any of its Subsidiaries is subject or by which the Company or any of its
Subsidiaries is bound, except for any of the foregoing which would not be
reasonably expected to have, individually or in the aggregate, a Material
Adverse Effect on the Company. Except as set forth on Schedule 3.8, neither the
Company nor any of the Subsidiaries is party to
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any agreement which is currently in effect, or by which the Company or any of
the Subsidiaries is currently bound, granting any rights to any person which
conflict with the rights to be granted by the Company in this Agreement
(including the registration rights granted to the Purchaser pursuant to Section
4.16) and each other agreement contemplated hereby. Except as set forth on
Schedule 3.8, the execution, delivery and performance of this Agreement and each
other agreement contemplated hereby by the Company and the consummation by it of
the transactions contemplated hereby and thereby will not result in a "change of
control" or similar event occurring under any agreement, indenture, mortgage,
contract or plan to which the Company or any of its Subsidiaries is subject or
by which the Company or any of its Subsidiaries is bound or give rise to a
payment by the Company or any of its Subsidiaries under a change of control or
similar provision in any agreement, indenture, mortgage or contract to which the
Company or any of its Subsidiaries is subject or by which the Company or any of
its Subsidiaries is bound.
3.9 SEC Filings. Except as set forth on Schedule 3.9, the Company has
filed all SEC Filings required to be filed by it since December 31, 1997 under
the Securities Act or the Exchange Act, and all amendments thereto. The Company
heretofore has delivered to the Purchaser true and complete copies of (a) its
audited consolidated financial statements of the Company and the Subsidiaries
(balance sheet and statements of operations, cash flows and stockholders' equity
and cash flows, together with the notes thereto) for the fiscal years ended and
as at December 31, 1996 and December 31, 1997 (as such financial statements
appear in the Company's Form 10-K for each of the fiscal years ended December
31, 1996 and December 31, 1997, which were filed with the Securities and
Exchange Commission (the "Commission") on April 1, 1997 and March 30, 1998,
respectively, and the Company's Amendment No. 1 to Form 10-K for the fiscal year
ended December 31, 1997, which was filed with the Commission on April 29, 1998
("Amendment No. 1") (collectively, the "Financial Statements")), (b) its
Quarterly Reports on Form 10-Q for the quarters ended September 30, 1997, March
1, 1998, June 30, 1998 and September 30, 1998, (c) its Annual Report on Form 10-
K for the fiscal year ended December 31, 1997, as amended by Amendment No. 1,
(d) each of its Proxy Statements on Schedule 14A under the Exchange Act, dated
May 7, 1997 and April 27, 1998, respectively, and (e) all other reports,
statements, registration statements and other documents (including Current
Reports on Form 8-K) filed by it with the Commission under the Securities Act or
the Exchange Act, and all amendments and supplements thereto, since December 31,
1997 (the foregoing subsections (a) through (e), including all exhibits and
Schedules thereto and documents incorporated by reference therein, are
collectively referred to in this Agreement as the "SEC Filings"). As of the
respective date that it was filed with the Commission, each of the SEC Filings
complied as to form and content, in all material respects, with the requirements
of the Securities Act or the Exchange Act, as the case may be, and the rules and
regulations promulgated thereunder, and did not contain any untrue statement of
a material fact or omit to state any material fact required to be stated therein
or necessary to make the statements therein, in light of the circumstances under
which they were made, not misleading. Except as set forth on Schedule 3.9, the
Financial Statements included in the SEC Filings were prepared in accordance
with generally accepted accounting principles ("GAAP"), consistently applied,
and (except as may be indicated therein or in the notes thereto) present fairly
the consolidated financial position, results of operations and cash flows of
Company as of the dates and for the respective periods indicated (subject, in
the case of unaudited financial statements, to normal recurring year-end
adjustments and any other adjustments described therein). The Company has (i)
delivered to the Purchaser true and complete copies of (x) all correspondence
relating to the Company between the Commission, on the one hand, and the Company
or its legal counsel or, to the Knowledge of the Company, after inquiry, its
accountants, on the other hand, since January 1, 1996 (other than routine filing
package cover letters) and (y) all audit letters delivered to the Company by its
counsel and all correspondence relating thereto, and all letters to or from the
Company relating to any dispute or disagreement between the Company and the
Company's auditors with respect to any audit or financial review or with
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respect to the Company's accounting policies, in each case since January 1,
1996, and (ii) disclosed to the Purchaser the content of all material
discussions between the Commission, on the one hand, and the Company or its
legal counsel and, to the Knowledge of the Company, after inquiry, its
accountants, on the other hand, concerning the adequacy or form of any SEC
Filings filed with the Commission since January 1, 1996, except for routine
discussions with respect to filings now effective. The Company is not aware of
any issues raised by the Commission with respect to any of the SEC Filings,
other than those disclosed to the Purchaser pursuant to this paragraph. For
purposes of this Agreement, "Knowledge of the Company" means the actual
knowledge of Richard A. Barasch ("Barasch"), Robert Waegelein ("Waegelein"),
Gary Bryant ("Bryant"), Bradley Leonard and Bertram Harnett, Esq.
3.10 SAP Financial Statements; Reserves.
(a) The Company heretofore has delivered to the Purchaser true and complete
copies of the following (the "SAP Financial Statements"):
(i) the annual statements required by applicable state statutes
("Annual Statements") for American Exchange Life Insurance Company, a Texas
corporation, (ii) American Pioneer Life Insurance Company, a Florida
corporation, and (iii) American Progressive Life & Health Insurance Company
of New York, a New York corporation ((i), (ii) and (iii) being collectively
referred to herein as the "Insurance Company Subsidiaries") for each of the
years ended December 31, 1996 and 1997, in each case as filed with the
departments of insurance in the respective states of domicile of the
Insurance Company Subsidiaries including all exhibits, interrogatories,
notes and schedules thereto and any actuarial opinions, affirmation or
certification filed in connection therewith;
(ii) the Quarterly Statements for the Insurance Company Subsidiaries
for the quarters ended March 31, June 30 and September 30, 1998, including
all exhibits, interrogatories, notes and schedules thereto; and
(iii) the statutory annual statements and quarterly statements of the
Insurance Company Subsidiaries which were filed for 1996, 1997 or 1998
(with respect to the quarters ended March 31 and June 30) in any
jurisdiction (other than such Subsidiary's jurisdiction of domicile) and
that differ from the corresponding Annual Statements and Quarterly
Statements for such periods.
Each such statement was prepared in accordance with SAP and, except as set forth
in Schedule 3.10, presents fairly in all material respects the statutory
financial position of the Insurance Company Subsidiaries as of the respective
dates thereof and the related summary of operations and changes in capital and
surplus and in cash flows of the Insurance Company Subsidiaries for and during
the respective periods covered thereby.
(b) Except as set forth on Schedule 3.10, all statutory reserves and other
similar amounts with respect to insurance as established or reflected in the
December 31, 1997 Annual Statement and September 30, 1998 Quarterly Statement of
the Insurance Company Subsidiaries were determined in accordance with SAP and
were based on actuarial assumptions that were in material compliance with the
then-applicable requirements of the insurance laws of the respective states of
domicile of the Insurance Company Subsidiaries. Except as set forth on Schedule
3.10, all such reserves and other similar amounts were adequate in all material
respects as of the respective dates of such statements, based upon then-current
information and assumptions concerning investment income, mortality and
morbidity experience, persistency and expenses, to cover the total amount of all
reasonably anticipated matured and unmatured benefits, dividends, claims and
other liabilities of the Insurance Company Subsidiaries under all insurance
contracts under which the Insurance Company Subsidiaries had any liability
(including without limitation any liability arising under or as a result of any
reinsurance, coinsurance or other similar contract) on the respective dates of
such financial statements. Except as set forth above, nothing in this
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Section 3.10(b) shall be deemed a guaranty or warranty by the Company that
claims actually paid and other liabilities actually incurred by the Insurance
Company Subsidiaries will not exceed the reserves established as set forth
hereinabove in this Section 3.10(b) by the Insurance Company Subsidiaries.
Except as set forth on Schedule 3.10, the Insurance Company Subsidiaries own
assets that qualify as admitted assets under applicable insurance laws in an
amount at least equal to all such required reserves of such Subsidiaries.
3.11 Litigation. Except as set forth in the SEC Filings or otherwise
disclosed to the Purchaser in writing, there are no actions, suits, proceedings,
claims, complaints, disputes or investigations pending of which the Company has
received notice or, to the Knowledge of the Company, threatened, at law, in
equity, in arbitration or before any governmental authority against the Company
or any of its Subsidiaries and with respect to which the Company or any of its
Subsidiaries is responsible by way of indemnity or otherwise, that would, if
adversely determined, (a) have a Material Adverse Effect on the Company or (b)
materially impede or impair the ability of the Company to perform its
obligations under this Agreement and each other agreement contemplated hereby to
which it is a party. No injunction, writ, temporary restraining order, decree or
order of any nature has been issued by any court or other governmental authority
against the Company or any of its Subsidiaries purporting to enjoin or restrain
the execution, delivery or performance of this Agreement or any other agreement
contemplated hereby.
3.12 Compliance with Laws. Except as set forth on Schedule 3.12:
(a) each of the Company and the Subsidiaries (including the forms of
insurance policies and riders issued by the Company and the Subsidiaries) is in
compliance with all Requirements of Law in all respects, except to the extent
that the failure to comply with such Requirements of Law would not have a
Material Adverse Effect on the Company;
(b) (i) each of the Company and the Subsidiaries has all licenses, permits,
orders or approvals of any governmental authority (collectively, "Permits") that
are material to or necessary for the conduct of the business of the Company in
the manner described in the SEC Filings filed with the Commission prior to the
date hereof, except to the extent that the failure to have such Permits would
not have a Material Adverse Effect on the Company, (ii) such Permits are in full
force and effect, and (iii) no material violations are recorded in respect to
any Permit;
(c) the Company and the Subsidiaries (exclusive of their independent
agents) and, to the Knowledge of the Company, their independent agents, have
marketed, sold and issued products of the Company and the Subsidiaries in
material compliance with all laws applicable to the business of the Company and
the Subsidiaries in the respective jurisdictions in which such products have
been sold; and
(d) the Company has previously delivered or made available to the Purchaser
true and complete copies of the reports (or the most recent draft thereof, to
the extent any final report is not available) reflecting the results of the two
most recent financial examinations and market conduct examinations of the
Company and any Subsidiary issued by any insurance regulator.
3.13 No Material Adverse Change. Except (a) as set forth in the SEC
Filings, (b) as contemplated by this Agreement, the Shareholders' Agreement, the
Registration Rights Agreement and the Employment Agreements and (c) as set forth
on Schedule 3.13, since December 31, 1997, neither the Company nor any of the
Subsidiaries, taken as a whole, has (a) experienced any material adverse change
in their business, financial condition or results of operations, (b) conducted
its business in any material respect other than in the ordinary course or (c)
suffered any material casualty losses not covered by insurance.
3.14 Private Offering. No form of general solicitation or general
advertising was used by the Company or any of the Subsidiaries or their
respective representatives in connection with the offer or sale of the Shares.
Assuming the accuracy of the Purchaser's representations in
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Section 2.6, no registration of the Shares, pursuant to the provisions of the
Securities Act or any state securities or "blue sky" laws, will be required by
the offer, sale or issuance of the Shares.
3.15 Taxes. Except as provided in Schedule 3.15, (a) (i) all income tax
returns required to be filed by or with respect to each of the Company and its
Subsidiaries have been timely filed, (ii) all such income tax returns are
correct and complete in all material respects, (iii) all income taxes owed and
due by the Company or its Subsidiaries (whether or not shown on any income tax
return) have been paid, (iv) the Company has given or otherwise made available
to the Purchaser correct and complete copies of all income tax returns,
examination reports and statements of deficiencies for all periods for which the
statute of limitations has not expired, (v) there are no outstanding agreements
to extend or waive the statutory period of limitations with respect to income
taxes due from the Company or its Subsidiaries for any taxable period and (vi)
the Company has delivered to the Purchaser true and complete copies of any Tax
sharing agreements to which it or any of its Subsidiaries is party and such
agreements have not been amended in any manner.
(b) No audit or other proceeding by any taxing authority, court or similar
person is pending or, to the knowledge of the Company, threatened with respect
to any Taxes due from or with respect to the operations of the Company or any of
its Subsidiaries or any Tax return filed by or with respect to the operations of
the Company or any of its Subsidiaries. To the Knowledge of the Company, no
assessment of Taxes is proposed against the Company, any of its Subsidiaries or
any of their assets.
(c) the Tax treatment under the Code of each insurance, annuity, contract,
agreement or product, or any similar or related policy, contract, agreement or
product, issued or sold by the Company or the Subsidiaries (collectively,
"Products") is and at all times has been the same as or not less favorable to
any purchaser, policyholder, or beneficiaries thereof that is subject to U.S.
Tax than the Tax treatment under the Code which the Company or any Subsidiary
represented could be obtained at the time of its issuance, purchase,
modification or exchange. The Company promptly investigates complaints made by
customers to the Company regarding conduct of its independent agents, including
conduct regarding representations made regarding the Tax treatment of any of the
Products. For purposes of this Section 3.15(c), the provisions of the Code
relating to the Tax treatment of such contracts shall include, but shall not be
limited to, Sections 72, 79, 101, 104, 105, 106, 125, 130, 401, 402, 403, 404,
408, 412, 415, 419, 419A, 457, 501, 505, 817, 817A, 818, 1035, 7702, and 7702A
of the Code.
(d) each Insurance Company Subsidiary is taxable as a life insurance
company within the meaning of Section 816 of the Code.
(e) For purposes of this Agreement, "Tax" or "Taxes" (or any derivation
thereof) means any and all federal, state, local, foreign and other taxes,
levies, fees, imposts duties and similar governmental charges (including any
interest, fines, assessments, penalties or additions to tax imposed in
connection therewith or with respect thereto) including, without limitation,
taxes imposed on, or measured by, income, franchise, profits or gross receipts,
ad valorem, value added, sales, use, service, real or personal property, capital
stock, license, payroll, estimated, withholding, employment, social security (or
similar), unemployment, compensation, utility, severance, production, excise,
stamp, occupation, premium, windfall profits, transfer and gains taxes and
customs duties.
3.16 Brokers. Except with respect to fees payable to Chase, CSI and to
Advest, Inc., the Company has not paid or become obligated to pay any fee or
commission to any broker, finder, investment banker or other intermediary in
connection with this Agreement.
3.17 Certain Agreements. (a) Except as disclosed on Schedule 3.17 or in
the SEC Filings, neither the Company nor any of the Subsidiaries is a party to
any written (i) agreement, contract, indenture or other instrument relating to
the borrowing of money or the guarantee of
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any obligation for the borrowing of money, (ii) employment, consulting,
compensation or severance agreement with any of its directors, employees or
consultants, (iii) agreement, contract or commitment limiting or restraining it
from engaging or competing in any business, (iv) distribution, dealer,
representation or agency agreement, other than agency agreements, brokerage
agreements or other distribution agreements with insurance agents in the
ordinary course of business, or (v) contract, agreement, obligation or
commitment with any affiliates (each of the foregoing a "Listed Contract"). Each
Listed Contract is in full force and effect and has been complied with by the
Company and the Subsidiaries and, to the Knowledge of the Company, has been
complied with by all other parties thereto.
(b) All transactions between the Company and its affiliates which were
required to have been identified or reported to and/or approved by the
applicable departments of insurance have been identified, reported and/or
approved in all material respects. For purposes of this Agreement, "affiliates"
means, as to a specified person, any other person that directly or indirectly,
through one or more intermediaries, controls, is controlled by, or is under
common control with, the specified person.
3.18 Year 2000 Compliance. The information included under the heading
"Impact of Year 2000" in the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, filed with the Commission on November 16,
1998, accurately reflects the status of the Company's program to address, on a
timely basis, the risk that its computer systems are not Year 2000 compliant.
There have been no circumstances or events since September 30, 1998 that would
adversely effect or change, in any material respect, the Company's expectations
to resolve its Year 2000 issues on a timely basis.
3.19 Insurance and Reinsurance.
(a) Schedule 3.19 is a true and complete list of each material contract
providing for reinsurance, coinsurance, excess insurance, ceding of insurance,
assumption of insurance or indemnification of insurance liabilities to which the
Company or any Subsidiary is a party which is currently in effect (the
"Reinsurance Agreements").
(b) Except as disclosed on Schedule 3.19, neither the Company nor any
Subsidiary is in material default under any Reinsurance Agreement and, to the
Knowledge of the Company, there is no reasonable basis for a reinsurer to
terminate or refuse to pay under any Reinsurance Agreement. Except as disclosed
in Schedule 3.19, to the Knowledge of the Company, no reinsurer that is a party
to any of the Reinsurance Agreements has a valid defense to payment of its
material obligations under such Reinsurance Agreements or is in default in any
material respect under any Reinsurance Agreement. Each Reinsurance Agreement is
in compliance with applicable insurance laws and regulations regarding life and
health reinsurance agreements. Schedule 3.19 sets forth a list of all surplus
relief reinsurance treaties of the Company. The Company is appropriately
recording all reinsurance in accordance with SAP.
(c) The A.M. Best rating presently held by the Insurance Company
Subsidiaries has not been reduced, and none of the Insurance Company
Subsidiaries have been given any notice of any intended or potential downgrading
by A.M. Best.
3.20 Employee Benefit Plans.
(a) Schedule 3.20 lists all employee benefit plans, arrangements, policies
or commitments (whether or not an employee benefit plan within the meaning of
Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended
("ERISA")), including any employment (other than the Employment Agreements),
consulting or deferred compensation agreement, executive compensation, bonus,
incentive, pension, profit-sharing, savings, retirement, stock option, stock
purchase or severance pay plan, any life, health, disability, or accident
insurance plan or any holiday or vacation practice, as to which the Company or
the Subsidiaries has or in the future would have any direct or indirect, actual
or contingent liability ("Benefit Plans"). With
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respect to each such Benefit Plan, the Company heretofore has delivered to the
Purchaser true, correct and complete copies of (i) all plan texts and agreements
and related trust agreements or annuity contracts, (ii) all summary plan
descriptions and material employee communications, (iii) the most recent annual
report (including all schedules thereto); (iv) if the plan is intended to
qualify under Section 401(a) or 403(a) of the Code, the most recent
determination letter received from the Internal Revenue Service (the "IRS"), and
(v) all material communications with any governmental authority with respect to
Benefit Plans.
(b) Each Benefit Plan conforms in all material respects to, and its
administration is in substantial compliance with, its terms and all Requirements
of Law and regulations. Each Benefit Plan intended to be qualified under Code
section 401(a) has been determined to be so qualified by the IRS and each trust
established in connection with any Benefit Plan that is intended to be exempt
from federal income taxation under Code section 501(a) has been determined to be
so exempt by the IRS and, since the date of each most recent determination, no
event has occurred and no condition or circumstance has existed to adversely
affect the qualified status of any Benefit Plan.
(c) Except as set forth on Schedule 3.20 or as contemplated by this
Agreement, the consummation of the transactions contemplated by this Agreement
will not (i) entitle any current or former employee to severance pay or
unemployment compensation, (ii) accelerate the time of payment or vesting, or
increase the amount of any compensation due to, any current or former employee
or (iii) result in a payment that would constitute a parachute payment within
the meaning of Section 280G of the Code.
(d) No Benefit Plan is a "multiple employer plan" or a "multiemployer plan"
within the meaning of the Code or ERISA and neither the Company nor the
Subsidiaries, or any member of their controlled group (as defined in Section 414
of the Code) has had any liability to contribute to a multiemployer plan in the
previous six years.
(e) No Benefit Plan that is a welfare plan (as defined in Section 3611 of
ERISA) provides for payments of medical or death benefits with respect to
current or former employees of the Company or the Subsidiaries beyond their
termination of employment (other than as mandated by law).
(f) No "reportable event" as defined in Section 4043 of ERISA has occurred
with respect to any Benefit Plan and no accumulated funding deficiency, whether
or not waived, exists with respect to any Benefit Plan; and, to the Knowledge of
the Company, there is no risk of termination of any Benefit Plan by the Pension
Benefit Guaranty Corporation under Section 4042 of ERISA and no event has
occurred which has or is likely to subject the Company or any of the
Subsidiaries to liability under Section 4062 of ERISA.
(g) None of the Company or the Subsidiaries, or any organization with
respect to which the Company is a successor or parent corporation, within the
meaning of Section 4069(b) of ERISA, has engaged in any transaction described in
Section 4069 of ERISA.
3.21 Labor Relations. Neither the Company nor any of the Subsidiaries is
engaged in any unfair labor practice. There is (a) no unfair labor practice
complaint pending or, to the Knowledge of the Company, threatened in writing
against the Company or any of the Subsidiaries before the National Labor
Relations Board and no grievance or arbitration proceeding arising out of or
under any collective bargaining agreement is so pending or, to the Knowledge of
the Company, threatened, (b) no strike, labor dispute, slowdown or stoppage
pending or threatened against the Company, (c) no union representation question
existing with respect to the employees of the Company or any of the Subsidiaries
and, to the Knowledge of the Company, no union organizing activities are taking
place and (d) there is and has not been a "mass layoff" or "plant closing," as
such terms are defined by the Worker Adjustment and
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Retraining Notification Act, with respect to the employees of the Company or any
of the Subsidiaries.
3.22 Potential Conflicts of Interest. To the Knowledge of the Company,
except as set forth on Schedule 3.22, no officer, director or affiliate of the
Company or any of the Subsidiaries: (a) owns, directly or indirectly, any
interest in a company (excepting less than 1% stock holdings for investment
purposes in securities of publicly held and traded companies), or is an officer,
director, employee or consultant of, any such company that is engaged in
business as, a competitor, lessor, lessee, supplier, distributor, sales agent or
customer of, or lender to or borrower from, the Company or any of its
Subsidiaries; (b) owns, directly or indirectly, in whole or in part, any
tangible or intangible property that the Company or any of the Subsidiaries uses
in the conduct of its business; or (c) has any cause of action or other claim
whatsoever against, or owes any amount to, the Company or any of the
Subsidiaries, except for claims in the ordinary course of business such as for
accrued vacation pay, accrued benefits under the Benefit Plans, and similar
matters and agreements arising in the ordinary course of business.
3.23 Representations and Warranties on Closing Date. The representations
and warranties contained in this Article III shall be true and correct in all
material respects on and as of the Closing Date with the same force and effect
as though such representations had been made on and as of the Closing Date
(except as to those representations or warranties which specifically relate to
an earlier date, which are or will be true and correct in all material respects
as of such specified date).
ARTICLE IV
COVENANTS AND AGREEMENTS
4.1 Conduct of Business Prior to the Closing; Management of the
Company. During the period from the date hereof to the Closing Date, except as
otherwise contemplated by this Agreement, the PennCorp Purchase Agreement or as
the Purchaser shall otherwise agree in writing in advance (which agreement shall
not be unreasonably withheld), or except as set forth on Schedule 4.1, the
Company shall not:
(a) except in the ordinary course of business, incur any indebtedness
for borrowed money or issue any debt securities or assume, guarantee or
endorse the obligations of any other person;
(b) except in the ordinary course of business (including the managing
by the Company of its investment assets), (i) sell, transfer or otherwise
dispose of any of its property or assets, (ii) mortgage or encumber any of
its property or assets or (iii) enter into any material contracts;
(c) repurchase any of its capital stock or any capital stock of any of
the Subsidiaries;
(d) declare, set aside or pay any dividend or other distribution in
respect of its capital stock;
(e) amend its Certificate of Incorporation or Bylaws or merge with or
into or be consolidated with any other person;
(f) split, combine or reclassify its capital stock;
(g) other than in connection with ordinary course exercises of
outstanding options or grants under existing stock option plans of the
Company described in the SEC Filings, issue or sell (or agree to issue or
sell) any of its equity securities or any options, warrants, conversion or
other rights to purchase any such securities or any securities convertible
into or exchangeable for such securities, or grant, or agree to grant any
such rights;
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(h) increase the rates of compensation (including bonuses) payable or
to become payable to any of its officers, employees, agents, independent
contractors or consultants other than increases made in the ordinary course
of business consistent with past practice;
(i) enter into any new or amend any existing employment contracts,
severance agreements or consulting contracts, other than the Employment
Agreements; or other than in the ordinary course of business, institute or
agree to institute any increase in benefits or alter its employment
practices or the terms and conditions of employment;
(j) except as may be required by applicable law, change in any
material respect its underwriting, actuarial or tax or financial accounting
methods, principles or practices;
(k) enter into or amend or terminate any transaction or contract the
result of which is reasonably likely to have a Material Adverse Effect on
the Company;
(l) enter into any joint ventures or partnerships of any kind; or
(m) enter into any contract or other agreements to do any of the
foregoing.
During the period from the date hereof to the Closing Date or this
Agreement is terminated in accordance with its terms, at the request of the
Purchaser, the Company will discuss in good faith with the Purchaser significant
policies, decisions and practices of the Company and the Subsidiaries.
4.2 Proxy Statement and Meeting of Company's Shareholders.
(a) As soon as reasonably practicable following the date hereof, the
Company shall (i) prepare and file with the Commission, (ii) use its reasonable
efforts to cause to be cleared by the Commission and (iii) within 5 business
days following clearance with the Commission, mail to its shareholders the Proxy
Statement (as defined below) with respect to a special meeting of shareholders
of the Company (the "Special Meeting") to consider and vote, among other things,
(A) to amend the Certificate of Incorporation to authorize for issuance
additional shares of Common Stock and, with respect to the holders of the Series
C-1 Shares, to obtain approval for the issuance of debt to finance the
Acquisition (the "Amendment and Approval"), (B) to issue the Shares as
contemplated hereby and (C) such other related matters as the Company deems
appropriate. The Board of Directors of the Company has authorized and approved
the Amendment and Approval and the issuance of the Shares to the Purchaser and
shall submit to its shareholders for approval the Amendment and Approval and the
issuance of the Shares to the Purchaser. The Purchaser agrees to assist and
cooperate with the Company in the preparation of the Proxy Statement with
respect to the information therein concerning the Purchaser.
(b) The Company, on the one hand, and the Purchaser, on the other hand,
hereby represents, warrants and agrees with the other that the Proxy Statement
will not, at the time the Proxy Statement is mailed, and at the date of the
Special Meeting, contain any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they are made, not
misleading, or to correct any statement made in any earlier communication with
respect to the solicitation of any proxy or approval of the transactions
contemplated by this Agreement in connection with which the Proxy Statement
shall be mailed, except that no representation or warranty is being made by any
party hereto with respect to information supplied in writing by any other party
hereto for inclusion in the Proxy Statement. The Company further represents,
warrants and agrees that the Proxy Statement will comply as to form in all
material respects with the provisions of the Exchange Act. The letter to
shareholders, notice of meeting, proxy statement and form of proxy, or any
information statement filed under the Exchange Act, as the case may be, that may
be provided to shareholders of the Company in connection with the transactions
contemplated by this Agreement (including any supplements), and any schedules
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required to be filed with the Commission in connection therewith, as from time
to time amended or supplemented, are collectively referred to as the "Proxy
Statement."
(c) The Company shall take all actions necessary in accordance with the
Business Corporation Law of New York and the Certificate of Incorporation and
Bylaws of the Company to duly call, give notice of, convene and hold the Special
Meeting within 45 calendar days after the mailing of the Proxy Statement to
approve the matters set forth therein.
4.3 Further Assurances. Upon the terms and subject to the conditions
herein provided, the Purchaser and the Company agree to use their reasonable
best efforts to take, or cause to be taken, all action, and to do, or cause to
be done, all things necessary, proper or advisable to consummate the
transactions contemplated by this Agreement and each other agreement
contemplated hereby including (a) to lift or rescind any injunction or
restraining order or other order adversely affecting the ability of the parties
to consummate the transactions contemplated hereby and (b) to fulfill all
conditions on its part to be fulfilled under this Agreement and each other
agreement contemplated hereby. In case at any time after the Closing Date any
further action is reasonably necessary or desirable to carry out the purposes of
this Agreement and each other agreement contemplated hereby, the proper
partners, officers or directors of all parties to this Agreement shall take all
such reasonably necessary action. No party hereto will take any action for the
purpose of delaying, impairing or impeding the receipt of any required consent,
authorization, order or approval or the making of any required filing. Each
party hereto shall give prompt notice to all other parties of (i) the
occurrence, or failure to occur, of any event which occurrence or failure would
be likely to cause any representation or warranty of such party contained in
this Agreement to be untrue or inaccurate in any material respect any time from
the date hereof to the Closing Date and (ii) any material failure of such party,
as the case may be, to comply with or satisfy any covenant, condition or
agreement to be complied with or satisfied by it hereunder, and such party shall
use all reasonable efforts to remedy such failure.
4.4 Indemnification by the Company.
(a) If the Closing occurs, the Company will indemnify the Purchaser and its
affiliates and their respective directors, officers, partners, members,
employees, agents and representatives (the "Purchaser Indemnified Parties"),
against and hold the Purchaser Indemnified Parties harmless from all claims,
obligations, costs and expenses (including, without limitation, reasonable
attorneys' fees and expenses of one counsel for all Purchaser Indemnified
Parties in any action between such Purchaser Indemnified Party and the Company
or between any Purchaser Indemnified Party and any third party or otherwise) and
liabilities of and damages to such Purchaser Indemnified Party arising out of
the breach of any representation, warranty, covenant or agreement of the Company
in this Agreement.
(b) Such Purchaser Indemnified Party agrees to give the Company prompt
written notice of any claim, assertion, event or proceeding by or in respect of
a third party of which it has knowledge concerning any liability or damage as to
which such Purchaser Indemnified Party is entitled to indemnification hereunder.
The Company shall have the right to direct, through counsel of its own choosing,
the defense or settlement of any such claim, assertion, event or proceeding
(provided that the Company shall have acknowledged its indemnification
obligations hereunder specifically in respect of such claim, assertion, event or
proceeding) at its own expense, which counsel shall be reasonably satisfactory
to such Purchaser Indemnified Party. If the Company elects to assume the defense
of any such claim, assertion, event or proceeding, such Purchaser Indemnified
Party may participate in such defense, but in such case the expenses of such
Purchaser Indemnified Party incurred in connection with such participation shall
be paid by such Purchaser Indemnified Party. Such Purchaser Indemnified Party
shall cooperate with the Company in the defense or settlement of any such claim,
assertion, event or proceeding. If the Company elects to direct the defense of
any such claim or proceeding, such Purchaser Indemnified Party shall not pay, or
permit to be paid, any part of any claim or demand arising
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from such asserted liability, unless the Company consents in writing (which
consent shall not unreasonably be withheld) to such payment or unless the
Company withdraws from the defense of such asserted liability, or unless a final
judgment from which no appeal may be taken by or on behalf of the Company is
entered against such Purchaser Indemnified Party for such liability. If the
Company shall elect not to defend any such claim, assertion, event or
proceeding, such Purchaser Indemnified Party shall have the right to undertake
the defense or settlement thereof at the Company's expense, but such matter
shall not be settled without the Company's consent, which consent shall not be
unreasonably withheld. If the Company shall, after commencing or undertaking a
defense, fail to prosecute or withdraws from such defense, such Purchaser
Indemnified Party shall have the right to undertake the defense or settlement
thereof at the Company's expense.
4.5 Indemnification by the Purchaser.
(a) If the Closing occurs, the Purchaser will indemnify the Company and its
affiliates, and their respective officers, directors, employees, agents and
representatives (the "Company Indemnified Parties"), against and hold the
Company Indemnified Parties harmless from all claims, obligations, costs and
expenses (including, without limitation, reasonable attorneys' fees and expenses
of one counsel for all Company Indemnified Parties in any action between any
Company Indemnified Party and the Purchaser or between such Company Indemnified
Party and any third party or otherwise) and liabilities of and damages to such
Company Indemnified Party arising out of the breach of any representation,
warranty, covenant or agreement of the Purchaser in this Agreement.
(b) Such Company Indemnified Party agrees to give the Purchaser prompt
written notice of any claim, assertion, event or proceeding by or in respect of
a third party of which it has knowledge concerning any liability or damage as to
which such Company Indemnified Party is entitled to indemnification hereunder.
The Purchaser shall have the right to direct, through counsel of their own
choosing, the defense or settlement of any such claim, assertion, event or
proceeding (provided that the Purchaser shall have first acknowledged its
indemnification obligations hereunder specifically in respect of such claim,
assertion, event or proceeding) at its own expense, which counsel shall be
reasonably satisfactory to such Company Indemnified Party. If the Purchaser
elects to assume the defense of any such claim, assertion, event or proceeding,
such Company Indemnified Party may participate in such defense, but in such case
the expenses of such Company Indemnified Party incurred in connection with such
participation shall be paid by such Company Indemnified Party. Such Company
Indemnified Party shall cooperate with the Purchaser in the defense or
settlement of any such claim, assertion, event or proceeding. If the Purchaser
elects to direct the defense of any such claim, assertion, event or proceeding,
such Company Indemnified Party shall not pay, or permit to be paid, any part of
any claim or demand arising from such asserted liability, unless the Purchaser
consents in writing (which consent shall not unreasonably be withheld) to such
payment or unless the Purchaser withdraws from the defense of such asserted
liability, or unless a final judgment from which no appeal may be taken by or on
behalf of the Purchaser is entered against such Company Indemnified Party for
such liability. If the Purchaser shall elect not to defend any such claim,
assertion, event or proceeding, such Company Indemnified Party shall have the
right to undertake the defense or settlement thereof at the Purchaser's expense,
but such matter shall not be settled without the Purchaser's consent, which
consent shall not be unreasonably withheld. If the Purchaser shall, after
commencing or undertaking a defense, fail to prosecute or withdraws from such
defense, such Company Indemnified Party shall have the right to undertake the
defense or settlement thereof at such Purchaser's expense.
4.6 Limitations on Indemnification.
(a) Neither the Company nor the Purchaser shall be obligated to pay any
amounts for indemnification under Section 4.4 or Section 4.5 for any breaches of
any representations and
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warranties in Article II or Article III until the aggregate amount for
indemnification equals Five Hundred Thousand Dollars ($500,000), whereupon the
Company and the Purchaser shall be obligated to pay only amounts in excess
thereof.
(b) Neither the Company nor the Purchaser shall be obligated to pay any
amounts for indemnification under Section 4.4 or Section 4.5 for breaches of any
representations and warranties in Article II or Article III in excess of the
Purchase Price.
(c) The Company shall not be liable in any event to pay any amounts for
indemnification under Section 4.4 in respect of any events, conditions or
circumstances for which an adjustment was made pursuant to Section 1.6.
4.7 Disclosure Supplements. From time to time prior to the Closing, the
Company may supplement the Schedules delivered in connection with this Agreement
with respect to any matter which, if existing or occurring at or prior to the
date of this Agreement, would have been required to be set forth or described in
such Schedule or which is necessary to correct any information in such Schedule
which has been rendered inaccurate thereby. Such supplements shall not be given
effect for purposes of Section 5.3(b); however, if the Closing occurs, the
Purchaser shall be deemed to have waived any right or claim it may otherwise
have or have had on account of any matter so disclosed in such supplement.
4.8 Additional Indemnification Obligation.
(a) Indemnification Relating to Section 4.15 of this Agreement.
(i) The Purchaser agrees to indemnify and hold harmless, without
offset, the Company Indemnified Parties from any liability under the
PennCorp Purchase Agreement resulting from the Company's inability to take
action under the PennCorp Purchase Agreement as a result of the failure of
or refusal by the Purchaser to give any consent required pursuant to
Section 4.15 of this Agreement.
(ii) Responsibility for any liability under the PennCorp Purchase
Agreement resulting from actions of the character described in Section 4.15
that are taken (or not taken) by the Company upon mutual agreement with the
Purchaser will be allocated as follows: the Purchaser will be responsible
for, and will indemnify and hold harmless, without offset, the Company
Indemnified Parties from and against, 60% and the Company will be
responsible for, and indemnify and hold harmless, without offset, the
Purchaser Indemnified Parties from and against, 40%.
(iii) The Company will be responsible for, and will indemnify and hold
harmless, without offset, the Purchaser Indemnified Parties from and
against, any liability resulting from any actions taken by the Company in
violation of Section 4.15 (including the failure of the Company to close
the transactions contemplated by the PennCorp Purchase Agreement, if the
Purchaser has notified the Company in writing that all conditions to
closing thereunder have been satisfied and that the Purchaser demands that
the Company close such transaction).
(b) Indemnification Relating to the Unavailability of the Chase
Facility. The Purchaser will indemnify and hold harmless, without offset, the
Company Indemnified Parties, and/or the Company will indemnify and hold
harmless, without offset, the Purchaser Indemnified Parties, in each case from
and against any and all liabilities arising under the PennCorp Purchase
Agreement as a result of the Company's failure to proceed with the Acquisition
(the "Acquisition Liabilities"), as follows:
(i) If the conditions to the Chase Facility have not been satisfied as
a result solely of (A) conditions, events or circumstances which cause any
of the conditions contained in Section 5.3(a), (b) or (e) of this Agreement
not to be satisfied or (B) conditions, events or circumstances which
constitute (x) a breach or violation of any representation or warranty
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under this Agreement that involves or results from false statements or
omissions made intentionally (in the sense of intending to mislead) or (y)
a willful breach (in the sense that such breach is not inadvertent) by the
Company of any covenant or agreement under this Agreement, then, in either
such case, the Company, without offset, shall be solely responsible for,
and shall indemnify and hold harmless, without offset, the Purchaser
Indemnified Parties from and against, all Acquisition Liabilities.
(ii) If the conditions to the Chase Facility have not been satisfied
as a result of conditions, events or circumstances which constitute a
breach or violation of any representation, warranty, covenant or agreement
of the Company under this Agreement (other than (x) those set forth in
clause (i) above or (y) breaches of representations or warranties that did
not exist as of the date hereof but arise after such date and prior to the
Closing Date because of conditions, events or circumstances outside the
reasonable control of the Company), then the Company, without offset, shall
be responsible for, and shall indemnify and hold harmless Purchaser
Indemnified Parties from and against, 6% of the Acquisition Liabilities,
and the Purchaser, without offset, shall be responsible for, and shall
indemnify and hold harmless the Company Indemnified Parties from and
against, 94% of the Acquisition Liabilities.
(iii) If the conditions to the Chase Facility have not been met for
any other reason whatsoever (including as a result of the failure of the
Purchaser to proceed with the Purchase in violation of the terms of this
Agreement), then the Purchaser, without offset, shall be solely responsible
for, and shall indemnify and hold harmless the Company Indemnified Parties
from and against all fees and expenses due to Chase under the Chase
Commitment Letter and all Acquisition Liabilities.
(c) Required Additional Investment. If Chase and/or the lenders under the
Chase Facility has notified the Company that the Chase Facility will not be
available to the Company unless a specified amount of additional equity is
invested in the Company (the "Required Equity"), then the Purchaser, together
with the other shareholders of the Company, shall have the right (but no
obligation) to purchase additional shares of Common Stock in order to fund such
Required Equity. If the Purchaser and any shareholder of the Company as of the
date hereof (any such shareholders, the "Opting Shareholders") opt to purchase
such shares, the Purchase Price Per Share shall be (x) if the Purchaser and the
Company prior to the Closing agree on the price to be paid by the Purchaser and
the Opting Shareholders for such additional shares of Common Stock, such agreed
price, and (y) if the Purchaser and the Company cannot agree on the price to be
paid for such additional shares of Common Stock by the Purchaser and the Opting
Shareholders, a price per share equal to 60% of the per share Purchase Price
determined under Article I. The Purchaser and the Opting Shareholders will be
entitled to purchase such additional shares of Common Stock in proportion to
their respective percentage shareholdings of the Company (after giving effect to
the Closing but without giving effect to the infusion of the Required Equity).
Nothing in this subsection (c), or any failure to invest under this subsection,
shall impair any indemnity obligation under Sections 4.8(a) and (b).
4.9 Consents. The Company and the Purchaser will use their reasonable
best efforts to obtain all necessary waivers, consents and approvals of all
third parties and governmental authorities necessary to the consummation of the
transactions contemplated by this Agreement and each agreement contemplated
hereby, including, but not limited to, those required in connection with the
filing of any required HSR Reports and Forms A to the Departments of Insurance
of the applicable states and any filings to be made in connection with or in
compliance with the provisions of each of the Securities Act, the Exchange Act
and any applicable state securities laws.
4.10 Use of Proceeds. The Company covenants and agrees that it will use
the proceeds from the sale of the Shares hereunder solely to consummate the
Acquisition.
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4.11 HSR Reports. If the Purchaser is required to file an HSR Report in
connection with the Purchase, then the Purchaser shall so notify the Company in
writing and, within 15 business days from the receipt by the Company of such
notice, the Purchaser and the Company shall file with the Federal Trade
Commission and the Antitrust Division of the Department of Justice, an HSR
Report and any supplemental information which may be requested in connection
with such HSR Reports. The Purchaser and the Company shall cooperate fully in
the preparation of such filings.
4.12 Exclusivity. The Company hereby agrees that prior to the Closing
Date, the Company shall not, directly or indirectly, solicit, entertain or
accept offers from persons (other than the Purchaser) for the investment
contemplated by this Agreement. The Company hereby agrees that it will not,
during the term of this Agreement and for a period of two years thereafter,
consummate the Acquisition (or any other purchase or acquisition (by merger or
otherwise) of any of the businesses or assets of PennCorp) without first
consummating the Purchase, unless (i) this Agreement is terminated due to a
breach by Purchaser of its obligations hereunder (ii) the Company and the
Purchaser mutually agree not to consummate the transactions contemplated by the
PennCorp Purchase Agreement or (iii) the Company is unable to consummate the
transactions contemplated by the PennCorp Purchase Agreement as a result of the
failure of or refusal by the Purchaser to give consent pursuant to Section 4.15
of this Agreement. If the Company enters into a transaction with PennCorp after
the occurrence of any of the events described in (i), (ii) or (iii) above, the
Company will either (x) obtain from PennCorp a complete release of the Purchaser
from any liability or claims relating to the PennCorp Purchase Agreement (and
the transactions contemplated thereby) or (y) indemnify the Purchaser for all
such liabilities and claims.
4.13 SEC Filings and Annual Statements. From and after the date hereof to
the Closing the Company shall make all SEC Filings required to be filed under
the Securities Act or the Exchange Act, and all amendments thereto. The Company
shall deliver to the Purchaser a copy of each such SEC Filing and any Annual
Statements of the Insurance Company Subsidiaries filed with any departments of
insurance from and after the date hereof to the Closing (including all exhibits,
interrogatories, notes and schedules thereto and any actuarial opinions,
affirmations or certifications filed in connection therewith).
4.14 Amendment or Termination of Purchase Agreement. The Company shall
not amend or terminate the PennCorp Purchase Agreement without the prior written
consent of the Purchaser (which consent may be given or withheld in the
Purchaser's sole discretion).
4.15 Actions Relating to the PennCorp Purchase Agreement. The Company
shall not, without the Purchaser's prior consent (which consent may be given or
withheld in the Purchaser's sole discretion), (i) indicate or acknowledge
fulfillment of or waive any of the conditions to Closing set forth in Article VI
of the PennCorp Purchase Agreement or (ii) with respect to any such conditions
in the PennCorp Purchase Agreement that by their terms require that a specified
event, action or circumstance occur or be performed to the satisfaction of the
Company, indicate or acknowledge the Company's satisfaction as to such
occurrence or performance. The Company shall perform all of its obligations
under the PennCorp Purchase Agreement required to be performed by it prior to
the closing of the Acquisition.
4.16 Registration Rights Agreement. In connection with the transactions
contemplated by this Agreement, the Company and the Purchaser will enter into
the Registration Rights Agreement, a form of which is attached hereto as Exhibit
C (the "Registration Rights Agreement").
4.17 Shareholders Agreement. In connection with the transactions
contemplated by this Agreement, the Company, the Purchaser and certain other
shareholders of the Company will enter into a shareholders agreement, a form of
which is attached hereto as Exhibit D (the "Shareholders Agreement").
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4.18 Employment Agreement. In connection with the transactions
contemplated by this Agreement, the Company and Richard Barasch, President and
Chief Executive Officer of the Company, will enter into an employment agreement,
in the form of the draft dated December 30, 1998 (10:12 p.m. version) (the
"Employment Agreement").
ARTICLE V
CONDITIONS PRECEDENT
5.1 Conditions to Each Party's Obligations. The respective obligations of
each party to effect the transactions contemplated by this Agreement shall be
subject to the fulfillment (or waiver by the Purchaser and the Company) on or
prior to the Closing Date of the following conditions:
(a) no United States or state authority or other agency or commission
or United States or state court of competent jurisdiction shall have
enacted, issued, promulgated, enforced or entered any statute, rule,
regulation, injunction or other order (whether temporary, preliminary, or
permanent) which is in effect and has the effect of prohibiting
consummation of the transactions contemplated by this Agreement or
restricting the operation of the business of the Company and the
Subsidiaries as conducted on the date hereof in a manner that would have a
Material Adverse Effect on the Company;
(b) any waiting period applicable to the transactions contemplated by
this Agreement and each agreement contemplated hereby, including, without
limitation, those applicable to any HSR Report, any Form A required to be
filed by, or any further approval required by, any Department of Insurance
of any State or any other regulatory filing or any filing in connection
with or in compliance with the provisions of each of the Securities Act,
the Exchange Act and any applicable state securities laws shall have
expired or been terminated;
(c) the Closing provided for in Section 1.3 hereof shall occur
simultaneously with the closing of the transactions contemplated by the
PennCorp Purchase Agreement;
(d) the shareholders of the Company shall have duly approved at the
Special Meeting the Amendment, the issuance of the Shares to Capital Z and
the other matters set forth in Section 4.2 of this Agreement; and
(e) each of the Purchaser and the Company shall have received fully
executed copies of the Registration Rights Agreement, the Shareholders'
Agreement, the Employment Agreement and any and all other agreements,
documents, certificates or instruments contemplated by this Agreement and
any of the foregoing.
5.2 Conditions to the Obligations of the Company. The obligation of the
Company to effect the transactions contemplated by this Agreement shall be
subject to the fulfillment (or waiver by the Company) on or prior to the Closing
Date of the following additional conditions:
(a) the Purchaser shall have performed in all material respects its
obligations under this Agreement required to be performed by it on or prior
to the Closing Date pursuant to the terms hereof, including without
limitation payment of the Purchase Price pursuant to Section 1.1;
(b) the representations and warranties of the Purchaser contained in
this Agreement shall be true and correct in all material respects at and as
of the Closing Date as if made at and as of such date, except to the extent
that any such representation or warranty is made as of a specified date in
which case such representation or warranty shall have been true and correct
as of such date. The Purchaser shall have delivered a certificate to the
effect set forth in Sections 5.2(a) and (b);
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(c) the Company shall have received fully executed copies of the Chase
Facility set forth in the Chase Commitment Letter or similar arrangement;
(d) all of the conditions to Closing set forth in Article VI of the
PennCorp Purchase Agreement shall have been satisfied or waived;
(e) the Company shall have received, in a form reasonably satisfactory
to the Company, a favorable fairness opinion of its financial advisor in
connection with the transactions contemplated hereunder and under the
PennCorp Purchase Agreement, as of the date of the mailing of the Proxy
Statement, as to the fairness on a financial basis of the terms of the
Purchase and the transactions contemplated by this Agreement; and
(f) all necessary waivers or consents to, approvals of and notices or
filings with respect to the transactions contemplated by Sections 2.3, 3.8
and 3.17 of this Agreement shall have been obtained.
5.3 Conditions to the Obligations of the Purchaser. The obligations of
the Purchaser to effect the transactions contemplated by this Agreement shall be
subject to the fulfillment (or waiver by the Purchaser) on or prior to the
Closing Date of the following additional conditions (and the Purchaser agrees
that if the conditions set forth below and in Section 5.1 above have been
satisfied (or waived by the Purchaser), the Purchaser shall consummate the
Purchase):
(a) the Company shall not have violated its obligations under Sections
4.1(a), (c), (d), (e), (f) and (g), or Section 4.14 or 4.15 of this
Agreement;
(b) the representations and warranties of the Company contained in
Sections 3.1, 3.2, 3.3, 3.5 and 3.7 of this Agreement shall be true and
correct in all material respects at and as of the Closing Date as if made
at and as of such date, except to the extent that any such representation
or warranty is made as of a specified date in which case such
representation or warranty shall have been true and correct in all material
respects as of such date. The Company shall have delivered to the Purchaser
a certificate to the effect set forth in Sections 5.3(a) and (b);
(c) the Purchaser shall have received the opinion of Simpson Thacher &
Bartlett, special counsel to the Company in the form attached hereto as
Exhibit E;
(d) all necessary waivers or consents to, approvals of and notices or
filings with respect to the transactions contemplated by Sections 2.3 and
3.8 of this Agreement shall have been obtained;
(e) neither the Company nor any of Barasch, Waegelein and Bryant shall
have committed criminal fraud or otherwise engaged in felonious criminal
conduct with respect to, or in the operation of, the business or affairs of
the Company or any of its Subsidiaries;
(f) all of the conditions to Closing set forth in Article VI of the
PennCorp Purchase Agreement shall have been satisfied or waived; and
(g) the Purchaser shall not have exercised its option, pursuant to
Section 4.19 of this Agreement and Section 10.12 of the PennCorp Purchase
Agreement, to cause an affiliate to assume the rights and obligations of
the Company under the PennCorp Purchase Agreement and to terminate the
Purchaser's obligation to Purchase the Shares pursuant to this Agreement.
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<PAGE> 131
ARTICLE VI
MISCELLANEOUS
6.1 Termination. This Agreement may be terminated and the transactions
contemplated hereby abandoned:
(a) by either the Company or the Purchaser, simultaneously with or at
any time following the termination of the PennCorp Purchase Agreement;
(b) by the Company, on the one hand, or the Purchaser, on the other
hand, upon notice to the other, five Business Days after the failure by the
shareholders of the Company to approve at the Special Meeting the Amendment
and the issuance of the Shares pursuant to this Agreement;
(c) if the transactions contemplated by the PennCorp Purchase
Agreement fail to close by the date set forth in Section 9(b)(ii) of the
PennCorp Purchase Agreement;
(d) by either the Company or the Purchaser at any time after May 30,
1999; or
(e) pursuant to the terms of Section 1.6(g).
6.2 Amendment. This Agreement may be amended only by written agreement
between the parties hereto.
6.3 Waiver. At any time prior to the Closing Date, either party may (a)
extend the time for the performance of any of the obligations or other acts of
the other party, (b) waive any inaccuracies in the representations and
warranties of the other party contained herein or in any document delivered
pursuant hereto, and (c) waive compliance by the other party with any of the
agreements or conditions herein; provided, that any such waiver of or failure to
insist on strict compliance with any such representation, warranty, agreement or
condition shall not operate as a waiver of, or estoppel with respect to, any
subsequent or other failure. Any agreement on the part of one party to any such
extension or waiver shall be valid only if set forth in an instrument in writing
signed on behalf of such party.
6.4 Survival. The representations and warranties set forth in this
Agreement shall survive the Closing for a period of 18 months thereafter.
Notwithstanding the foregoing, (i) the representations and warranties contained
in Sections 3.1, 3.2, 3.3, 3.5 and 3.7 shall survive without limitation and (ii)
the representations and warranties contained in Sections 3.15 and 3.20 shall
survive until the date which is 30 days after the date upon which the liability
to which any claim may relate is barred by all applicable statutes of
limitations (including all periods of extension, whether automatic or
permissive). Claims based on the covenants and agreements set forth in Sections
1.4 and Articles II, III and IV which, by their terms are to be performed at or
prior to the Closing may be made during the 18 month period following the
Closing. All other covenants (including without limitation those contained in
Section 1.6(g)) shall survive the Closing without limitation.
6.5 Notices. All notices and other communications given or made pursuant
hereto shall be in writing and shall be deemed to have been given or made if in
writing and delivered personally, sent by commercial carrier or registered or
certified mail (postage prepaid, return receipt
A-24
<PAGE> 132
requested) or transmuted by facsimile with automated receipt confirmation to the
parties at the following addresses and numbers:
If to the Company, to:
Universal American Financial Corp.
Six International Drive, Suite 190
Rye Brook, NY 10573-1068
Fax: (914) 934-9123
Attention: Richard A. Barasch
with copies to:
Harnett Lesnick & Ripps, P.A.
NationsBank Tower
150 E. Palmetto Park Road
Suite 500
Boca Raton, FL 33432-4832
Fax: (561) 368-4315
Attention: Judge Bertram Harnett
and
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017-3954
Fax: (212) 455-2502
Attention: Gary I. Horowitz, Esq.
If to the Purchaser, to:
Capital Z Partners, Ltd.
One Chase Manhattan Plaza
44th Floor
New York, NY 10005
Fax: (212) 898-8720
Attention: Bradley E. Cooper
with copies to:
Paul, Weiss, Rifkind, Wharton & Garrison
1285 Avenue of the Americas
New York, NY 10019-6064
Fax: (212) 757-3990
Attention: David K. Lakhdhir, Esq.
6.6 Headings; Agreement. The headings contained in this Agreement are
inserted for convenience only and do not constitute a part of this Agreement.
The term "Agreement" for purposes of representations and warranties hereunder
shall be deemed to include the Exhibits hereto to be executed and delivered by
parties relevant thereto.
6.7 Publicity. So long as this Agreement is in effect, except as required
by law, regulation or stock exchange requirements, the parties hereto shall not,
and shall cause their affiliates not to, issue or cause the publication of any
press release or other announcement with respect to the transactions
contemplated by this Agreement or the other agreements contemplated hereby
without the consent of the other party, which consent shall not be unreasonably
withheld or delayed or without consulting with the other parties as to the
content of such press release or other announcement.
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<PAGE> 133
6.8 Entire Agreement. This Agreement (including all Exhibits hereto)
constitutes the entire agreement among the parties with respect to the subject
matter hereof and supersedes all other prior agreements and understandings, both
written and oral, among the parties, or any of them.
6.9 Assignment. This Agreement and all of the provisions hereof shall be
binding upon and inure to the benefit of the parties hereto and their respective
successors and permitted assigns. The Purchaser may transfer or assign this
Agreement and all of its rights, interests and obligations hereunder to one or
more of the following entities: any partnership of which the Purchaser is,
directly or indirectly, the general partner, any limited liability company of
which the Purchaser is, directly or indirectly, the managing member or any
Associate of the Purchaser (provided that the Purchaser remains fully liable
under this Agreement) or any other fund of which the general partner of the
Purchaser is the general partner, and such assignee shall be a "Purchaser" for
all purposes under this Agreement. Except as provided in the immediately
preceding sentence, neither this Agreement nor any of the rights, interests or
obligations shall be assigned by any of the parties hereto without the prior
written consent of the other party.
6.10 Counterparts. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement and
each of which shall be deemed an original.
6.11 Governing Law. The validity and interpretation of this Agreement
shall be governed by the laws of the State of New York, without reference to the
conflict of laws principles thereof which might indicate the applicability of
the laws of any other jurisdiction.
6.12 Third Party Beneficiaries. This Agreement is not intended to confer
upon any other person any rights or remedies hereunder.
6.13 Costs and Expenses. Upon the consummation of the transactions
contemplated hereby, the Company will pay all costs and expenses (including
sales or transfer taxes, if any) incurred by the Purchaser in connection with
the transactions contemplated hereby, including without limitation the
reasonable legal fees and expenses of Paul, Weiss, Rifkind, Wharton & Garrison
and any filing fees paid in connection with the filing of HSR Reports and Forms
A by the Purchaser; provided, that if the transactions contemplated hereby are
not consummated and the Company would be required to indemnify the Purchaser
pursuant to Section 4.8(b)(i), the Company will pay all costs and expenses of
the Purchaser referred to above.
6.14 Specific Performance. The parties hereto agree that irreparable
damage would occur in the event any provision of this Agreement is not performed
in accordance with the terms hereof, and that the parties shall be entitled to
specific performance of the terms hereof, in addition to any other remedy at law
or in equity.
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<PAGE> 134
IN WITNESS WHEREOF, the Purchaser and the Company have caused this
Agreement to be duly signed as of the date first written above.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /s/ RICHARD BARASCH
------------------------------------
Name: Richard Barasch
Title: Chief Executive Officer
CAPITAL Z FINANCIAL SERVICES FUND II,
L.P.
By: Capital Z Partners, L.P., general
partner
By: Capital Z Partners Ltd., its
General
Partner
By: /s/ BRADLEY COOPER
------------------------------------
Name: Bradley Cooper
Title: Partner
A-27
<PAGE> 135
ANNEX
B
PURCHASE AGREEMENT
AMONG
UNIVERSAL AMERICAN FINANCIAL CORP.
PENNCORP FINANCIAL GROUP, INC.,
PACIFIC LIFE AND ACCIDENT INSURANCE COMPANY,
PENNSYLVANIA LIFE INSURANCE COMPANY,
SOUTHWESTERN FINANCIAL CORPORATION,
CONSTITUTION LIFE INSURANCE COMPANY
AND
PENNCORP FINANCIAL SERVICES, INC.
------------------------
DATED DECEMBER 31, 1998
------------------------
<PAGE> 136
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
ARTICLE I
DEFINITIONS................................................................ B-2
SECTION 1.1 Definitions................................................. B-2
SECTION 1.2 Other Definitions........................................... B-5
SECTION 1.3 Reserves.................................................... B-8
SECTION 1.4 Certain Interpretive Matters................................ B-8
ARTICLE II
THE ACQUISITION............................................................ B-8
SECTION 2.1 Consideration for the Shares and the PCFS Assets............ B-8
SECTION 2.2 Closing Transactions........................................ B-9
SECTION 2.3 Purchase Price Adjustment................................... B-10
SECTION 2.4 Reserves Adjustment......................................... B-12
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PFG, PLAC, SFC AND PCFS.................. B-14
SECTION 3.1 Organization and Qualification.............................. B-14
SECTION 3.2 Authorization............................................... B-14
SECTION 3.3 No Violation................................................ B-15
SECTION 3.4 Capitalization of the Companies............................. B-15
SECTION 3.5 PFI Subsidiaries and PCFS Assets............................ B-16
SECTION 3.6 Consents and Approvals...................................... B-16
SECTION 3.7 Financial Statements; Reserves.............................. B-17
SECTION 3.8 Absence of Undisclosed Liabilities.......................... B-18
SECTION 3.9 Absence of Certain Changes.................................. B-18
SECTION 3.10 Litigation.................................................. B-19
SECTION 3.11 Property; Liens and Encumbrances............................ B-19
SECTION 3.12 Certain Agreements.......................................... B-20
SECTION 3.13 Employee Benefit Plans...................................... B-20
SECTION 3.14 Taxes....................................................... B-22
SECTION 3.15 Compliance with Applicable Law; Permits; Policies........... B-25
SECTION 3.16 Brokers Fees and Commissions................................ B-27
SECTION 3.17 Proprietary Rights; Year 2000 Compliance.................... B-27
SECTION 3.18 Insurance................................................... B-28
SECTION 3.19 Environmental Matters....................................... B-28
SECTION 3.20 Books and Records........................................... B-28
SECTION 3.21 Bank Accounts............................................... B-28
SECTION 3.22 Insurance and Reinsurance................................... B-29
SECTION 3.23 Labor Matters............................................... B-29
SECTION 3.24 Purchase for Investment..................................... B-30
SECTION 3.25 Affiliate Transactions...................................... B-30
SECTION 3.26 Bonuses..................................................... B-30
SECTION 3.27 All Related Assets.......................................... B-30
SECTION 3.28 Litigation Arising Between Signing and Closing.............. B-30
</TABLE>
B-ii
<PAGE> 137
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF BUYER.................................... B-31
SECTION 4.1 Organization; Qualifications and Operations................. B-31
SECTION 4.2 Authorization............................................... B-31
SECTION 4.3 No Violation................................................ B-31
SECTION 4.4 Capitalization.............................................. B-32
SECTION 4.5 Consents and Approvals...................................... B-32
SECTION 4.6 Brokers' Fees and Commissions............................... B-32
SECTION 4.7 Purchase for Investment..................................... B-32
SECTION 4.8 Financing................................................... B-33
SECTION 4.9 SEC Reports................................................. B-33
SECTION 4.10 Absence of Undisclosed Liabilities.......................... B-33
SECTION 4.11 Absence of Certain Changes.................................. B-33
SECTION 4.12 Compliance with Applicable Law; Permits; Licenses........... B-33
ARTICLE V
COVENANTS.................................................................. B-34
SECTION 5.1 Conduct of Business Prior to the Closing.................... B-34
SECTION 5.2 Management of Companies..................................... B-36
SECTION 5.3 Access to Information....................................... B-36
SECTION 5.4 HSR Act Filings............................................. B-37
SECTION 5.5 State Regulatory Approvals.................................. B-37
SECTION 5.6 Pre-Closing Restructuring Transactions...................... B-37
SECTION 5.7 Estimated Statement......................................... B-37
SECTION 5.8 Transaction Bonuses......................................... B-38
SECTION 5.9 Payments to Agents.......................................... B-38
SECTION 5.10 All Reasonable Efforts...................................... B-38
SECTION 5.11 Public Announcements........................................ B-38
SECTION 5.12 Disclosure Supplements...................................... B-39
SECTION 5.13 Employment and Employee Benefits............................ B-39
SECTION 5.14 Nonsolicitation............................................. B-40
SECTION 5.15 Acquisition Proposals....................................... B-40
SECTION 5.16 Section 338(h)(10) Election, Allocation of Purchase Price
under Sections 338 and 1060 and Matters Relating to
SWLIC..................................................... B-41
SECTION 5.17 Tax Matters................................................. B-41
SECTION 5.18 Financial Matters; Proxy Statement.......................... B-43
SECTION 5.19 Peninsular Licenses......................................... B-43
SECTION 5.20 PCFS Licenses............................................... B-44
SECTION 5.21 Change of Name.............................................. B-44
SECTION 5.22 Litigation Arising Between Signing and Closing.............. B-44
ARTICLE VI
CLOSING CONDITIONS......................................................... B-44
SECTION 6.1 Conditions to the Obligations of Buyer under this
Agreement................................................. B-44
SECTION 6.2 Conditions to the Obligations of Sellers under this
Agreement................................................. B-46
</TABLE>
B-iii
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<TABLE>
<CAPTION>
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<S> <C> <C>
ARTICLE VII
CLOSING.................................................................... B-47
SECTION 7.1 Closing..................................................... B-47
ARTICLE VIII
SURVIVAL/INDEMNIFICATION................................................... B-48
SECTION 8.1 Survival of Representations and Warranties;
Indemnification Obligations............................... B-48
SECTION 8.2 Obligation of Buyer to Indemnify............................ B-50
SECTION 8.3 Notice and Opportunity to Defend............................ B-50
SECTION 8.4 Limitations on Indemnification.............................. B-51
SECTION 8.5 Set-off Rights.............................................. B-51
SECTION 8.6 Adjustment to Purchase Price; Offsetting Tax Benefits....... B-52
SECTION 8.7 Exclusive Remedy............................................ B-52
ARTICLE IX
TERMINATION AND ABANDONMENT................................................ B-52
SECTION 9.1 Termination................................................. B-52
SECTION 9.2 Expenses in the Event of Termination........................ B-53
SECTION 9.3 Procedure and Effect of Termination......................... B-53
SECTION 9.4 Mutual Agreement of Parties................................. B-53
SECTION 9.5 Confidentiality............................................. B-54
ARTICLE X
MISCELLANEOUS PROVISIONS................................................... B-54
SECTION 10.1 Post-Closing DI Reserves Information........................ B-54
SECTION 10.2 Amendment and Modification.................................. B-55
SECTION 10.3 Waiver of Compliance; Consents.............................. B-55
SECTION 10.4 Validity.................................................... B-55
SECTION 10.5 Expenses and Obligations.................................... B-55
SECTION 10.6 Parties in Interest......................................... B-55
SECTION 10.7 Notices..................................................... B-55
SECTION 10.8 Governing Law............................................... B-56
SECTION 10.9 Counterparts................................................ B-57
SECTION 10.10 Headings.................................................... B-57
SECTION 10.11 Entire Agreement............................................ B-57
SECTION 10.12 Assignment.................................................. B-57
</TABLE>
B-iv
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<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
ANNEX A Disclosure Schedule
ANNEX B Terms of the Acquisition Notes
ANNEX C Terms of Pledge and Security Agreement
ANNEX D Form of Voting Agreement
ANNEX E Pre-Closing Restructuring Transactions
ANNEX F Opinions of Counsel to Sellers
ANNEX G Opinions of Counsel to Buyer
EXHIBIT A Terms of AmeriLife Marketing/Equity Arrangement
EXHIBIT B Terms of Cologne Re Reinsurance Agreement
EXHIBIT C Terms of Sale or Reinsurance of Union Bankers Comprehensive Accident
and Health Insurance
EXHIBIT D Terms of Raleigh Lease Agreement
EXHIBIT E Form of ConLife-Peninsular Reinsurance Agreement
EXHIBIT F Terms of PCFS Services Agreement
EXHIBIT G NOL Example
</TABLE>
[Annexes and Exhibits have been intentionally omitted for
purposes of this proxy statement]
B-v
<PAGE> 140
PURCHASE AGREEMENT
PURCHASE AGREEMENT (this "Agreement"), dated December 31, 1998, among
Universal American Financial Corp., a New York corporation ("Buyer"), and
PennCorp Financial Group, Inc., a Delaware corporation ("PFG"), Pacific Life and
Accident Insurance Company, a Texas corporation ("PLAC"), Pennsylvania Life
Insurance Company, a Pennsylvania corporation ("PennLife"), Southwestern
Financial Corporation, a Delaware corporation ("SFC"), Constitution Life
Insurance Company, a Texas corporation ("ConLife"), and PennCorp Financial
Services, Inc., a Delaware corporation ("PCFS"). PFG, PLAC, PennLife, SFC,
ConLife and PCFS are collectively referred to herein as the "Sellers."
R E C I T A L S:
WHEREAS, PFG is the record and beneficial owner of all of the issued and
outstanding shares of common stock, par value $1.00 per share (the "PFI
Shares"), of PennCorp Financial, Inc., a Delaware corporation ("PFI");
WHEREAS, PLAC, a wholly owned Subsidiary of PFG, is the record and
beneficial owner of all of the issued and outstanding shares of common stock,
par value $100.00 per share (the "PennLife Shares"), of PennLife;
WHEREAS, PennLife is the record and beneficial owner of all of the issued
and outstanding shares of common stock, par value $2.25 per share (the
"Peninsular Shares"), of Peninsular Life Insurance Company, a North Carolina
corporation ("Peninsular");
WHEREAS, PennLife is the record and beneficial owner of all of the issued
and outstanding shares of common stock, no par value (the "PC-Canada Common
Shares"), of PennCorp Life Insurance Company, a Canadian corporation
("PC-Canada"), and all of the issued and outstanding preferred shares, no par
value (the "PC-Canada Preferred Shares" and, together with the PC-Canada Common
Shares, the "PC-Canada Shares"), of PC-Canada;
WHEREAS, SFC, a wholly owned Subsidiary of PFG, is the record and
beneficial owner of all of the issued and outstanding shares of common stock,
par value $60.00 per share (the "ConLife Shares"), of ConLife;
WHEREAS, ConLife is the record and beneficial owner of all of the issued
and outstanding shares of common stock, par value $2.00 per share (the "Union
Bankers Shares"), of Union Bankers Insurance Company, a Texas corporation
("Union Bankers");
WHEREAS, Union Bankers is the record and beneficial owner of all of the
issued and outstanding shares of common stock, par value $1.00 per share (the
"Marquette Shares"), of Marquette National Life Insurance Company, a Texas
corporation ("Marquette");
WHEREAS, PCFS is a wholly owned Subsidiary of PFG;
WHEREAS, PennLife and ConLife and their respective Subsidiaries are engaged
in the insurance business and PFI and its Subsidiaries are engaged in the
financial services business; and
WHEREAS, Buyer, acting through its Subsidiaries, is engaged in the life and
accident and health insurance business.
B-1
<PAGE> 141
NOW, THEREFORE, in consideration of the mutual covenants, representations,
warranties and agreements herein contained, the parties hereto agree as follows:
ARTICLE I
DEFINITIONS
SECTION 1.1 Definitions. For purposes of this Agreement, the term:
(a) "affiliate" means, as to a specified Person, any other Person that
directly or indirectly, through one or more intermediaries, controls, is
controlled by, or is under common control with, the specified Person.
(b) "Allocation Schedule" means the Allocation Schedule relating to the
338(h)(10) Election.
(c) "Annual Statement" means, with respect to a referenced Person, the
annual statement of such Person filed with or submitted to the insurance
regulatory authority in the jurisdiction in which such Person is domiciled on
forms prescribed or permitted by such authority.
(d) "Assumed Liabilities" means all obligations under the PCFS Licenses and
other contracts (if any) included as part of the PCFS Assets, to the extent such
obligations arise after the Closing Date.
(e) "AVR" means, with respect to any Person domiciled in the United States,
the Asset Valuation Reserve set forth in the balance sheet of such Person in
accordance with SAP.
(f) "Business Day" means any day that is not a Saturday, Sunday or other
day on which banking institutions in the city of New York, New York are
authorized or required by law or executive order to be closed.
(g) "Chase Bank Facility" means the term loan facility and revolving credit
facility provided to Buyer upon the terms and subject to the conditions of the
Chase Commitment.
(h) "Closing Statement" means the statement prepared by PennLife and
ConLife calculating the capital and surplus (excluding AVR and IMR) of each of
the PennLife Companies and each of the ConLife Companies in accordance with SAP
as of the Closing Date (immediately prior to the Closing but after giving effect
to the Closing Transactions) using the same assumptions and methodologies
utilized in the preparation of such companies' December 31, 1998 Annual
Statements and the preparation of the Estimated Statement.
(i) "Code" means the Internal Revenue Code of 1986, as amended (including
any successor code), and the rules and regulations promulgated thereunder.
(j) "Commission" means the Securities and Exchange Commission.
(k) "Companies" means the ConLife Companies, the PennLife Companies and the
PFI Companies.
(l) "ConLife Companies" means ConLife, Union Bankers and Marquette, but
shall not include SWLIC.
(m) "ConLife Employees" means (i) those employees of Services who primarily
render services to or on behalf of any or all of the ConLife Companies as listed
on Schedule 1.1(m) and (ii) all former employees of Services who, during the
term of their employment with Services, primarily rendered services to or on
behalf of any or all of the ConLife Companies and whose employment with Services
was terminated for any reason (including retirement) prior to the Closing Date
and who, as of the Closing Date, are not employed by PFG or any of its
affiliates (excluding any of the Companies).
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(n) "ConLife Surplus Notes" mean (i) the Surplus Debenture, dated December
14, 1995, in the original principal amount of $80 million, issued by ConLife in
favor of SFC or a wholly owned Subsidiary of SFC and (ii) the Surplus Debenture
dated January 1, 1996, in the original principal amount of $40 million, issued
by ConLife in favor of SFC or a wholly owned Subsidiary of SFC, each as amended
from time to time to comply with requests or the requirements of the Texas
Department of Insurance.
(o) "Disclosure Schedule" means the Disclosure Schedule attached hereto as
Annex A.
(p) "Environmental Laws" means all applicable U.S. and Canadian federal,
state, provincial or local laws (including but not limited to federal and state
common law), statutes, codes, rules or regulations relating to the environment,
natural resources, and pollution including, without limitation, the
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA),
the Hazardous Materials Transportation Act, 49 U.S.C. sec. 1801 et seq., as
amended from time to time (HMTA), the Resource Conservation and Recovery Act, 42
U.S.C. sec. 6901 et seq., as amended from time to time (RCRA), the Federal Water
Pollution Control Act, 33 U.S.C. sec. 1251 et seq., as amended from time to time
(FWPCA), the Clean Air Act, 42 U.S.C. sec. 7401 et seq., as amended from time to
time (CAA), and/or the Toxic Substances Control Act, 15 U.S.C. sec. 2601 et
seq., as amended from time to time (TSCA).
(q) "Exchange Act" means the Securities Exchange Act of 1934, as amended.
(r) "Governmental Authority" means any nation or government, any state or
other political subdivision thereof and any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government.
(s) "Hazardous Materials" means (i) any wastes, substances, or materials
which are defined as "hazardous material," "hazardous waste," "hazardous
substance," "toxic material" or other similar designations in, or otherwise
subject to regulation under, any applicable Environmental Laws; (ii) petroleum
or petroleum byproducts; (iii) friable asbestos and/or any material which
contains friable asbestos; and (iv) electrical equipment containing
polychlorinated biphenyls (PCBs) in excess of 50 parts per million.
(t) "IMR" means, with respect to any Person domiciled in the United States,
the Interest Maintenance Reserve set forth on the balance sheet of such Person
in accordance with SAP.
(u) "Lincoln National Agreement" means the reinsurance agreement, dated
September 30, 1998, between PennLife and Lincoln National Reassurance Company.
(v) "Material Adverse Effect" means a materially adverse effect on the
business, results of operations or financial condition of the PennLife
Companies, the PFI Companies and the PCFS Assets, taken as a whole, or the
ConLife Companies, taken as a whole, excluding the reserve deficiencies
specifically identified in the reports of the Reserves Consultants.
(w) "Nasdaq" means The Nasdaq Stock Market, Inc.
(x) "PennLife Companies" means PennLife, Peninsular and PC-Canada.
(y) "PennLife Employees" means (i) all employees of the PennLife Companies
and (ii) all former employees of the PennLife Companies whose employment with
the PennLife Companies was terminated for any reason (including retirement)
prior to the Closing Date and who, as of the Closing Date, are not employed by
PFG or any of its affiliates (excluding any of the Companies).
(z) "Person" means an individual, corporation, limited liability company,
partnership, joint venture, association, trust, unincorporated organization or,
as applicable, any other entity.
(aa) "PCFS Assets" means those assets of PCFS listed on Schedule 1.1(aa).
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(ab) "PCFS Employees" means (i) those employees of PCFS who primarily
render services to or on behalf of any or all of the Companies as listed on
Schedule 1.1(ab) and any other employees of PCFS performing services primarily
for the Companies who are hired between the date hereof and the Closing Date in
accordance with Section 5.13(a) and (ii) all former employees of PCFS who,
during the term of their employment with PCFS, primarily rendered services to or
on behalf of any or all of the Companies and whose employment with PCFS was
terminated for any reason (including retirement) prior to the Closing Date and
who, as of the Closing Date, are not employed by PFG or any of its affiliates
(excluding any of the Companies).
(ac) "PFI Companies" means PFI and its wholly owned Subsidiaries.
(ad) "PFI Employees" means (i) all employees of the PFI Companies and (ii)
all former employees of the PFI Companies whose employment with the PennLife
Companies was terminated for any reason (including retirement) prior to the
Closing Date and who, as of the Closing Date, are not employed by PFG or any of
its affiliates (excluding any of the Companies).
(ae) "Phase III Taxes" means Taxes imposed under Section 815(f) of the Code
by reference to Section 815 as in effect prior to the enactment of the Tax
Reform Act of 1984.
(af) "Quarterly Statement" means, with respect to a referenced Person, the
quarterly statement of such Person submitted to the insurance regulatory
authority in the state in which such Person is domiciled on forms prescribed or
permitted by such authority.
(ag) "Release" means any emission, spill, seepage, leak, escape, leaching,
discharge, injection, pumping, pouring, emptying, dumping, disposal, release, or
threatened release of Hazardous Materials into the environment.
(ah) "Reserves Consultants" means (i) with respect to the disability income
claims reserves of PennLife, Tillinghast, (ii) with respect to the
non-disability income claims reserves of PennLife, BAS Actuarial Services, and
(iii) with respect to all other reserves of PennLife (excluding life insurance
reserves), another independent actuarial firm of national reputation.
(ai) "SAP" means the statutory accounting practices required or permitted
by the National Association of Insurance Commissioners or the insurance
regulatory authority in the jurisdiction of domicile of the referenced Person.
(aj) "Services" means Southwestern Financial Services Corporation, a
Delaware corporation and wholly owned Subsidiary of SFC.
(ak) "Settlement Actuary" means Tillinghast, excluding the St. Louis office
("Tillinghast") or, if such firm is not available, such other independent
actuarial firm of national reputation selected by the mutual agreement of Buyer
and PFG or if Buyer and PFG cannot agree, a nationally recognized actuarial firm
chosen by Tillinghast.
(al) "Settlement Auditor" means PricewaterhouseCoopers or, if such firm is
not available, such other independent accounting firm of national reputation
selected by the mutual agreement of Buyer and PFG, or if Buyer and PFG cannot
agree, a nationally recognized accounting firm chosen by PricewaterhouseCoopers.
(am) "Shares" means the PFI Shares, the PennLife Shares, the Peninsular
Shares, the PC-Canada Shares, the ConLife Shares and the Union Bankers Shares,
collectively.
(an) "Subsidiary" means, as to any Person, any other Person of which at
least a majority of the outstanding shares or other equity interests having
ordinary voting power for the election of directors or comparable managers of
such Person is owned, directly or indirectly, by the referenced Person. For
purposes of this Agreement, Buyer's Subsidiaries shall not include any of the
Companies, notwithstanding the consummation of any of the Closing Transactions.
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(ao) "SWLIC" means Southwestern Life Insurance Company, a Texas corporation
and wholly owned Subsidiary of ConLife.
(ap) "Taxes" means any and all federal, state, provincial, local, foreign
and other taxes, levies, fees, imposts, duties, and similar governmental charges
(including any interest, fines, assessments, penalties or additions to tax
imposed in connection therewith or with respect thereto) including, without
limitation, taxes imposed on, or measured by, income, franchise, profits or
gross receipts, ad valorem, value added, capital gains, sales, goods and
services, use, real or personal property, capital stock, license, branch,
payroll, Phase III Taxes, estimated withholding, employment, social security (or
similar), unemployment, compensation, utility, severance, production, excise,
stamp, occupation, premium, windfall profits, transfer and gains taxes, and
customs duties.
(aq) "Tax Returns" means any report, return, declaration, claim for refund,
information report or return or statement required to be supplied to a taxing
authority in connection with Taxes, including any schedule or attachment thereto
or amendment thereof.
(ar) "Union Bankers Special Dividend" means the sum of the Peninsular
Purchase Price and the PC-Canada Purchase Price, or such lesser amount necessary
to keep the Union Bankers Target Capital Amount at the level specified in
Section 2.3(e) based on the Estimated Statement.
(as) "U.S. Insurance Companies" means ConLife, Union Bankers, Marquette,
PennLife and Peninsular, collectively.
(at) "WARN" means the Worker Adjustment and Retraining Notification Act of
1988 and any similar state, local or Canadian "plant closing" or layoff statute.
SECTION 1.2 Other Definitions. When used in this Agreement, the following
terms shall have the meanings ascribed to them in Sections noted below:
<TABLE>
<CAPTION>
TERM DEFINED IN
- ---- ----------
<S> <C>
1998 SAP Financial Statements............................... Section 5.18(a)
338(h)(10) Election......................................... Section 5.16
Accounts.................................................... Section 3.21
Acquisition Note Purchase Price............................. Section 2.1
Acquisition Notes........................................... Section 2.1
Actual Loss Experience...................................... Section 2.4(a)
Advest...................................................... Section 4.6
Agent Compensation.......................................... Section 3.15(e)
Aggregate Target Capital Amount............................. Section 2.3(e)
Agreement................................................... Preamble
Asserted Liability.......................................... Section 8.3(a)
Audited Financial Statements................................ Section 5.18
Banks....................................................... Section 3.21
Basket Amount............................................... Section 8.4(a)
Basket Exclusions........................................... Section 8.4(a)
Benefit Plans............................................... Section 3.13(a)
Bill of Sale, Assignment and Assumption Agreement........... Section 2.2
Buyer....................................................... Preamble
Buyer Actuary............................................... Section 2.4(a)
Buyer Approvals............................................. Section 4.5
Buyer Common Stock.......................................... Section 4.4
Buyer Indemnitees........................................... Section 8.1(b)
Buyer Material Adverse Effect............................... Section 4.1
</TABLE>
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<TABLE>
<CAPTION>
TERM DEFINED IN
- ---- ----------
<S> <C>
Buyer Parties............................................... Section 4.1
Buyer Plans................................................. Section 5.13(b)
Buyer Sub................................................... Section 2.2(i)
Capital Z................................................... Section 4.8
Cash Purchase Price......................................... Section 2.1
Chase Bank.................................................. Section 4.8
Chase Commitment............................................ Section 4.8
Chase Securities............................................ Section 4.6
Claim....................................................... Section 8.1(b)
Claims Notice............................................... Section 8.3(a)
Closing..................................................... Section 7.1
Closing Date................................................ Section 7.1
Closing Transactions........................................ Section 2.2
Cologne Re.................................................. Section 2.3(e)
Company Employees........................................... Section 5.13(a)
Confidentiality Agreement................................... Section 9.4(a)
ConLife..................................................... Preamble
ConLife Acquisition Note Purchase Price..................... Section 2.1(b)
ConLife Cash Purchase Price................................. Section 2.1(b)
ConLife Group............................................... Section 3.14(n)
ConLife Insurance Approvals................................. Section 3.6
ConLife Purchase Price...................................... Section 2.1(b)
ConLife Shares.............................................. Recitals
Deposit..................................................... Section 3.15(i)
DOJ......................................................... Section 3.6
ERISA....................................................... Section 3.13(a)
ERISA Affiliate............................................. Section 3.13(e)
Estimated Statement......................................... Section 5.7
Financial Statements........................................ Section 3.7(d)
Fundamental Representations................................. Section 8.1
GAAP........................................................ Section 3.7(d)
HSR Act..................................................... Section 3.6
Indemnifying Party.......................................... Section 8.3(a)
Indemnitee.................................................. Section 8.3(a)
Integon..................................................... Section 6.1(g)
Investment Agreements....................................... Section 5.9(b)
Intellectual Property....................................... Section 3.17
IRS......................................................... Section 1.1(k)
KPMG........................................................ Section 5.18(a)
Leased Properties........................................... Section 3.11(b)
Liens....................................................... Section 3.11(b)
Litigation.................................................. Section 3.10
Losses...................................................... Section 8.1(b)
Marquette................................................... Recitals
Marquette Shares............................................ Recitals
Material Contract........................................... Section 3.12(a)
MEC......................................................... Section 3.14(x)
Multiemployer Plan.......................................... Section 3.13(a)
</TABLE>
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<TABLE>
<CAPTION>
TERM DEFINED IN
- ---- ----------
<S> <C>
New Employee Claims......................................... Section 5.22
New Litigation.............................................. Section 5.22
NOLs........................................................ Section 3.14(ac)
Offsetting Tax Benefit...................................... Section 8.6(b)
Owned Properties............................................ Section 3.11(b)
PBGC........................................................ Section 3.13(e)
PC-Canada................................................... Recitals
PC-Canada Common Shares..................................... Recitals
PC-Canada Preferred Shares.................................. Recitals
PC-Canada Purchase Price.................................... Section 2.1(d)
PC-Canada Shares............................................ Recitals
PCFS........................................................ Preamble
PCFS Licenses............................................... Section 5.20
PCFS Purchase Price......................................... Section 2.1(g)
Peninsular.................................................. Recitals
Peninsular Purchase Price................................... Section 2.1(c)
Peninsular Shares........................................... Recitals
PennLife.................................................... Preamble
PennLife Acquisition Note Purchase Price.................... Section 2.1(e)
PennLife Cash Purchase Price................................ Section 2.1(e)
PennLife Insurance Approvals................................ Section 3.6
PennLife Insurance Reserves................................. Section 5.3(b)
PennLife Purchase Price..................................... Section 2.1(e)
PennLife Shares............................................. Recitals
PFG......................................................... Preamble
PFG Group................................................... Section 3.14(n)
PFI......................................................... Recitals
PFI Acquisition Note Purchase Price......................... Section 2.1(f)
PFI Cash Purchase Price..................................... Section 2.1(f)
PFI Purchase Price.......................................... Section 2.1(f)
PFI Shares.................................................. Recitals
PFI Subsidiaries............................................ Section 3.5(a)
PLAC........................................................ Preamble
PLAC Group.................................................. Section 3.14(n)
Post-Closing Compensation Obligations....................... Section 5.9(b)
Pre-Closing Restructuring Transactions...................... Section 5.6
Pre-Sale Obligations........................................ Section 5.9(a)
Proxy Statement............................................. Section 5.18(c)
Purchase Price.............................................. Section 2.1
Reinsurance Agreements...................................... Section 3.22(a)
Required Permits............................................ Section 3.15(b)
Review Letter............................................... Section 5.18(a)
SAP Financial Statements.................................... Section 3.7(a)
SEC Reports................................................. Section 4.9
Seller Refund............................................... Section 5.17(d)
Seller Net Refund Amount.................................... Section 5.17(d)
Sellers..................................................... Preamble
Series C-1 Holders.......................................... Section 4.2
</TABLE>
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<TABLE>
<CAPTION>
TERM DEFINED IN
- ---- ----------
<S> <C>
SFC......................................................... Preamble
Substituted Buyer........................................... Section 10.12
SWLIC Basis Adjustments..................................... Section 5.16(c)
SWLIC Valuation Opinion..................................... Section 5.16(c)
SWLIC Value................................................. Section 5.16(c)
Target Capital Amount....................................... Section 2.3(e)
Tax Representation Claim.................................... Section 8.1(a)
Technology Systems.......................................... Section 3.17(b)
Transaction Bonus........................................... Section 3.26
UAFC Share Purchase Agreement............................... Section 4.8
Unaudited Financial Statements.............................. Section 3.7(d)
Union Bankers............................................... Recitals
Union Bankers Acquisition Note Purchase Price............... Section 2.1(a)
Union Bankers Cash Purchase Price........................... Section 2.1(a)
Union Bankers Purchase Price................................ Section 2.1(a)
Union Bankers Shares........................................ Recitals
</TABLE>
SECTION 1.3 Reserves. With respect to health claims reserves, references
herein to such reserves include loss adjustment expenses.
SECTION 1.4 Certain Interpretive Matters. Unless otherwise noted, all
references herein to "$" or dollar amounts are to lawful currency of the United
States of America. Unless the context otherwise requires, all references to
Sections, Articles, Annexes or Exhibits are to Sections, Articles, Annexes or
Exhibits to this Agreement.
ARTICLE II
THE ACQUISITION
SECTION 2.1 Consideration for the Shares and the PCFS Assets. At the
Closing, upon the terms and subject to the conditions of this Agreement and in
reliance upon the representations, warranties and agreements contained herein,
Sellers shall sell to Buyer, and Buyer shall purchase or cause to be purchased
from Sellers, in the manner described in Section 2.2, all of the Shares and the
PCFS Assets for an aggregate purchase price of $136,000,000 in cash (the "Cash
Purchase Price") and 8.0% subordinated notes (the "Acquisition Notes") issued by
Buyer in the aggregate original principal amount of $39,000,000, containing the
material terms set forth on Annex B and otherwise in form and substance mutually
satisfactory to Buyer and Sellers, subject to adjustment as provided in Sections
2.3 and 2.4, allocable as set forth below, and subject to Section 5.19:
(a) for the Union Bankers Shares, $18,748,000 in cash (the "Union
Bankers Cash Purchase Price") and $7,052,000 principal amount of
Acquisition Notes (the "Union Bankers Acquisition Note Purchase Price" and,
together with the Union Bankers Cash Purchase Price, the "Union Bankers
Purchase Price");
(b) for the ConLife Shares, $6,250,000 in cash (the "ConLife Cash
Purchase Price") and $2,350,000 principal amount of Acquisition Notes (the
"ConLife Acquisition Note Purchase Price" and, together with the ConLife
Cash Purchase Price, the "ConLife Purchase Price");
(c) for the Peninsular Shares, $13,300,000 in cash (the "Peninsular
Purchase Price");
(d) for the PC-Canada Shares, $18,000,000 in cash (the "PC-Canada
Purchase Price");
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(e) for the PennLife Shares, $73,542,000 in cash (the "PennLife Cash
Purchase Price") and $27,658,000 principal amount of Acquisition Notes (the
"PennLife Acquisition Note Purchase Price" and, together with the PennLife
Cash Purchase Price, the "PennLife Purchase Price");
(f) for the PFI Shares, $5,160,000 in cash (the "PFI Cash Purchase
Price") and $1,940,000 principal amount of Acquisition Notes (the "PFI
Acquisition Note Purchase Price" and, together with the PFI Cash Purchase
Price, the "PFI Purchase Price"); and
(g) for the PCFS Assets, $1.0 million in cash (the "PCFS Purchase
Price").
The Union Bankers Acquisition Note Purchase Price, the ConLife Acquisition
Note Purchase Price, the PennLife Acquisition Note Purchase Price and the PFI
Acquisition Note Purchase Price are collectively referred to as the "Acquisition
Note Purchase Price," and the Cash Purchase Price and the Acquisition Note
Purchase Price, as adjusted pursuant to Sections 2.3 and 2.4, are collectively
referred to as the "Purchase Price."
SECTION 2.2 Closing Transactions. Subject to Section 5.19, at and
simultaneously with the Closing, on the terms and subject to the conditions of
this Agreement, the parties shall cause the following transactions (the "Closing
Transactions") to occur in the order set forth below:
(a) Union Bankers shall distribute to ConLife the Union Bankers
Special Dividend;
(b) in consideration for the Peninsular Purchase Price, PennLife shall
sell, assign, transfer and convey to Buyer, and Buyer shall purchase and
acquire from PennLife, the Peninsular Shares, free and clear of any Liens,
other than those which may be created by Buyer;
(c) (i) in consideration for payment by PLAC of an amount equal to the
PC-Canada Purchase Price, PennLife shall sell, assign, transfer and convey
to PLAC, and PLAC shall purchase and acquire from PennLife, the PC-Canada
Shares, free and clear of any Liens, and (ii) in consideration for the
PC-Canada Purchase Price, PLAC shall sell, assign, transfer and convey to
Buyer or such other entity as Buyer may designate, and Buyer or Buyer's
designee shall purchase and acquire from PLAC, the PC-Canada Shares, free
and clear of any Liens, other than those which may be created by Buyer;
(d) in consideration for the Union Bankers Purchase Price, ConLife
shall sell, assign, transfer and convey to Buyer, and Buyer shall purchase
and acquire from ConLife, the Union Bankers Shares, free and clear of any
Liens, other than those which may be created by Buyer, and in consideration
for the PennLife Purchase Price, PLAC shall sell, assign, transfer and
convey to Buyer, and Buyer shall purchase and acquire from PLAC, the
PennLife Shares, free and clear of any Liens, other than those which may be
created by Buyer;
(e) in full repayment of ConLife's obligations under the ConLife
Surplus Notes after which, without further action, such Notes shall be
canceled and shall be null and void and ConLife shall have no further
liability to SFC with respect thereto, ConLife (i) shall distribute all of
the issued and outstanding capital stock of SWLIC to SFC and (ii) shall pay
to SFC the Union Bankers Acquisition Note Purchase Price and an amount in
cash equal to the sum of (x) the Union Bankers Cash Purchase Price and (y)
the Union Bankers Special Dividend and (iii) shall distribute and transfer
to SFC any remaining capital and surplus of ConLife in excess of $3.3
million;
(f) in consideration for the ConLife Purchase Price, SFC shall sell,
assign, transfer and convey to Buyer, and Buyer shall purchase and acquire
from SFC, the ConLife Shares, free and clear of any Liens, other than those
which may be created by Buyer;
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(g) in consideration for the PFI Purchase Price, PFG shall sell,
assign, transfer and convey to Buyer, and Buyer shall purchase and acquire
from PFG, the PFI Shares, free and clear of any Liens, other than those
which may be created by Buyer; and
(h) in consideration for the PCFS Purchase Price, PCFS shall sell,
assign, transfer and convey to Buyer, and Buyer shall purchase and acquire
from PCFS, the PCFS Assets, free and clear of any Liens, other than those
which may be created by Buyer; and
(i) Buyer shall sell, assign, transfer and convey to American Exchange
Life Insurance Company, a Texas corporation, and/or such other subsidiary
of Buyer as Buyer may designate ("Buyer Sub"), all (or, at Buyer's option,
a portion) of the Shares and other assets acquired by Buyer under this
Agreement in exchange for (x) shares of Buyer Sub and (y) surplus notes of
Buyer Sub with an aggregate principal amount less than or equal to the sum
of the Acquisition Note Purchase Price attributable to the Shares sold to
Buyer Sub and the amount borrowed from Chase Bank and other financial
institutions to finance the acquisition contemplated hereby.
(j) On the Closing Date or, at the option of Buyer, on the day
following the Closing Date, Union Bankers shall distribute the Marquette
Shares to Buyer Sub.
If requested by Buyer, Sellers shall cooperate in good faith to restructure
the manner and order in which the Companies or their operations are acquired and
if Buyer designates a purchaser for the PC-Canada Shares as described in Section
2.2(c) above, Sellers shall transfer the PC-Canada Shares to Buyer's designee,
provided that such restructuring or designation either (x) does not result in
additional cost to Sellers or additional indemnification obligations of Sellers
under Section 8.1 or (y) at Buyer's option, Buyer unconditionally indemnifies
Sellers with respect to any such additional costs and waives any such additional
indemnification obligations as referenced in (x) above.
Upon each sale, assignment, transfer and conveyance of the respective
Shares described above, the relevant Seller shall deliver to Buyer, in the case
of (b), (c), (d), (f) and (g) above, share certificates constituting such
Shares, duly endorsed in blank or accompanied by stock powers duly executed in
blank, in proper form for transfer.
Upon the sale, assignment, transfer and conveyance of the PCFS Assets as
described above, PCFS and Buyer will execute and deliver a bill of sale,
assignment and assumption agreement (the "Bill of Sale, Assignment and
Assumption Agreement") with respect to the sale by PCFS of the PCFS Assets and
the assumption by Buyer of the Assumed Liabilities. Subject to the
indemnification provided in Section 8.1(b)(xii), Buyer waives compliance with
any and all bulk sales laws in connection with the sale and purchase of the PCFS
Assets.
SECTION 2.3 Purchase Price Adjustment.
(a) As promptly as practicable (but in no event more than 90 days) after
the Closing Date, Buyer will cause PennLife and ConLife to prepare the Closing
Statement and will deliver it to PFG. The capital and surplus amounts reflected
in the Closing Statement shall be in sufficient detail to permit PFG to verify
the same. The Closing Statement to be delivered to PFG will be accompanied by a
certificate of Buyer's Chief Financial Officer certifying that the Closing
Statement has been prepared in accordance with SAP as of the Closing Date using
the same assumptions and methodologies utilized in the preparation of the
Estimated Statement. At the request of PFG, after the Closing Statement has been
prepared, Buyer will cause its personnel and independent auditors to (i) provide
to PFG and PFG's independent auditors (A) a reconciliation of the differences
between the Closing Statement and the Estimated Statement in sufficient detail
for PFG to reconcile such differences and (B) copies of financial statements and
such work papers and other documents relating to the preparation of the Closing
Statement as PFG or PFG's independent auditors may reasonably request and (ii)
cooperate with, and be reasonably available to, PFG and PFG's independent
auditors and provide such other information
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reasonably requested by PFG or PFG's independent auditors concerning the Closing
Statement and any accounting, auditing and actuarial issues related thereto, in
each case in good faith and in a manner and at such times so as to enable PFG to
complete its review and analysis of the Closing Statement within the period
specified in paragraph (b) below.
(b) Within 20 Business Days after PFG's receipt of the Closing Statement,
PFG will provide Buyer with written notice indicating whether PFG agrees or
disagrees with the capital and surplus amounts (excluding AVR and IMR) reflected
in such statement. If PFG in such notice agrees with the capital and surplus
amounts (excluding the AVR and IMR) reflected in the Closing Statement or if PFG
fails to deliver to Buyer such written notice within such 20 Business Day
period, the Closing Statement shall be deemed final and binding upon the
parties. If PFG in such notice disagrees with the capital and surplus amounts
(excluding AVR and IMR) reflected in the Closing Statement, within ten Business
Days after PFG delivers such notice to Buyer of its disagreement with Buyer's
calculation, PFG and Buyer will begin good faith negotiations to resolve such
disagreement.
(c) If PFG and Buyer are unable to resolve such disagreement in good faith
within ten Business Days after such negotiations begin, such disagreement will
be submitted to the Settlement Auditor for resolution. PFG and Buyer will
cooperate with the Settlement Auditor and will proceed in good faith to cause
the Settlement Auditor to resolve such disagreement within 30 days after such
disagreement is submitted to the Settlement Auditor. PFG and Buyer will each pay
one-half of the fees and expenses of the Settlement Auditor; provided, however,
that if the Settlement Auditor's written report indicates that PFG or Buyer was
the prevailing party in the dispute, the non-prevailing party shall pay 100% of
the fees and expenses of the Settlement Auditor.
(d) The Settlement Auditor, in its sole discretion, will determine (i) the
nature and extent of the participation by PFG, Buyer, and their respective
agents in connection with any disagreement submitted to the Settlement Auditor
for resolution, (ii) the nature and extent of information that PFG and Buyer may
submit to the Settlement Auditor for consideration in connection with such
resolution and (iii) the personnel of the Settlement Auditor who will review
such information and resolve such disagreement. The Settlement Auditor's
resolution of any such disagreement, with respect to dollar amounts, must fall
within the range of the disputed amounts stated by PFG and Buyer and will be
reflected in a written report which will be delivered promptly to, and will be
final and binding upon, PFG and Buyer. The Closing Statement will be adjusted
accordingly to reflect any such resolution and, as adjusted, shall be final and
binding upon the parties.
(e) Upon the earlier to occur of (i) the parties' agreement with respect to
the capital and surplus amounts reflected in the Closing Statement or (ii) the
delivery of the report of the Settlement Auditor as provided in Section 2.3(d)
hereof with respect to a dispute relating to the Closing Statement: (A) PFG will
pay to Buyer the amount, if any, by which (x) in the case of the PennLife
Companies (excluding PC-Canada) or the ConLife Companies, the capital and
surplus (excluding AVR and IMR) reflected in the Closing Statement for such
Company is less than the Target Capital Amount (defined below) for such Company
and (y) in the case of PC-Canada, total shareholders equity (calculated in
accordance with Canadian generally accepted accounting principles) reflected in
the Closing Statement under the heading "PC-Canada Section 2.3(e)(A) Amount" is
less than the Target Capital Amount for PC-Canada; and (B) PFG will pay to Buyer
the amount, if any, by which the aggregate capital and surplus (for all PennLife
Companies, including PC-Canada, and all ConLife Companies, calculated in
accordance with SAP) of the PennLife Companies and the ConLife Companies, taken
as a whole, reflected in the Closing Statement is less than (x) the sum of $72.3
million plus the earnings of the PennLife Companies and the ConLife Companies
for the period commencing on January 1, 1999 and ending on the Closing Date, as
reflected in the Closing Statement (the "Aggregate Target Capital Amount") minus
(y) any amounts payable by PFG pursuant to clause (A) of this Section 2.3(e).
For purposes of this Section 2.3(e), "earnings" means operating earnings of the
Companies and
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specifically excludes (A) earnings from wholly owned Subsidiaries that are not
Companies and the earnings of the Companies otherwise includable in another
Company's earnings if duplicative or redundant, (B) earnings that do not
increase surplus, including, without limitation, the amortization of the ceding
commission of Cologne Life Reinsurance Company ("Cologne Re") at Union Bankers,
(C) tax payments or liabilities from wholly owned Subsidiaries (including the
Companies) and (D) earnings associated with the transactions contemplated or
required by this Agreement, including without limitation those set forth in
Annex E. Such payment will be made by wire transfer of immediately available
funds to such account as the party entitled to receive such payment specifies in
writing to the party required to make such payment. "Target Capital Amount"
means (i) $3.3 million, in respect of ConLife, (ii) $14.0 million, in respect of
Union Bankers (not including any amounts attributable to Marquette), (iii) $5.1
million, in respect of Marquette, (iv) $36.0 million, in respect of PennLife,
(v) $10.2 million, in respect of Peninsular (which amounts will be reflected in
the Forms A to be filed with the appropriate insurance regulatory authorities),
and (vi) Can.$21.946 million, in respect of PC-Canada. Sellers will use their
reasonable best efforts to cause any additional capital and surplus in the
Companies over and above the sum of their individual Target Capital Amounts (but
not greater than the Aggregate Target Capital Amount) to be contributed to
PennLife; provided, that for purposes only of this sentence, the Target Capital
Amount for PC-Canada will be deemed to be $500,000 or actual capital and surplus
in accordance with SAP, if greater.
(f) At the Closing, PFI will have $4.5 million in cash recorded on its
balance sheet.
(g) If Buyer does not request that Sellers recapture the Lincoln National
Agreement prior to the Closing, the Target Capital Amount for PennLife and the
Aggregate Target Capital Amount will be calculated without giving effect to the
surplus generated as a result of the Lincoln National Agreement through the
Closing Date.
SECTION 2.4 Reserves Adjustment.
(a) On the fifth anniversary of the Closing Date, Buyer will cause an
actuary of national reputation (the "Buyer Actuary") to compare (i) the
disability insurance claims reserves of PennLife as of the Closing Date, as set
forth in the Closing Statement (the "DI Reserves"), to (ii) actual loss payments
and loss adjustment expense payments and actual losses and loss adjustment
expenses incurred by PennLife during the five-year period following the Closing
Date relating to all disability insurance policies in force as of the Closing
Date, together with any outstanding claims reserves in respect of disability
insurance policies in force as of the Closing Date that remain in force as of
the fifth anniversary of the Closing Date (if any) (the "Actual Loss
Experience"). The Buyer Actuary will prepare and deliver a report on the
adequacy of the DI Reserves in relation to Actual Loss Experience, including a
calculation of the difference between the DI Reserves and the Actual Loss
Experience (the "DI Claims Report"). The DI Claims Report shall be prepared in
accordance with sound actuarial practice, taking into account SAP and the
actuarial assumptions and methodologies used by Buyer for SAP financial
reporting purposes, and shall set forth in reasonable detail, including the
supporting assumptions and methodologies, the actuaries' determination of the
amount by which the DI Reserves were deficient compared to Actual Loss
Experience or the amount by which the DI Reserves exceeded Actual Loss
Experience. Upon completion of such review (which shall not be later than 90
days after the fifth anniversary of the Closing Date), Buyer shall deliver the
DI Claims Report to PFG. At the request of PFG, after the DI Claims Report has
been prepared, Buyer will cause its personnel and the Buyer Actuary to (i)
provide to PFG and its independent actuaries copies of such workpapers and other
documents relating to the preparation of the DI Claims Report as PFG or its
independent actuaries may reasonably request and (ii) cooperate with, and be
reasonably available to, PFG and its independent actuaries and provide such
other information reasonably requested by PFG or its independent actuaries
concerning the DI Claims Report and any issues related thereto, in each case in
good faith and in a manner and at such times as to enable PFG and its
independent actuaries to complete its review and analysis of the DI Claims
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Report within the period specified in paragraph (b) below. The amount by which
the DI Reserves are deficient compared to Actual Loss Experience or the amount
by which the DI Reserves exceed Actual Loss Experience, as agreed by the parties
or reflected in the DI Claims Report (as modified by the Settlement Actuary), in
each case discounting the Actual Loss Experience to the Closing Date at a
discount rate of 4.5%, are referred to as the "DI Reserve Deficiency" and the
"DI Reserve Positive Development," respectively.
(b) Within 30 Business Days after PFG's receipt of the DI Claims Report,
PFG will provide Buyer with written notice indicating whether PFG agrees or
disagrees with the information contained in the DI Claims Report. If PFG in such
notice agrees with the information contained in the DI Claims Report or if PFG
fails to deliver to Buyer such written notice within such 30 Business Day
period, the information contained in the DI Claims Report shall be final and
binding upon the parties. If PFG in such notice disagrees with the information
contained in the DI Claims Report, within ten Business Days after PFG delivers
such notice to Buyer of its disagreement with the DI Claims Report, PFG and
Buyer will begin good faith negotiations to resolve such disagreement.
(c) If PFG and Buyer are unable to resolve such disagreement in good faith
within ten Business Days after such negotiations begin, such disagreement will
be submitted to the Settlement Actuary for resolution. PFG and Buyer will
cooperate with the Settlement Actuary and will proceed in good faith to cause
the Settlement Actuary to resolve such disagreement within 30 days after such
disagreement is submitted to the Settlement Actuary. PFG and Buyer will each pay
one-half of the fees and expenses of the Settlement Actuary.
(d) The Settlement Actuary, in its sole discretion, will determine (i) the
nature and extent of the participation by PFG, Buyer and their respective agents
in connection with any disagreement submitted to the Settlement Actuary for
resolution, (ii) the nature and extent of information that PFG and Buyer may
submit to the Settlement Actuary for consideration in connection with such
resolution and (iii) the personnel of the Settlement Actuary who will review
such information and resolve such disagreement. The Settlement Actuary's
resolution of any such disagreement, with respect to dollar amounts, must fall
within the range of the disputed amounts stated by PFG and Buyer and will be
reflected in a written report which will be delivered promptly to, and will be
final and binding upon, PFG and Buyer.
(e) Within five Business Days after the earlier to occur of (i) the
parties' agreement with respect to the level of the DI Reserve Deficiency or DI
Reserve Positive Development or (ii) the delivery of the report of the
Settlement Actuary as provided in Section 2.4(d) hereof: (A) in the event of a
DI Reserve Deficiency, PFG will make a cash payment to Buyer equal to the DI
Reserve Deficiency (tax-effected in accordance with the principles of Section
8.6) plus interest thereon at a rate equal to the interest rate on the
Acquisition Notes, compounded quarterly from the Closing Date to the date on
which such payment is made up to a maximum amount equal to the original
principal amount of the Acquisition Notes plus accrued interest thereon at a
rate equal to the interest rate on the Acquisition Notes compounded quarterly
from the Closing Date to the date of such payment; provided, however, that PFG
may, at its option, satisfy any portion or all of its obligation by directing
Buyer to reduce the then-accreted value of the Acquisition Notes by the amount
that it is satisfying pursuant to this proviso; and (B) in the event of a
Positive Reserve Development, Buyer will issue additional Acquisition Notes
having an aggregate principal amount as of the date of issuance equal to the
amount of the DI Reserve Positive Development (tax-effected in accordance with
the principles of Section 8.6(b) to take into account the amount by which
Buyer's taxable income is greater than it would have been had there been no DI
Reserve Positive Development) plus interest thereon at a rate equal to the
interest rate on the Acquisition Notes, compounded quarterly from the Closing
Date to the date on which such additional Acquisition Notes are issued, up to a
maximum of $10 million plus interest thereon at a rate equal to the interest
rate on the Acquisition Notes, compounded quarterly. Any reduction in the
principal amount of the Acquisition Notes pursuant to the proviso
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in clause (A) above will be effected in accordance with, and upon the terms and
subject to the conditions of, the Pledge and Security Agreement to be entered
into by PFG and Buyer, on the terms attached hereto as Annex C.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PFG, PLAC, SFC AND PCFS
PFG, with respect to all matters set forth in this Article III, jointly and
severally with PLAC, SFC and PCFS, represents and warrants to Buyer; PLAC, with
respect only to matters relating to itself and the PennLife Companies, severally
and not jointly with any other Seller (except PFG) represents and warrants to
Buyer; and SFC, with respect only to matters relating to itself and the ConLife
Companies, severally and not jointly with any other Seller (except PFG)
represents and warrants to Buyer; and PCFS, with respect to matters relating to
itself and the PCFS Assets, severally and not jointly with any other Seller
(except PFG) represents and warrants to Buyer, as follows:
SECTION 3.1 Organization and Qualification.
(a) Each of the Sellers and the Companies is a corporation duly organized,
validly existing and in good standing under the laws of its jurisdiction of
incorporation, which as to each of the Companies is set forth opposite its name
in Section 3.1(a) of the Disclosure Schedule, with all requisite corporate power
and authority to own, operate and lease its properties and to carry on its
business as it is now being conducted. Sellers have delivered or made available
to Buyer a true and complete copy of the Certificate or Articles of
Incorporation and Bylaws (or similar organizational documents) of each of the
Companies.
(b) Each of the Companies is qualified or licensed to do business as a
foreign corporation or extra-provincial corporation and is in good standing in
every jurisdiction where the nature of the business conducted by it or the
properties owned or leased by it requires qualification, except where the
failure to be so qualified, licensed or in good standing would not reasonably be
expected to have a Material Adverse Effect. Schedule T of each of the PennLife
Companies' (except PC-Canada) and ConLife Companies' Annual Statements for the
year ended December 31, 1997 and the Annual Statement of PC-Canada set forth a
true and complete list of each jurisdiction in which each of the respective
PennLife Companies (including PC-Canada) and ConLife Companies is qualified or
licensed to do business and is in good standing to transact the business of life
and/or accident and health insurance.
(c) Each U.S. domiciled PennLife Company and ConLife Company is domiciled
in its jurisdiction of incorporation, is not deemed to be domiciled in any other
jurisdiction, and is licensed to write the types of insurance shown in Section
3.1(c) of the Disclosure Schedule in the jurisdictions shown in such Section,
which are all the types of insurance issued by such Companies and all the
jurisdictions in which each such Company writes such insurance. Except as set
forth in Section 3.1(c) of the Disclosure Schedule, no such license is the
subject of a proceeding for suspension or revocation or any similar proceedings
and, to the knowledge of Sellers, there is no pending threat of such suspension
or revocation by any licensing authority. Each U.S. domiciled PennLife Company
and ConLife Company is a "life insurance company" within the meaning of Section
816 of the Code.
SECTION 3.2 Authorization. Sellers have full corporate power and
authority to execute and deliver this Agreement and to consummate the
transactions contemplated hereby. The execution and delivery of this Agreement
by Sellers, the performance by Sellers of their respective obligations
hereunder, and the consummation by Sellers of the transactions contemplated
hereby, have been duly authorized by their respective Boards of Directors and,
where applicable, their respective shareholders. No other corporate action on
the part of Sellers is necessary to authorize the execution and delivery of this
Agreement or the consummation of the transactions
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contemplated hereby. This Agreement has been duly and validly executed and
delivered by each Seller and constitutes a valid and binding obligation of each
Seller, enforceable against each Seller in accordance with its terms, subject to
applicable bankruptcy, insolvency, fraudulent conveyance, reorganization,
moratorium and similar laws affecting creditors' rights and remedies generally,
and subject, as to enforceability, to general principles of equity, including
principles of commercial reasonableness, good faith and fair dealing (regardless
of whether enforcement is sought in a proceeding at law or in equity).
SECTION 3.3 No Violation. Except as set forth in Section 3.3 of the
Disclosure Schedule, neither the execution and delivery of this Agreement by
Sellers, the performance by Sellers of their obligations hereunder nor the
consummation by Sellers or the Companies of the transactions contemplated hereby
will (a) violate, conflict with or result in any breach of any provision of the
Certificate or Articles of Incorporation or Bylaws (or similar organizational
documents) of any Seller or any of the Companies, (b) violate or conflict with
or result in a violation or breach of, or constitute a default or give rise to
any right of termination or acceleration (with or without due notice or lapse of
time or both) or result in the acceleration of any payments under the terms,
conditions or provisions of any note, bond, mortgage, indenture or deed of
trust, license, lease or agreement to which any Seller or any of the Companies
is a party or by which any of their assets is bound, (c) violate any order,
writ, judgment, injunction, decree, statute, rule or regulation of any
Governmental Authority applicable to any Seller or any of the Companies or any
of their respective assets or (d) result in the creation of any Lien upon any of
the assets of any Seller, any of the Companies or PCFS (other than any Liens
created by Buyer), except in the cases of clauses (b), (c) and (d) above, for
those violations, conflicts, breaches and defaults which would not reasonably be
expected to have a Material Adverse Effect.
SECTION 3.4 Capitalization of the Companies.
(a) The authorized capital stock of PennLife consists of 50,000 PennLife
Shares. As of the date hereof, there are 45,946 PennLife Shares issued and
outstanding, all of which have been validly issued, are fully paid and
non-assessable and were not issued in violation of any preemptive rights. The
authorized capital stock of PFI consists of 1,000 PFI Shares. As of the date
hereof, there are 1,000 PFI Shares issued and outstanding, all of which have
been validly issued, are fully paid and non-assessable and were not issued in
violation of any preemptive rights. The authorized capital stock of ConLife
consists of 50,000 ConLife Shares. As of the date hereof, there are 49,998
ConLife Shares issued and outstanding, all of which have been validly issued,
are fully paid and non-assessable and were not issued in violation of any
preemptive rights. The authorized capital stock of Union Bankers consists of
1,360,000 Union Bankers Shares. As of the date hereof, there are 1,334,001 Union
Bankers Shares issued and outstanding, all of which have been validly issued,
are fully paid and non-assessable and were not issued in violation of any
preemptive rights. The authorized capital stock of Marquette consists of
2,100,000 Marquette Shares. As of the date hereof, there are 175,000 Marquette
Shares issued and outstanding, all of which have been validly issued, are fully
paid and non-assessable and were not issued in violation of any preemptive
rights. The authorized capital stock of Peninsular consists of 7,200,000
Peninsular Shares. As of the date hereof, there are 1,208,599 Peninsular Shares
issued and outstanding, all of which have been validly issued, are fully paid
and non-assessable and were not issued in violation of any preemptive rights.
The authorized capital stock of PC-Canada is unlimited. As of the date hereof,
there are 100 PC-Canada Common Shares and 100 PC-Canada Preferred Shares issued
and outstanding, all of which have been validly issued, are fully paid and
non-assessable and were not issued in violation of any preemptive rights.
(b) Except as set forth in Section 3.4(b) of the Disclosure Schedule, there
are no (i) options, warrants, calls, subscriptions, conversion or other rights,
agreements or commitments obligating any Company to issue any additional shares
of capital stock or any other
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securities convertible into, exchangeable for or evidencing the right to
subscribe for any shares of capital stock of such Company, (ii) agreements or
commitments obligating such Company to repurchase, redeem or otherwise acquire
any shares of its capital stock, (iii) restrictions on transfer of any shares of
capital stock of such Company (other than pursuant to this Agreement) or (iv)
voting or similar shareholder agreements relating to any shares of capital stock
of such Company.
(c) The Peninsular Shares and the PC-Canada Shares are owned beneficially
and of record by PennLife, free and clear of all Liens. The PFI Shares are owned
beneficially and of record by PFG, free and clear of all Liens. The ConLife
Shares are owned beneficially and of record by SFC, free and clear of all Liens,
except as set forth in Section 3.4(c) of the Disclosure Schedule. The Union
Bankers Shares are owned beneficially and of record by ConLife, free and clear
of all Liens, except as set forth in Section 3.4(c) of the Disclosure Schedule.
The Marquette Shares are owned beneficially and of record by Union Bankers, free
and clear of all Liens. The PennLife Shares are owned beneficially and of record
by PLAC, free and clear of all Liens. At the Closing, good and valid title to
the Shares shall be conveyed to Buyer or the other parties as provided for in
Section 2.2, in the manner contemplated by Section 2.2, free and clear of all
Liens, other than those which may be created by Buyer.
(d) Except as set forth in Section 3.4(d) of the Disclosure Schedule, none
of the Companies owns, directly or indirectly, 5% or more of the outstanding
voting securities of or otherwise possesses, directly or indirectly, the power
to direct or cause the direction of the management or policies of any Person,
other than capital stock of one of the Companies owned by another Company and
securities held for investment purposes only.
SECTION 3.5 PFI Subsidiaries and PCFS Assets.
(a) Section 3.5(a) of the Disclosure Schedule sets forth (i) the name of
all Subsidiaries of PFI (the "PFI Subsidiaries") and their respective
jurisdictions of incorporation and (ii) the name and number of all authorized,
issued and outstanding shares of capital stock of each PFI Subsidiary. Except
for the PFI Subsidiaries, PFI directly or indirectly does not own or have the
power to vote the shares of any capital stock or other ownership interest or
have ordinary voting power to elect the majority of directors of any corporation
or other entity or other Person or body performing a similar function of any
such entity, as the case may be.
(b) All of the outstanding shares of capital stock of each PFI Subsidiary
have been duly authorized and validly issued, are fully paid and non-assessable,
have not been issued in violation of any preemptive rights, and are owned of
record and beneficially by the entities named in Section 3.5(a) of the
Disclosure Schedule, free and clear of any Liens except as set forth in Section
3.5(a) of the Disclosure Schedule.
(c) Except as set forth in Section 3.5(c) of the Disclosure Schedule, there
are no (i) options, warrants, calls, subscriptions, conversion or other rights,
agreements or commitments obligating any of the PFI Subsidiaries to issue any
additional shares of capital stock of such Subsidiary or any other securities
convertible into, exchangeable for or evidencing the right to subscribe for any
shares of such capital stock, (ii) agreements or commitments obligating any such
Subsidiary to repurchase, redeem or otherwise acquire any shares of its capital
stock, (iii) restrictions on the transfer of any shares of capital stock of any
such Subsidiary (other than pursuant to this Agreement) or (iv) voting or
similar shareholder agreements relating to any shares of capital stock of any
such Subsidiary.
(d) PCFS has good and indefeasible title to all of the PCFS Assets, in each
case free and clear of all Liens, and PCFS will convey to Buyer good and
indefeasible title to all of the PCFS Assets, in each case free and clear of all
Liens other than those which may be created by Buyer.
SECTION 3.6 Consents and Approvals. Except as set forth in Section 3.6 of
the Disclosure Schedule, no filing or registration with, no notice to and no
permit, authorization, consent or
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approval of any Governmental Authority is necessary for the consummation by any
Seller or the Companies of the transactions contemplated by this Agreement other
than consents and approvals of or filings or registrations with (a) the
Antitrust Division of the United States Department of Justice (the "DOJ")
pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), and (b) the insurance departments of the States of Pennsylvania
and North Carolina and the federal or provincial government and other requisite
federal and provincial regulatory authorities of Canada (the "PennLife Insurance
Approvals") and the insurance department of the State of Texas (the "ConLife
Insurance Approvals").
SECTION 3.7 Financial Statements; Reserves.
(a) Sellers have previously delivered to Buyer true and complete copies of
the following (the "SAP Financial Statements"):
(i) the Annual Statements for each PennLife Company and ConLife
Company for each of the years ended December 31, 1996 and 1997 and for
Executive Fund Life Insurance Company for the year ended December 31, 1995,
in each case as filed with the departments of insurance in the respective
states of domicile or Canada, as the case may be, of each PennLife Company
and ConLife Company including all exhibits, interrogatories, notes and
schedules thereto and any actuarial opinion, affirmation or certification
filed in connection therewith;
(ii) the Quarterly Statements for each PennLife Company and ConLife
Company for the quarters ended March 31, June 30 and September 30, 1998
including all exhibits, interrogatories, notes and schedules thereto; and
(iii) the statutory annual statements and quarterly statements of each
PennLife Company and ConLife Company which were filed for 1996, 1997 or
1998 (with respect to the quarters ended March 31, June 30 and September
30) in any jurisdiction other than such Company's jurisdiction of domicile
and that differ from the corresponding Annual Statements and Quarterly
Statements for such periods.
Except as set forth in Section 3.7(a) of the Disclosure Schedule, the SAP
Financial Statements were, and when delivered in accordance with the provisions
of Section 5.18, the 1998 SAP Financial Statements will be, prepared in all
material respects in accordance with SAP. Except as set forth in Section 3.7(a)
of the Disclosure Schedule, the SAP Financial Statements present fairly in all
material respects and, when delivered in accordance with the provisions of
Section 5.18, the 1998 SAP Financial Statements will present fairly in all
material respects, the statutory financial position of the applicable Company as
of the respective dates thereof and the related summary of operations and
changes in capital and surplus and in cash flows of such Company for and during
the respective periods covered thereby in conformity with SAP, applied on a
consistent basis.
(b) Except as set forth in Section 3.7(b) of the Disclosure Schedule, all
statutory reserves and other similar amounts with respect to insurance as
established or reflected in the December 31, 1997 Annual Statement and September
30, 1998 Quarterly Statement of each PennLife Company and ConLife Company were
determined (and, when delivered in accordance with the provisions of Section
5.18, all statutory reserves and other similar amounts with respect to insurance
as reflected or established in the 1998 SAP Financial Statements will be
determined) in all material respects in accordance with SAP and sound actuarial
practice, based on actuarial assumptions and methodologies that were (or will
be), as of the date of preparation, in compliance in all material respects with,
and met (or will meet) in all material respects the requirements of the
insurance laws of the respective states of domicile of, the PennLife Companies
and ConLife Companies. Except as set forth in Section 3.7(b) of the Disclosure
Schedule or in the report delivered by the Reserves Consultants pursuant to
Section 5.3(b) hereof, all such reserves and other similar amounts are (and, in
the case of the 1998 SAP
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Financial Statements, will be) adequate in all material respects, based upon
then-current information and assumptions concerning investment income, mortality
and morbidity experience, persistency and expenses, to cover the total amount of
all reasonably anticipated matured and unmatured benefits, dividends, claims and
other liabilities of such Company under all insurance contracts under which such
Company had any liability (including without limitation any liability arising
under or as a result of any reinsurance, coinsurance or other similar contract)
on the respective dates of such financial statements. Except as set forth in
Section 3.7(b) of the Disclosure Schedule, each PennLife Company and ConLife
Company owns assets that qualify as legal reserve assets under insurance laws
applicable to such Company in an amount at least equal to all such reserves and
other similar amounts required by such laws to be owned by such Company.
(c) Since January 1, 1998, Sellers have recorded in accordance with GAAP
and SAP additional reserves of at least $20 million relating to adverse reserve
development applicable to the disability income claim reserves of PennLife,
which additional reserves have not been released.
(d) Sellers have previously delivered or made available to Buyer a true and
complete copy of the unaudited combined financial statements for the Companies
(and PCFS, to the extent required under Item 13 of Schedule 14A under the
Exchange Act for purposes of the Proxy Statement) as at and for the nine-month
period ended September 30, 1998 (the "Unaudited Financial Statements"). The
Unaudited Financial Statements fairly present in all material respects and, when
delivered in accordance with the provisions of Section 5.18, the Audited
Financial Statements, taken together with the notes thereto, will fairly present
in all material respects the financial position and results of operations of the
Companies (and PCFS, to the extent required under Item 13 of Schedule 14A under
the Exchange Act for purposes of the Proxy Statement) as of the respective dates
and for the periods indicated therein, in each case in accordance with generally
accepted accounting principles ("GAAP") consistently applied except as
identified in the report delivered by the Reserves Consultants pursuant to
Section 5.3(b) hereof and, in the case of the Unaudited Financial Statements,
for the absence of notes. The Unaudited Financial Statements were prepared
consistent with past practices of the Companies in the preparation of unaudited
financial statements (subject to normal, recurring year-end audit adjustments
that in the aggregate are not materially adverse). As used herein, "Financial
Statements" means the Unaudited Financial Statements, the Audited Financial
Statements and the SAP Financial Statements, collectively.
SECTION 3.8 Absence of Undisclosed Liabilities. As of the date hereof,
and as of the date of the 1998 Audited Financial Statements, except for matters
relating to the transactions contemplated by this Agreement, there are and will
be no liabilities or obligations of the Companies or PCFS (including without
limitation any Liens) that are required to be reflected on a balance sheet
prepared in accordance with SAP or GAAP, as applicable, other than (a)
liabilities and obligations reserved against in the Financial Statements and not
heretofore discharged, (b) policyholder benefits payable or other liabilities or
obligations arising in the ordinary course of business after September 30, 1998,
or (c) liabilities and obligations disclosed in Section 3.8 of the Disclosure
Schedule.
SECTION 3.9 Absence of Certain Changes. Except as disclosed in Section
3.9 of the Disclosure Schedule or as permitted or contemplated by this
Agreement, since September 30, 1998, none of the Companies or PCFS has (a)
experienced any change, event or condition which, individually or in the
aggregate, has had or could reasonably be expected to have a Material Adverse
Effect, (b) conducted its business in any material respect other than in the
ordinary course, (c) except in the ordinary course of business, incurred any
indebtedness for borrowed money or issued any debt securities or assumed,
guaranteed or endorsed the obligations of any other Person, (d) except in the
ordinary course of business, (i) sold, transferred or otherwise disposed of any
of its property or assets or (ii) mortgaged or
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encumbered any of its property or assets, (e) suffered any material casualty
losses not covered by insurance, (f) repurchased any of its capital stock or any
capital stock of any of its Subsidiaries, (g) declared, set aside or paid any
dividend or other distribution in respect of its capital stock, other than
ordinary dividends and payments pursuant to the ConLife Surplus Notes permitted
under applicable insurance laws, (h) amended its Certificate or Articles of
Incorporation or Bylaws (or similar organizational documents) or merged with or
into or consolidated with any other Person, (i) split, combined or reclassified
its capital stock, (j) issued or sold (or agreed to issue or sell) any of its
equity securities or any options, warrants, conversion or other rights to
purchase any such securities or any securities convertible into or exchangeable
for such securities, or granted, or agreed to grant any such rights, (k)
increased the rates of compensation (including bonuses) payable or to become
payable to any of its officers, employees, agents, independent contractors or
consultants other than increases made in the ordinary course of business, (l)
entered into any new or amended any existing employment contracts, severance
agreements or consulting contracts or instituted or agreed to institute any
increase in benefits or altered its employment practices or the terms and
conditions of employment in each case other than in the ordinary course of
business, (m) changed in any material respect its underwriting, actuarial or tax
accounting methods, principles or practices, (n) in the case of the PennLife
Companies and the ConLife Companies, ceased its lead generation activities other
than in the ordinary course of business, (o) in the case of the PennLife
Companies and the ConLife Companies, terminated any material reinsurance or
coinsurance contract (including without limitation, any surplus relief or
financial reinsurance contract), whether as reinsurer or reinsured other than in
the ordinary course of business, (p) entered into any joint ventures or
partnerships of any kind, or (q) entered into any contract or other agreements
to do any of the foregoing.
SECTION 3.10 Litigation. Section 3.10 of the Disclosure Schedule sets
forth a list, as of the date hereof, of all material actions, suits,
arbitrations, investigations or proceedings ("Litigation") pending or, to the
knowledge of Sellers, threatened against any of the Companies or PCFS before any
Governmental Authority or arbitrator. Except as set forth in Section 3.10 of the
Disclosure Schedule, none of the Companies is in default under any material
judgment, decree, injunction or order of any Governmental Authority or
arbitrator outstanding against it.
SECTION 3.11 Property; Liens and Encumbrances.
(a) Section 3.11(a) of the Disclosure Schedule contains a complete and
accurate list of all real property owned or leased by the Companies as of the
date hereof.
(b) Except as set forth in Section 3.11(b) of the Disclosure Schedule or in
the Financial Statements, all properties and assets owned by the Companies (the
"Owned Properties") or leased by the Companies (the "Leased Properties") are
free and clear of all liens, pledges, claims, security interests, mortgages,
assessments, easements, rights of way, covenants, restrictions, rights of first
refusal, defects in title, encroachments and other burdens (collectively,
"Liens") except (i) statutory Liens not yet delinquent or the validity of which
are being contested in good faith by appropriate actions, (ii) purchase money
Liens arising in the ordinary course, (iii) Liens for taxes not yet delinquent,
(iv) Liens reflected in the Financial Statements (which have not been
discharged) and (v) Liens which in the aggregate do not materially detract from
the value or, in the case of personal property, materially impair the use by the
Companies of the property subject thereto or, in the case of real property,
materially impair the present and continued use of such property in the usual
and normal conduct of the business of the Companies. The Companies have good and
indefeasible title to the Owned Properties and good and valid leasehold
interests in the Leased Properties and there are no pending or, to the knowledge
of Sellers, threatened condemnation proceedings affecting any of the Owned
Properties or Leased Properties. To the knowledge of Sellers, the use, occupancy
and condition of each parcel of real property that is an Owned Property or a
Leased Property is in compliance in all material respects with all applicable
laws.
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SECTION 3.12 Certain Agreements.
(a) Except as disclosed in Section 3.12 of the Disclosure Schedule or in
the Financial Statements, none of the Companies or PCFS is a party to any
written (a) agreement, contract, indenture or other instrument relating to the
borrowing of money or the guarantee of any obligation for the borrowing of
money; (b) employment, consulting, compensation or severance agreement with any
of its directors, employees or consultants; (c) agreement, contract or
commitment limiting or restraining it from engaging or competing in any
business; (d) lease pursuant to which it leases the real property set forth in
Section 3.11(a) of the Disclosure Schedule; (e) distribution, dealer,
representation, commission or agency agreement, other than agency agreements
with insurance agents in the ordinary course of business; (f) contract or
agreement with any of its affiliates that will continue after Closing; or (g)
any other contract that is material to the businesses of the Companies to the
extent such contract would be required to be filed pursuant to Item 601(b)(10)
of Regulation S-K under the Exchange Act if the Companies (as a whole) were
subject to the reporting requirements thereunder (each of the foregoing a
"Material Contract"). Each Material Contract is in full force and effect and has
been complied with in all material respects by the Companies and PCFS and, to
the knowledge of Sellers, has been complied with in all material respects by all
other parties thereto. Except as set forth in Section 3.12 of the Disclosure
Schedule, no consent is required under any Material Contract in connection with
the consummation of the transactions contemplated by this Agreement.
(b) Sellers have delivered to Buyer copies of all compensation agreements,
and have otherwise disclosed to Buyer in Section 3.12 of the Disclosure Schedule
all compensation arrangements, between Sellers and/or the Companies on the one
hand, and Gerald Weiner on the other hand.
SECTION 3.13 Employee Benefit Plans. Section 3.13(a) of the Disclosure
Schedule contains (i) a true and complete list by employer of all Persons
employed by the Companies, (ii) all ConLife Employees and PCFS Employees who
will be offered employment as contemplated by Section 5.13 and (iii) the terms
of any severance plans pursuant to which any Company Employee would be entitled
to receive payments.
(a) No Seller or any of their affiliates and none of the Companies (i)
currently maintains, administers or contributes to or has any liability
under or with respect to, other than benefits claims in the ordinary course
of business, or (ii) during the six year period preceding the Closing Date
maintained, administered or contributed to: (A) in respect of any plans or
employees in the United States, any employee benefit plan, as defined in
Section 3(3) of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), including without limitation, any multiemployer plan as
defined in Section 3(37) of ERISA ("Multiemployer Plan") or any other plan
subject to Title IV of ERISA; or (B) any employment contract, bonus,
deferred compensation, incentive compensation, performance compensation,
stock purchase, stock option, stock appreciation, phantom stock, saving and
profit sharing, severance or termination pay other than statutory or the
common law requirements for reasonable notice, health or other medical,
salary continuation, vacation, sick leave, holiday pay, fringe benefit,
reimbursement program, incentive, life, disability or other (whether
insured or self-insured) insurance, supplementary unemployment benefit,
pension retirement, supplementary retirement, welfare or other employee
plan, program, policy or arrangement, whether written or unwritten, for the
benefit of PFI Employees, PCFS Employees, PennLife Employees or ConLife
Employees, except as described in Section 3.13(a) of the Disclosure
Schedule ("Benefit Plans"), but for greater certainty excluding any such
Benefit Plans which are required to be maintained, administered or complied
with under applicable law.
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(b) All Benefit Plans comply in all material respects with and are
operated in all material respects in accordance with their terms and
applicable laws and, in respect of U.S. Benefit Plans, all such Benefit
Plans comply in all material respects with and are, and during the six year
period preceding the Closing Date have been, operated in all material
respects in accordance with their terms and in accordance with ERISA and
the Code.
(c) True and complete copies of each written Benefit Plan and a
description of any unwritten benefit plan, summary plan descriptions, and
the most recent annual reports on Form 5500, including schedules, audited
financial statements and actuarial valuation reports and funding
agreements, if any, have been delivered to Buyer.
(d) Each Benefit Plan intended to be qualified under Section 401(a) of
the Code has received a favorable determination letter from the IRS as to
its qualification under the Code and to the effect that any trust of such
Benefit Plan is exempt from taxation under Section 501(a) of the Code, all
of which have been delivered or made available to Buyer; and nothing has
occurred since the date of such determination letter that reasonably would
be expected to negatively affect such qualification or exemption. Except as
disclosed in Section 3.13(d) of the Disclosure Schedule, all Canadian
Benefit Plans are duly registered where required by applicable law
(including registration with the relevant tax authorities where such
registration is required to qualify for tax exemption or other beneficial
tax status) and are in material compliance with, all applicable legislation
and administrative guidelines issued by the regulatory authorities having
jurisdiction over such plans.
(e) None of the Companies or any entity required to be aggregated with
any of the Companies pursuant to Code section 414 or ERISA section 4001(b)
("ERISA Affiliate") have incurred or are reasonably expected to incur,
either directly or indirectly, any liability (other than premiums) to the
Pension Benefit Guaranty Corporation ("PBGC"). No ERISA Affiliate has
contributed to or been obligated to contribute to a Multiemployer Plan
during the six year period preceding the Closing Date.
(f) Except as disclosed in Section 3.13(f) of the Disclosure Schedule,
there are no pending or, to the knowledge of Sellers, threatened actions,
suits, claims, trials, arbitrations, investigations or other proceedings by
any person, including any present or former participant or beneficiary
under any Benefit Plan (or any beneficiary of any such participant or
beneficiary) involving any Benefit Plan or any rights or benefits under any
Benefit Plan other than ordinary and usual claims for benefits by
participants or beneficiaries thereunder. There has been no failure to act
on the part of Sellers, their affiliates, the Companies, or, to the
knowledge of Sellers, any funding agent or any administrator of any of the
Benefit Plans that could reasonably be expected to subject Sellers, their
affiliates, the Companies or the fund of any such Benefit Plan to the
imposition of any penalty with respect to any Benefit Plans, whether by way
of indemnity or otherwise. All contributions required to have been made or
remitted by Sellers or the Companies to any Benefit Plan under the terms of
any such plan any agreement or any other applicable law have been made
within the time prescribed by any such plan, agreement or law. No
"reportable events" (as defined in ERISA section 4043), "prohibited
transactions" (as defined in ERISA section 406) or "accumulated funding
deficiency" (as defined in ERISA section 302) have occurred with respect to
any Benefit Plan for which liability would be incurred by Buyer.
(g) Except as disclosed in Section 3.13(g) of the Disclosure Schedule,
neither PFG nor any of its affiliates maintains or contributes to any
Benefit Plan which provides, or has any liability or obligation to provide,
life insurance, medical or other employee welfare benefits to PFI
Employees, PCFS Employees, PennLife Employees or ConLife Employees (or
their beneficiaries) upon and/or after their retirement, except as may be
required by U.S. or Canada federal, state, provincial or local laws, rules
or regulations, and all such Benefit Plans may be amended and terminated in
accordance with the terms thereof.
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(h) Section 3.13(h) of the Disclosure Schedule properly and adequately
reflects, and in the case of clause (ii) below, reflects in accordance with
accounting principles agreed to by Buyer and the Companies and reflected in
Section 3.13(h) of the Disclosure Schedule, any and all liabilities and
obligations of the Companies, on a company-by-company basis, as of January
1, 1998 (or such more recent date as is practicable) for or in respect of:
(i) severance benefits (except for statutory or common law requirements for
reasonable notice); (ii) post-retirement welfare benefits payable in
respect of any PFI Employees, PCFS Employee, PennLife Employees or ConLife
Employees who have retired as of such date; and (iii) any short term
disability compensation or benefits in respect of any active PFI Employees,
PCFS Employee, PennLife Employees or ConLife Employees.
(i) Except as disclosed in Section 3.13(i) of the Disclosure Schedule,
none of the Benefit Plans contains any provision which would result in any
additional benefits, accelerated vesting and/or accelerated payments or
which would subject any employee to an excise tax or result in the loss of
deductibility under Sections 280G or 4999 of the Code solely as a result of
the consummation of the transactions contemplated by this Agreement. No
step has been taken, no event has occurred and no condition or circumstance
exists that has resulted or could reasonably result in any Canadian Benefit
Plan being ordered or required to be terminated or wound-up in whole or in
part or having its registration under any applicable law being refused or
revoked or being placed under the administration of any trustee or receiver
or any regulatory authority.
(j) None of the Companies, or any organization with respect to which
such Company is a successor or parent corporation (within the meaning of
ERISA section 4069) has engaged in any transaction described in ERISA
section 4069.
(k) Since the date of the documents provided in accordance with
Section 3.13(c) above, no promises or commitments have been made by Sellers
or any of their affiliates or the Companies to amend any Benefit Plan or to
provide increased benefits thereunder, except as required by applicable law
or by the Benefit Plans.
(l) Any Benefit Plan that is a pension plan registered under the
Income Tax Act (Canada) which has been created as a result of the division
of a predecessor pension plan or the merger of one or more pension plans,
has received approval therefor from all appropriate regulatory authorities.
(m) Except as permitted by the Canadian Benefit Plans and applicable
law, there has been no withdrawal of surplus assets or any other amounts
from any of the Canadian Benefit Plans other than proper payments of
benefits to eligible beneficiaries, refunds of over-contributions to plan
members and permitted payments of reasonable expenses incurred by or in
respect of such Benefit Plan, for which there is any unsatisfied liability.
(n) All employer contribution holidays have been permitted by the
terms by the Canadian Benefit Plans and have been in accordance with
applicable law, except where there is no unsatisfied liability.
SECTION 3.14 Taxes. Except as set forth in Section 3.14 of the Disclosure
Schedule:
(a) all Tax Returns required to be filed by or with respect to each of
the Companies have been filed, and the Companies have paid all Taxes that
are shown to be due on such Tax Returns and all information provided with
respect to such Tax Returns is complete and accurate in all material
respects;
(b) the Companies have paid all Taxes owed by such Companies (whether
or not shown on any Tax Return) for all taxable periods through and
including the Closing Date and there are not and will not be any additional
liabilities for Taxes for any such period other than as reflected in the
Financial Statements as current Taxes and, with respect to any
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period between the latest Financial Statements and the Closing Date, as
reflected in the Closing Statement;
(c) the Companies have given or otherwise made available to Buyer
correct and complete copies of all Tax Returns, examination reports and
statements of deficiencies for periods ending, or transactions consummated,
after December 31, 1994;
(d) there are no outstanding agreements extending or waiving the
statutory period of limitation applicable to any claim for, or the period
for the collection or assessment or reassessment of, Taxes due from any
Company for any taxable period;
(e) no audit or other proceeding by any Governmental Authority is
pending or, to the knowledge of Sellers, threatened with respect to any
Taxes due from or with respect to any Company and no claim has been made by
any Governmental Authority in a jurisdiction where any of the Companies
does not file Tax Returns that it is or may be subject to taxation by that
jurisdiction;
(f) there are no Liens for Taxes upon the assets or properties of any
of the Companies, except for statutory Liens for current Taxes not yet due;
(g) no Company is a party to any agreement relating to the sharing or
allocation of, or indemnification agreement with respect to, Taxes, or any
similar contract or arrangement;
(h) each U.S. domiciled PennLife Company and ConLife Company is an
"insurance company" within the meaning of Treas. Reg. sec.1.801-3(a) (under
former Section 801 of the Code) and subject to taxation under Subchapter L
of the Code for the taxable period ending on the Closing Date and for all
prior taxable periods for which the statute of limitations has not expired;
(i) none of the Companies (i) has income that is includable in
computing the taxable income of a United States person (defined in Section
7701 of the Code) under Section 951 of the Code and (ii) is a passive
foreign investment company within the meaning of Section 1297 of the Code;
(j) none of the Companies has filed a consent under Section 341(f) of
the Code;
(k) no property owned by any of the Companies (i) is property required
to be treated as being owned by another Person pursuant to the provisions
of Section 168(f)(8) of the Internal Revenue Code of 1954, as amended and
in effect immediately prior to the enactment of the Tax Return Act of 1986,
(ii) constitutes "tax-exempt use property" within the meaning of Section
168(h)(1) of the Code or (iii) is tax-exempt bond financed property within
the meaning of Section 168(g) of the Code;
(l) none of the Companies is a party to any contract, agreement or
other arrangement which could result in the payment of amounts that could
be nondeductible by reason of Section 162(m) of the Code;
(m) none of the Companies has agreed, or is required to make, any
adjustment under Section 481(a) or Section 807(f) of the Code;
(n) none of the Companies has been a member of an affiliated group
filing a consolidated federal Income Tax Return (other than a group the
common parent of which was PLAC (the "PLAC Group"), in the case of the
PennLife Companies, ConLife (the "ConLife Group"), in the case of the
ConLife Companies, PFG (the "PFG Group"), in the case of the PFI Companies)
or has any liability for Taxes of any Person (other than any member of the
PLAC Group, the ConLife Group or the PFG Group, as the case may be) under
Treas. Reg. sec.1.1502-6, sec.1.1502-78 or similar provision of state,
local or foreign law or regulation, as a transferee or successor, by
contract or otherwise;
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(o) federal consolidated income Tax Returns or extensions to file have
been (or will be timely) filed by or on behalf of the PLAC Group, the
ConLife Group and the PFG Group for periods with filing dates prior to the
Closing Date;
(p) the Companies have each withheld from their respective employees,
independent contractors, creditors, stockholders and third parties and
timely paid to the appropriate taxing authority proper and accurate amounts
in all respects through all periods in compliance with all Tax withholding
and remitting provisions of applicable laws and have each complied in all
material respects with all Tax information reporting provisions of all
applicable laws;
(q) no Seller is a foreign person within the meaning of Section 1445
of the Code;
(r) the amount of the policyholders surplus account and shareholder
surplus account (as defined in Section 815 of the Code) of each of the U.S.
Insurance Companies is accurately set forth in Section 3.14 of the
Disclosure Schedule;
(s) each U.S. Insurance Company is taxable as a life insurance company
within the meaning of Section 816 of the Code;
(t) all life insurance contracts issued by each U.S. Insurance Company
(whether developed or administered by or reinsured with any unrelated
party) that are subject to Section 7702 of the Code qualify as "life
insurance contracts" within the meaning of Section 7702(a) of the Code;
(u) all contracts issued by each U.S. Insurance Company (whether
developed or administered by or reinsured with any unrelated party) that
are subject to Section 817 of the Code and the Treasury Regulations
promulgated thereunder have met the diversification requirements applicable
thereto since the issuance of the contract;
(v) all annuity contracts issued by each U.S. Insurance Company
(whether developed or administered by or reinsured with any unrelated
party) that are subject to Section 72(s) of the Code contain all of the
necessary provisions of Section 72(s) of the Code;
(w) the Tax treatment under the Code of all insurance, annuity or
investment policies or contracts; all financial products or annuities; or
any similar or related policy, contract, plan or product, whether
individual, group, or otherwise, issued or sold by any of the U.S.
Insurance Companies (whether developed or administered by or reinsured with
any unrelated party) is and at all times has been the same or not less
favorable to the purchaser, policyholder, or beneficiaries thereof than the
Tax treatment under the Code for which such contracts (products, etc.)
qualified or purported to qualify or which the Insurance Companies
represented could be obtained at the time of its issuance, purchase,
modification, or exchange. For purposes of this Section 3.14(w), the
provisions of the Code relating to the Tax treatment of such contracts
shall include, but shall not be limited to, Sections 72, 79, 101, 104, 105,
106, 125, 130, 401, 402, 403, 404, 408, 412, 415, 419, 419A, 457, 501, 505,
817, 817A, 818, 1035, 7702, and 7702A of the Code;
(x) any life insurance contract issued by any U.S. Insurance Company
(whether developed or administered or reinsured with any unrelated party)
which is a modified endowment contract under Section 7702A of the Code
(each, an "MEC") has been marketed as such at all relevant times or the
policyholder otherwise has consented to such MEC status;
(y) all U.S. Insurance Companies have computed their respective tax
reserves in accordance with the requirements of Sections 807, 811 and 846
of the Code;
(z) all annuity contracts issued by each U.S. Insurance Company
(whether developed or administered by or reinsured with any unrelated
party) that are provided under or
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connected with a plan described in Section 401(a), 403(a) or 403(b) of the
Code or which is an individual retirement annuity or provided under an
individual retirement account or annuity, satisfies the federal income tax
laws applicable to such annuity contract;
(aa) there are no currently pending or, to the knowledge of Sellers,
threatened federal, state, provincial, local or foreign audits or other
administrative or judicial proceedings with regard to the Tax treatment of
any product or plan sold, issued or administered by the Insurance Companies
(whether developed by or reinsured with any unrelated third party);
(ab) no Insurance Company is a party to any hold harmless, sharing,
allocation or indemnification agreement with respect to the Tax
qualification or treatment of any product or plan sold, issued or
administered by any Insurance Company (whether developed by or reinsured
with any unrelated third party);
(ac) there is no claim, audit, action, suit, proceeding or
investigation now pending or threatened against, with respect to or in
limitation of the net operating loss carryforwards of the Companies as set
forth in Section 3.14 of the Disclosure Schedule (the "NOLs") as of the
Closing Date, including without limitation any limitations under Section
382 of the Code (other than limitations incurred in connection with the
Closing Transactions);
(ad) PennLife is a "qualified insurance corporation" within the
meaning of Section 810 of the Income Tax Regulations (Canada) for the
purposes of Section 116 of the Income Tax Act (Canada) and no Section 116
certificate is required to be obtained pursuant to the Income Tax Act
(Canada) in respect of the transfer of the PC-Canada Shares by PennLife to
PLAC;
(ae) PennLife is not and will not be required to pay any Taxes
pursuant to subsection 219(5.1) of the Income Tax Act (Canada) in respect
of any period ending on or prior to the Closing Date and neither PennLife
nor PC-Canada has made or will make in respect of any period ending on or
prior to the Closing Date any election pursuant to subsection 219(5.2) of
the Income Tax Act (Canada);
(af) PC-Canada is a "life insurance corporation" as defined for
purposes of the Income Tax Act (Canada);
(ag) PennLife and PC-Canada are registered under Part IX of the Excise
Tax Act (Canada); and
(ah) each of PennLife and PC-Canada has remitted all Canada Pension
Plan and Quebec Pension Plan contributions, employment insurance premiums,
employer health taxes, workers' compensation premiums and assessments and
any other Taxes payable by it for any period ending on or before the
Closing Date in respect of its employees to the appropriate taxing
authority within the time required by law.
SECTION 3.15 Compliance with Applicable Law; Permits; Policies.
(a) The businesses of the Companies and PCFS are being conducted in all
material respects in compliance with all applicable provisions of any U.S. and
Canadian federal, state, provincial, local or foreign statute, law, ordinance,
rule, regulation, judgment, decree, order, concession, grant, franchise, permit
or license or other governmental authorization or approval applicable to them,
except as set forth in Section 3.15(a) of the Disclosure Schedule and except for
such noncompliance as has not had or could not reasonably be expected to have a
Material Adverse Effect.
(b) Each Company and PCFS own or validly hold all licenses, franchises,
permits, approvals, authorizations, exemptions, classifications, certificates,
registrations and similar documents or instruments that are required for its
business and operations (in the case of PCFS, relating to the PCFS Assets),
except for those the failure of which to have has not had or
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could not reasonably be expected to have a Material Adverse Effect (the
"Required Permits"). All Required Permits relating to insurance are set forth in
Schedule T of each of the PennLife Companies' and ConLife Companies' Annual
Statements for the year ended December 31, 1997, and all other Required Permits
are listed in Section 3.15(b) of the Disclosure Schedule. In all cases, the
Required Permits are valid and in full force and effect and none of Sellers or
any Company has received any notice of any inquiry or proceeding that could
reasonably be expected to result in the suspension, revocation or material
limitation of any such permit; and to the knowledge of Sellers, there is no
reasonable basis for any such suspension, revocation or limitation. None of the
Companies or PCFS is currently the subject of any supervision, conservation,
rehabilitation, liquidation, receivership, insolvency or other similar
proceeding nor, other than as described in Section 3.15(b) of the Disclosure
Schedule, are any of the Companies or PCFS operating under any formal or
informal agreement or understanding with the licensing authority of any State
which restricts its authority to do business or requires it to take, or refrain
from taking, any action.
(c) Except as disclosed in Section 3.15(c) of the Disclosure Schedule, all
forms of insurance policies and riders thereto currently issued by any PennLife
Company or ConLife Company are, to the extent required under applicable laws, on
forms approved by applicable insurance regulatory authorities of the
jurisdictions in which issued or have been filed with and not objected to by
such insurance regulatory authorities within the period provided for such
objection and any premium rates with respect to such policies or riders required
to be filed with or approved by such applicable insurance regulatory authorities
have been so filed or approved and premiums charged conform thereto. No material
deficiencies have been asserted by any Governmental Authority with respect to
any such filings which have not been cured or otherwise resolved to the
satisfaction of such Governmental Authority.
(d) Except as set forth in Section 3.15(d) of the Disclosure Schedule, each
Company (exclusive of their independent agents) and, to the knowledge of
Sellers, their independent agents, have marketed, sold and issued products of
such Company in compliance in all material respects with all laws applicable to
the business of such Company in the respective jurisdictions in which such
products have been sold, including but not limited to laws regulating
advertisements, requiring mandatory disclosure of policy information, requiring
employment of standards to determine if the purchase of a policy or contract is
suitable for an applicant, prohibiting the use of unfair methods of competition
and deceptive acts or practices and regulating replacement transactions. For
purposes of this Section 3.15(d), "advertisement" means any material designed to
create public interest in life and health insurance policies, annuity contracts
or in an insurer, or in an insurance producer, or to induce the public to
purchase, increase, modify, reinstate, borrow on, surrender, replace or retain
such a policy or contract, and (ii) "replacement transaction" means a
transaction in which a new life or health insurance policy or annuity contract
is to be purchased by a prospective insured and the proposing producer should
know that one or more existing life or health insurance policies or annuity
contracts is to be lapsed, forfeited, surrendered, reduced in value or pledged
as collateral. Except as set forth in Section 3.15(d) of the Disclosure
Schedule, Sellers have not received notice (written or oral) and are not
otherwise aware of any review or investigation by any Governmental Authority of
any marketing conduct and/or selling practices of the Companies or their
independent agents, other than periodic market conduct examinations arising in
the ordinary course of business and Attorney General inquiries in connection
with which no material issues have been raised that have not been resolved to
the satisfaction of the relevant insurance authorities or Attorneys General, as
the case may be.
(e) Except as set forth in Section 3.15(e) of the Disclosure Schedule, no
agent of any of the Companies has any claim against any of the Companies for any
compensation or other amounts (the "Agent Compensation") (other than the
Pre-Sale Obligations, Post-Closing Compensation Obligations or sales commissions
and advances in the ordinary course of
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business and except for commitments made by Buyer or by a designee of Buyer on
Buyer's behalf, including PFG but only to the extent PFG is specifically
authorized by Buyer in writing).
(f) The Companies have previously delivered or made available to Buyer true
and complete copies of the reports (or the most recent draft thereof, to the
extent any final report is not available) reflecting the results of the two most
recent financial examinations and market conduct examinations of any of the
Companies issued by any insurance regulator.
(g) Except as set forth in Section 3.15(g) of the Disclosure Schedule, no
insurance policy gives the holder thereof the right to receive dividends,
distributions or other benefits based on the earnings or revenues of such
Company.
(h) The PennLife Companies and the ConLife Companies have (i) timely paid
all material state and Canadian guaranty association assessments that are due,
or claimed or asserted by any insurance regulatory authority to be due, from
such Companies, or (ii) provided for all such material assessments in their
statutory financial statements, filed with the appropriate insurance regulatory
authority, to the extent necessary to be in conformity in all material respects
with SAP for such statements.
(i) Except as set forth in Section 3.15(i) of the Disclosure Schedule, the
December 31, 1997 SAP Financial Statements list all material funds maintained in
a state of licensure by any of the PennLife Companies or the ConLife Companies
under any applicable insurance law (each a "Deposit"), including, without
limitation, any Deposit the beneficial interest of which may have been
transferred in connection with a Reinsurance Agreement. Except as set forth in
Section 3.15(i) of the Disclosure Schedule, the December 31, 1997 SAP Financial
Statements accurately set forth as of December 31, 1997 the dollar amount of
each such Deposit and the name of the depository in which such Deposit is
maintained.
SECTION 3.16 Brokers Fees and Commissions. Except for Salomon Smith
Barney and Fox-Pitt, Kelton Inc., no Seller and no Company (or their respective
directors, officers, employees or agents) has employed any investment banker,
broker or finder in connection with the transactions contemplated hereby. PFG
shall be solely responsible for the fees and expenses of Salomon Smith Barney
and Fox-Pitt, Kelton Inc. in connection with the transactions contemplated
hereby.
SECTION 3.17 Proprietary Rights; Year 2000 Compliance. (a) Except as
disclosed in Section 3.17(a) of the Disclosure Schedule, each Company owns or
possesses the right to use all material trademarks, service marks, patents,
patent rights, assumed names, logos, trade secrets, copyrights and trade names
("Intellectual Property") and all material computer software, programs and
similar systems that are used by it in the conduct of its business and PCFS owns
or possesses the right to use all Intellectual Property and all material
computer software, programs and systems that are used by PCFS in the conduct of
its business, and all such assets and rights are included in the PCFS Assets.
All such Intellectual Property and material computer software, programs and
similar systems are in full force and effect in accordance with their terms.
None of the Companies or PCFS has received any notice of any conflict with or
violation or infringement of or any claimed conflict with or violation or
infringement of, any asserted rights of any other Person with respect to any
such Intellectual Property or computer software, programs, or similar systems.
None of the Companies or PCFS is in conflict with or in violation or
infringement of any asserted rights of any other Person with respect to any such
Intellectual Property or computer software, programs, or similar systems, except
to the extent that any such conflict, violation or infringement does not have,
or could not be reasonably expected to have, a Material Adverse Effect.
(b) Except as disclosed in Section 3.17(b) of the Disclosure Schedule, all
material computer hardware and software (including all computer hardware and
software in embedded systems) used by the Companies and PCFS (whether such
hardware and software is owned by
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the Companies or PCFS or licensed from third parties) (collectively, the
"Technology Systems") is designed or is being modified to be used prior to,
during and after the calendar year 2000 and the Companies have taken measures
they believe to be sufficient to prepare such hardware and software to continue
to operate during each such time period to accurately process date data
(including, but not limited to calculating, comparing and sequencing) from, into
and between the twentieth and twenty-first centuries, including leap year
calculations.
SECTION 3.18 Insurance. Section 3.18 of the Disclosure Schedule
summarizes the amount and scope of the insurance currently in force insuring the
Companies and the PCFS Assets and their respective operations and properties
against loss or liability. All such policies or contracts of insurance are in
material compliance with all applicable laws and all Material Contracts to which
any of the Companies or PCFS is a party. All insurance policies pursuant to
which any such insurance is provided are in full force and effect. No notice of
cancellation or termination of any such insurance policy has been given to any
Company or PCFS and all premiums required to be paid in connection with such
insurance policies have been paid in full.
SECTION 3.19 Environmental Matters. Except as disclosed on Section 3.19
of the Disclosure Schedule:
(a) the operations of the Companies and the real property currently owned,
leased or operated by the Companies or included in the PCFS Assets are in
compliance and, during the period of the ownership or tenancy of the Companies
and PCFS have been in compliance, with all applicable Environmental Laws, except
for such noncompliance as would not reasonably be expected to have a Material
Adverse Effect;
(b) no judicial or administrative proceedings or investigations are pending
or, to the knowledge of Sellers, threatened against any of the Companies or to
the extent relating to the PCFS Assets, PCFS, pursuant to any applicable
Environmental Laws, except for judicial or administrative proceedings or
investigations that could not reasonably be expected to have a Material Adverse
Effect;
(c) no condition exists on any real property currently (or to the knowledge
of Sellers, formerly) owned, operated or leased by any of the Companies or
included in the PCFS Assets arising out of or resulting from any Release of any
Hazardous Material that could reasonably be expected to result in the Companies
or PCFS incurring any liability under Environmental Laws that would have a
Material Adverse Effect and no such property is listed or has been proposed for
listing on the National Priorities List, the Comprehensive Environmental
Response Compensation and Liability and Information System (CERCLIS) or any
analogous state or Canadian federal or provincial lists; and
(d) Sellers have delivered or made available to Buyer copies of all
environmental investigations, audits, assessments or other analyses conducted by
or on behalf of, or which are otherwise in the possession of, Sellers or any
Company relating to any real property currently or formerly owned or leased by
any of the Companies or included in the PCFS Assets.
SECTION 3.20 Books and Records. Copies of all the minute books and stock
record books of the Companies have been delivered or made available to Buyer for
inspection and contain accurate records of all meetings of, and written consents
by, the boards of directors (and any committees thereof) and shareholders of the
Companies from January 1, 1995 to the date hereof and, to the knowledge of
Seller, since their respective incorporations.
SECTION 3.21 Bank Accounts. Section 3.21 of the Disclosure Schedule
contains (a) a true and complete list of the names and locations of all banks,
trust companies, securities brokers, and other financial institutions ("Banks")
at which each of the Companies has an account or safe deposit box or maintains a
banking, custodial, trading, trust or other similar relationship ("Accounts"),
(b) a true and complete list and description of each such Account, including a
list of all authorized signatories and (c) a true and complete description of
all
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Accounts included in the PCFS Assets and a list of the names and locations of
all Banks where such Accounts are located.
SECTION 3.22 Insurance and Reinsurance.
(a) Section 3.22(a) of the Disclosure Schedule is a true and complete
description of each material contract providing for reinsurance, coinsurance,
excess insurance, ceding of insurance, assumption of insurance or
indemnification of insurance liabilities to which any PennLife Company or
ConLife Company is a party which is currently in effect (the "Reinsurance
Agreements").
(b) Except as required by law or as disclosed in Section 3.22(b) of the
Disclosure Schedule, all amounts payable as of the date of this Agreement by any
PennLife Company or ConLife Company under any Reinsurance Agreement and, to the
knowledge of Sellers, all amounts payable as of the date of this Agreement by
any other Person that is a party to any Reinsurance Agreement have been paid in
accordance with the terms of the contracts under which they arose except, in
each case, for immaterial non-payments or discrepancies that would not adversely
affect any of the rights of any PennLife Company or ConLife Company under any
such Reinsurance Agreement. Except as disclosed in Section 3.22(b) of the
Disclosure Schedule, to the knowledge of Sellers, no reinsurer (other than the
Companies) that is a party to any of the Reinsurance Agreements has a valid
defense to payment of its material obligations under such Reinsurance Agreements
or is in default in any material respect under any Reinsurance Agreement and
Seller is not aware of any impairment of the financial condition of any such
other party to the extent that a default thereunder could reasonably be
anticipated. Each Reinsurance Agreement is in compliance in all material
respects with applicable insurance laws and regulations regarding life and
health reinsurance agreements. The Companies have not entered into any
transaction or series of transactions that are required to be recorded as
financial reinsurance pursuant to SAP.
(c) As of the date hereof, the A.M. Best rating presently held by any of
the Companies has not been reduced since August 27, 1998, and other than as set
forth in Section 3.22(c) of the Disclosure Schedule, the Sellers have not, as of
the date hereof, received any notice of any intended or potential downgrading by
A.M. Best.
SECTION 3.23 Labor Matters.
(a) None of the Companies is a party to any labor or collective bargaining
agreement.
(b) No employees of any Company and none of the ConLife Employees or PCFS
Employees are represented by any labor organization that is certified to
represent such employees under the National Labor Relations Act or other
applicable law. No labor organization or group of employees of any Company or
any ConLife Employees or PCFS Employees has made a pending demand for
recognition, certification, successor rights or a related employer declaration,
and there are no representation, certification, successor rights or related
employer proceedings or petitions or applications for certification seeking a
representation proceeding presently pending or threatened to be brought before
or filed with the National Labor Relations Board or any other labor relations
tribunal or authority. To the knowledge of Sellers, there are no organizing
activities involving any Company or PCFS or Services pending with any labor
organization or group of employees of any Company or any ConLife Employees or
PCFS Employees.
(c) Except as set forth in Section 3.23(c) of the Disclosure Schedule,
there are no strikes, work stoppages, slowdowns, lockouts, material arbitrations
or material grievances or other material labor disputes pending or threatened
against or involving any Company or Services or PCFS, to the extent applicable
to the ConLife Employees or PCFS Employees who are currently employed by
Services or PCFS, as the case may be.
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(d) Each of the Companies and Services (with respect to the ConLife
Employees) and PCFS (with respect to the PCFS Employees) is in compliance with
all laws, regulations and orders applicable to such Company or the ConLife
Employees or PCFS Employees, as the case may be, relating to the employment of
labor, including all such laws, regulations and orders relating to wages, hours,
employment standards, WARN, collective bargaining, discrimination, civil rights,
safety and health, workers' compensation and the collection and payment of
withholding and/or social security taxes and any similar tax, other than such
noncompliance that could not reasonably be expected to have a Material Adverse
Effect.
(e) There is no "mass layoff," "plant closing" or similar event as defined
by WARN or similar Canadian legislation with respect to any of the Companies;
provided, that no representation is made as to actions taken by Buyer in
connection with or after the Closing.
(f) Except as set forth in Section 3.23(f) of the Disclosure Schedule, as
of the date hereof, there are no pending or, to the knowledge of Sellers,
threatened complaints, charges or claims against any Company or Services or PCFS
brought or filed with any Governmental Authority, arbitrator or court based on,
arising out of, in connection with or otherwise relating to the employment or
termination of employment by any Company or Services or, to the extent relating
to the PCFS Employees, PCFS, of any individual.
SECTION 3.24 Purchase for Investment. PFG is acquiring the Acquisition
Notes for its own account for investment purposes and not with a view to the
resale or distribution of the Acquisition Notes. PFG has such knowledge and
experience in financial and business matters so as to be capable of evaluating
the merits and risks of its investment in the Acquisition Notes. PFG is an
"accredited investor" as defined in Rule 501 of the Securities Act of 1933, as
amended. PFG will not, directly or indirectly, dispose of the Acquisition Notes
except in compliance with applicable federal and state securities laws.
SECTION 3.25 Affiliate Transactions. Section 3.25 of the Disclosure
Schedule sets forth, as of the date hereof, all contracts, agreements,
obligations, commitments and liabilities between any of the Companies and/or
between any of the Companies and PFG or any of PFG's affiliates (other than the
Companies). All such transactions which were required to have been identified or
reported to or approved by the applicable departments of insurance have been
identified, reported and/or approved.
SECTION 3.26 Bonuses. Except as set forth on Section 3.26 of the
Disclosure Schedule, no current or former officer, director or employee or agent
of any of the Companies is a party to or beneficiary of any contract or other
agreement pursuant to which such Person shall receive or is entitled to receive
any retention or other transaction bonus or other payment (a "Transaction
Bonus") from any Company in connection with the transactions contemplated
hereby.
SECTION 3.27 All Related Assets. As of the Closing Date, immediately
following the Closing Transactions, the Companies will own, lease or license all
property and assets necessary to carry on their business and operations as
presently conducted (except to the extent such property or assets have been
transferred or disposed of in connection with the Pre-Closing Restructuring
Transactions), all such assets and properties (other than as Buyer and Sellers
may mutually agree) will be conveyed to Buyer (either indirectly by means of the
transfer of Shares or through the transfer of the PCFS Assets in accordance with
Section 2.2) at the Closing and will as of the Closing permit Buyer to conduct
such businesses and operations in the same manner as such businesses and
operations have been conducted prior to the Closing (except to the extent such
property or assets have been transferred or disposed of in connection with the
Pre-Closing Restructuring Transactions).
SECTION 3.28 Litigation Arising Between Signing and Closing. The
Litigation pending or, to the knowledge of Sellers, threatened against any of
the Companies or PCFS before any Governmental Authority or arbitrator as of the
Closing Date (including the New Litigation and
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New Employee Claims), considered in the aggregate, will not expose the Companies
to any materially greater risks or liabilities than the Litigation set forth on
Section 3.10 of the Disclosure Schedule, considered in the aggregate.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF BUYER
Buyer hereby represents and warrants to Sellers as follows:
SECTION 4.1 Organization; Qualifications and Operations. Each of Buyer
and its Subsidiaries (collectively, the "Buyer Parties") is a corporation duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its organization, with all requisite corporate power and
authority to own, operate and lease its properties and to carry on its business
as it is now being conducted and, in the case of Buyer, to own the Shares and
the PCFS Assets. Each Buyer Party is qualified or licensed to do business and is
in good standing in each jurisdiction in which the ownership or leasing of
property by it or the conduct of its business requires such licensing or
qualification, except where the failure to be so qualified or licensed will not
affect Buyer's ability to consummate the transactions contemplated by this
Agreement and will not have a material adverse effect on the business, results
of operations or financial condition of the Buyer Parties, taken as a whole (a
"Buyer Material Adverse Effect").
SECTION 4.2 Authorization. Buyer has full corporate power and authority
to execute and deliver this Agreement and each other document to be delivered by
Buyer in connection herewith, including the Acquisition Notes and the UAFC Share
Purchase Agreement, and to consummate the transactions contemplated hereby and
thereby. The execution and delivery by Buyer of this Agreement, the Acquisition
Notes and the UAFC Share Purchase Agreement, the performance by Buyer of its
obligations hereunder and thereunder, and the consummation by Buyer of the
transactions contemplated hereby and thereby, have been duly authorized by
Buyer's Board of Directors. Except for the approval of the shareholders of Buyer
of the matters requiring shareholder approval set forth in the UAFC Share
Purchase Agreement, no other corporate proceeding on the part of Buyer is
necessary to authorize the execution and delivery of this Agreement and each
other document to be delivered by Buyer in connection herewith, including the
Acquisition Notes and the UAFC Share Purchase Agreement, or to consummate the
transactions contemplated hereby and thereby. Simultaneously with the execution
of this Agreement, (i) shareholders owning at least 51% of the issued and
outstanding voting securities of Buyer and (ii) shareholders owning at least 51%
of the issued and outstanding Series C-1 Convertible Preferred Stock of Buyer
(the "Series C-1 Holders") are executing a voting agreement in the form attached
hereto as Annex G, pursuant to which such shareholders are agreeing to vote in
favor of the matters requiring shareholder approval set forth in the UAFC Share
Purchase Agreement (which percentage of shareholders, in respect of the issued
and outstanding voting securities and in respect of the Series C-1 Holders,
voting as a separate class, is sufficient to approve such matters). Each of this
Agreement, the Acquisition Notes and the UAFC Share Purchase Agreement has been
duly and validly executed and delivered by Buyer and constitutes a valid and
binding obligation of Buyer enforceable against it in accordance with its terms,
subject to applicable bankruptcy, insolvency, fraudulent conveyance,
reorganization, moratorium and similar laws affecting creditors' rights and
remedies generally, and subject, as to enforceability, to general principles of
equity, including principles of commercial reasonableness, good faith and fair
dealing (regardless of whether enforcement is sought in a proceeding at law or
in equity).
SECTION 4.3 No Violation. Subject to the receipt by Buyer of the Buyer
Approvals identified in Section 4.5 below and except as set forth in Section 4.3
of the Disclosure Schedule, neither the execution and delivery by Buyer of this
Agreement, the Acquisition Notes or the UAFC Share Purchase Agreement, the
performance by Buyer of its obligations hereunder and
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thereunder nor the consummation by Buyer of the transactions contemplated hereby
and thereby will (a) violate, conflict with or result in any breach of any
provision of the Articles of Incorporation or Bylaws of any Buyer Party, (b)
violate or conflict with or result in a violation or breach of, or constitute a
default (with or without due notice or lapse of time or both) under the terms,
conditions or provisions of any note, bond, mortgage, indenture or deed of
trust, or any license, lease or agreement to which any Buyer Party is a party or
by which any of their assets is bound or (c) violate any order, writ, judgment,
injunction, decree, statute, rule or regulation of any Governmental Authority
applicable to any Buyer Party or any of their assets, except in each case as
would not have a Buyer Material Adverse Effect.
SECTION 4.4 Capitalization. As of the date hereof, the authorized capital
stock of Buyer consists of: (i) 20,000,000 shares of common stock, par value
$0.01 per share ("Buyer Common Stock"); (ii) 500 shares of Series B Convertible
Preferred Stock, par value $1.00 per share, of the Company (the "Series B
Preferred"); (iii) 100,000 shares of Series C Convertible Preferred Stock, par
value $1.00 per share, of the Company (the "Series C Preferred"); (iv) 22,500
shares of Series D-1 Convertible Preferred Stock, par value $1.00 per share, of
the Company (the "Series D-1 Preferred"); and (v) 17,500 shares of Series D-2
Convertible Preferred Stock, par value $1.00 per share, of the Company (the
"Series D-2 Preferred"). As of the date hereof, Buyer has 7,638,057 shares of
Buyer Common Stock, 400 shares of Series B Preferred, 51,680 shares of Series C
Preferred, 22,500 shares of Series D-1 Preferred and no shares of Series D-2
Preferred issued and outstanding. All of such outstanding shares have been
validly issued, are fully paid and, except as provided under Section 630 of the
Business Corporation Law of New York (relating to employee wages),
nonassessable, and were not issued in violation of any preemptive rights. Except
as set forth in Section 4.4 of the Disclosure Schedule, as of the date hereof,
there are 2,673,991 warrants to purchase Buyer Common Stock issued and
outstanding.
SECTION 4.5 Consents and Approvals. Except as set forth in Section 4.5 of
the Disclosure Schedule, no filing or registration with, no notice to and no
permit, authorization, consent or approval of any third party or any
Governmental Authority is necessary for Buyer to enter into this Agreement or
the UAFC Share Purchase Agreement and issue the Acquisition Notes or for the
consummation by Buyer of the transactions contemplated by this Agreement or the
UAFC Share Purchase Agreement other than consents and approvals of or filings or
registrations with (a) the DOJ pursuant to the HSR Act, (b) the PennLife
Insurance Approvals and the ConLife Insurance Approvals, (c) the insurance
departments of the States of New York, Texas, Florida; (d) and the federal and
provincial governments of Canada, (e) the Commission pursuant to the
requirements of the Exchange Act and (f) the approval of the shareholders of
Buyer at a special meeting of shareholders of Buyer of the matters requiring
shareholder approval as set forth in the UAFC Share Purchase Agreement, in
accordance with New York law and the rules of Nasdaq (collectively, the "Buyer
Approvals"). Sellers acknowledge that Buyer intends to sell some or all of the
Shares and the PCFS Assets to one or more Subsidiaries of Buyer pursuant to
Section 2.2(j), and that the term "Buyer Approval" will include, for purposes of
this Section 4.5 and of Section 6.1(a), any and all approvals of the relevant
insurance regulators in connection with such transactions.
SECTION 4.6 Brokers' Fees and Commissions. Except for Chase Securities
Inc. ("Chase Securities"), Capital Z Management Inc., Chase Bank and Advest,
Inc. ("Advest"), neither Buyer nor any of its directors, officers, employees or
agents has employed any investment banker, broker or finder in connection with
the transactions contemplated hereby. Buyer shall be solely responsible for the
fees and expenses of Chase Securities, Capital Z Management Inc., Chase Bank and
Advest in connection with the transactions contemplated hereby.
SECTION 4.7 Purchase for Investment. Buyer is acquiring the Shares for
its own account for investment purposes and not with a view to the distribution
of the Shares. Buyer has such knowledge and experience in financial and business
matters so as to be capable of evaluating the merits and risks of its investment
in the Shares. Buyer is an "accredited investor" as defined
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in Rule 501 of the Securities Act of 1933, as amended. Buyer will not, directly
or indirectly, dispose of the Shares except in compliance with applicable
federal and state securities laws.
SECTION 4.8 Financing. Concurrently with the execution of this Agreement,
Buyer is entering into a Stock Purchase Agreement, dated as of the date hereof
(the UAFC Share Purchase Agreement"), with Capital Z Financial Services Fund II,
L.P. ("Capital Z"), pursuant to which Buyer has agreed to issue and sell to
Capital Z, and Capital Z has agreed to purchase and acquire from Buyer, on the
terms and subject to the conditions contained therein, shares of Buyer Common
Stock (subject to adjustment in accordance with the UAFC Share Purchase
Agreement) for the purchase price set forth in the UAFC Share Purchase
Agreement. The proceeds of such issuance will be used to fund a portion of the
Cash Purchase Price. In addition, Chase Manhattan Bank, N.A. ("Chase Bank") and
Chase Securities have issued a commitment letter (the "Chase Commitment") for
the Chase Bank Facility, the proceeds of which will be used to finance the
balance of the Cash Purchase Price. True and complete copies of the UAFC Share
Purchase Agreement and the Chase Commitment have been delivered to PFG.
SECTION 4.9 SEC Reports. Except as set forth in Section 4.9 of the
Disclosure Schedule, Buyer has timely filed with the Commission (a) Buyer's
Annual Report on Form 10-K for the year ended December 31, 1997, (b) Buyer's
Quarterly Reports on Form 10-Q for the quarters ended March 31, June 30, and
September 30, 1998, (c) all proxy statements relating to meetings of
shareholders of Buyer occurring in 1997 and 1998, (d) all Current Reports on
Form 8-K required to be filed since January 1, 1998, (e) all amendments and
supplements required to be filed to all such reports, and (f) all other forms,
reports, statements and other documents required to be filed with the Commission
(all such documents in clauses (a) through (f) herein are referred to as the
"SEC Reports"). Such SEC Reports filed with the Commission were prepared in all
material respects in accordance with the requirements of applicable law and did
not at the time they were filed contain any untrue statement of a material fact
or omit to state a material fact required to be stated therein or necessary in
order to make the statements therein not misleading in light of the
circumstances under which they were made. Buyer has delivered or made available
to Sellers true and complete copies of all of the SEC Reports.
SECTION 4.10 Absence of Undisclosed Liabilities. Except as set forth in
Section 4.10 of the Disclosure Schedule, as of the date hereof, and as of the
Closing Date, except for matters relating to the transactions contemplated by
this Agreement or as disclosed in the SEC Reports filed prior to the date
hereof, there are no liabilities or obligations of the Buyer Parties that are
required to be reflected on a balance sheet prepared in accordance with GAAP
other than (a) liabilities and obligations reserved against in the financial
statements constituting a part of the SEC Reports and not heretofore discharged,
(b) policyholder benefits payable or other liabilities or obligations arising in
the ordinary course of business, or (c) liabilities and obligations disclosed in
Section 4.10 of the Disclosure Schedule.
SECTION 4.11 Absence of Certain Changes. Except as disclosed in Section
4.11 of the Disclosure Schedule or the SEC Reports filed prior to the date
hereof or as permitted or contemplated by this Agreement, since September 30,
1998, none of the Buyer Parties has (a) experienced any change, event or
condition which, individually or in the aggregate, has had or could reasonably
be expected to have a Buyer Material Adverse Effect or (b) conducted its
business in any material respect other than in the ordinary course.
SECTION 4.12 Compliance with Applicable Law; Permits; Licenses. Except as
set forth in Section 4.12 of the Disclosure Schedule:
(a) The businesses of the Buyer Parties are being conducted in all
material respects in compliance with all applicable provisions of any
material federal, state, local or foreign statute, law, ordinance, rule,
regulation, judgment, decree, order, concession, grant, franchise, permit
or license or other governmental authorization or approval applicable to
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them, except for such noncompliance as has not had or could not reasonably
be expected to have a Buyer Material Adverse Effect.
(b) Each Buyer Party owns or validly holds all material licenses,
franchises, permits, approvals, authorizations, exemptions,
classifications, certificates, registrations and similar documents or
instruments that are required for its business and operations, except for
those the failure of which to have has not had or could not reasonably be
expected to have a Buyer Material Adverse Effect. All such licenses,
franchises, permits, approvals, authorizations, exemptions,
classifications, certificates, registrations and similar documents or
instruments are valid and in full force and effect and none of the Buyer
Parties has received any notice of any inquiry or proceeding that could
reasonably be expected to result in the suspension, revocation or material
limitation of any such license; and to the knowledge of Buyer, there is no
reasonable basis for any such suspension, revocation or limitation. None of
the Buyer Parties is currently the subject of any supervision,
conservation, rehabilitation, liquidation, receivership, insolvency or
other similar proceeding nor are any of the Buyer Parties operating under
any formal or informal agreement or understanding with the licensing
authority of any State which restricts its authority to do business or
requires it to take, or refrain from taking, any action.
ARTICLE V
COVENANTS
SECTION 5.1 Conduct of Business Prior to the Closing. Except as expressly
contemplated by this Agreement (including without limitation the Pre-Closing
Restructuring Transactions (defined below), the Closing Transactions and the
other transactions described as conditions to the consummation of the
transactions contemplated by this Agreement specified in Article VI hereof), as
set forth in Section 5.1 of the Disclosure Schedule or with the prior written
consent of Buyer (not to be unreasonably withheld or delayed), during the period
from the date of this Agreement to the Closing, PFG and PLAC will cause each
PennLife Company to, PFG and SFC will cause each ConLife Company and Services
to, and PFG will cause each PFI Company and PCFS to, conduct its business and
operations according to its ordinary and usual course of business and will use
all reasonable efforts consistent therewith to preserve intact and, as
applicable, maintain in good repair its properties, assets and business
organizations, to keep available the services of its officers, agents and
employees and to maintain satisfactory relationships with policyholders, agents
and regulators, in each case in the ordinary course of business. Without
limiting the generality of the foregoing, and except as otherwise provided in
this Agreement and as set forth in Section 5.1 of the Disclosure Schedule or
with the prior written consent of Buyer (not to be unreasonably withheld or
delayed), prior to the Closing, PFG and PLAC will not permit any of the PennLife
Companies to, PFG and SFC will not permit any of the ConLife Companies or
Services to, and PFG will not permit any of the PFI Companies or PCFS to:
(a) propose or adopt any amendment to its Certificate or Articles of
Incorporation or Bylaws (or similar organizational documents);
(b) except in the ordinary course of business, incur any indebtedness
for borrowed money or issue any debt securities or assume, guarantee or
endorse the obligations of any other Person except for obligations of its
Subsidiaries;
(c) (i) adopt any new Benefit Plan (including any stock option, stock
benefit or stock purchase plan) or amend any existing Benefit Plan in any
material respect, except for changes which are less favorable to
participants in such plans or as may be required by applicable law or (ii)
increase in any manner the rate or terms of compensation of any of its
directors, officers, agents or employees, except such increases as are
granted in the
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ordinary course of business consistent with past practice, or enter into
any employment, severance or collective bargaining agreement;
(d) enter into any agreement with any officer, director, employee,
general agent or sales agent of the Companies, Services or PCFS pursuant to
which such Persons will be entitled to receive from any Company any
Transaction Bonus;
(e) (i) sell, transfer or otherwise dispose of any of its property or
assets (not including those assets constituting investment securities of
the Companies, which are the subject of paragraph (f) below) other than in
the ordinary course consistent with past practices and, in any event, if
the value of such properties or assets would, individually or in the
aggregate, exceed $500,000 or (ii) mortgage or encumber any of its property
or assets;
(f) except in the ordinary course consistent with past practices,
sell, transfer or otherwise dispose of any securities in the Companies'
investment portfolios;
(g) enter into or terminate any other material agreements, commitments
or contracts, except agreements, commitments or contracts made or
terminated in the ordinary course of business;
(h) (i) split, combine or reclassify the Shares, (ii) declare, set
aside or pay any dividend or other distribution payable in cash, stock or
property with respect to the Shares, other than those dividends or
distributions set forth in Section 5.1(h) of the Disclosure Schedule, (iii)
issue, sell or pledge, or authorize or propose the issuance, sale or pledge
of any additional shares of, or securities convertible into or exchangeable
for, or options, warrants, calls, commitments or rights of any kind to
acquire, the Shares or any of its capital stock, or (iv) redeem, purchase
or otherwise acquire directly or indirectly any of its capital stock;
(i) except in the ordinary course of business or with respect to
capital projects approved prior to the date hereof, enter into any
agreement or commitment involving an aggregate capital expenditure or
commitment exceeding $100,000;
(j) take any action that would intentionally result in a breach of the
representations and warranties contained in Article III of this Agreement;
(k) adopt a plan of complete or partial liquidation or resolutions
providing for or authorizing such liquidation or a dissolution, merger,
consolidation, restructuring, recapitalization or other reorganization;
(l) materially change any of the tax or financial accounting methods
or practices used by it unless required by GAAP, SAP or applicable law;
(m) settle or compromise any claim (including arbitration) or
litigation, which after insurance reimbursement involves an amount in
excess of $250,000 or otherwise is material to the Company involved or the
Companies taken as a whole;
(n) file any amended Tax Return or settle or compromise any claim
relating to Taxes;
(o) make any payment, loan or advance of any amount to or in respect
of, or engage in the sale, transfer or lease of any of its property or
assets to, or enter into any contract with, any affiliate (other than those
dividends or distributions set forth in Section 5.1(h) of the Disclosure
Schedule or pursuant to arrangements already in place prior to the date
hereof and described in Section 3.25 of the Disclosure Schedule);
(p) amend the terms of or terminate any (i) Material Contracts or
Reinsurance Agreements (other than an extension of the terms, or
termination in accordance with the scheduled termination, of such Material
Contract or Reinsurance Agreements expressly required by their terms) or
(ii) contracts, agreements or arrangements with any affiliate to
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cause any change in the cost, services being provided, or term of any such
agreements, other than as specifically contemplated by this Agreement;
(q) enter into or renew (other than a renewal of such contract
expressly required by the terms of such contract) any contract that would
be considered a Material Contract or Reinsurance Agreement (including any
contracts, agreements or arrangements with any affiliates);
(r) engage in any transaction with any affiliate, except to the extent
provided in this Agreement; or
(s) agree to take any of the foregoing actions.
SECTION 5.2 Management of Companies. Sellers shall, from the date of this
Agreement through the Closing Date, cause management of the Companies to consult
on a periodic basis and in good faith with the employees and representatives of
Buyer concerning the management of the Companies' businesses, including without
limitation the policies and practices of the Companies with respect to (i) the
ceding or assumption of reinsurance or the termination or modification of
existing Reinsurance Agreements (except as contemplated by this Agreement), (ii)
significant underwriting, actuarial, Tax or accounting issues (including matters
related to Tax audits or the establishment, review and modification of insurance
and other reserves), (iii) significant matters relating to the conditions, forms
and pricing of new kinds of policies and (iv) significant matters relating to
the agency force, product distribution, commissions and similar matters;
provided, however, that management of the Companies shall not consult with
employees and representatives of Buyer on any matter if, based on advice of
counsel, management determines that such consultation might violate the
provisions of the HSR Act or any other laws.
SECTION 5.3 Access to Information.
(a) Between the date hereof and the Closing Date, PLAC, PFG and SFC shall
cause the Companies, Services and PCFS to give to Buyer and its counsel,
accountants and other authorized representatives and agents, full access, during
regular business hours and upon reasonable advance notice, to any and all of
their respective premises, properties, contracts, books and records, and will
cause their respective officers and employees to furnish to Buyer and its
representatives, except where prohibited by law, any and all data and
information pertaining, directly or indirectly, to the Companies, the ConLife
Employees, the PCFS Employees and the PCFS Assets that Buyer shall from time to
time reasonably request, and shall permit Buyer and its representatives to make
extracts and copies thereof. Buyer shall not exercise its rights under this
Section 5.3(a) in such a manner as to unreasonably interfere with the ordinary
operations of any of the Companies, Services or PCFS.
(b) As part of the foregoing review, PennLife shall, and PFG and PLAC shall
cause PennLife to, retain and permit the Reserves Consultants to conduct
independent reviews of all insurance reserves of PennLife (other than life
insurance reserves) (the "PennLife Insurance Reserves"), including but not
limited to disability income claim reserves.
(c) If the transactions contemplated herein are consummated, Buyer
covenants and agrees that it shall preserve and keep the records of the
Companies delivered to it hereunder for a period of seven years from the Closing
Date, and shall make such records available to PLAC, PFG and SFC (without
charge, other than reasonable photocopying expenses if copies are so requested
by PFC, PLAC or SFC), as reasonably requested by PLAC, PFG and SFC in connection
with any legal proceedings by or against, or governmental investigations of,
PLAC, PFG and SFC or any of their affiliates, or in connection with any tax
examination of PLAC, PFG and SFC or any consolidated group of which any of them
was a part or for any other proper business purpose of PLAC, PFG or SFC or their
affiliates.
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(d) If the transactions contemplated herein are consummated, Buyer, Sellers
and the Companies jointly covenant and agree that, from and after the Closing
Date, each will use its reasonable best efforts to cooperate with each other in
connection with (i) the preparation of any Tax Return described in Section
5.17(e) or 5.17(f) of this Agreement and (ii) any action, suit, proceeding,
investigation or audit of any of them relating to any Tax liability that may be
the subject of indemnification under Article VIII of this Agreement. In
furtherance thereof, Buyer, Sellers and the Companies further covenant and agree
to promptly respond to all inquiries related to such matters and to provide, to
the extent reasonably possible, substantiation of transactions and to make
available and furnish appropriate documents and personnel in connection
therewith.
SECTION 5.4 HSR Act Filings. As soon as practicable after the date
hereof, PFG and Buyer shall make appropriate filings with the DOJ under the HSR
Act, with respect to the transactions contemplated by this Agreement. In
connection with such filings, the parties hereto shall, in cooperation with each
other, and as promptly as reasonably practicable from time to time hereafter,
make all such further filings and submissions, and take such further action, as
may be required in connection therewith. Each party shall furnish the others all
information in its possession necessary for compliance by the others with the
provisions of this Section 5.4. No party shall withdraw any such filing or
submission prior to the termination of this Agreement without the written
consent of the other parties.
SECTION 5.5 State Regulatory Approvals. As soon as practicable after the
date hereof, Buyer shall file all applications and other documents, and shall
use its reasonable best efforts to obtain all consents and approvals, as are
required to be filed or obtained by it under the applicable laws of the States
of Texas, North Carolina, Pennsylvania, New York and Florida and the federal or
provincial government of Canada, as applicable, and of any other applicable
jurisdictions, including all requisite approvals of the insurance regulatory
authorities in such jurisdictions and all other governmental approvals required
for consummation of the transactions contemplated by this Agreement, in each
case as promptly as is practicable. PFG and PLAC shall cause the PennLife
Companies, PFG and SFC shall cause the ConLife Companies and Services, to the
extent necessary, and PFG shall cause the PFI Companies and PCFS, to the extent
necessary, to take all such actions (other than the payment of money not then
due and owing or the provision of other consideration) as are reasonably
requested by Buyer to assist Buyer in completing all such filings and obtaining
all such consents and approvals as are required to be made and obtained. Buyer
shall take all such actions (other than the payment of money not then due and
owing or the provision of other consideration) as are reasonably requested by
PLAC, PFG, SFC and ConLife to assist in completing all filings and obtaining all
consents and approvals as any of them may be required to make and obtain.
SECTION 5.6 Pre-Closing Restructuring Transactions; Other Pre-Closing
Matters.
(a) At or prior to the Closing, PLAC, PFG and SFC shall cause to occur the
transactions listed in Annex H (the "Pre-Closing Restructuring Transactions");
provided, however, that the parties acknowledge that a portion of the Cash
Purchase Price will be used to effect certain Pre-Closing Restructuring
Transactions simultaneously with the Closing.
(b) Prior to the Closing, Sellers shall pay in full all amounts due or to
become due in respect of the lease for 3 Bethesda Metro Center, Suite 1600,
Bethesda, Maryland. In addition, prior to the Closing, PFG will assign the Jack
Kent Cook Stadium Lease Agreement to a Subsidiary of PFG (other than any of the
Companies); provided, that if PFG is unable to assign such lease agreement, PFG
shall pay all amounts owing and due with respect to such lease agreement for the
full term thereof and shall be entitled to all of the benefits thereof.
SECTION 5.7 Estimated Statement. PFG shall prepare and deliver (no later
than five Business Days prior to the Closing Date) to Buyer a pro forma
statement (the "Estimated Statement") reflecting PFG's good faith estimate of
the capital and surplus (excluding AVR and
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IMR) of the PennLife Companies and the ConLife Companies as of the Closing Date
assuming that the transactions contemplated hereby (including the Closing
Transactions and the Pre-Closing Restructuring Transactions) occurred on and as
of such date. The Estimated Statement shall be prepared in accordance with SAP
using the assumptions and methodologies used in the preparation of the 1998 SAP
Financial Statements.
SECTION 5.8 Transaction Bonuses. PFG, PLAC or SFC shall pay at or prior
to Closing all Transaction Bonuses payable to those officers, directors,
employees or agents set forth on Section 3.26 of the Disclosure Schedule or
otherwise agreed by Buyer and Sellers prior to Closing in accordance with
Section 5.1(d). To the extent such payments are made by any of the Companies,
PFG, PLAC or SFC shall reimburse the relevant Companies for the full amount of
such payments at Closing. Buyer shall cause the Companies to assume all
obligations under the retention agreements referenced in Section 3.26 of the
Disclosure Schedule arising after the Closing, other than the obligation to pay
the Transaction Bonuses.
SECTION 5.9 Payments to Agents. (a) Except as provided in Sections 5.9(b)
or (c) below, at or prior to Closing, PFG, PLAC or SFC shall pay any and all
amounts payable to any and all agents and other persons under compensation
arrangements made or allegedly made in connection with, in contemplation of or
otherwise relating to the proposed management-led buyout of PennLife (the
"Pre-Sale Obligations").
(b) At or prior to Closing, Buyer will (i) enter into investment agreements
(the "Investment Agreements") with respect to the Buyer Common Stock to be
purchased by certain agents of PennLife, (ii) adopt commission schedules and
(iii) adopt stock-based and other compensation plans, in each case on terms
consistent with Schedule 5.9(b) (the "Post-Closing Compensation Obligations").
(c) At and after the Closing, Buyer will cause PennLife to make all cash
payments that relate to the Pre-Sale Obligations to the extent that such amounts
are reserved for such purpose on the Unaudited Financial Statements and the
Audited Financial Statements and set forth in Section 5.9 of the Disclosure
Schedule.
SECTION 5.10 All Reasonable Efforts.
(a) Subject to the terms and conditions herein provided, each of the
parties hereto agrees to use all reasonable efforts to take, or cause to be
taken, all action, and to do, or cause to be done as promptly as practicable,
all things necessary, proper and advisable under applicable laws and regulations
to consummate and make effective as promptly as practicable the transactions
contemplated by this Agreement including, without limitation, all actions
necessary to satisfy any conditions set forth in the Chase Commitment. If at any
time after the Closing any further action is necessary or desirable to carry out
the purposes of this Agreement, including, without limitation, the execution of
additional instruments, the proper officers and directors of each party to this
Agreement shall take all such necessary action.
(b) At the Closing, PFG will assign to Buyer the non-exclusive right to
enforce the rights of PFG under the confidentiality agreements entered into
between Salomon Smith Barney, as agent for PFG and the Companies, and the
prospective purchasers of the Companies to the extent that such rights pertain
to the Companies.
SECTION 5.11 Public Announcements. The parties hereto will consult with
each other and will mutually agree (the agreement of each party not to be
unreasonably withheld or delayed) upon the content and timing of any press
release or other public statements with respect to the transactions contemplated
by this Agreement and shall not issue any such press release or make any such
public statement prior to such consultation and agreement, except as may be
required by applicable law or by obligations pursuant to any listing agreement
with any securities exchange or any stock exchange regulations as advised by
counsel; provided, however, that each party will give prior notice to the other
parties of the content and timing of any such press
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release or other public statement required by applicable law or by obligations
pursuant to any listing agreement with any securities exchange or any stock
exchange regulations.
SECTION 5.12 Disclosure Supplements. From time to time prior to the
Closing, PLAC, PFG and SFC may supplement or amend the Disclosure Schedule
delivered in connection herewith with respect to any matter which, if existing
or occurring at or prior to the date of this Agreement, would have been required
to be set forth or described in such Disclosure Schedule or which is necessary
to correct any information in such Disclosure Schedule which has been rendered
inaccurate thereby. Such supplements and amendments shall not be given effect
for purposes of Section 6.1(d); however, if the Closing occurs, Buyer shall be
deemed to have waived any right or claim it may otherwise have or have had on
account of any matter so disclosed in such supplement or amendment.
SECTION 5.13 Employment and Employee Benefits.
(a) Buyer shall offer employment to all PCFS Employees (other than such
employees who are disabled for purposes of the long-term disability plans, if
any, applicable to such employees) employed immediately prior to the Closing
Date upon the same terms and conditions of employment as in effect immediately
prior to the Closing Date, which employment shall be effective on the Closing
Date; provided, however, that Buyer shall not be obligated to offer employment
to any PCFS Employees hired between the date hereof and the Closing Date who
were hired without the consent of Buyer other than replacement employees
performing functions substantially similar to his or her predecessor. Buyer
shall be liable, and shall indemnify and hold Sellers harmless from any and all
obligations or liabilities, contingent or otherwise, relating to or arising from
the employment or termination of employment of the PennLife Employees or PFI
Employees or any PCFS Employees hired pursuant to the first sentence of this
Section 5.13(a) (together, the "Company Employees"), with respect to periods
after the Closing Date. Sellers shall be liable for, and shall indemnify and
hold Buyer harmless from any and all obligations or liabilities, contingent or
otherwise, relating to or arising from the employment or termination of
employment of any other employees of PFG or any of its affiliates (other than
any of the Companies), including any PCFS Employees not hired pursuant to the
first sentence of this Section 5.13(a) and any ConLife Employees with respect to
periods up to and after the Closing Date, except to the extent that such
obligations and liabilities are accrued for and are reflected on the Companies'
balance sheets.
(b) At and following the Closing Date: (i) Buyer shall administer and pay
the claims, liabilities and expenses, and shall indemnify and hold Sellers
harmless with respect to Benefit Plans that are sponsored or maintained by the
Companies (the "Buyer Plans"), to the extent that such claims, liabilities and
expenses relate to the Company Employees and (A) relate to periods after the
Closing Date or (B) relate to periods prior to the Closing to the extent that
such claims, liabilities and expenses are accrued and are reflected on the
Companies' balance sheets; and (ii) Sellers shall indemnify and hold Buyer
harmless with respect to claims, liabilities and expenses under the Buyer Plans,
to the extent that such claims, liabilities and expenses relate to periods prior
to the Closing and are not accrued or reflected on the Companies' balance
sheets. At and following the Closing Date, Sellers shall administer and pay the
claims, liabilities and expenses, and shall indemnify and hold Buyer harmless,
with respect to all claims, liabilities and expenses relating to (i) any Benefit
Plans that are not Buyer Plans, (ii) any "employee benefit plans" (as defined in
Section 3(3) of ERISA) other than the Benefit Plans currently or previously
sponsored by Sellers, and (iii) any pension plans, whether or not subject to
Title IV of ERISA, and any liabilities or expenses incurred by any entity that
is required to be aggregated with the Companies pursuant to section 414(b), (c)
or (m) of the Code, immediately prior to, but not immediately after, the Closing
Date, to the extent that any such claims, liabilities and expenses are not
accrued or are not reflected in the Companies' balance sheets.
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(c) Without limiting or expanding Buyer's obligations with respect to the
Post-Closing Stock-Based Compensation contemplated in Section 5.9(b) and subject
to the last sentence of Section 5.13(d), Buyer shall, and shall cause its
Subsidiaries (including the Companies), to provide employee benefits for Company
Employees that are at least substantially comparable in the aggregate to the
employee benefits and compensation provided to similarly situated Persons (i) by
Sellers or their affiliates under the Benefit Plans and compensation
arrangements in effect as of the Closing Date or (ii) by Buyer under its
employee benefit plans and compensation arrangements in effect for its
employees. Buyer shall or shall cause the Companies to pay all accrued and
unpaid compensation, including vacation pay, as of the Closing Date in respect
of the Company Employees except as provided in Section 5.8 or 5.13(b).
(d) If Company Employees are included in any benefit plan (including
without limitation, provision for vacation) of Buyer or its Subsidiaries, such
employees shall receive credit for service prior to the Closing Date with
Sellers or any of their Subsidiaries or affiliates to the same extent such
service was counted under similar Benefit Plans for purposes of eligibility,
vesting and eligibility for retirement, and benefit accrual with respect to
vacation, disability and severance. Buyer shall use reasonable efforts to
provide medical, dental and health plan coverage to Company Employees as of the
Closing Date that shall not include pre-existing condition exclusions, except to
the extent such exclusions were applicable under the similar Benefit Plan as of
the Closing Date, and such plans shall provide credit for any deductibles and
co-payments applied or made with respect to each Company Employee in the
calendar year of the Closing. Buyer assumes the obligation, if any, to provide
coverage to the extent required by Part 6 of Title I of ERISA from and after the
Closing Date to Company Employees (but not any ConLife Employees or PCFS
Employees) who terminated their employment on or before the Closing Date. No
benefits are guaranteed or promised hereunder to any Company Employee with
respect to stock option, bonus or incentive plans, but may be so provided by
Buyer in its sole discretion.
(e) Prior to or effective as of the Closing Date, Sellers shall cause the
Companies to contribute or accrue employer matching contributions for the
portion of the calendar year prior to the Closing Date, with respect to all
Company Employees, and shall immediately thereafter fully vest all such Company
Employees' accounts under any 401(k) plan maintained by Sellers or their
Subsidiaries prior to the Closing Date for the benefit of Company Employees. As
soon as practicable after the Closing Date, Buyer shall cause a 401(k) plan
maintained by Buyer or the Companies to accept "eligible rollover
contributions," within the meaning of Section 402(f)(2)(A) of the Code, from any
401(k) plan maintained by Sellers or their Subsidiaries prior to the Closing
Date, for the benefit of Company Employees.
SECTION 5.14 Nonsolicitation. Each of PLAC, PFG and SFC and any of its
affiliates (other than the Companies) hereby agrees that, for a period
commencing on the Closing Date and ending on the second anniversary of the
Closing Date, it shall not, without Buyer's prior written consent, directly or
indirectly, solicit or hire any of the current officers, general agents or sales
agents (down to the level of district manager) of any of the Companies except
those officers disclosed in Section 5.14 of the Disclosure Schedule; provided,
however, that nothing herein shall prohibit it or any of its Subsidiaries from
publishing a general solicitation of employment in any newspaper, magazine,
trade publication or other medium or from soliciting or hiring any person who
was an officer of any of the Companies on the Closing Date but whose employment
by such Company thereafter ceases, except as a result of Sellers' solicitation
or hiring of such person in violation of the first clause of this Section 5.14.
SECTION 5.15 Acquisition Proposals. No Seller shall, nor shall it
authorize or permit any of its officers, directors or employees or any
investment banker, attorney or other advisor or representative acting on its
behalf to, directly or indirectly, (a) make any offer or proposal to any Person
or enter into any contract with any Person to (i) sell or otherwise transfer any
of the capital stock or assets or properties of the Companies or any of the PCFS
Assets or (ii) effect
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any recapitalization, refinancing, restructuring, merger, consolidation or other
business combination involving the Companies or any of the PCFS Assets; (b)
entertain, solicit, encourage, accept, negotiate or otherwise hold substantive
discussions regarding any offer or proposal from any Person to (i) purchase or
otherwise acquire any of the capital stock or assets or properties of the
Companies or any of the PCFS Assets, (ii) effect any recapitalization,
refinancing, restructuring, merger, consolidation, or other business combination
involving the Companies or any of the PCFS Assets, or (c) provide any non-public
information regarding the Companies or the PCFS Assets to any prospective
purchaser thereof. If any such offer or proposal is made to or received from any
Person, Sellers will promptly advise such Person by written notice of the terms
of this Section 5.15 and will promptly deliver a copy of such notice to Buyer.
SECTION 5.16 Section 338(h)(10) Election, Allocation of Purchase Price
under Sections 338 and 1060 and Matters Relating to SWLIC. (a) An election
under Section 338(h)(10) of the Code and any corresponding elections under the
state, local or foreign tax law (the "338(h)(10) Election") shall be made by PFG
and Buyer in respect of the purchase and sale of the PFI Shares. The parties
agree that the Purchase Price will be allocated as provided in Section 2.1 to
the assets of PCFS and PFI for all purposes (including Tax and financial
accounting purposes) in accordance with the rules under Section 338(b)(5) and
Section 1060 of the Code and the Treasury Regulations promulgated thereunder.
The parties agree to cooperate in good faith in preparing the Allocation
Schedule as soon as practicable. Sellers, PCFS, PFI and Buyer will file all Tax
Returns (including amended returns and claims for refund) and information
reports in a manner consistent with such allocation.
(b) If requested by Buyer, Sellers shall also join in the filing of a
Section 338(h)(10) Election with respect to the purchase and sale of the ConLife
Shares. Any Tax liability resulting from such election and all costs associated
with such election shall be borne by Buyer. If such election is made, the
principles of the second, third and fourth sentences of Section 5.16(a) shall
apply.
(c) As promptly as practicable (but in no event more than 90 days) after
the Closing Date, PFG shall deliver to Buyer (i) a calculation certified by
PFG's Chief Financial Officer stating ConLife's estimated tax basis in the
shares of common stock, par value $1.00 per share, of SWLIC as of the Closing
Date, which shall separately state adjustments for income, losses,
distributions, contributions and other relevant adjustments from January 1, 1998
through the Closing Date with respect to such tax basis (the "SWLIC Basis
Adjustments") and (ii) if requested by Buyer, an updated appraisal from
Tillinghast setting forth the fair market value of SWLIC as of the latest
practical date up to and including the Closing Date (the "SWLIC Valuation
Opinion"). If Buyer requests the SWLIC Valuation Opinion, the costs thereof
shall be shared equally by Buyer and PFG. If Buyer requests the SWLIC Valuation
Opinion, the Buyer Actuary shall review the SWLIC Valuation Opinion with
Tillinghast in order to arrive at a mutually agreed upon fair market value of
SWLIC (the "SWLIC Value"). If the SWLIC Value is greater than $220 million plus
the SWLIC Basis Adjustments, 35% of such excess shall be recorded as a liability
for Taxes on the Closing Statement with respect to ConLife. PFG and SFC agree
that unless such a liability is recorded on the Closing Statement as set forth
in the preceding sentence, they shall not take the position in any Tax Return
that the Tax basis of SWLIC immediately after the Closing Transactions exceeds
$220 million plus or minus, as the case may be, the SWLIC Basis Adjustments.
SECTION 5.17 Tax Matters.
(a) Sellers shall be responsible and shall pay all Taxes imposed on the
income of the Companies, including, without any limitation, any amounts included
in income under Treasury Regulation Sections 1.1502-13 and 1.1502-14, any excess
loss accounts taken into income under Treasury Regulation Section 1.1502-19 and
any Taxes resulting from the transactions contemplated under this Agreement, for
all periods through and including the Closing Date to the extent
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not provided as a current Tax liability on the Closing Statement. Except as
required by law, PFG, PLAC and SFC shall take no position on such Tax Returns
that relate to the Companies that would adversely affect the Companies after the
Closing Date. The income of the Companies shall be apportioned to the period up
to and including the Closing Date (excluding income after the Closing but prior
to the end of the Closing Date (i) that is not incurred in the ordinary course
of business, (ii) that is not incurred pursuant to the transactions contemplated
by this Agreement and (iii) that is caused by Buyer, which in each case shall be
attributed to the period after the Closing Date) and the period after the
Closing Date by closing the books of the Companies as of the end of the Closing
Date.
(b) PFG, PLAC and SFC shall make no election to retain any net operating
loss carryovers or capital loss carryovers of the Companies under Treasury
Regulation Section 1.1502-20(g) or any similar provision of federal, state,
local or foreign law.
(c) PFG, PLAC and SFC shall allow the Companies and its counsel to
participate in any audits of the consolidated federal income Tax Returns of PFG,
PLAC or SFC to the extent that such Tax Returns relate to the Companies.
(d) PFG, PLAC and SFC shall immediately pay to Buyer any Tax refund (or
reduction in Tax liability) resulting from a carryback of a postacquisition Tax
attribute of any of the Companies into a consolidated, combined or unitary Tax
Return of PFG, PLAC or SFC, when such refund or reduction is realized by PFG,
PLAC or SFC. PFG, PLAC and SFC shall cooperate with the Companies in obtaining
such refunds (or reduction in Tax liability), including through the filing of
amended Tax Returns. PFG shall be entitled to any Tax refund (or reduction in
Tax liability) from a Tax Return for a taxable year that ends on or prior to the
Closing Date or the portion ending on the Closing Date of any taxable year that
includes the Closing Date that was not reflected on the Closing Statement and is
not described in the first sentence of this Section 5.17(d) (a "Seller Refund"),
net of any tax payable by Buyer or the Companies in respect of the receipt or
accrual of such Seller Refund or any additional correlative tax liability in
another taxable year (a "Seller Net Refund Amount"). If Buyers or any of the
Companies realize such Seller Refund in cash or through the reduction of another
Tax liability for which Buyer is responsible hereunder after the Closing Date,
they shall pay the associated Seller Net Refund Amount over to PFG within five
days of receipt.
(e) PFG, PLAC and SFC will prepare or cause to be prepared, and file or
cause to be filed in a manner consistent with past practice and in the ordinary
course of business (subject to any departure required to comply with any
applicable law) (i) all consolidated, combined, or unitary Tax Returns of the
Sellers, the PLAC Group, the ConLife Group or the PFG Group that include the
Companies for all periods that begin prior to the Closing Date and (ii) all
other Tax Returns required to be filed by or on behalf of the Companies on or
prior to the Closing Date. PFG, PLAC and SFC agree to consult with Buyer with
respect to the Tax Returns described in this section, and shall deliver drafts
of such Tax Returns to Buyer no later than 10 Business Days prior to the date,
including extensions, on which such Tax Returns are required to be filed.
(f) Buyer will prepare or cause to be prepared, and file or cause to be
filed, all Tax Returns of the Companies other than those set forth in Section
5.17(e). Buyer will prepare all Tax Returns which reflect any Taxes for which
PFG, PLAC and SFC may be obligated to indemnify the Buyer Indemnitees under this
Agreement, in a manner consistent with past practice (subject to any departure
required to comply with any applicable law). Buyer agrees to consult with PFG
with respect to the Tax Returns described in the preceding sentence, and shall
deliver drafts of such Tax Returns to PFG no later than 10 Business Days prior
to the date, including extensions, on which such Tax Returns are required to be
filed.
(g) The Consolidated Federal Income Tax Liability Allocation Agreement,
dated December 14, 1995, among ConLife, Union Bankers and Marquette, as amended
by the First Amendment to Consolidated Federal Income Tax Liability Allocation
Agreement, dated as of
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January 1, 1996, among ConLife, Union Bankers, Marquette and SWLIC (other than
Section 4 thereof) shall remain in effect solely as between ConLife and SWLIC
with respect to taxable periods through and including the Closing Date. Except
as provided in the foregoing sentence, effective as of the Closing Date, PFG,
PLAC and SFC shall terminate, or cause to be terminated, any agreements relating
to the sharing or allocation of, or indemnification agreement with respect to,
Taxes, or any similar contract or arrangement to which any of the Companies is
party such that none of the Companies has any further Tax liability thereunder
except as provided as a current Tax liability on the Closing Statement, which
shall be paid as soon as reasonably practicable after the Closing.
SECTION 5.18 Financial Matters; Proxy Statement. (a) As soon as
reasonably practicable following the date of this Agreement, PFG shall deliver
to Buyer true and complete copies of (i) the audited combined financial
statements of the Companies (and PCFS, to the extent required under Item 13 of
Schedule 14A under the Exchange Act for purposes of the Proxy Statement) as at
and for the years ended December 31, 1995, 1996, 1997 and 1998, together with
the notes thereto (the "Audited Financial Statements"), which shall be certified
by KPMG Peat Marwick LLP ("KPMG"), independent public accountants for PFG, (ii)
a review letter in form and substance reasonably satisfactory to Buyer relating
to the Unaudited Financial Statements (the "Review Letter") and (iii) the Annual
Statements for each PennLife Company and ConLife Company for the year ended
December 31, 1998, including all exhibits, interrogatories, notes and schedules
thereto and any actuarial opinion, affirmation or certification filed in
connection therewith (the "1998 SAP Financial Statements"). In addition, PFG
shall, as promptly as practicable, provide all other financial data and other
information relating to the Companies reasonably requested by Buyer, so as to
permit Buyer to satisfy any reporting or disclosure obligations of Buyer
relating to the transactions contemplated by this Agreement.
(b) Prior to the Closing Date, PennLife shall, and PFG and PLAC shall cause
PennLife to, record in accordance with GAAP and SAP additional reserves relating
to adverse loss development applicable to the disability income claim reserves
of PennLife to the extent appropriate as indicated in the applicable report of
the Reserves Consultants; provided, that PennLife shall not be required to
record additional reserves in excess of $5 million.
(c) As soon as reasonably practicable after the delivery to Buyer of the
Audited Financial Statements for 1995, 1996 and 1997, Buyer shall file with the
Commission a preliminary proxy statement (the "Proxy Statement") with respect
to, among other things, the solicitation of shareholder votes to amend Buyer's
certificate of incorporation to increase its authorized capital stock. Buyer
shall use its commercially reasonable efforts to promptly respond to any
comments raised by the Commission with respect to the Proxy Statement and shall
cause the definitive Proxy Statement to be mailed to the shareholders of Buyer
at the earliest practicable date. If any event with respect to Buyer, or with
respect to other information supplied by the Companies or Sellers for inclusion
in the Proxy Statement, shall occur which is required to be described in a
supplement to the Proxy Statement, such event shall be so described, and such
supplement shall be promptly filed with the Commission and, as required by law,
disseminated to shareholders of Buyer. The Proxy Statement will comply as to
form in all material respects with the provisions of the Exchange Act and the
rules and regulations thereunder.
SECTION 5.19 Peninsular Licenses.
(a) Prior to the Closing, Sellers shall cooperate with and assist, and
shall cause the Companies to cooperate with and assist, Buyer in causing
Peninsular (i) to remove such restrictions as is reasonably necessary to permit
Peninsular to write new business in the states in which Peninsular holds
licenses to conduct insurance business as of the date hereof and (ii) to obtain
licenses to conduct insurance business in the states listed in Section 5.19 of
the Disclosure Schedule and to obtain such product approvals in such states as
Buyer reasonably requests.
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(b) Buyer will reimburse PFG and/or PLAC, as applicable, for all actual
out-of-pocket costs incurred in connection with obtaining the licenses and
product approvals contemplated in Section 5.19(a) above.
(c) If Buyer is unable to acquire the Peninsular Shares, (i) the Cash
Purchase Price will be reduced by the Peninsular Purchase Price, (ii) PFG or its
designee will purchase the Peninsular Shares for an amount in cash equal to the
Peninsular Purchase Price, (iii) the Aggregate Capital Amount will be reduced by
$12,725,000 and the Target Capital Amount for Peninsular will be eliminated, and
(iv) all ConLife business being reinsured by Peninsular pursuant to the
reinsurance transaction contemplated in item 9 of Annex E will be transferred by
Peninsular to a party designated by Buyer under a reinsurance agreement
containing terms reasonably satisfactory to Buyer.
SECTION 5.20 PCFS Licenses. At or prior to Closing, Sellers shall use
their commercially reasonable best efforts to obtain all software licenses (the
"PCFS Licenses") required to be obtained in connection with the sale of the PCFS
Assets to Buyer. At the Closing, Buyer shall reimburse PFG for 50% of all costs
incurred in connection with obtaining the PCFS Licenses.
SECTION 5.21 Change of Name. As soon as reasonably practicable after the
Closing Date, Buyer shall cause PC-Canada and PFI (and, to the extent
applicable, any Subsidiaries thereof) to amend their respective organizational
documents and take all other regulatory and other actions to change their
respective names to a name that does not include the word "PennCorp" or any
variant thereof. Notwithstanding the foregoing, PC-Canada and PFI (and any
applicable Subsidiaries thereof) may, until such name change occurs, continue to
use stationery, letterhead, policy forms, business cards and other property or
assets on which the name "PennCorp" or any variant thereof appears so long as
Buyer uses its reasonable efforts to cause appropriate notations to be made
thereon indicating that such Companies are divisions of UAFC and are not part of
the PennCorp Financial Group, Inc. group of companies.
SECTION 5.22 Litigation Arising Between Signing and Closing. Sellers will
provide Buyer with prompt notice in reasonable detail of any Litigation,
complaints, charges or claims against any of the Companies or PCFS before any
Governmental Authority or arbitrator initiated or, to the knowledge of Sellers,
threatened between the date hereof and the Closing Date that would have been
required to be disclosed in Section 3.10 of the Disclosure Schedule ("New
Litigation") or Section 3.23(f) of the Disclosure Schedule ("New Employee
Claims") had they arisen or been in existence on or prior to the date of this
Agreement.
ARTICLE VI
CLOSING CONDITIONS
SECTION 6.1 Conditions to the Obligations of Buyer under this
Agreement. The obligations of Buyer under this Agreement to consummate the
Closing Transactions shall be subject to the satisfaction, at or prior to the
Closing, of the following conditions:
(a) subject to Section 5.19(c) hereof, all authorizations, consents
and approvals contemplated by Sections 3.6 and 4.5, including the PennLife
Insurance Approvals, the ConLife Insurance Approvals (which shall include
approval to restructure the capital of the PennLife Companies and the
ConLife Companies to reset unassigned surplus to not less than zero) and
the Buyer Approvals, shall have been obtained and shall be in full force
and effect and applicable regulators shall not have imposed any material
and adverse prohibitions, limitations, conditions or restrictions on Buyer
or any of the Companies in connection with the approvals by such regulators
of the Forms A to be filed by the parties as contemplated hereby, including
but not limited to a restriction on the ability of any of the Companies to
pay ordinary dividends or to write any material line of business.
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(b) any waiting period applicable to the consummation of the sale and
purchase of the Shares under the HSR Act shall have expired or been
terminated;
(c) no injunction, restraining order or other ruling or order issued
by any Governmental Authority or other legal restraint or prohibition
preventing the consummation of the Closing Transactions shall be in effect;
(d) each of the obligations of PLAC, PFG, SFC and PCFS required to be
performed by it at or prior to the Closing pursuant to this Agreement shall
have been duly performed and complied with in all material respects, and
the representations and warranties of PLAC, PFG, SFC and PCFS contained in
this Agreement shall be true and correct in all material respects as of the
date of this Agreement and as of the Closing Date as though made at and as
of the Closing Date (except (i) as to those representations or warranties
which specifically relate to an earlier date, which need to be true and
correct in all material respects as of such specified dates and (ii) to the
extent that the representation and warranty set forth in Section 3.15(e)
has been rendered inaccurate as the result of any claims asserted with
respect to Agent Compensation between the date hereof and the Closing), and
Buyer shall have received a certificate to that effect signed by a senior
officer of each of PLAC, PFG, SFC and PCFS;
(e) any and all material permits, consents, waivers, clearances,
approvals and authorizations of Governmental Authorities and all material
consents, licenses, waivers or approvals of any other third parties (other
than those contemplated by subparagraph (a) above), including the PCFS
Licenses, which are necessary in connection with the consummation of the
Closing Transactions and the consummation of the transactions contemplated
by the Universal Share Purchase Agreement shall have been obtained;
(f) Buyer shall have received opinions of counsel to Sellers, in the
forms attached hereto as Annex E;
(g) Security Life and Trust Insurance Company ("Integon") and PennLife
shall have entered into a lease agreement containing the material terms set
forth on Exhibit D on terms reasonably satisfactory to Buyer pursuant to
which, following the Closing, PennLife will continue to occupy office space
currently occupied by PennLife Employees at the facility located at Wycliff
Road in Raleigh, North Carolina, for the term described in Exhibit D;
(h) Buyer or any of the Companies and AmeriLife Marketing Inc. shall
have entered into an agreement containing the material terms set forth on
Exhibit A and otherwise on terms reasonably satisfactory to Buyer;
(i) the capital and surplus (excluding AVR and IMR) of the PennLife
Companies and the ConLife Companies reflected on the Estimated Statement
shall equal or exceed the Target Capital Amount for each Company and the
Aggregate Target Capital Amount shall have been satisfied;
(j) all intercompany indebtedness owed by PFG and its affiliates
(other than the Companies) to any of the Companies or owed by the Companies
to PFG or its affiliates (other than the Companies) as listed on Section
3.25 of the Disclosure Schedule shall have been paid in full, and all other
affiliate transactions described on Section 3.25 of the Disclosure Schedule
shall have been terminated (other than such affiliate transactions solely
among the Companies), with no further liability to any of the Companies or
relating to the PCFS Assets;
(k) PFG shall have executed and delivered the Pledge and Security
Agreement;
(l) the conditions set forth in the Chase Commitment shall have been
satisfied, to the satisfaction of Chase Bank and Chase Securities;
provided, however, that upon receipt of notice from Chase Bank that the
reports delivered by the Reserves Consultants and the 1998
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Audited Financial Statements are satisfactory under the terms of the Chase
Commitment (which shall be deemed satisfactory for purposes of this clause
if no objection is made within 30 days of delivery of the last of such
reports and financial statements), the conditions specified in this Section
6.1(m) shall no longer be conditions to the consummation by Buyer of the
Closing Transactions;
(m) the Reserves Consultants shall have completed their review of all
of the PennLife Insurance Reserves and the results of such reviews shall be
reasonably satisfactory to Buyer; provided, however, that Buyer shall make
its determination of the adequacy of such reports within 30 days of
delivery of the last of such reports;
(n) each of the Pre-Closing Restructuring Transactions shall have been
completed or otherwise provided for to the reasonable satisfaction of
Buyer;
(o) Sellers shall have delivered to Buyer for inclusion in the Proxy
Statement the 1998 Audited Financial Statements specified in Section
5.18(a)(i) and the shareholders of Buyer shall have approved at a special
meeting of shareholders of Buyer the matters requiring shareholder approval
as set forth in the UAFC Share Purchase Agreement, in accordance with New
York law and the rules of Nasdaq;
(p) the Companies shall have received either (i) a rating of B+ or
better from A.M. Best or (ii) assurances from A.M. Best satisfactory to
Buyer that on or immediately after the Closing, the Companies will be
assigned at least a B+ rating;
(q) Buyer or a designated subsidiary of Buyer shall have entered into
an agreement with Integon, Occidental Life Insurance Company of North
Carolina and Professional Insurance Company containing the material terms
set forth on Exhibit F or otherwise on terms reasonably satisfactory to
Buyer and PFG pursuant to which Buyer or such subsidiary shall have agreed
to provide the services specified in Exhibit F for the period specified in
Exhibit F;
(r) the Review Letter shall not indicate any material deficiency in
the Unaudited Financial Statements; and
(s) Sellers shall have delivered to Buyer a certificate complying with
Treasury Regulations section 1.1445-2(b)(2), in form and substance
reasonably satisfactory to Buyer, duly executed and acknowledged,
certifying that Sellers are not foreign persons within the meaning of such
section.
SECTION 6.2 Conditions to the Obligations of Sellers under this
Agreement. The obligation of Sellers under this Agreement to consummate the
Closing Transactions shall be subject to the satisfaction, at or prior to the
Closing, of the following conditions:
(a) all authorizations, consents and approvals contemplated by
Sections 3.6 and 4.5, including the PennLife Insurance Approvals, the
ConLife Insurance Approvals and the Buyer Approvals shall have been
obtained and shall be in full force and effect and applicable regulators
shall not have imposed any material and adverse prohibitions, liabilities,
limitations, conditions or restrictions on Sellers or (to the extent
Sellers would be prevented from consummating the transactions contemplated
by this Agreement) the Companies, in connection with the approvals by such
regulators of the Forms A to be filed by the parties as contemplated hereby
including but not limited to a restriction on the ability of Union Bankers
to pay the Union Bankers Special Dividend or on the ability of the Sellers
or the Companies to make any other reallocation of capital and surplus as
otherwise permitted or required by this Agreement;
(b) any waiting period applicable to the consummation of the sale and
purchase of the Shares under the HSR Act shall have expired or been
terminated;
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(c) no injunction, restraining order or other ruling or order issued
by any Governmental Authority or other legal restraint or prohibition
preventing the consummation of the Closing Transactions shall be in effect;
(d) each of the obligations of Buyer required to be performed by it at
or prior to the Closing pursuant to the terms of this Agreement shall have
been duly performed and complied with in all material respects, and the
representations and warranties of Buyer contained in this Agreement shall
be true and correct in all material respects as of the date of this
Agreement and as of the Closing Date as though made at and as of the
Closing Date (except as to any representation or warranty which
specifically relates to an earlier date), and Sellers shall have received a
certificate to that effect signed by an officer of Buyer;
(e) Buyer or a designated subsidiary of Buyer shall have entered into
an agreement with Integon, Occidental Life Insurance Company of North
Carolina and Professional Insurance Company containing the material terms
set forth on Exhibit F or otherwise on terms reasonably satisfactory to
Buyer and PFG pursuant to which Buyer or such subsidiary shall have agreed
to provide the services specified in Exhibit F after the Closing for the
period specified in Exhibit F;
(f) Sellers shall have received an opinion of counsel to Buyer, in the
form attached hereto as Annex F; and
(g) the shareholders of Buyer shall have approved at a special meeting
of shareholders of Buyer the matters requiring shareholder approval as set
forth in the UAFC Share Purchase Agreement, in accordance with New York law
and the rules of Nasdaq.
ARTICLE VII
CLOSING
SECTION 7.1 Closing. The closing of the Closing Transactions (the
"Closing") shall take place at the offices of Weil, Gotshal & Manges LLP, 767
Fifth Avenue, New York, NY 10153, subject to the satisfaction or waiver of the
conditions set forth in Sections 6.1 and 6.2, as soon as practicable after the
date hereof and in any event not later than June 30, 1999, or at such other time
and place and on such other date as Buyer and PFG shall agree (the "Closing
Date"). As a further condition to Closing, at the Closing:
(a) PLAC, PFG, SFC and PCFS, as applicable, shall deliver or cause to
be delivered to Buyer the following:
(i) the certificates described in Section 6.1(d);
(ii) share certificates representing all of the Shares in
appropriate form for transfer to Buyer duly endorsed in blank or
accompanied by stock powers duly executed in blank;
(iii) resignations of the directors of each of the Companies;
(iv) an executed Bill of Sale, Assignment and Assumption Agreement;
and
(v) a section 116 certificate in respect of the PC-Canada shares
bearing a certificate amount not less than the amount of the PC-Canada
Purchase Price; provided, that if the certificate is not so delivered,
Buyer shall make such withholdings as may be required pursuant to the
Income Tax Act (Canada).
(b) Buyer shall deliver or cause to be delivered to Sellers the
following:
(i) the certificate described in Section 6.2(d);
(ii) the Acquisition Notes; and
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(iii) an executed Bill of Sale, Assignment and Assumption
Agreement; and
(c) Buyer shall pay or cause to be paid to Sellers, by wire transfer
of immediately available funds to such account or accounts as Sellers shall
have designated in writing at least two days prior to the Closing Date, the
Cash Purchase Price.
ARTICLE VIII
SURVIVAL/INDEMNIFICATION
SECTION 8.1 Survival of Representations and Warranties; Indemnification
Obligations.
(a) Notwithstanding any right of Buyer to investigate fully the affairs of
the Company and the Subsidiaries and notwithstanding any knowledge of facts
determined or determinable by Buyer pursuant to such investigation or right of
investigation, Buyer has the right to rely fully upon the representations,
warranties, covenants and agreements of Sellers contained in this Agreement or
in any documents delivered pursuant to this Agreement. All representations and
warranties contained in this Agreement shall survive the execution and delivery
of this Agreement and the Closing (except that the representations and
warranties contained in Sections 4.9, 4.10, 4.11 and 4.12 shall not survive the
Closing). The representations and warranties of Sellers contained in this
Agreement shall terminate and expire (i) with respect to any Claim (as defined
below) based on the representations and warranties contained in Section 3.14 (a
"Tax Representation Claim") on the date which is 30 days after the date upon
which the liability to which any such Tax Representation Claim may relate is
barred by all applicable statutes of limitations (including all periods of
extension, whether automatic or permissive); (ii) with respect to any Claim
based on the representations and warranties contained in Section 3.19, three
years after the Closing Date; (iii) with respect to any Claim based on the
representations and warranties contained in Section 3.13, on the date upon which
the liability to which any such Claim may relate is barred by all applicable
statutes of limitations (including all periods of extension, whether automatic
or permissive); and (iv) with respect to any Claim based on any other
representation and warranty (except for those representations and warranties in
Sections 3.1, 3.2, 3.4, 3.5, 3.16 and 3.24 (the "Fundamental Representations"),
all of which Fundamental Representations shall survive without limitation), on
the date which is 18 months after the Closing Date. Unless a specified period is
set forth in this Agreement (in which event such specified period will control),
the covenants and agreements of this Agreement will survive the Closing and
remain in effect indefinitely.
(b) PFG, with respect to all matters contemplated by this Agreement,
jointly and severally with PLAC, SFC and PCFS; PLAC, with respect only to
matters relating to itself and the PennLife Companies, severally and not jointly
with any other Seller (except PFG); SFC, with respect only to matters relating
to itself and the ConLife Companies, severally and not jointly with any other
Seller (except PFG); and PCFS, with respect only to matters relating to itself,
severally and not jointly with any other Seller (except PFG), will indemnify,
defend and hold harmless Buyer and, following the Closing, the Companies
(together with their respective directors, officers, employees, affiliates,
successors and assigns, the "Buyer Indemnitees") from and against all actions,
causes of action, suits, claims, complaints, demands, litigations, or legal,
administrative or arbitral proceedings or investigations ("Claim"), losses,
liabilities, damages (excluding any indirect, consequential or special damages),
deficiencies, judgments, assessments, fines, settlements, costs or expenses
(including interest, penalties and fees, reasonable expenses and disbursements
of outside attorneys, experts and consultants) incurred by the indemnified party
in any action or proceeding between the indemnifying party and the indemnified
party or between
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the indemnified party and any third party, or otherwise ("Losses") based upon,
arising out of or otherwise in respect of:
(i) any inaccuracy in or any breach of any representation, warranty,
covenant or agreement of Sellers contained in this Agreement or in any
documents delivered by Sellers pursuant to this Agreement (including any
breach of the representation and warranty in Section 3.15(e) relating to
claims for Agent Compensation not listed in Section 3.15(e) of the
Disclosure Schedule); provided, that for purposes of this Section 8.1(b)(i)
only, any inaccuracy in or breach of a representation or warranty shall be
determined without reference to any materiality or Material Adverse Effect
qualifier (other than such qualifier contained in Section 3.28 hereof) that
may be set forth therein;
(ii) any derivative lawsuits or lawsuits based upon violations of
federal and state securities laws against PFG or its affiliates or their
respective officers and directors which are pending as of the date of this
Agreement or which may be brought after the date of this Agreement, whether
or not Buyer, the Companies or any Buyer Indemnitee is named or joined as a
party thereto; provided, that Buyer shall not be entitled to
indemnification under this Section 8.1(b)(ii) for any Losses incurred by
Buyer in connection with such lawsuits that result from any actions of
Buyer that are independent from, and not in breach or violation of, any of
the transactions or other matters contemplated by this Agreement or any
other documents executed and delivered in connection with the transactions
contemplated by this Agreement;
(iii) any Taxes of any member of an affiliated, consolidated,
combined, or unitary group of which any of the Companies is or was a member
on or prior to the Closing Date by reason of the liability of the Companies
pursuant to Treasury Regulation Section 1.1502-6(a) or any analogous or
similar state, local or foreign law or any contractual liability for Taxes
of any party other than the Companies;
(iv) any Phase III Taxes of any Company relating to any period up to
and including the Closing Date;
(v) any Phase III Taxes of any Company relating to any period after
the Closing Date up to and including five taxable years following the
Closing Date and all or any portion of any later taxable year through and
including the fifth anniversary of the Closing Date; provided, that if any
Phase III Taxes arise after the Closing Date as a result of any action
taken by Buyer, Buyer shall only be entitled to be indemnified for 75% of
such Taxes; provided further, that PFG, SFC and PLAC shall not be liable
hereunder with respect to any Phase III Taxes caused solely by Buyer's
failure to make reasonable efforts, for such period, to (A) maintain in
force the reinsurance agreement between ConLife and Peninsular contemplated
by item 9 of Annex H (unless otherwise required by applicable regulators)
and (B) maintain Peninsular as a life insurance company within the meaning
of Section 816 of the Code;
(vi) any reductions in or limitations on the NOLs resulting from any
challenge by a Governmental Authority or limitation imposed under the Code
(other than limitations imposed solely by reason of the Closing
Transactions), including without limitation any increased liability or
Taxes with respect to periods after the Closing;
(vii) in the event the NOLs available for carryover, as provided in
Section 3.14(ac), are less than $20 million, the amount of the difference
multiplied by 35%, utilizing a discount rate of 15% per annum, utilizing
the date when such unavailable amount of NOLs would otherwise have been
available and reflecting the principles of Section 382 of the Code, will
constitute the amount of Buyer's loss. An example of the application of
this calculation is set forth in Exhibit G.
(viii) any of the Pre-Closing Restructuring Transactions (whether such
Losses relate to Taxes or otherwise);
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(ix) any Taxes, or for any Loss of Tax benefits, incurred in
connection with or as a result of any 338(h)(10) Election pursuant to
Section 5.16 of this Agreement;
(x) any Taxes related to the Closing Transactions;
(xi) the Transaction Bonuses and the Pre-Sale Obligations (other than
any Losses resulting from the failure by Buyer to perform its obligations
under Section 5.9(b) or (c));
(xii) any liabilities of PCFS that Buyer has not expressly assumed;
(xiii) the failure of PCFS to comply, in connection with the sale of
the PCFS Assets, with all applicable bulk sales or bulk transfer laws;
(xiv) the presence at any time prior to the Closing of underground
fuel storage tanks at, or the use prior to the Closing as an auto service
station of, the commercial property located at 645 Riverside Avenue,
Jacksonville, Florida 32204 (referred to in Section 3.19 of the Disclosure
Schedule) and arising pursuant to Environmental Laws; and
(xv) the wrongful discharge claim by Mr. Ernie Brezden (item 16 of
Section 3.10 of the Disclosure Schedule), the discrimination claim by
Bernadette Somerville (item 6 of Section 3.10 of the Disclosure Schedule)
and the discrimination claim by Robert Foster (item 18 of Section 3.10 of
the Disclosure Schedule).
SECTION 8.2 Obligation of Buyer to Indemnify. Buyer agrees to indemnify,
defend and hold harmless Sellers (other than, following the Closing, the
Companies) and their respective directors, officers, employees, affiliates,
successors and assigns from and against all Losses based upon, arising out of or
otherwise in respect of (i) any inaccuracy in or any breach of any
representation, warranty, covenant or agreement of Buyer contained in this
Agreement or in any documents delivered by Buyer pursuant to this Agreement and
(ii) a breach by Buyer of its obligations under Section 5.9(b) or (c) of this
Agreement, including the Post-Closing Compensation Obligations.
SECTION 8.3 Notice and Opportunity to Defend.
(a) Notice of Asserted Liability. The party making a claim under this
Article VIII is referred to as the "Indemnitee," and the party against whom such
claims are asserted under this Article VIII is referred to as the "Indemnifying
Party." All claims by any Indemnitee under this Article VIII shall be asserted
and resolved as follows: Promptly after receipt by the Indemnitee of notice of
any Claim or circumstances which, with the lapse of time, would or might give
rise to a Claim or the commencement (or threatened commencement) of a Claim
including any action, proceeding or investigation (an "Asserted Liability") that
may result in a Loss, the Indemnitee shall give notice thereof (the "Claims
Notice") to the Indemnifying Party. The Claims Notice shall describe the
Asserted Liability in reasonable detail, and shall indicate the amount
(estimated, if necessary and to the extent feasible) of the Loss that has been
or may be suffered by the Indemnitee.
(b) Opportunity to Defend. (i) The Indemnifying Party may elect to
compromise or defend, at its own expense and by its own counsel, any Asserted
Liability (excluding those related to Taxes relating to any period ending after
the Closing Date). If the Indemnifying Party elects to compromise or defend such
Asserted Liability, it shall within 30 days (or sooner, if the nature of the
Asserted Liability so requires) notify the Indemnitee of its intent to do so,
and the Indemnitee shall cooperate, at the expense of the Indemnifying Party, in
the compromise of, or defense against, such Asserted Liability. If the
Indemnifying Party elects not to compromise or defend the Asserted Liability,
fails to notify the Indemnitee of its election as herein provided or contests
its obligation to indemnify under this Agreement, the Indemnitee may pay,
compromise or defend such Asserted Liability. Notwithstanding the foregoing,
neither the Indemnifying Party nor the Indemnitee may settle or compromise any
Asserted Liability over the objection of the other; provided, however, that
consent to settlement or compromise shall not be unreasonably withheld.
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In any event, the Indemnitee and the Indemnifying Party may participate, at
their own expense, in the defense of such Asserted Liability. If the
Indemnifying Party chooses to defend any Asserted Liability, the Indemnitee
shall make available to the Indemnifying Party any books, records or other
documents within its control as well as reasonable access to its employee and
consultants, in each case to the extent necessary or appropriate for such
defense. In the event it is determined by a court of competent jurisdiction that
an Indemnitee is not entitled to indemnification pursuant to this Article VIII
for any Asserted Liability, then the Indemnitee shall promptly reimburse the
Indemnifying Party for all fees, costs and expenses (including reasonable fees,
expenses and disbursements of outside attorneys, experts and consultants)
incurred by the Indemnitee in connection with the defense of such Asserted
Liability.
SECTION 8.4 Limitations on Indemnification. The indemnification provided
for in Sections 8.1 and 8.2 shall be subject to the following limitations:
(a) The Indemnifying Parties shall not be obligated to indemnify the
Buyer Indemnitees for Losses arising under Section 8.1(b)(i) with respect
to breaches of representations and warranties until the aggregate amounts
for indemnification under Section 8.1(b)(i) equals $2.5 million (the
"Basket Amount"), whereupon the Indemnifying Parties shall be obligated to
pay only the amount of such Losses in excess of the Basket Amount;
provided, however, that the foregoing limitation shall not apply to, and
the Indemnifying Parties shall be obligated to indemnify the Buyer
Indemnitees for the full amount of, Losses arising under Section 8.1(b)(i)
based upon, arising out of or otherwise in respect of the Fundamental
Representations and Sections 3.13 and 3.14 (collectively, the "Basket
Exclusions") without regard to the Basket Amount; provided further, that
any Losses based upon, arising out of or otherwise in respect of the Basket
Exclusions shall not be counted against the Basket Amount.
(b) The Sellers, collectively, shall not be obligated to make any
payment for indemnification under Section 8.1(b) with respect to breaches
of representations and warranties (except those based upon, arising out of
or otherwise in respect of the Fundamental Representations and Sections
3.13(e) and 3.14(n)) and under Sections 8.1(b)(iv), (v), (vi), (ix) and (x)
in excess of the Purchase Price; provided, that (i) SFC shall not be
obligated to make any payment for indemnification under Section 8.1(b) in
excess of the sum of the Union Bankers Purchase Price and the ConLife
Purchase Price, (ii) PLAC shall not be obligated to make any payment for
indemnification under Section 8.1(b) in excess of the sum of the Peninsular
Purchase Price, the PC-Canada Purchase Price and the PennLife Purchase
Price and (iii) PCFS shall not be obligated to make any payment for
indemnification under this Section 8.1(b) in excess of $1.0 million.
(c) Buyer shall not be obligated to make any payment for
indemnification under Section 8.2 in excess of $50 million.
SECTION 8.5 Set-off Rights. In addition to, and not in replacement of,
the rights of Buyer set forth in Section 2.4 above, each of PFG, PLAC, SFC and
PCFS agrees that Buyer shall have the right, but not the obligation, to set-off
against the payment obligations under the Acquisition Notes the full amount of
any Losses required to be paid by such Seller pursuant to Section 8.1(b), as
more fully set forth in the Pledge and Security Agreement. Buyer's set-off right
will terminate on the fifth anniversary of the Closing Date; provided, that such
rights will continue unimpaired beyond the fifth anniversary of the Closing Date
with respect to any Claim as to which Buyer shall have notified PFG and is
pending as of the fifth anniversary of the Closing Date or as to which Buyer
shall have given notice in good faith to PFG prior to such date. The termination
of Buyer's set-off rights as provided in the preceding sentence shall not apply
to Buyer's rights to set-off in connection with the DI Reserves, which rights
are set forth in Section 2.4 of this Agreement.
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SECTION 8.6 Adjustment to Purchase Price; Offsetting Tax Benefits.
(a) It is the intention of the parties hereto that any payment under
Sections 2.3 or 2.4 or under this Article VIII shall be treated as an adjustment
to the Purchase Price for all Tax purposes and the parties agree to file their
Tax returns accordingly. In the event that any such payment to Buyer or its
Subsidiaries (including the Companies) is not so treated, the amount of such
payment shall be increased so that, after payments of all Taxes due thereon, the
amount retained by Buyer is equal to the amount that Buyer would have retained
if no such Taxes had been due.
(b) The amount of an indemnified Loss shall be reduced by (or the
Indemnitee shall pay to the Indemnifying Party) any Tax benefits actually
realized by the Indemnitee or its affiliates which are directly attributable to
the Indemnifiable Loss (including, without limitation, any Tax benefits arising
from the payment or accrual of the indemnified Loss or any correlative
offsetting Tax benefit realized in a taxable period) (an "Offsetting Tax
Benefit"), promptly after realizing such Offsetting Tax Benefit in cash.
SECTION 8.7 Exclusive Remedy. Each party hereto agree that, to the
fullest extent permitted by law, such party's sole and exclusive remedy with
respect to any claim or cause of action asserted by it relating to or arising
from breaches of the representations and warranties or covenants and agreements
of any other party contained in this Agreement shall be limited to its rights
under, and subject to the terms and conditions of, this Article VIII.
Notwithstanding the foregoing, (i) the parties shall have the right to obtain
equitable relief in the form of a temporary or permanent injunction or order for
specific performance and (ii) each party shall have the right to assert any
claim for fraud against any other party for any breach of this Agreement.
ARTICLE IX
TERMINATION AND ABANDONMENT
SECTION 9.1 Termination. This Agreement may be terminated and the
transactions contemplated hereby may be abandoned at any time prior to the
Closing:
(a) by mutual consent of each of the Sellers and Buyer;
(b) by any of the Sellers or Buyer:
(i) if a Governmental Authority shall have issued an order, decree
or ruling or taken any other action (which order, decree or ruling the
parties hereto shall use their best efforts to lift), in each case
permanently restraining, enjoining or otherwise prohibiting any of the
Closing Transactions and such order, decree, ruling or other action
shall have become final and nonappealable; or
(ii) if the Closing shall not have occurred on or before March 31,
1999; provided, however, that this Agreement shall automatically extend
for up to two consecutive 30-day periods commencing on March 31, 1999 if
(A) Sellers prior to such time shall not have secured the PennLife
Insurance Approvals, ConLife Insurance Approvals and the Buyer Approvals
have not yet been obtained or (B) the Proxy Statement prior to such time
shall not have cleared review by the Commission or the Proxy Statement
has cleared review by the Commission but additional time is required to
hold the meeting of shareholders of Buyer contemplated by Section 4.5(e)
of this Agreement or to close the transactions contemplated by this
Agreement after such meeting; provided further, however, that the right
to terminate this Agreement shall not be available to any party whose
breach of this Agreement has been the cause of, or resulted in, the
failure of the
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Closing to occur on or before March 31, 1999 (or the end of the second
30-day period, if applicable);
(c) by Buyer if a material default or breach shall be made by Sellers
with respect to the due and timely performance of any of their covenants or
agreements contained herein, or in any of their representations or
warranties contained in the Agreement, if such default or breach has not
been cured or waived within 30 days after written notice to such breaching
party specifying, in reasonable detail, such claimed material default or
breach and demanding its cure or satisfaction;
(d) by Sellers if a material default or breach shall be made by Buyer
with respect to the due and timely performance of any of its covenants or
agreements contained herein, or in any of its representations or warranties
contained in the Agreement, if such default or breach has not been cured or
waived within 30 days after written notice to Buyer specifying, in
reasonable detail, such claimed material default or breach and demanding
its cure or satisfaction; or
SECTION 9.2 Expenses in the Event of Termination. If this Agreement is
terminated by Buyer or Sellers for any reason other than pursuant to Section
9.1(a), (b)(i), (b)(ii)(A) (with respect to approvals to be obtained in Florida
and New York by Buyer (only if such approvals are not obtained because of the
unsuitability of Buyer, Buyer Sub or Capital Z)), (b)(ii)(B) (except if the
Proxy Statement has not cleared review by the Commission solely because of the
Financial Statements required to be included in the Proxy Statement) or (d) or
the failure of Buyer to obtain the shareholder approval contemplated by Section
4.5, Sellers shall pay to Buyer and Capital Z an amount necessary to reimburse
Buyer and Capital Z for 75% of all actual out-of-pocket costs and expenses of
Buyer and Capital Z incurred through the date of termination by Capital Z and
Buyer in connection with the transactions contemplated by this Agreement
(exclusive of any bank commitment fees) and the UAFC Share Purchase Agreement
(including the negotiation of the Chase Bank Facility), which payment shall be
made by Sellers by wire transfer of immediately available funds within three
business days after receipt by Sellers from Buyer and/or Capital Z of an invoice
or invoices identifying such costs and expenses in reasonable detail, together
with all supporting invoices, and specifying the account or accounts into which
funds should be deposited.
SECTION 9.3 Procedure and Effect of Termination. In the event of
termination and abandonment of the transactions contemplated hereby pursuant to
Section 9.1, written notice thereof shall forthwith be given to the other
parties to this Agreement and this Agreement shall terminate and the
transactions contemplated hereby shall be abandoned, without further action by
any of the parties hereto. If this Agreement is terminated as provided herein:
(a) upon request therefor, each party will redeliver all documents,
work papers and other material of any other party relating to the
transactions contemplated hereby, whether obtained before or after the
execution hereof, to the party furnishing the same; and
(b) no party hereto shall have any liability or further obligation to
any other party to this Agreement resulting from such termination except
(i) that the provisions of this Section 9.3 and Sections 9.2, 9.4 and 9.5
shall remain in full force and effect and (ii) no party waives any claim or
right against a breaching party to the extent that such termination results
from the breach by a party hereto of any of its representations,
warranties, covenants or agreements set forth in this Agreement.
SECTION 9.4 Mutual Agreement of Parties. (a) In the event of termination
of this Agreement, neither Buyer nor any Seller shall, for a period commencing
on the date of such termination and ending 18 months thereafter, without the
consent of the other, directly or indirectly solicit for employment or hire any
employee or agent of Buyer or any Seller, as the case may be, of whom Buyer or
any Seller, as the case may be, became aware as a result of the
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transactions contemplated by this Agreement; provided, however, that no party
shall be prohibited from publishing a general solicitation of employment in any
newspaper or magazine or from hiring an employee or agent of another party who
seeks employment without solicitation. This Section 9.4 will supersede the
agreement between the parties with respect to the subject matter hereof
contained in the Confidentiality Agreement, dated May 29, 1998, between PFG and
Capital Z (the "Confidentiality Agreement").
(b) Notwithstanding the foregoing, nothing contained in Section 9.4(a)
shall mean or shall be interpreted to mean that, upon termination of this
Agreement, Buyer or Sellers in any way would be restricted or prohibited from
working with or engaging in business in any form whatsoever with Gary Boesch or
any affiliated entity.
SECTION 9.5 Confidentiality. Each party hereto acknowledges that the
other parties have legitimate and continuing proprietary interests in the
protection of their confidential information and that the parties have invested
substantial sums and will continue to invest substantial sums to develop,
maintain and protect such confidential information. Prior to and after the
Closing, each party agrees not to disclose, furnish or make accessible to anyone
or use for its own benefit (other than as contemplated hereby) any trade secrets
or other confidential or proprietary information of another party relating to
the Companies and/or their respective businesses, the PCFS Assets or the other
parties including, but not limited to, information obtained by or revealed to
such party during any investigations, negotiations or review relating to this
Agreement, the UAFC Share Purchase Agreement and any other document contemplated
hereby or thereby or any past or future actions taken in connection with,
pursuant to, in accordance with, or under this Agreement, including without
limitation any business plans, marketing plans, financial information,
strategies, systems, programs, methods, employee lists, computer programs,
insurance profiles and customer lists; provided, however, that such protected
information shall not include (i) information required to be disclosed by law,
legal or judicial process (including a court order, subpoena or order of a
Governmental Authority) or the rules of any stock exchange (including Nasdaq),
(ii) information that is or becomes available to the disclosing party on a
non-confidential basis from a source other than the other parties and not
obtained in violation of this Agreement and (iii) information known to the
public or otherwise in the public domain without violation of this Section 9.5.
ARTICLE X
MISCELLANEOUS PROVISIONS
SECTION 10.1 Post-Closing DI Reserves Information. Until the fifth
anniversary of the Closing Date, from time to time, Buyer shall afford Sellers
reasonable access, and shall cause the officers, employees, agents and
representatives of PennLife to permit Sellers, reasonable access to review and
examine Buyer's procedures and policies for payment of claims and estimation of
reserves relating solely to the DI Reserves (the "DI Reserve Information"). In
connection therewith, Buyer shall cause PennLife to give Sellers (including
Sellers' officers, attorneys, accountants and actuaries) access, during normal
business hours, to the books and records of PennLife to the extent they relate
to the DI Reserves Information; provided, that such access does not unreasonably
disrupt the normal operations of Buyer. Buyer will cause the employees and
agents of PennLife to cooperate fully with Sellers in connection with such
review, to the extent such cooperation does not unreasonably interfere with the
normal operations of PennLife. Sellers acknowledge the strict confidential
nature of the DI Reserves Information and hereby agree that any information
prepared in connection with or in any way relating to Sellers' review and
examination of the DI Reserves Information shall be kept confidential in
accordance with Section 9.5 of this Agreement, except as may otherwise be
necessary in connection with the Reserves Adjustment to take place on the fifth
anniversary of the Closing Date in accordance with Section 2.4 of this
Agreement. Notwithstanding the foregoing, Buyer shall not be required
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under this Section 10.1 to take any action that would unreasonably interfere
with the conduct of its business or that of PennLife or cause Buyer or PennLife
to incur any expense (unless Sellers agree to promptly reimburse Buyer and
PennLife for any such expense).
SECTION 10.2 Amendment and Modification. This Agreement may only be
amended, modified or supplemented by a written instrument signed by all the
parties hereto.
SECTION 10.3 Waiver of Compliance; Consents. Any failure of Buyer to
comply with any obligation, covenant, agreement or condition contained herein
may be waived in writing by PFG, but such waiver or failure to insist upon
strict compliance with such obligation, covenant, agreement or condition shall
not operate as a waiver of, or estoppel with respect to, any other failure. Any
failure of Sellers to comply with any obligation, covenant, agreement or
condition contained herein may be waived in writing by Buyer, but such waiver or
failure to insist upon strict compliance with such obligation, covenant,
agreement or condition shall not operate as a waiver of, or estoppel with
respect to, any other failure.
SECTION 10.4 Validity. The invalidity or unenforceability of any
provision of this Agreement shall not affect the validity or enforceability of
any other provisions of this Agreement, which shall remain in full force and
effect.
SECTION 10.5 Expenses and Obligations. PFG, PLAC, SFC and PCFS shall be
responsible for paying all third-party costs and expenses incurred by them and
all third-party costs and expenses in excess of $1.5 million incurred by the
Companies in connection with the Pre-Closing Restructuring Transactions (not
including those costs associated with the termination by Sellers prior to the
Closing of the Lincoln National Agreement) and in preparing the Companies for
sale to Buyer.
SECTION 10.6 Parties in Interest. This Agreement shall be binding upon
and inure solely to the benefit of each party hereto and their successors and
assigns. Except for Section 9.1(e), nothing in this Agreement, express or
implied, is intended to confer upon any other Person any rights or remedies of
any nature whatsoever under or by reason of this Agreement, whether by a claim
of third party beneficiary or otherwise, and PFG agrees that it has no third
party beneficiary rights or any other enforceable rights under the UAFC Share
Purchase Agreement and the Chase Commitment Letter.
SECTION 10.7 Notices. All notices and other communications hereunder
shall be in writing and shall be deemed given upon the earlier of delivery
thereof if by hand or upon receipt if sent by mail (registered or certified,
postage prepaid, return receipt requested) or on the second next Business Day
after deposit if sent by a recognized overnight delivery service or upon
transmission if sent by telecopy or facsimile transmission (with electronic
acknowledgment of transmission confirmed) as follows:
(a) If to Buyer or, after the Closing, any of the Companies, to:
Universal American Financial Corp.
Six International Drive
Suite 190
Rye Brook, New York 10573-1068
Attention: Richard A. Barasch
Facsimile No.: (914) 934-9123
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with copies to:
Capital Z Partners
One Chase Manhattan Plaza
44th Floor
New York, New York 10005
Attention: Bradley E. Cooper
Facsimile No.: (212) 898-8720
and
Harnett Lesnick & Ripps P.A.
NationsBank Tower 150
East Palmetto Park Road
Suite 500
Boca Raton, Florida 33432-4832
Attention: Judge Bertram Harnett
Facsimile No.: (561) 368-4315
and
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, New York 10017-3909
Attention: Gary I. Horowitz
Facsimile No.: (212) 455-2502
and
Paul, Weiss, Rifkind, Wharton & Garrison
1285 Avenue of the Americas
New York, New York 10019-6064
Attention: David K. Lakhdhir
Facsimile No.: (212) 757-3000
(b) If to any Seller including, prior to the Closing, any Seller
which is a Company, to:
PennCorp Financial Group, Inc.
c/o Southwestern Financial Services Corporation
717 North Harwood Street
Dallas, Texas 75201
Attention: Scott D. Silverman
Facsimile No.: (214) 954-7906
with a copy to:
Weil, Gotshal & Manges LLP
100 Crescent Court, Suite 1300
Dallas, Texas 75201
Attention: Jeremy W. Dickens
Facsimile No.: (214) 746-7777
SECTION 10.8 Governing Law. This Agreement shall be governed by and
construed in accordance with the laws of the State of New York applicable to
contracts to be performed within that state.
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SECTION 10.9 Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same agreement.
SECTION 10.10 Headings. The article and section headings contained in
this Agreement are solely for the purpose of reference, are not part of the
agreement of the parties and shall not affect in any way the meaning or
interpretation of this Agreement.
SECTION 10.11 Entire Agreement. This Agreement, the Disclosure Schedule,
the Annexes hereto and the Confidentiality Agreement embody the entire agreement
and understanding of the parties hereto in respect of the subject matter
contained herein or therein. There are no agreements, representations,
warranties or covenants other than those expressly set forth herein or therein.
This Agreement, the Disclosure Schedule and the Annexes hereto supersede all
prior agreements and understandings (other than the Confidentiality Agreement)
between the parties with respect to such subject matter.
SECTION 10.12 Assignment. Except as otherwise provided in this Section
10.12, this Agreement shall not be assigned by operation of law or otherwise;
provided, however, that each of Buyer and PFG may assign all of its rights and
delegate all of its obligations under this Agreement to any Person in connection
with the sale of Buyer or PFG, as the case may be, or all or substantially all
of the assets of Buyer or PFG, as the case may be, to such Person, whether by
stock sale, merger, share exchange, asset sale, consolidation or otherwise, so
long as such Person expressly assumes Buyer's or PFG's (as the case may be)
obligations hereunder; provided, further, however, that Buyer will not assign
its rights or delegate its obligations under this Agreement to any Person prior
to the Closing. Notwithstanding anything in this Agreement to the contrary,
Buyer may give notice to PFG that, pursuant to the terms of the UAFC Share
Purchase Agreement, Buyer is assigning all of its rights and obligations under
this Agreement to an affiliate of Capital Z (the "Substituted Buyer"); provided,
that (a) such Substituted Buyer is a newly-formed acquisition company or other
entity, in each case, reasonably acceptable to PFG and (b) Capital Z shall have
committed to provide equity financing to the Substituted Buyer, and Chase Bank
(and/or other financial institutions) shall have committed to provide debt
financing to the Substituted Buyer, in an aggregate amount at least equal to
that necessary to consummate the Closing Transactions. If Buyer so elects to
assign its rights and obligations under this Agreement, (i) the date specified
in Section 9.1(ii) shall be extended for 90 days (or such later date as shall be
mutually agreed to by the Substituted Buyer and Sellers) and (ii) the
Substituted Buyer and Sellers shall agree to such conforming modifications to
this Agreement (such agreement or modifications not to be unreasonably withheld)
as may be necessary to reflect the assignment by Buyer (without recourse) of all
of its rights and obligations to the Substituted Buyer.
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IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed on its behalf by its duly authorized officers, all as of the day and
year first above written.
UNIVERSAL AMERICAN FINANCIAL
CORP.
By: /s/ RICHARD BARASCH
------------------------------------
Name: Richard Barasch
Title: Chief Executive Officer
PENNCORP FINANCIAL GROUP, INC.
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
PACIFIC LIFE AND ACCIDENT
INSURANCE COMPANY
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
SOUTHWESTERN FINANCIAL
CORPORATION
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
PENNSYLVANIA LIFE INSURANCE
COMPANY
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
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CONSTITUTION LIFE INSURANCE
COMPANY
By: /s/ CHARLES LUBOCHINSKI
------------------------------------
Name: Charles Lubochinski
Title: Senior Vice President
PENNCORP FINANCIAL SERVICES,
INC.
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
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<PAGE> 199
ANNEX C
ADVEST, INC.
1 ROCKEFELLER PLAZA
NEW YORK, NEW YORK 10020
December 31, 1998
Board of Directors
Universal American Financial Corp.
Six International Drive-Suite 190
Rye Brook, New York 10573
Members of the Board:
Universal American Financial Corp. ("UHCO" or the "Company") entered into
agreements (the "Agreements") as of December, 1998 to accept a
controlling-interest investment in the Company (the "Investment") by Capital Z
Financial Services Fund II, L.P. ("Capital Z"), together with the additional
investment by UAFC L.P. ("UAFC") and certain management and agents of the Career
Sales Division ("CSD") of PennCorp Financial Group, Inc. ("PFG") (collectively
referred to as "Management"), the purpose of which is to provide the requisite
funds, augmented by a credit facility, to acquire Pennsylvania Life Insurance
Company, PennCorp Life Insurance Company, Peninsular Life Insurance Company,
Constitution Life Insurance Company, Union Bankers Insurance Company, Marquette
National Life Insurance Company, Penn Corp Financial, Inc. and certain assets of
PennCorp Financial Services Inc., (the "Acquisition"), all of which are
hereafter referred to as CSD. Hereafter, Capital Z, UAFC, and Management will be
collectively referred to as the "Investors".
The Agreements provide that the Investors will invest $83,500,000 for a
64.6% equity ownership (fully diluted basis) in UHCO; UHCO will then borrow
$71,400,000 from a bank consortium led by Chase Securities, Inc. and purchase
CSD for $175,000,000, which payment will be comprised of $136,000,000 of cash
and $39,000,000 of subordinated notes of UHCO. The remainder of the proceeds
raised ($18,900,000) will be utilized for transaction fees and working capital
($12,400,000), to refinance debt ($5,000,000) and as additional capital
contributions ($1,500,000).
Capital Z and Management will invest in the Company through a direct
purchase of common stock at a price of $3.15 per share, subject to reduction in
the event of a material adverse event ("MAE") as defined in the Share Purchase
Agreement between UHCO and Capital Z, but only if such MAE occurs between the
date of execution of a definitive agreement and that of transaction closing.
UAFC will invest in UHCO through the purchase of 40,000 shares of
convertible preferred Series D stock, par value $1, for a purchase price of $100
per share. The Series D stock will be sold in two separate tranches: 22,500
shares of Series D-1 stock and 17,500 shares of Series D-2 stock. The Series D-1
stock is convertible to UHCO common stock at a price of $2.70 per share. The
effect of the conversion price of $2.70 for this tranche is not material to the
overall Investment. The Series D-2 stock (which UAFC has the right to cancel
until January 30, 1999) is convertible at the "change of control" price, which
is expected to be $3.15, subject to reduction in the event of a MAE.
You have asked us whether, in our opinion, the financial terms of (1) the
Investment by the Investors and (2) the Acquisition of CSD, are fair, from a
financial point of view, to the Company and its shareholders.
In arriving at our opinions set forth below, we have, among other things,
performed the following analyses and investigations: In the case of the
Investment, we have attempted to determine whether a fair value price was paid
for the equity interest purchased in the Company. In this regard, the price paid
was compared to UHCO's common stock price trading range and record; we also
compared the price paid on a price/earnings and price/book value basis to
current and recent market valuations of similar publicly traded life/health
insurers; we evaluated the share price/earnings and price/book valuations paid
for the new UHCO shares against valuations paid for life/health insurers in
similar take-over transactions; we also reviewed the
<PAGE> 200
Board of Directors December 31, 1998
price paid for the UHCO shares relative to liquidation values derived in an
independent actuarial valuation of UHCO, for its business in-force and other
assets, and weighed the price being paid by the Investors with a valuation
derived from a discounted cash flow analysis. In the process we reviewed the
Company's Forms 10-K and 10-Q for the years 1995-1998, its Annual Reports to
shareholders (1995-1997), statutory statements for each of the Company's
subsidiaries, American Pioneer Life, American Progressive Life and Health, and
American Exchange Life, and the GAAP basis statements of WorldNet Services
Corp., comparative financial and operating data for companies selected for each
of the peer groups, plus operating projections for UHCO prepared by the Company
and its advisors. In addition, we conducted discussions with members of
management concerning various aspects of the Company's operations, financial
prospects, and projections.
In the case of the Acquisition we also examined statutory financial results
for the CSD companies, years 1995-1998. We have also compared the pricing of the
CSD deal on a price/earnings and price/book value basis relative to market and
transaction peer groups and, in doing so, we utilized several different
paradigms of value, and did so on both a current and Pro Forma basis. We have
also examined statutory audits for the CSD companies for the prior year. Future
period financial projections, on which much of our evaluation analysis is based,
were provided by the Company and its financial advisors.
We have independently performed sensitivity analyses to determine the
effects of leverage and earnings volatility on dividend capacity for debt
service coverage, in order to quantify the level of financial risk in the
transaction on a pro forma basis, and we have reviewed such other financial
information, studies and analyses and performed such other investigations and
took into account such other matters as we deemed necessary.
In preparing these opinions we have relied on the accuracy and completeness
of all information supplied or otherwise made available to us by the Company,
CSD and outside professional organizations retained, and we have not
independently verified such information, nor have we undertaken an independent
appraisal of the assets or liabilities of the Company. As part of our
engagement, the Company has agreed to pay Advest a fee for delivery of this
opinion letter. These opinions are necessarily based upon circumstances and
conditions as they exist and can be evaluated by us as of the date of this
letter. We have assumed for purposes of these opinions that there has been no
material change in the financial condition of the Company, CSD, or any other
party integral to either the Investment or Acquisition from those existing on
September 30, 1998.
In reliance upon and subject to the foregoing it is our opinion that, as of
the date hereof, the financial terms and effects of the Investment and the
Acquisition, both individually and in the aggregate, are fair, from a financial
point of view, to the Company and its shareholders.
Very truly yours,
ADVEST, INC.
By: /s/ ALEXANDER M. CLARK
------------------------------------
Alexander M. Clark
Managing Director
AMC:gc
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<PAGE> 201
ANNEX D
PROPOSED AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF
UNIVERSAL AMERICAN FINANCIAL CORP.
UNDER SECTION 807 OF THE BUSINESS CORPORATION LAW
* * * * * * * * *
WE, THE UNDERSIGNED, RICHARD A. BARASCH and JOAN FERRARONE, being
respectively the president and secretary of UNIVERSAL AMERICAN FINANCIAL CORP.,
hereby certify:
A. The name of the corporation is:
UNIVERSAL AMERICAN FINANCIAL CORP.
B. The Certificate of Incorporation of said corporation was filed by the
Department of State on the 31st day of August, 1981, under the name "UNIVERSAL
HOLDING CORP."
C. The Certificate of Incorporation is amended to:
(1) increase the authorized number of shares in Article FOURTH;
(2) delete the provisions in Article EIGHTH that relate to a
classified Board of Directors;
(3) change Article TENTH to specifically provide for action of the
stockholders by written consent in lieu of a meeting, and that such written
consent need only be by the number of stockholders required to approve such
action;
(4) delete Article ELEVENTH in its entirety and add a new Article
ELEVENTH to provide for supermajority approval by the Board of Directors
for a list of enumerated corporate actions; and
(5) revise Article FOURTEENTH to require supermajority approval by the
stockholders only to amend Article TWELFTH of the Certificate of
Incorporation which relates to certain transactions with interested
parties.
D. The Amendments to Articles of the Restated Certificate of Incorporation
made hereby and the Restatement of the Certificate of Incorporation were
authorized by the vote of the majority of the Board of Directors at a duly
called meeting at which a quorum was present throughout.
E. The Certificate of Incorporation as heretofore and as hereby amended is
hereby restated as set forth below in full.
FIRST: The name of the corporation is:
"UNIVERSAL AMERICAN FINANCIAL CORP."
SECOND: The purposes for which it is formed are: To purchase, own, and hold
the stock of other corporations; to direct the operations of other corporations
through the ownership of stock therein; to purchase, subscribe for, acquire,
own, hold, sell, exchange, assign, transfer, create security interests in,
pledge, or otherwise dispose of, shares or voting trust certificates for shares
of the capital stock, or any bonds, notes, securities, or evidences of
indebtedness created by any other corporation or corporations organized under
the laws of this state or any other state or district or country, nation, or
government and also bonds or evidences of indebtedness of the United States or
of any state, district, territory, dependency or country or subdivision or
municipality thereof; to issue in exchange therefor shares of the capital stock,
bonds, notes or other obligations of the corporation and while the owner
thereof, to exercise all the rights, powers and privileges of ownership,
including the right to vote on any shares of stock or voting trust certificates
so owned; to promote, lend money to, and guarantee the dividends, stocks,
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bonds, notes, evidences of indebtedness, contracts, or other obligations of, and
otherwise aid in any manner which shall be lawful, any corporation or
association of which any bonds, stocks, voting trust certificates, or other
securities or evidences of indebtedness shall be held by or for this
corporation, or in which, or in the welfare of which, this corporation shall
have any interest, and to do any acts and things permitted by law and designed
to protect, preserve, improve, or enhance the value of any such bonds, stocks,
or other securities or evidences of indebtedness or the property of this
corporation.
To engage in consultant and advisory work in connection with the
organization, financing, management, operation, and reorganization, of
industrial and commercial enterprises. To manage and to provide management for
and supervise all or part of any and every kind of investment or business
enterprise, and to contract or arrange with any corporation, association,
partnership, or individual for the management, conduct, operation, and
supervision of all kinds of investments and businesses. To advertise, promote,
merchandise, and otherwise purvey the services authorized herein; to negotiate
and contract with respect to furnishing of the same for or on behalf of any
person, firm or corporation, domestic or foreign; to enter into and carry out
agency or joint arrangements with other persons, firms, or corporations engaged
in like or similar activities; and generally to exploit the services and objects
of the corporation by all lawful means.
The corporation, in addition to and in furtherance of the corporate powers
above set forth, shall have all of the powers enumerated in Section 202 of the
Business Corporation Law, subject to any limitation provided in the Business
Corporation Law or any other statute of the State of New York.
THIRD: The office of the corporation is to be located in the Village of
Rye Brook, County of Westchester and State of New York.
FOURTH: (a) The total number of shares which the corporation is to be
authorized to issue is 82,000,000; consisting of 80,000,000 shares of Common
Stock of the par value of $.01 each, and 2,000,000 shares of Preferred Stock of
the par value of $1.00 each.
(b) The Preferred Stock may be issued in series, and the number,
designations, relative rights, preferences and limitations of shares of each
series of Preferred Stock, $1.00 par value, shall be fixed by the Board of
Directors.
FIFTH A: DESIGNATIONS, PREFERENCES AND SPECIAL RIGHTS OF SERIES B
PREFERRED STOCK(1)
Designation, Amount and Rank. Five hundred (500) shares of a preferred
stock, $1.00 par value per share, shall constitute a series of such preferred
stock designated as "Series B Convertible Preferred Stock" (the "Series B
Preferred Stock"). With respect to dividend rights, redemption rights and rights
on liquidation, winding up and dissolution, the Series A Preferred Stock shall
rank prior to the Series B Preferred Stock. With respect to dividend rights, the
Series B Preferred Stock shall rank pari passu with the Common Stock and shall
rank prior to the Common Stock and any other class of capital stock or series of
preferred stock hereafter created with respect to redemption rights, rights on
liquidation, winding up and dissolution. The
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1 Since the Series B Preferred Stock will be converted at the closing of the
Capital Z Issuance, after the closing, a second amended and restated certificate
of incorporation will be filed deleting references to the Series B Preferred
Stock.
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Series B Preferred Stock shall be issued pursuant to the following additional
terms and conditions:
1. Series B Convertible Preferred Stock.
1.1. Definitions. As used herein, unless the context otherwise requires,
the following terms have the following meanings:
1.1.1. "Additional Shares of Common Stock" means all shares (including
treasury shares) of Common Stock issued or sold (or, pursuant to Sections 1.7.2
or 1.7.3, deemed to be issued) by the corporation after the date hereof, whether
or not subsequently reacquired or retired by the corporation other than (a) the
issuance of shares upon conversion of the Series A Preferred Stock; (b) shares
issued upon the exercise of the Currently Outstanding Warrants; (c) shares to be
issued to directors and employees pursuant to corporation sponsored employee
benefit and compensation arrangements, but not to exceed 650,000 shares (subject
to equitable adjustment in the event of any combination, reclassification, stock
split, dividend or recapitalization of the corporation); and (d) such additional
number of shares, if any, as may become issuable upon the conversion or exercise
of any of the securities referred to in the foregoing clauses (a) through (d)
and by reason of adjustments required pursuant to the anti-dilution provisions
applicable to such Series A Preferred Stock as in effect on the date hereof, but
only if and to the extent that such adjustments are required as the result of
the original issuance of such Series B Preferred Stock.
1.1.2. "Business Day" means any day other than a Saturday or a Sunday or a
day on which commercial banking institutions in the City of New York are
authorized by law or other governmental action to be closed. Any reference to
"days" (unless Business Days are specified) shall mean calendar days.
1.1.3. "Closing", means the date of closing of any Triggering Event, as
contemplated by Section 1.6.2 hereof.
1.1.4. "Common Stock" means the corporation's Common Stock, $.01 par
value, such term to include any stock into which such Common Stock shall have
been changed of any stock resulting from any reclassification of such Common
Stock, and all other stock of any class or classes (however designated) of the
corporation the holders of which have the right, without limitation as to
amount, either to all or to a share of the balance of current dividends and
liquidating dividends and distributions after the payment of dividends and
distributions on any shares entitled to preference.
1.1.5. "Conversion Price", means $2.25, subject to adjustment pursuant to
Sections 1.7 and 1.9 hereof.
1.1.6. "Convertible Securities" means any evidences of indebtedness,
shares of stock (other than Common Stock) or other securities directly or
indirectly convertible into or exchangeable for Additional Shares of Common
Stock.
1.1.7. "Current Market Price" means on any date specified herein, the
average daily Market Price during the period of the most recent twenty (20)
days, ending on such date, on which the national securities exchanges were open
for trading, except that if no Common Stock is then listed or admitted to
trading on any national securities exchange or quoted in the over-the-counter
market, the Current Market Price shall be the Market Price on such date.
1.1.8. "Currently Outstanding Warrants" means the currently outstanding
Common Stock Purchase Warrants designated on Schedule 1 hereto, for the purchase
of an aggregate of 2,115,760 shares of the Common Stock.
1.1.9. "Market Price" means on any date specified herein, the amount per
share of the Common Stock, equal to (a) the last sale price of such Common
Stock, regular way, on such
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date or, if no such sale takes place on such date, the average of the closing
bid and asked prices thereof on such date, in each case as officially reported
on the principal national securities exchange on which such Common Stock is then
listed or admitted to trading, or (b) if such Common Stock is not then listed or
admitted to trading on any national securities exchange but is designated as a
national market system security by the NASD, the last trading price of the
Common Stock on such date, or (c) if there shall have been no trading on such
date or if the Common Stock is not so designated, the average of the closing bid
and asked prices of the Common Stock on such date as shown by the NASD automated
quotation system, or (d) if such Common Stock is not then listed or admitted to
trading on any national securities exchange or quoted in the over-the-counter
market, the value as determined by any firm of independent public accountants of
recognized national standing selected by the Board of Directors of the
corporation (and approved by the holders of a majority of the outstanding shares
of Series B Preferred Stock) as of the last day of any month ending within
thirty (30) days preceding the date as of which the determination is to be made.
1.1.10. "Options" means rights, options or warrants to subscribe for,
purchase or otherwise acquire either Additional Shares of Common Stock or
Convertible Securities.
1.1.11. "Other Securities" means any stock (other than Common Stock) and
other securities of the corporation or any other Person (corporate or otherwise)
which the holders of Preferred Stock at any time shall be entitled to receive,
or shall have received, upon the conversion of Preferred Stock, in lieu of or in
addition to Common Stock, or which at any time shall be issuable or shall have
been issued in exchange for or in replacement of Common Stock or other
Securities.
1.1.12. "Person" means a corporation, an association, a partnership, an
organization, a business, an individual, a government or political subdivision
thereof or a governmental agency.
1.1.13. "Preferred Stock" means, collectively, the Series A Preferred
Stock and the Series B Preferred Stock.
1.1.14. "Securities Act" means the Securities Act of 1933, as amended.
1.1.15. "Series A Preferred Stock" means the Series A Convertible
Preferred Stock, $1.00 par value, of the corporation created pursuant to a
Certificate of Amendment filed April 19, 1991 with the Secretary of State of the
State of New York.
1.1.16. "Series B Preferred Stock" means the Series B Convertible
Preferred Stock, $1.00 par value, of the corporation created pursuant to a
Certificate of Amendment filed December 21, 1994 with the Secretary of State of
the State of New York.
1.1.17. "Special Redemption Date" means any date fixed for redemption of
shares of Series B Preferred Stock pursuant to the provisions of Section 1.5.2
hereof.
1.1.18. "Special Redemption Event" has the meaning set forth in Section
1.5.4.
1.1.19. "Stated Value" per share means with respect to the Series B
Preferred Stock, Ten Thousand Dollars ($10,000).
1.1.20. "Triggering Event" means the consummation of a public offering
pursuant to an effective registration statement under the Securities Act
covering the offering and sale of shares of Common Stock (i) in which the
aggregate proceeds to the corporation exceed $8,000,000 and (ii) in which the
price per share at which the Common Stock is initially offered to the public
equals or exceeds $2.25 per share (which amount shall be equitably adjusted to
take into account any changes in capitalization of the corporation occurring
after August 1, 1994).
1.1.21. "Unpaid Dividends" means all dividends with respect to the Series
B Preferred Stock which have been declared but which have not been paid in cash.
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1.2. Dividends.
1.2.1. The holder of each issued and outstanding share of Series B
Preferred Stock shall be entitled to receive pari passu with holders of shares
of Common Stock any dividends or other distribution (including, without
limitation, any distribution of other Securities or property or options by way
of dividend, spinoff, reclassification, recapitalization or similar corporate
rearrangement) that are declared on the Common Stock by the Board of Directors
of the corporation, assuming for purposes of this Section 1.2.1 that the Series
B Preferred Stock had been converted into Common Stock immediately prior to the
record date for such Common Stock dividend.
1.3. Rights on Liquidation, Dissolution or Winding-Up.
1.3.1. In the event of any liquidation, dissolution or winding-up of the
corporation (including, without limitation, a liquidation or reorganization
under Chapter 7 or 11 of Title 11 of the United States Code, as amended), the
holders of shares of the Series A Preferred Stock and Series B Preferred Stock
then issued and outstanding shall be entitled to be paid out before any payment
shall be made to the holders of Common Stock or of shares of any other class or
series of stock of the corporation. If, upon any limitation, a liquidation or
reorganization under Chapter 7 or 11 of Title 11 of the United States Code, as
amended, the assets of the corporation available for distribution to its
stockholders shall be insufficient (a "Liquidation Insufficiency") to pay the
holders of shares of the Series A Preferred Stock and the Series B Preferred
Stock the full amounts to which they shall respectively be entitled, the holders
of shares of the Series A Preferred Stock shall be entitled to receive all the
assets of the corporation until such holders have received the full amounts to
which they are entitled pursuant to ARTICLE FIFTH of the Certificate of
Incorporation. Thereafter the holders of the Series B Preferred Stock shall be
entitled to receive pro rata the remaining assets of the corporation. If there
is no Liquidation Insufficiency and payment shall have been made to the holders
of the shares of the Series A Preferred Stock of the full amount to which they
shall be entitled, then the holders of shares of the Series B Preferred Stock
shall be entitled to receive the greater of (a) an amount equal to the Stated
Value per share, plus an amount equal to any Unpaid Dividends to and including
the date of Distribution with respect to such shares, and (b) the amount which
would be distributed on the shares of Common Stock into which the Series B
Preferred Stock is convertible at the date of the liquidation, dissolution or
winding up of the corporation (including, without limitation, a liquidation or
reorganization under Chapter 7 or 11 of Title 11 of the United States Code, as
amended).
1.4. Voting Power.
1.4.1. Except as otherwise expressly provided herein or as required by
law, (i) each holder of Series B Preferred Stock shall be entitled to vote on
all matters as to which stockholders of the corporation are entitled to vote,
and (ii) each holder of Series B Preferred Stock shall be entitled to cast a
number of votes equal to the greatest number of whole shares of Common Stock
into which such holder's shares of Series B Preferred Stock could be converted,
pursuant to the provisions of Section 1.6 hereof, at the record date for the
determination of stockholders entitled to vote on such matter or, if no such
record date is established, at the date such vote is taken or any written
consent of stockholders is solicited. Except as otherwise expressed provided
herein or as required by law, the holders of shares of Series B Preferred Stock
and Common Stock shall be entitled to vote together as a class with respect to
all matters as to which stockholders of the corporation are entitled to vote.
1.4.2. The holders of Series B Preferred Stock shall have the right,
voting separately as a class, to elect one (1) director to the Board of
Directors of the corporation, which, so long as any shares of Series B Preferred
Stock remain outstanding, shall be composed of no more than nine (9) directors.
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1.4.3. At any meeting held for the purpose of electing directors at which
the holders of Series B Preferred Stock shall have the right to elect directors
as provided herein, the presence in person or by proxy of the holders of
twenty-five percent (25%) of the then outstanding shares of Series B Preferred
Stock shall be required and shall be sufficient to constitute a quorum of such
class for the election of directors by such class. In the absence of a quorum of
the holders of the Series B Preferred Stock entitled to vote for the election of
directors, a majority of the holders present in person or by proxy of such class
shall have the power to adjourn the meeting for the election of directors which
the holders of such class are entitled to elect, from time to time, without
notice other than announcement at the meeting, until a quorum shall be present.
1.4.4. Unless the vote of the holders of a greater number of shares of
this Series B Preferred Stock shall then be required by law, the consent of the
holders of at least 66 2/3% of all of the shares of this Series B Preferred
Stock at the time outstanding, if any, voting together as a separate class,
shall be necessary for authorizing, effecting or validating any of the
following:
(a) the creation, authorization or issue of any shares of any class or
series of stock of the corporation, other than the Common Stock, ranking
prior to, or pari passu with, the shares of this Series B Preferred Stock
as to dividends or upon liquidation or otherwise, or the reclassification
of any authorized stock of the corporation into any such prior or pari
passu shares, or the creation, authorization or issue of any obligation or
security convertible into or evidencing the right to purchase any such
prior or pari passu shares; and
(b) the amendment, alteration or repeal of any of the provisions of
the Certificate of Incorporation or of any certificate amendatory thereof
or supplemental thereto so as to affect adversely the preferences, rights,
powers or privileges of this Series B Preferred Stock;
1.5. Special Redemption.
1.5.1. Upon occurrence of a Special Redemption Event (as hereinafter
defined), each holder of Series B Preferred Stock has the right to require that
the corporation redeem, to the extent the corporation lawfully may do so, all or
a portion of the shares of Series B Preferred Stock held by such holder, at a
redemption price in cash equal to the Stated Value per share (plus all Unpaid
Dividends thereon to the Special Redemption Date).
1.5.2. At least 30 days before the consummation of any Special Redemption
Event (as hereinafter defined), the corporation will mail to each holder of
Series B Preferred Stock a notice (the "Special Redemption Notice") (i) stating
that a Special Redemption Event is contemplated, (ii) setting forth a purchase
date (the "Special Redemption Date"), which shall be within five days prior to
or concurrently with the consummation of the Special Redemption Event; (iii)
setting forth the Conversion Price in effect with respect to such shares of
Preferred Stock, up to and including the date of consummation of the Special
Redemption Event; and (iv) setting forth the instructions reasonably determined
by the corporation, consistent with this Section 1.5 and applicable law, that a
holder must follow in order to require the redemption of his Series B Preferred
Stock.
Any holder of Series B Preferred Stock seeking to require that the
corporation redeem any shares will be required to (i) notify the corporation
within fifteen days after receipt of the Special Redemption Event Notice whether
it will elect to redeem any shares and (ii) surrender their shares to the
corporation prior to the close of business on the third Business Day prior to
the consummation of the Special Redemption Date.
1.5.3. Upon the Special Redemption Date, the redemption price of such
shares shall be payable to the order of the person whose name appears on the
certificate or certificates representing such shares as the owner thereof and
each surrendered certificate shall be canceled. In case fewer than all the
shares of Series B Preferred Stock represented by any surrendered certificate
are to be redeemed, a new certificate representing the shares of Series B
Preferred Stock not redeemed shall be issued without cost to the holder thereof.
From and after
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the date the corporation shall irrevocably deposit an amount equal to the
redemption price of the shares of Series B Preferred Stock to be redeemed in
trust for the holders of such shares with a bank having capital and surplus in
excess of $100 million, which bank shall be named in the redemption notice, all
rights of the holders of such Serious B Preferred Stock, except the right to
receive such redemption price without interest upon surrender of their
certificate or certificates, shall cease with respect to such shares, and such
shares shall not thereafter be transferred on the books of the corporation or be
deemed to be outstanding for any purpose whatsoever.
1.5.4. "Special Redemption Event" shall mean:
(a) consummation of any merger, reorganization or consolidation
transaction if consummation of such transaction results in another entity
or the stockholders of another entity having acquired voting securities of
the corporation sufficient to elect a majority of the Board of Directors of
the corporation; or
(b) the acquisition by purchase or otherwise of a controlling interest
in the business or assets of, or the stock or other evidence of beneficial
ownership of, any other Person if consummation of such transaction results
in a transfer of ownership of a majority of the voting securities of the
corporation to such other Person or its stockholders; or
(c) the sale, lease, conveyance, exchange, transfer, encumbrance or
other disposition, in one transaction or a series of related transactions,
of 40% or more of the assets of the corporation; or
(d) the sale, conveyance, exchange, transfer, encumbrance or other
disposition, on one transaction or a series of related transactions, of 40%
or more of the outstanding Common Stock of the corporation.
1.6. Conversion Rights.
1.6.1. Each holder of the shares of Series B Preferred Stock shall have
the right, at the election of such holder, exercised at any time and from time
to time, to convert, subject to the terms and provisions hereof, all or any
portion of such shares of Series B Preferred Stock into fully paid and
non-assessable shares of Common Stock of the corporation or any capital stock or
other securities into which such Common Stock shall have been changed or any
capital stock or other securities resulting from a reclassification thereof.
Such conversion of Series B Preferred Stock to shares of Common Stock shall be
made at the Conversion Price, subject to adjustments from time to time as set
forth herein. Series B Preferred Stock may be converted by the holder thereof
during normal business hours on any Business Day by surrender of the required
number of shares of the Series B Preferred Stock, accompanied by written
evidence (in form reasonably satisfactory to the corporation) of the holder's
election to convert such holder's Series B Preferred Stock or portion thereof,
out the corporation at its principal executive offices. Payment of the
Conversion Price for the shares of Common Stock specified in such election shall
be made by applying shares of Series B Preferred Stock, valued at the Stated
Value per share. Payment of Unpaid Dividends, if any, applicable to such
converted shares of Series B Preferred Stock shall be made in accordance with
Section 1.6.5.
1.6.2. All or part of the outstanding shares of Series B Preferred Stock
shall, at the option of the corporation and upon written notice to the holders
thereof given not less than ten (10) days prior to the Closing of a Triggering
Event be converted, by applying shares of Series B Preferred Stock valued at the
Stated Value per share, into shares of Common Stock at the Conversion Price as
of the date and time of the Closing, automatically and without any further
action by the holders of such shares and whether or not the certificates
representing such shares are surrendered to the corporation or its transfer
agent. Payment of Unpaid Dividends, if any, applicable to such converted shares
of Series B Preferred Stock shall be made in accordance with Section 1.6.5.
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1.6.3. Upon the conversion of Series B Preferred stock, the holders of
such Series B Preferred Stock shall surrender the certificates representing such
shares at the office of the corporation. The corporation shall not be obligated
to issue certificates evidencing the shares of Common Stock issuable upon such
conversion (or to pay any Unpaid Dividends in connection with such conversion)
unless certificates evidencing such shares of Series B Preferred Stock being
converted are either delivered to the corporation or the holder notifies the
corporation that such certificates have been lost, stolen, or destroyed and
delivers to the corporation an agreement satisfactory to the corporation, with a
surety satisfactory to the corporation, to indemnify the corporation from any
loss incurred by it in connection therewith.
1.6.4. Each conversion of Series B Preferred Stock shall be deemed to have
been effected immediately prior to the close of business on the Business Day on
which such Series B Preferred Stock shall have been surrendered to the
corporation as provided herein (except that if such conversion is in connection
with a Triggering Event, then such conversion shall be deemed to have been
effected concurrently with the Closing of such Triggering Event), and such
conversion shall be at the Conversion Price in effect at such time. On each such
day that the conversion of shares of Series B Preferred Stock is deemed
effected, the person or persons in whose name or names any certificate or
certificates for shares of Common Stock are issuable upon such conversion shall
be deemed to have become the holder or holders of record thereof.
1.6.5. As promptly as practical after the conversion of shares of Series B
Preferred Stock, in whole or in part, and in any event within five (5) Business
Days thereafter (unless such conversion is in connection with a Triggering
Event, in which event concurrently with such conversion), the corporation at its
expense (including the payment by it of any applicable issue, stamp or other
taxes, other than any income taxes and other than any taxes arising by reason of
issuance of shares of Common Stock to any person other than such holder) will
cause to be issued in the name of and delivered to the holder thereof or as such
holder may direct, (i) a certificate or certificates for the number of shares of
Common Stock to which such holder shall be entitled upon such conversion plus,
in lieu of any fractional shares to which such holder would otherwise be
entitled, cash in an amount equal to the same fraction of the Current Market
Price per share of Common Stock and (ii) Unpaid Dividends, if any, applicable as
of the time of conversion to those shares of Series B Preferred Stock which are
converted. Such Unpaid Dividends shall be paid in cash, without interest. In
case fewer than all the shares of Series B Preferred Stock represented by any
surrendered certificate are converted into Common Stock, a new certificate
representing the shares of Series B Preferred Stock not converted shall be
issued without cost to the holder thereof.
1.7. Anti-Dilution Adjustments. The number of shares of Common Stock
issuable upon any conversion provided for in Section 1.6 shall be subject to
adjustment, from time to time, in accordance with the following provisions:
1.7.1. Issuance of Additional Shares of Common Stock. In case the
corporation at any time or from time to time after the date hereof shall issue
or sell Additional Shares of Common Stock (including Additional Shares of Common
Stock deemed to be issued pursuant to Section 1.7.2 or 1.7.3) without
consideration or for a consideration per share less than the Conversion Price in
effect immediately prior to such issue or sale, then, in each such case, subject
to Section 1.7.7, such Conversion Price shall be reduced, concurrently with such
issue or sale, to a price (calculated to the nearest .001 of a cent) determined
by multiplying such Conversion Price by a fraction
(a) the numerator of which shall be (i) the number of shares of Common
Stock into which the outstanding Series B Preferred Stock is convertible
immediately prior to such issue or sale plus (ii) the number of shares of
Common Stock which the aggregate consideration received by the corporation
for the total number of such Additional Shares of Common Stock so issued or
sold would purchase at such Conversion Price, and
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(b) the denominator of which shall be (i) the number of shares of
Common Stock into which the outstanding Series B Preferred Stock is
convertible immediately prior to such issue or sale plus (ii) the number of
Additional Shares so issued or sold immediately after such issue or sale,
provided that, for the purpose of this Section 1.7.1, (x) immediately after
any Additional Shares of Common Stock are deemed to have been issued
pursuant to Section 1.7.2 or 1.7.3, such Additional Shares shall be deemed
to be outstanding and (y) treasury shares shall not be deemed to be
outstanding. This Section 1.7.1 shall not apply to dividends pursuant to
Section 1.2.1 that are payable in Additional Shares of the Common Stock.
1.7.2. Treatment of Options and Convertible Securities. In case the
corporation at any time or from time to time after the date hereof shall issue,
sell, grant or assume, or shall fix a record date for the determination of
holders of any class of securities entitled to receive, any options or
Convertible Securities, then and in each such case, the maximum number of
Additional Shares of Common Stock (as set forth in the instrument relating
thereto, without regard to any provisions contained therein for a subsequent
adjustment of such number) issuable upon the exercise of such options or, in the
case of Convertible Securities and Options therefor, the conversion or exchange
of such Convertible Securities, shall be deemed to be Additional Shares of
Common Stock issued as of the time of such issue, sale, grant or assumption or,
in case such a record date shall have been fixed, as of the close of business on
such record date (or, if the Common Stock trades on an ex-dividend basis, on the
date prior to the commencement of ex-dividend trading), provided that such
Additional Shares of Common Stock shall not be deemed to have been issued unless
the consideration per shares (determined pursuant to Section 1.7.4) of such
shares would be less than the Conversion Price in effect on the date of and
immediately prior to such issue, sale, grant or assumption or immediately prior
to the close of business on such record date (or, if the Common Stock trades on
an ex-dividend basis, on the date prior to the commencement of ex-dividend
trading), as the case may be, and provided, further, that in any such case in
which Additional Shares of Common Stock are deemed to be issued
(a) no further adjustment of the Conversion Price shall be made upon
the subsequent issue or sale of Convertible Securities or shares of Common
Stock upon the exercise of such options or the conversion or exchange of
such Convertible Securities;
(b) if such Options or Convertible Securities by their terms provide,
with the passage of time or otherwise, for any increase in the
consideration payable to the corporation or decrease in the number of
Additional Shares of Common Stock issuable, upon the exercise, conversion
or exchange thereof (by change of rate or otherwise), the Conversion Price
computed upon the original issue, sale, grant or assumption thereof (or
upon the occurrence of the record date, or date prior to the commencement
of ex-dividend trading, as the case may be, with respect thereto), and any
subsequent adjustments based thereon, shall, upon any such increase or
decrease becoming effective, be recomputed to reflect such increase or
decrease insofar as it affects such Options, or the rights of conversion or
exchange under such Convertible Securities, which are outstanding at such
time;
(c) upon the expiration (or purchase by the corporation and
cancellation or retirement) of any such options which shall not have been
exercised or the expiration of any rights of conversion or exchange under
any such Convertible Securities which shall not have been exercised (or
purchase by the corporation and cancellation or retirement of any such
Convertible Securities the rights of conversion or exchange under which
shall not have been exercised), the Conversion Price computed upon the
original issue, sale, grant or assumption (or upon the occurrence of the
record date, or date prior to the commencement of occurrence of the record
date, or date prior to the commencement of ex-dividend trading, as the case
may be, with respect thereto), and any subsequent adjustments based
thereon, shall, upon such expiration (or such cancellation or retirement,
as the case may be), be recomputed as if
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(i) in the case of Options for Common Stock or Convertible
Securities, the only Additional Shares of Common Stock issued or sold
were the Additional Shares of Common Stock, if any, actually issued or
sold upon the exercise of such Options or the conversion or exchange of
such Convertible Securities and the consideration received therefor was
the consideration actually received by the corporation for the issue,
sale, grant or assumption of all such options, whether or not exercised,
plus the consideration actually received by the corporation upon such
exercise, or for the issue or sale of all such Convertible Securities
which were actually converted or exchanged, plus the additional
consideration, if any, actually received by the corporation upon such
conversion or exchange, and
(ii) in the case of Options for Convertible Securities, only the
Convertible Securities, if any, actually issued or sold upon the
exercise of such options were issued at the time of the issue, sale,
grant or assumption of such Options, and the consideration received by
the corporation for the Additional Shares of Common Stock deemed to have
then been issued was the consideration actually received by the
corporation for the issue, sale, grant or assumption of all such
Options, whether or not exercised, plus the consideration deemed to have
been received by the corporation (pursuant to Section 1.7.4) upon the
issue or sale of such Convertible Securities with respect to which such
Options were actually exercised;
(d) no readjustment pursuant to subdivision (b) or (c) above shall
have the effect of increasing Conversion Price by an amount in excess of
the amount of the adjustment thereof originally made in respect of the
issue, sale, grant or assumption of such Options or Convertible Securities;
and
(e) in the case of any such options which expire by their terms not
more than thirty (30) days after the date of issue, sale, grant or
assumption thereof, no adjustment of the Conversion Price shall be made
until the expiration or exercise of all such Options, whereupon such
adjustment shall be made in the manner provided in subdivision (c) above.
1.7.3. Treatment of Stock Dividends, Stock Splits, etc. In case the
corporation at any time or from time to time after the date hereof shall declare
or pay any dividend on the Common Stock payable in Common Stock, or shall effect
a subdivision of the outstanding shares of Common Stock into a greater number of
shares of Common Stock (by reclassification or otherwise than by payment of a
dividend in Common Stock), then, and in each such case, Additional Shares of
Common Stock shall be deemed to have been issued (a) in the case of any such
dividend, immediately after the close of business on the record date for the
determination of holders of any class of securities entitled to receive such
dividend, or (b) in the case of any such subdivision, at the close of business
on the date immediately prior to the day upon which such corporate action
becomes effective.
1.7.4. Computation of Consideration. For the purposes of this Section
1.7,
(a) the consideration for the issue or sale of any Additional Shares
of Common Stock shall, irrespective of the accounting treatment of such
consideration,
(i) insofar as it consists of cash, be computed at the net amount
of cash received by the corporation, without deducting any expenses paid
or incurred by the corporation or any commissions or compensation paid
or concessions or discounts allowed to underwriters, dealers or others
performing similar services in connection with such issue or sale,
(ii) insofar as it consists of property (including securities)
other than cash, be computed at the fair value thereof at the time of
such issue or sale, as determined in good faith by the Board of
Directors of the corporation (subject to confirmation by a firm
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of independent certified public accountants of recognized national
standing approved by the holders of a majority of the Series B Preferred
Stock), and
(iii) in case Additional shares of Common Stock are issued or sold
together with other stock or securities or other assets of the
corporation for a consideration which covers both, be the portion of
such consideration so received, computed as provided in clauses (i) and
(ii) above, allocable to such Additional Shares of Common Stock, all as
determined in good faith by the Board of Directors of the corporation
(subject to confirmation by a firm of independent certified public
accountants of recognized national standing approved by holders of a
majority of the Series B Preferred Stock);
(b) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.2, relating to Options and Convertible Securities,
shall be deemed to have been issued for a consideration per share
determined by dividing
(i) the total amount, if any, received and receivable by the
corporation as consideration for the issue, sale, grant or assumption of
the options or Convertible Securities in question, plus the minimum
aggregate amount of additional consideration (as set forth in the
instruments relating thereto, without regard to any provision contained
therein for a subsequent adjustment of such consideration to protect
against dilution) payable to the corporation upon the exercise in full
of such Options or the conversion or exchange of such Convertible
Securities or, in the case of Options for Convertible Securities, the
exercise of such Options for Convertible Securities and the conversion
or exchange of such Convertible Securities, in each case computing such
consideration as provided in the foregoing subdivision (a),
(ii) the maximum number of shares of Common Stock (as set forth in
the instruments relating thereto, without regard to any provision
contained therein for a subsequent adjustment of such number to protect
against dilution) issuable upon the exercise of such options or the
conversion or exchange of such Convertible Securities; and
(c) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.3, relating to stock dividends, stock splits, etc.,
shall be deemed to have been issued for no consideration.
1.7.5. Adjustments for Combinations, etc. In case the outstanding shares
of Common Stock shall be combined or consolidated, by reclassification or
otherwise, into a lesser number of shares of Common Stock, the Conversion Price
in effect immediately prior to such combination or consolidation shall,
concurrently with the effectiveness of such combination or consolidation, be
proportionately increased.
1.7.6. Dilution in Case of Other Securities. In case any Other Securities
shall be issued or sold or shall become subject to issue or sale upon the
conversion or exchange of any stock (or other Securities) of the corporation (or
any issuer of other Securities or any other Person referred to in Section 1.8)
or to subscription, purchase or other acquisition pursuant to any options issued
or granted by the corporation (or any such other issuer or Person) for a
consideration such as to dilute, on a basis consistent with the standards
established in the other provisions of this Section 1.7, the conversion rights
granted to holders of Series B Preferred Stock, then, and in each such case, the
computations, adjustments and readjustments provided for in this Section 1.7
with respect to the Conversion Price shall be made as nearly as possible in the
manner so provided and applied to determine the amount of other Securities from
time to time receivable upon the conversion of the shares of Series B Preferred
Stock, so as to protect the holders of the Series B Preferred Stock against the
effect of such dilution.
1.7.7. Minimum Adjustment of Conversion Price. If the amount of any
adjustment of the Conversion Price required pursuant to this Section 1.7 would
be less than five percent (5%) of
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the Conversion Price in effect at the time such adjustment is otherwise so
required to be made, such amount shall be carried forward and adjustment with
respect thereto made at the time of and together with any subsequent adjustment
which, together with such amount and any other amount or amounts so carried
forward, shall aggregate at least five percent (5%) of such Conversion Price.
Notwithstanding the foregoing, the Conversion Price shall be adjusted at the
time of, and be effective with respect to, any conversion or redemption of any
shares of Series B Preferred Stock.
1.8. Consolidation Merger, etc.
1.8.1. Adjustments for Consolidation, Merger, Sale of Assets,
Reorganization, etc. In case the corporation after the date hereof (a) shall
consolidate with or merge into any other Person and shall not be the continuing
or surviving corporation of such consolidation or merger, or (b) shall permit
any other Person to consolidate with or merge into the corporation and the
corporation shall be the continuing or surviving Person but, in connection with
such consolidation or merger, the Common Stock or Other Securities shall be
changed into or exchanged for stock or other securities of any Other Person or
cash or any other property, or (c) shall transfer 40% or more of its properties
or assets to any other Person in a single transaction or a related series of
transactions, or (d) shall effect a capital reorganization or reclassification
of the Common Stock or Other Securities (other than a capital reorganization or
reclassification resulting in the issue of Additional Shares of Common Stock for
which adjustment in the Conversion Price is provided in subsection 1.7.1), then,
and in the case of each such transaction (excluding any such transaction which
constitutes a Triggering Event and in connection with which the corporation
requires conversion of the Series B Preferred Stock), proper provision shall be
made so that, upon the basis and the terms and in the manner provided herein,
the holders of shares of Series B Preferred Stock, upon the conversion thereof
at any time after the consummation of such transaction, shall be entitled to
receive (at the aggregate Conversion Price in effect at the time of such
consummation for all Common Stock or other Securities issuable upon such
exercise immediately prior to such consummation), in lieu of the Common Stock or
Other Securities issuable upon such exercise prior to such consummation, the
highest amount of securities, cash or other property to which such holder would
actually have been entitled as a stockholder upon such consummation if such
holder had exercised the conversion rights pertaining to the Series B Preferred
Stock immediately prior thereto.
1.8.2. Assumption of Obligations. Notwithstanding anything to the
contrary herein provided, the corporation will not effect any of the
transactions described in subsections (a) through (d) of Section 1.8.1
(excluding any such transaction which constitutes a Triggering Event and in
connection with which the corporation requires conversion of the Series B
Preferred Stock) unless, prior to the consummation thereof, each Person (other
than the corporation) which may be required to deliver any stock, securities,
cash or property upon the conversion of shares of Series B Preferred Stock as
provided herein shall assume, by written instrument delivered to, and reasonably
satisfactory to, the holders of the Series B Preferred Stock (a) the obligations
of the corporation with respect to the Series B Preferred Stock (and if the
corporation shall survive the consummation of such transactions such assumption
shall be in addition to, and shall not release the corporation from, any
continuing obligations of the corporation with respect to the Series B Preferred
Stock), and (b) the obligation to deliver to such holder such shares of stock,
securities, cash or property as, in accordance with the foregoing provisions of
this Section 1.8, such holder may be entitled to receive, and such Person shall
have similarly delivered to such holders of Series B Preferred Stock an opinion
of counsel for such Person, which counsel shall be reasonably satisfactory to
such holders, stating that the rights and privileges of the Series B Preferred
Stock shall thereafter continue in full force and effect and the terms thereof
(including, without limitation, all of the provisions of this Section 1.8) shall
be applicable to the stock, securities, cash or property which such Person may
be required to deliver upon any conversion of shares of Series B Preferred Stock
or the exercise of any rights pursuant hereto.
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1.9. Other Dilutive Events. In case any event shall occur as to which the
provisions of Section 1.7 or Section 1.8 are not strictly applicable but the
failure to make any adjustment would not fairly protect the conversion rights
pertaining to shares of Series B Preferred Stock in accordance with the
essential intent and principles of such sections, then, in each such case, the
corporation shall appoint a firm of independent certified public accountants of
recognized national standing (such firm to be subject to the approval of the
holders of a majority of the outstanding Series B Preferred Stock), which shall
give their opinion regarding the adjustment, if any, on a basis consistent with
the essential intent and principles established in Sections 1.7 and 1.8,
necessary to preserve, without dilution, the conversion rights of the Series B
Preferred Stock. Upon receipt of such opinion, the corporation will promptly
mail a copy thereof to each holder of Series B Preferred Stock and shall make
the adjustments described therein.
1.10. No Dilution or Impairment. The corporation will not, by amendment
of its certificate of incorporation or by-laws or through any consolidation,
merger, reorganization, transfer of assets, dissolution, issue or sale of
securities or any other voluntary action, avoid or seek to avoid the observance
or performance of any of the terms of the Series B Preferred Stock, but will at
all times in good faith assist in the carrying out of all such terms and in the
taking of all such action as may be necessary or appropriate in order to protect
the rights of the holders of shares of Series B Preferred Stock against dilution
or other impairment. Without limiting the generality of the foregoing, the
corporation (a) will not permit the par value of any shares of stock receivable
upon the conversion of Series B Preferred Stock to exceed the amount payable
therefor upon such exercise, (b) will take all such action as may be necessary
or appropriate in order that the corporation may validly and legally issue fully
paid and non-assessable shares of stock on the conversion of the shares of
Series B Preferred Stock from time to time outstanding, and (c) will not take
any action which results in any adjustment of the Conversion Price if the total
number of shares of Common Stock (or Other Securities) issuable after the action
upon the conversion of all of the outstanding shares of the Series B Preferred
Stock would exceed the total number of shares of Common Stock (or Other
Securities) then authorized by the corporation's certificate of incorporation
and available for the purpose of issue upon such exercise.
1.11. Accountants' Report as to Adjustments. In each case of any
adjustment or readjustment in the shares of Common Stock (or Other Securities)
issuable upon the conversion of shares of Series B Preferred Stock, the
corporation at its expense will promptly compute such adjustment or readjustment
in accordance with the terms hereof and, if requested by the holders of 20% of
the outstanding shares of Series B Preferred Stock, cause independent certified
public accountants of recognized national standing (such firm to be subject to
the approval of the holders of a majority of the outstanding Series B Preferred
Stock) selected by the corporation to verify such computation and prepare a
report setting forth such adjustment or readjustment and showing in reasonable
detail the method of calculation thereof and the facts upon which such
adjustment or readjustment is based, including a statement of (a) the
consideration received or to be received by the corporation for any Additional
Shares of Common Stock issued or sold or deemed to have been issued, (b) the
number of shares of Common Stock outstanding or deemed to be outstanding, and
(c) the Conversion Price in effect immediately prior to such issue or sale and
as adjusted and readjusted (if required by Section 1.7) on account thereof. The
corporation will forthwith mail a copy of each such report to each holder of
shares of Series B Preferred Stock and will, upon the written request at any
time of any holder of shares of Series B Preferred Stock, furnish to such holder
a like report setting forth the Conversion Price at the time in effect and
showing in reasonable detail how it was calculated. The corporation will also
keep copies of all such reports at its principal office and will cause the same
to be available for inspection at such office during normal business hours by
any holder of Series B Preferred Stock or any prospective purchaser of Series B
Preferred Stock designated by the holder thereof.
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1.12. Notices of Corporate Action. In the event of
(a) any taking by the corporation of a record of the holders of any
class of securities for the purpose of determining the holders thereof who
are entitled to receive any dividend or other distribution, or any right to
subscribe for, purchase or otherwise acquire any shares of stock of any
class or any other securities or property, or to receive any other right,
or
(b) any capital reorganization of the corporation, any
reclassification or recapitalization of the capital stock of the
corporation or any consolidation or merger involving the corporation and
any other Person or any transfer, in a single transaction or a related
series of transactions, of 40% or more of the assets of the corporation to
any other Person or any sale or transfer, in a single transaction or a
related series of transactions, by the corporation of Common Stock
amounting to 40% or more of the then outstanding Common Stock of the
corporation, or
(c) any voluntary or involuntary dissolution, liquidation or
winding-up of the corporation, the corporation will mail to each holder of
shares of Series B Preferred Stock a notice specifying (i) the date or
expected date on which any such record is to be taken for the purpose of
such dividend, distribution or right, and the amount and character of such
dividend, distribution or right, and (ii) the date or expected date on
which any such reorganization, reclassification, recapitalization,
consolidation, merger, transfer, dissolution, liquidation or winding-up is
to take place and the time, if any such time is to be fixed, as of which
the holders of record of Common Stock (or other Securities) shall be
entitled to exchange their shares of Common Stock (or Other Securities) for
the securities or other property deliverable upon such reorganization,
reclassification, recapitalization, consolidation, merger, transfer,
dissolution, liquidation or winding-up. Except for notices relating to
mandatory conversion in connection with a Triggering Event or to a Special
Redemption Event, such notices shall be mailed at least twenty (20)
Business Days prior to the date of the action therein specified.
1.13. Retirement of Converted or Redeemed Shares. No share or shares of
Series B Preferred Stock acquired by the corporation by reason of redemption,
purchase, conversion or otherwise shall be re-issued and all such shares shall
be canceled, retired and eliminated from the shares which the corporation shall
be authorized to issue. The corporation may from time to time take such
appropriate corporate action as may be necessary to reduce the authorized number
of shares of Series B Preferred Stock accordingly.
FIFTH B: DESIGNATIONS, PREFERENCES AND SPECIAL RIGHTS OF SERIES C
PREFERRED STOCK((2))
Designation, Amount and Rank. One Hundred Thousand (100,000) shares of a
preferred stock, $1.00 par value per share, shall constitute a series of such
preferred stock designated as a "Series C Convertible Preferred Stock" (the
"Series C Preferred Stock"). The Series C Preferred Stock will be issued as one
of two sub-series of preferred stock. Series C-1 Voting Preferred Stock (the
"Series C-1 Preferred Stock") and Series C-2 Non-Voting Preferred Stock (the
"Series C-2 Preferred Stock"), the number of shares of each such series to be
determined by resolution of the Board of Directors of the corporation. The
respective rights and preferences of the Series C Preferred Stock, with respect
to dividend rights, redemption rights and rights on
- ---------------
(2) Since the Series C-2 Preferred Stock will be converted at the closing of
the Capital Z Issuance, after the closing, a second amended and restated
certificate of incorporation will be filed deleting references to the Series C-2
Preferred Stock.
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liquidation, winding up and dissolution, shall be as set forth herein. The
Series C Preferred Stock shall be issued pursuant to the following additional
terms and conditions:
1. Series C Convertible Preferred Stock.
1.1. Definitions. As used herein, unless the context otherwise requires,
the following terms have the following meanings:
1.1.1. "Additional Shares of Common Stock" means all shares (including
treasury shares) of Common Stock issued or sold (or, pursuant to Sections 1.7.2
or 1.7.3, deemed to be issued) by the corporation after January 8, 1997, whether
or not subsequently reacquired or retired by the corporation other than (i) the
issuance of shares upon conversion of the Series B Preferred Stock; (ii) shares
issued upon the exercise of the Common Stock Purchase Warrants outstanding on
January 8, 1997; (iii) shares to be issued to directors, employees, agents and
others, pursuant to the corporation's Incentive Stock Option Plan for Employees,
Stock Option Plan for Directors and Stock Option Plan for Agents and Others, as
in effect on January 8, 1997; and (iv) such additional number of shares, if any,
as may become issuable upon the conversion or exercise of any of the securities
referred to in the foregoing clauses (i) through (iii) pursuant to the terms of
the instruments governing such securities as in effect on April 7, 1997.
1.1.2. "Adjusted Stated Value" shall mean the Stated Value, increased at
the rate of 8% per annum from the date of original issuance of each share of
Series C Preferred Stock, accruing daily, compounded annually. The date on which
the corporation initially issues any share of Series C Preferred Stock will be
deemed to be its "date of issuance" regardless of the number of times transfer
of such share of Series C Preferred Stock is made on the stock records
maintained by or for the corporation and regardless of the number of
certificates which may be issued to evidence such share of Series C Preferred
Stock.
1.1.3. "Affiliate" as applied to any Person means any other Person
directly or indirectly controlling, controlled by, or under common control with,
that Person. The term "control" (including, with correlative meanings, the terms
"controlling," "controlled by" and "under common control with"), as applied to
any Person, means the possession, directly or indirectly, of the power to vote
10% or more of the voting stock (or in the case of a Person which is not a
corporation, 10% or more of the ownership interest, beneficial or otherwise) of
such Person or otherwise to direct or cause the direction of the management and
polices of that Person, whether through the ownership of voting stock or other
ownership interest, by contract or otherwise. All of the corporation's executive
officers, 10% stockholders, directors, Subsidiaries, joint ventures and partners
shall be deemed to be Affiliates of the corporation for purposes of this
Agreement.
1.1.4. "Business Day" means any day other than a Saturday or a Sunday or a
day on which commercial banking institutions in the City of New York are
authorized by law or other governmental action to be closed. Any reference to
"days" (unless Business Days are specified) shall mean calendar days.
1.1.5. "Call Price" means the following price per share plus eight percent
(8%) accrued on the Stated Value thereof from the original date of issuance of
such Series C Preferred Stock through the applicable Redemption Date, compounded
annually.
<TABLE>
<CAPTION>
REDEMPTION
DATE PRICE
- ---------- -----
<S> <C>
Prior to or on December 31, 2000........................... $150
After December 31, 2000.................................... $175
</TABLE>
1.1.6. "Common Stock" means the corporation's Common Stock, $.01 par
value, such term to include any stock into which such Common Stock shall have
been changed or any stock resulting from any reclassification of such Common
Stock, and all other stock of any class or classes (however designated) of the
corporation the holders of which have the right, without
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limitation as to amount, either to all or to a share of the balance of current
dividends and liquidating dividends and distributions after the payment of the
dividends and distributions on any shares entitled to preference.
1.1.7. "Conversion Event" shall mean (a) any public offering, or public
sale of securities of the corporation (including a public offering registered
under the Securities Act of 1933 and a public sale pursuant to Rule 144 of the
Securities and Exchange Commission or any similar rule then in force), (b) any
sale of securities of the corporation to a person or group of persons (within
the meaning of the Securities Exchange Act of 1934, as amended (the "1934 Act"))
if, after such sale, such person or group of persons in the aggregate would own
or control securities which possess in the aggregate the ordinary voting power
to elect a majority of the corporation's directors (provided that such sale has
been approved by the corporation's Board of Directors or committee thereof, (c)
any sale of securities of the corporation to a person or group of persons
(within the meaning of the 1934 Act) if, after such sale, such person or group
of persons in the aggregate would own or control securities of the corporation
(excluding any Series C-2 Preferred Stock being converted and disposed of in
connection with such Conversion Event) which possess in the aggregate the
ordinary voting power to elect a majority of the corporation's directors, (d)
any sale of securities of the corporation to a person or group of persons
(within the meaning of the 1934 Act) if, after such sale, such person or group
of persons would not, in the aggregate, own, control or have the right to
acquire more than two percent (2%) of the outstanding securities of any class of
voting securities of the corporation and (e) a merger, consolidation or similar
transaction involving the corporation if, after such transaction, a person or
group of persons (within the meaning of the 1934 Act) in the aggregate would own
or control securities which possess in the aggregate the ordinary voting power
to elect a majority of the surviving corporation's directors (provided that the
transaction has been approved by the corporation's Board of Directors or a
committee thereof).
1.1.8. "Conversion Price" means $2.375, subject to adjustment from time to
time pursuant to Section 1.7.
1.1.9. "Convertible Securities" means any evidences of indebtedness,
shares of stock (other than Common Stock) or other securities directly or
indirectly convertible into or exchangeable for Additional Shares of Common
Stock.
1.1.10. "Indebtedness" shall mean at a particular time, without
duplication, (i) indebtedness for borrowed money or for the deferred purchase
price of property or services in respect of which any Person is liable,
contingently or otherwise, as obligor or otherwise (other than trade payables
and other current liabilities incurred in the ordinary course of business) or
any commitment by which any Person assures a creditor against loss, including
contingent reimbursement obligations with respect to letters of credit, (ii)
indebtedness guaranteed in any manner by any Person, including guarantees in the
form of an agreement to repurchase or reimburse, (iii) obligations under
capitalized leases in respect of which obligations any Person is liable,
contingently or otherwise, as obligor, guarantor or otherwise, or in respect of
which obligations any Person assures a creditor against loss and (iv) any
unsatisfied obligation of any Person for "withdrawal liability" to a
"multiemployer plan" as such terms are defined under the Employee Retirement
Income Security Act of 1974, as amended.
1.1.11. "Junior Securities" means any of the corporation's equity
securities other than the Series C Preferred Stock (including the Series B
Preferred Stock and the Common Stock) whether now outstanding or hereafter
issued.
1.1.12. "Liquidation" means liquidation, dissolution or winding-up
(including, without limitation, a liquidation or reorganization under Chapter 7
or 11 of Title 11 of the United States Code, as amended).
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1.1.13. "Options" means rights, options or warrants to subscribe for,
purchase or otherwise acquire either Additional Shares of Common Stock or
Convertible Securities.
1.1.14. "Organic Change" means any capital reorganization,
reclassification, consolidation, merger, lease, or sale of all or substantially
all of the corporation's assets to another Person which is effected in such a
way that holders of Common Stock are entitled to receive (either directly or
upon subsequent liquidation) stock, securities or assets with respect to or in
exchange for shares of Common Stock.
1.1.15. "Other Securities" means any stock (other than Common Stock) and
other securities of the corporation or any other Person (corporate or otherwise)
which the holders of Series B Preferred Stock at any time shall be entitled to
receive, or shall have received, upon the conversion of Series B Preferred
Stock, in lieu of or in addition to Common Stock, or which at any time shall be
issuable or shall have been issued in exchange for or in replacement of Common
Stock or Other Securities.
1.1.16. "Person" means an individual, a partnership, a corporation, a
limited liability company, an association, a joint stock company, a trust, a
joint venture, an unincorporated organization or a governmental entity or any
department, agency or political subdivision thereof.
1.1.17. "Regulated Stockholder" means any Series C Preferred Stockholder
that is subject to the provisions of Regulation Y of the Board of Governors of
the Federal Reserve System, 12 C.F.R. Part 225 (or any successor to such
Regulation).
1.1.18. "Regulatory Problem" means any set of facts or circumstances
wherein it has been asserted by any governmental regulatory agency (or a
Regulated Stockholder reasonably believes that there is a risk of such
assertion) that such Regulated Stockholder is not entitled to acquire, own, hold
or control, or exercise any significant right (including the right to vote) with
respect to any securities of the corporation or any subsidiary of the
corporation.
1.1.19. "Restricted Stock" means, with respect to any Regulated
Stockholder, any outstanding shares of stock ever held of record by such
Regulated Stockholder or its Affiliates, excluding treasury shares; provided,
however, that any such shares shall cease to be Restricted Stock with respect to
such Regulated Stockholder when such shares are transferred in a transaction
which is a Conversion Event or when such shares are acquired by the corporation
or any subsidiary of the corporation; and provided, further, that the
corporation shall have no responsibility for determining whether any outstanding
shares of stock constitute Restricted Stock with respect to a particular
Regulated Stockholder, but shall instead be entitled to receive, and rely
exclusively upon, a written notice provided by such Regulated Stockholder
designating such shares as Restricted Stock.
1.1.20. "Series B Preferred Stock" means the Series B Convertible
Preferred Stock, $1.00 par value, of the corporation created pursuant to a
Certificate of Amendment filed December 21, 1994 with the Secretary of State of
the State of New York.
1.1.21. "Stated Value" per share means, with respect to the Series C
Preferred Stock, One Hundred Dollars ($100) per share, as adjusted for any stock
splits, stock combinations, stock dividends or reclassifications affecting the
Series C Preferred Stock after the date of filing of this Certificate of
Amendment.
1.1.22. "Subsidiary" means any corporation of which the shares of stock
having a majority of the general voting power in electing the board of directors
are, at the time as of which any determination is being made, owned by the
corporation either directly or indirectly through Subsidiaries.
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1.1.23. "Triggering Amount" means the following amount in any 60-day
period ending in the applicable calendar year:
<TABLE>
<CAPTION>
TRIGGERING AMOUNT CALENDAR YEAR
----------------- -------------
<S> <C>
$3.45................................................. 1999
$4.25................................................. 2000
$5.15................................................. 2001
</TABLE>
in each case as adjusted for stock splits, stock combinations, stock dividends
or reclassifications affecting the Common Stock after the date of filing of this
Certificate of Amendment. If the sixty (60) day period includes portions in two
calendar years, the Triggering Amount applicable shall be the average of the
figures shown above of the two years, weighted to reflect in number the days in
each year included such sixty (60) day period.
1.1.24. "Triggering Bid Price" means that the average of the high and low
bid price reported on (i) the principal national securities exchange on which
the Common Stock is then listed or admitted to trading, or (ii) if not so listed
or admitted, the NASD automated quotation system, on those days on which a bid
price was so reported during each period of sixty (60) consecutive calendar days
between January 1, 1999 and December 31, 2001.
1.1.25. "Triggering Event" means the consummation of a public offering
pursuant to an effective registration statement under the Securities Act of
1933, as amended, covering the offering and sale of shares of Common Stock or of
securities convertible into Common Stock (i) in which the aggregate proceeds to
the corporation exceed $10,000,000 and (ii) in which the price per share at
which the Common Stock is initially offered to the public equals or exceeds
$3.45 per share or the other securities are initially offered to the public with
a conversion price of $3.45 or more per share (in each case as adjusted for
stock splits, stock combinations, stock dividends or reclassifications affecting
the Common Stock after April 7, 1997).
1.2. Dividends. The corporation shall not, without the prior written
consent of the holders of a majority of the shares of Series C Preferred Stock
then outstanding, pay or declare any dividend or distribution on any Junior
Securities (other than on Common Stock, and on Series B Preferred Stock to the
extent of participation in dividends declared on the Common Stock). In the event
that the corporation declares a dividend or distribution on the Common Stock,
the holders of the Series C Preferred Stock and the holders of the Series B
Preferred Stock and the Common Stock shall share pro rata (based, in the case of
holders of Series C and Series B Preferred Stock, on the number of shares of
Common Stock which each holder of Series C and Series B Preferred Stock would be
entitled to receive upon conversion of its Series C and Series B Preferred Stock
into Common Stock, respectively) in such dividend or distribution; provided,
that if the dividend consists of voting securities or options, warrants, or
rights to acquire such voting securities, or securities convertible into or
exchangeable for such voting securities (the "Voting Securities") of the
corporation, the corporation shall make available to each holder of Series C-2
Preferred Stock, at such holder's request, dividends consisting of non-voting
securities or options, warrants or rights to acquire such non-voting securities,
or securities convertible into or exchangeable for such non-voting securities of
the corporation which are otherwise identical to the Voting Securities and which
are convertible into or exchangeable for such Voting Securities. In the
application of this Section 1.2, Series C and Series D Preferred Stock shall be
treated equally, pari passu.
1.3. Rights on Liquidation. In the event of any liquidation, the holders
of shares of the Series C Preferred Stock then issued and outstanding shall be
entitled to be paid the amount specified below out of the assets of the
corporation available for distribution to its stockholders, pari-passu with the
holders of the Series B Preferred Stock and before any payment shall be made to
the holders of any other Junior Securities. If, upon any Liquidation of the
corporation, the assets of the corporation available for distribution to its
stockholders (the "Available
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Assets") shall be insufficient (a "Liquidation Insufficiency") to pay the
holders of shares of the Series B Preferred Stock and Series C Preferred Stock
the full amounts to which they shall respectively be entitled, the holders of
the Series B Preferred Stock and Series C Preferred Stock shall be entitled to
receive the Available Assets as follows:
(i) the holders of Series C Preferred Stock shall be entitled to
receive (pro rata based on the number of shares of Series C Preferred Stock
held by them) an amount equal to the Available Assets times the quotient
derived by dividing (x) the amount of the Available Assets the holders of
Series C Preferred Stock would be entitled to upon Liquidation if there had
been no Liquidation Insufficiency by (y) the total amount of the Available
Assets the holders of Series B Preferred Stock and Series C Preferred Stock
would be entitled to upon Liquidation if there had been no Liquidation
Insufficiency; and
(ii) the holders of Series B Preferred Stock shall be entitled to
receive (pro rata based on the number of shares of Series B Preferred Stock
held by them) an amount equal to the Available Assets times the quotient
derived by dividing (x) the amount of the Available Assets the holders of
Series B Preferred Stock would be entitled to upon Liquidation if there had
been no Liquidation Insufficiency by (y) the total amount of the Available
Assets the holders of Series B Preferred Stock and Series C Preferred Stock
would be entitled to upon Liquidation if there had been no Liquidation
Insufficiency; and if there is no Liquidation Insufficiency, then the
holders of shares of the Series C Preferred Stock shall be entitled to
receive the greater of (a) an amount equal to the Adjusted Stated Value per
share, calculated to and including the date of Distribution with respect to
such shares of Series C Preferred Stock, or (b) the amount which would be
distributed in such liquidation on the shares of Common Stock into which
the series C Preferred Stock is convertible at the date of the Liquidation
of the corporation, had such Series C Preferred Stock been converted. In
the application of this Section 1.3, Series C and Series D Preferred Stock
shall be treated equally, pari passu.
1.4. Voting Power.
1.4.1. Series C-1 Preferred Stock.
(a) In General. Except as otherwise expressly provided herein or as
required by law,
(i) the holders of shares of Series C-1 Preferred Stock and Common
Stock shall vote together as a single class with respect to all matters
as to which stockholders of the corporation are entitled to vote;
provided, however, the holders of the Series C-1 Preferred Stock shall
not be entitled to vote with respect to the election of directors to the
Board of Directors of the corporation except with respect to the
election of the Series C Director as set forth in Section 1.4.1(b);
(ii) each holder of Series C-1 Preferred Stock shall be entitled to
cast a number of votes equal to the greatest number of whole shares of
Common Stock into which such holder's shares of Series C-1 Preferred
Stock could be converted, pursuant to the provisions of Section 1.6
hereof, at the record date for the determination of stockholders
entitled to vote on such matter or, if no such record date is
established, at the date such vote is taken or any written consent of
stockholders is first solicited.
(b) Election of Directors. As long as at least 20% of the shares of
Series C Preferred Stock originally issued are outstanding, the holders of
Series C-1 Preferred Stock shall have the right, voting separately as a
class, unless waived in writing by the holders of a majority of the
outstanding Series C-1 Preferred Stock, and to the exclusion of all other
classes of the corporation's stock, to elect, remove and replace (including
the filling of a vacancy) one (1) director to the Board of Directors of the
corporation (the "Series C Director"), which, so long as the Series C-1
Preferred Stock has the right to elect a director, shall be composed of no
more than twelve (12) directors. Any and all committees of the Board of
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Directors of the corporation shall have as a member the Series C Director,
unless no such director is willing or able to so serve. The special right
of the holders of Series C-1 Preferred Stock to elect and remove the Series
C Director contained in this Section 1.4.1(b) may be exercised either at a
special meeting of the holders of Series C-1 Preferred Stock called as
provided below, at any annual or special meeting of the stockholders of the
corporation, or by written consent of the holders of Series C-1 Preferred
Stock in lieu of a meeting. At any time when the holders of Series C-1
Preferred Stock have the special rights set forth in this Section 1.4.1(b),
the secretary of the corporation shall, upon the written request of the
holders of record of shares of Series C-1 Preferred Stock having at least
10% of the votes possessed by the then outstanding Series C-1 Preferred
Stock, call a special meeting of the holders of Series C-1 Preferred Stock
for the purpose of electing or removing the Series C Director. Such meeting
shall be held at the earliest practicable date at the corporation's
principal office or at such other place designated by the holders of Series
C-1 Preferred Stock having at least 10% of the votes possessed by the then
outstanding Series C-1 Preferred Stock. If such meeting shall not be called
by a proper officer of the corporation within ten (10) days after personal
service of such written request upon the secretary of the corporation or
within twenty (20) days after mailing the same to the secretary of the
corporation at the corporation's principal office, then the holders of
record of Series C-1 Preferred Stock having at least 10% of the votes
possessed by the then outstanding Series C-1 Preferred Stock may designate
in writing one of their number to call such meeting at the expense of the
corporation, and such meeting may be called by such persons so designated
upon the shortest legally permissible notice. Any holders of Series C-1
Preferred Stock so designated shall have reasonable access to the stock
books of the corporation during regular business hours, at the principal
office of the corporation or its transfer agent, for the purpose of calling
a meeting of the stockholders pursuant to these provisions.
At any stockholders meeting at which the holders of Series C-1
Preferred Stock shall have the special right to elect or remove the Series
C Director as provided in this Section 1.4.1(b), the presence, in person or
by proxy, of the holders of record of shares of Series C-1 Preferred Stock
having a majority of the votes possessed by the then outstanding Series C-1
Preferred Stock shall be required to constitute a quorum of the Series C-1
Preferred Stock for such election of removal. At any such meeting or
adjournment thereof, the absence of a separate quorum of the Series C
Preferred Stock shall not prevent the election of those directors to be
elected at such meeting, other than the Series C Director. In the absence
of a separate quorum of the Series C-1 Preferred Stock, the holders of
record of shares representing a majority of the voting power present in
person or by proxy of the Series C-1 Preferred Stock shall have power to
adjourn the meeting for the election of the Series C Director without
notice other than announcement at the meeting.
(c) Special Matters. The corporation shall not authorize, effect or
validate any of the following without (i) the consent in writing or by
votes at a meeting of the holders of at least 50% of all of the shares of
the Series C-1 Preferred Stock at the time outstanding, if any, voting
together as a separate class and to the exclusion of all other classes of
the corporation's stock or (ii) complying with the terms of Section 1.5.3.
below:
(i) Ten Percent Redemptions. Subject to Section 1.8 below,
directly or indirectly redeem, purchase or otherwise acquire, or permit
any Subsidiary to directly or indirectly redeem, purchase or otherwise
acquire, ten percent (10%) or more of any of the corporation's, or any
Subsidiary's (except wholly-owned Subsidiary's), outstanding equity
securities except as required by the terms of the Series C Preferred
Stock and other than pursuant to the terms of the agreements with
employees, officers, directors and consultants of the corporation,
pursuant to which the corporation may repurchase such shares upon the
occurrence of certain events, in all cases as in effect on April 7,
1997.
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(ii) Security Issuances. Authorize, issue, or enter into any
agreement providing for the issuance (contingent or otherwise) by the
corporation or any of its Subsidiaries of, (x) any notes or debt
securities convertible into or exchangeable for equity securities,
issued in connection with the issuance of equity securities or
containing profit participation features or (y) any equity securities
(or any securities convertible into or exchangeable for any equity
securities), provided, however, that this Section 1.4.1(c)(ii) shall not
prevent the issuance of Junior Securities, or securities convertible or
exchangeable for Junior Securities.
(iii) Mergers. Merge or consolidate with any Person or permit any
Subsidiary to merge or consolidate with any Person except for (i)
mergers of a wholly-owned Subsidiary with or into the corporation or any
other wholly-owned Subsidiary or (ii) mergers or consolidations in which
the corporation or Subsidiary is the surviving corporation and at the
conclusion of which the stockholders of the corporation immediately
preceding such consolidation or merger own greater than fifty percent
(50%) of the equity securities of the surviving corporation.
(iv) Liquidations. Liquidate, dissolve or effect a
recapitalization or reorganization in any form of transaction or make an
assignment for the benefit of creditors or admit in writing the
corporation's or any Subsidiary's inability to pay its debts generally
as they become due; or petition or apply to any tribunal for the
appointment of a custodian, trustee, receiver or liquidator of the
corporation or a Subsidiary, or of any substantial part of the assets of
the corporation or a Subsidiary, or commence any proceeding (other than
a proceeding for the voluntary liquidation and dissolution of a
Subsidiary) relating to the corporation or a Subsidiary under any
bankruptcy, reorganization, arrangement, insolvency, readjustment of
debt, dissolution or liquidation law of any jurisdiction.
(v) Certificate of Incorporation Amendments. Make or authorize any
amendment to the corporation's articles of incorporation or by-laws, or
any Subsidiary's organizational documents, or file any resolution of the
Board of Directors of the corporation or any Subsidiary, with the
Secretary of State or any other incorporation agency in the state in
which it is organized, in each case which would have the effect of
amending, altering or changing the designations, powers, preferences,
rights, privileges or restrictions of the Series C Preferred Stock or
otherwise have an adverse effect on the Series C Preferred Stock.
(vi) Affiliate Transactions. Enter into, or permit any subsidiary
to enter into, any transaction with any of its or any Subsidiary's
Affiliates, except for (i) normal employment arrangements and benefit
programs on reasonable terms, (ii) transactions among Universal and/or
one or more of its wholly-owned Subsidiaries, and (iii) transactions not
less favorable to Universal and its subsidiaries, taken as a whole, than
would be one entered into at arm's length with unaffiliated parties.
(vii) Sale of Assets. Sell, lease or otherwise dispose of, all or
substantially all assets of the corporation, directly or through a
Subsidiary of the corporation, in any transaction or series of related
transactions, including the sale by the corporation of any one of
American Pioneer Life Insurance corporation or American Progressive Life
and Health Insurance corporation of New York (together, the "Insurance
corporation Subsidiaries"). This Section 1.4.1(c)(vii) shall not,
however, prevent transactions in which ownership of assets is
transferred among Universal and/or one or more of its wholly-owned
Subsidiaries.
(viii) Indebtedness. Create, incur, assume or suffer to exist, or
permit the corporation and its Subsidiaries, taken as a whole, to
create, incur, assume or suffer to exist, Indebtedness in an aggregate
amount which result in the sum of (i) the aggregate
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principal amount of all Indebtedness outstanding, plus (ii) the par
value of all Preferred Stock outstanding, to exceed 80% of the statutory
book value (including "Asset Valuation Reserve" and "Interest
Maintenance Reserve") of both Insurance corporation Subsidiaries, except
(x) trade debt incurred in the normal course of business and (y)
Indebtedness, if any, provided for in the corporation's annual budget
approved by the Board of Directors.
The taking by the corporation of an action described in (i) through
(vi) above without obtaining the consent required by this Section
1.4.1(c) shall be referred to as a "Call Price Action" and the taking by
the corporation of an action described in (vii) and (viii) above without
first obtaining the consent required by this Section 1.4.1(c) shall be
referred to as an "Adjusted Stated Value Action."
1.4.2. Voting Rights of Series C-2 Preferred Stock. Except as set forth
herein or as otherwise required by law, no outstanding share of Series C-2
Preferred Stock shall be entitled to vote on any matter on which the
stockholders of the company shall be entitled to vote, and no shares of Series
C-2 Preferred Stock shall be included in determining the number of shares voting
or entitled to vote on any such matters; provided that the holders of Series C-2
Preferred Stock shall have the right to vote as a separate class on any merger
or consolidation of the corporation with or into another entity or entities, or
any recapitalization or reorganization, in which shares of Series C-2 Preferred
Stock would receive or be exchanged for consideration different on a per share
basis from consideration received with respect to or in exchange for the shares
of Series C-1 Preferred Stock or would otherwise be treated differently from
shares of Series C-1 Preferred Stock in connection with such transaction, except
that if the consideration received with respect to, or in exchange for, Series
C-1 includes voting securities, shares of Series C-2 Preferred Stock may,
without such a separate class vote, receive or be exchanged for non-voting
securities which are otherwise identical on a per share basis in amount and form
to the voting securities received with respect to or exchanged for the Series
C-1 Preferred Stock so long as (i) such non-voting securities are convertible
into such voting securities on the same terms as the Series C-2 Preferred Stock
is convertible into voting stock and (ii) all other consideration is equal on a
per share basis. Notwithstanding the foregoing, holders of shares of Series C-2
Preferred Stock shall be entitled to vote as a separate class on any amendment
to this paragraph (2) of this Section A and on any amendment, repeal or
modification of any provision of this Certificate of Incorporation that
adversely affects the powers, preferences or special rights of holders of the
Series C-2 Preferred Stock.
1.4.3. Series D Preferred Stock. In the application of this Section 1.4,
Series C-2 and Series D Preferred Stock shall be treated equally, pari passu.
1.5. Redemption.
1.5.1. Fixed Redemption. On December 31, 2002 (the "Fixed Redemption
Date") all of the then issued and outstanding Series C Preferred Stock shall be
redeemed at a redemption price (the "Fixed Redemption Price") equal to the
Adjusted Stated Value on December 31, 2002. One-half of the Fixed Redemption
Price shall be paid in cash to the person whose name appears in the records of
the corporation as the owner of the shares redeemed, by check mailed to such
person's address on such records on the Fixed Redemption Date, and the other
half shall be payable in the same manner, on the first anniversary of the Fixed
Redemption Date.
1.5.2. Call of the Corporation. The Series C Preferred Stock may be
redeemed by the corporation, at its option, upon ninety (90) days prior written
notice to the Holders, at the Call Price then in effect.
Such redemption may be effected under this Section 1.5.2 at any time after
January 1, 2000 and before December 31, 2002. The conversion right set forth in
Section 1.6.1 shall not be
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affected by the giving of a redemption notice hereunder until the close of
business the Business Day prior to the date specified in such notice as the
proposed effective date of the redemption.
1.5.3. Non-Compliance Provisions. If the corporation proposes to take any
action which constitutes either a Call Price Action or an Adjusted Stated Value
Action without securing the approval by vote or in writing required by Section
1.4.1(c) (each such action or breach, an "Event of Non-Compliance") then each of
the holders of the Series C Preferred Stock may require redemption of all or any
part of such holder's Series C Preferred Stock at a redemption price in cash
equal to (i) in the event of a Call Price Action, the Call Price in effect on
the Non-Compliance Redemption Date and (ii) in the event of an Adjusted Stated
Value Action, the Adjusted Stated Value in effect on the Non-Compliance
Redemption Date. In implementation of this Section 1.5.3:
(a) At least 15 days before the consummation of any Event of
Non-Compliance, each holder of Series C Preferred Stock will receive a
notice from the corporation (i) stating that an Event of Non-Compliance is
contemplated, (ii) setting forth a redemption date (the "Non-Compliance
Redemption Date"), which shall be the date of the Event of Non-Compliance,
(iii) setting forth the Conversion Price in effect with respect to such
shares of Series C Preferred Stock, up to and including the date of
consummation of the Event of Non-Compliance, and (iv) stating that during
such 15-day period, each stockholder wishing to require the corporation to
redeem all or any part of its Series C Preferred Stock, pursuant to
subsection (b) below, must give the corporation written notice of its
intention to require such redemption prior to the consummation of the Event
of Non-Compliance.
(b) Any holder of Series C-1 Preferred Stock that withheld its consent
to the Event of Non-Compliance and any holder of Series C-2 Preferred Stock
that has advised the corporation in writing prior to consummation of an
Event of Non-Compliance of its intention to require the corporation to
redeem its shares, may require that the corporation redeem any shares
hereunder by surrendering its shares to the corporation on the
Non-Compliance Redemption Date or within thirty (30) days thereafter and
will be entitled to payment therefor within ten (10) days of such surrender
in full satisfaction of such shares.
(c) Any holder of shares of Series C-1 Preferred Stock that does not
tender such shares pursuant to Section 1.5.3(b) above shall be deemed to
have consented to the subject Event of Non-Compliance.
(d) It is an express condition of this Series C Preferred Stock that
this Section 1.5.3 shall constitute the sole remedy of the Series C
Preferred Stockholders with respect to the corporation's failure to obtain
the consent otherwise required by Section 1.4.1(c) above. Without
limitation, there shall be no right to injunctive or any other kind of
equitable relief, or to any other remedy at law whatsoever, by virtue of
the corporation's failure to obtain the consent otherwise required by
Section 1.4.1(c) above with respect to such Event of Non-Compliance.
1.5.4. Failure to Pay Redemption Price or Installment. If payment of the
Fixed Redemption Price is not made as provided in Section 1.5.1 and said default
is not cured within fifteen (15) days, the holder of each share of Series C
Preferred Stock which was redeemed shall be entitled to require the corporation
to issue a promissory note for the unpaid portion of the Fixed Redemption Price,
including any amount which would otherwise not have been payable until the first
anniversary of the Fixed Redemption Date, which note shall be due one year after
the Fixed Redemption Date (or the first anniversary thereof, whichever is
applicable), together with interest at twenty (20%) percent per annum until
paid, subject to pre-payment at any time, with interest accrued, without
penalty. Any such promissory note shall contain substantially the same terms and
conditions of the Series C Preferred Stock, including negative and affirmative
covenants equal to the rights of the holders of the Series C-1 Preferred Stock
set forth in
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Section 1.4.1(c) and board observation rights comparable to the rights of the
holders of Series C-1 Preferred Stock set forth in Section 1.4.1(b).
1.5.5. Legal Availability. If the funds of the corporation legally
available for redemption of Series C Preferred Stock on any Redemption Date are
insufficient to redeem the total number of Series C Preferred Stock to be
redeemed on such date, those funds which are legally available shall be used to
redeem the maximum possible number of Series C Preferred Stock ratably among the
holders of the Series C Preferred Stock to be redeemed. At any time thereafter
when additional funds of the corporation are legally available for the
redemption of Series C Preferred Stock, such funds shall immediately be used to
redeem the balance of the Series C Preferred Stock which the corporation has
become obligated to redeem on any Redemption Date but which it has not redeemed.
In case fewer than the total number of Series C Preferred Shares represented by
any certificate are redeemed, a new certificate representing the number of
unredeemed Series C Preferred Stock shall be issued to the holder thereof
without cost to such holder within three Business Days after surrender of the
certificate representing the redeemed Series C Preferred Stock. In the event
that any Series C Preferred Stock is redeemed under Section 1.5.1, 1.5.2 or
1.5.3 and the certificates for the Series C Preferred Stock to be redeemed have
not been delivered to the corporation, from and after the date on which the
corporation makes the entire Fixed Redemption Price or Call Price, as the case
may be, available or irrevocably deposits an amount equal to such Fixed
Redemption Price or Call Price, as the case may be, for the shares of Series C
Preferred Stock to be redeemed in trust for the holders of such shares with a
bank having capital and surplus in excess of $100 million, which bank shall be
named in the redemption notice, all rights of the holders of such Series C
Preferred Stock, except the right to receive the Fixed Redemption Price or Call
Price, as the case may be (whether in cash or in the form of the promissory note
provided for in Section 1.5.4, above, without interest except as provided with
respect to the promissory note), upon surrender of their certificate or
certificates, shall cease with respect to such shares, and such shares shall not
thereafter be transferred on the books of the corporation or be deemed to be
outstanding for any purpose whatsoever.
1.5.6. Other Redemptions or Acquisitions. Neither the corporation nor any
Subsidiary shall redeem or otherwise acquire any share of Series C Preferred
Stock, except as expressly authorized herein or pursuant to a purchase offer
made pro rata to all holders of Series C Preferred Stock on the basis of the
number of shares owned by each such holder.
1.5.7. Series D Preferred Stock. In the application of this Section 1.5,
Series C and Series D Preferred Stock shall be treated equally, pari passu.
1.6. Conversion Rights.
1.6.1. At the Option of the Holder. Each holder of the outstanding shares
of Series C Preferred Stock shall have the right to convert all or any portion
of such shares of Series C Preferred Stock into the number of fully paid and
non-assessable shares of Common Stock computed by multiplying the number of
shares of Series C Preferred Stock to be converted times the Stated Value and
dividing the result by the Conversion Price. Within 15 days of any such
conversion of Series C-2 Preferred Stock into Common Stock, such converted
shares may be converted back into the same number of Series C-2 Preferred
Shares, provided that such shares were not voted following the initial
conversion of Series C-2 Preferred Stock into Common Stock. Series C Preferred
Stock may be converted by the holder thereof during normal business hours on any
Business Day by surrender of the required number of shares of Series C Preferred
Stock, accompanied by written evidence (in form reasonably satisfactory to the
corporation) of the holder's election to convert such holder's Series C
Preferred Stock or portion thereof, to the corporation at its principal
executive offices.
1.6.2. At the Option of a Transferee of Series C-2 Preferred
Stock. Subject to Section 1.6.4, below, each outstanding share of Series C-2
Preferred Stock may be converted into one fully
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paid and nonassessable share of Series C-1 Preferred Stock by any transferee of
such shares of Series C-2 Preferred Stock, provided that each holder of Series
C-2 Preferred Stock may convert such shares into Series C-1 Preferred Stock if
such holder reasonably believes that such converted shares will be transferred
within fifteen (15) days pursuant to a Conversion Event and such holder agrees
not to vote any such shares of Series C-1 Preferred Stock prior to such
Conversion Event and undertakes to promptly convert such shares back into Series
C-2 Preferred Stock if such shares are not transferred pursuant to a Conversion
Event. Series C-2 Preferred Stock may be converted by the transferee during
normal business hours on any Business Day by surrender of the certificate or
certificates representing the Series C-2 Preferred Stock (or, if no stock
certificate has yet been issued to the holder of the Series C-2 Preferred Stock,
a written statement that the holder has not yet received a stock certificate and
instructing the corporation to treat such certificate, when and if issued, as if
such certificate had been surrendered by the holder) to the corporation at its
principal executive offices. The surrendered certificate or certificates shall
be accompanied by written evidence (in form reasonably satisfactory to the
corporation) of the transferee's election to convert its Series C-2 Preferred
Stock or portion thereof.
1.6.3. At the Option of the Corporation. Upon the occurrence of a
Triggering Event, or if the Triggering Bid Price for any period of sixty (60)
consecutive calendar days has exceeded the Triggering Amount, the corporation
may require that each of the outstanding shares of Series C Preferred Stock be
converted into Common Stock computed by multiplying the number of shares of
Series C Preferred Stock to be converted times the Stated Value and dividing the
result by the Conversion Price in effect at the time of such conversion. Such
right may be exercised by written notice to the holders thereof given (i) not
less than ten (10) days prior to the date of closing of a Triggering Event or
(ii) within thirty (30) days after the end of any sixty (60) day period in which
the Triggering Bid Price has exceeded the Triggering Amount, which notice shall
specify the record date set for conversion. Such conversion shall be effected,
automatically and without any further action by the holders of such shares and
whether or not the certificates representing such shares are surrendered to the
corporation or its transfer agent.
1.6.4. Restricted Stock. Series C-2 Preferred Stock constituting
Restricted Stock with respect to a particular Regulated Stockholder may not be
converted into Common Stock or Series C-1 Preferred Stock to the extent that
immediately prior thereto, or as a result of such conversion, the number of
shares of Common Stock or Series C-1 Preferred Stock which constitute such
Restricted Stock held by all holders thereof would exceed the number of shares
of Common Stock or Series C-1 Preferred Stock which such Regulated Stockholder
reasonably determines it and its Affiliates may own, control or have the power
to vote under any law, regulation, rule or other requirement of any governmental
authority at the time applicable to such Regulated Stockholder or its
Affiliates. Each Regulated Stockholder may provide for further restrictions upon
the conversion of any shares of Restricted Stock by providing the corporation
with signed, written instruction specifying such additional restrictions and
legending such shares as to the existence of such restrictions.
1.6.5. Conversion Procedure. Upon the conversion of Series C Preferred
Stock, the holders of such Series C Preferred Stock shall surrender the
certificates representing such shares at the office of the corporation. The
corporation shall not be obligated to issue certificates evidencing the shares
of stock issuable upon such conversion unless certificates evidencing such
shares of Series C Preferred Stock being converted are either delivered to the
corporation or the holder notifies the corporation that such certificates have
been lost, stolen, or destroyed and delivers to the corporation an agreement
satisfactory to the corporation, with a surety satisfactory to the corporation,
to indemnify the corporation from any loss incurred by it in connection
therewith.
1.6.6. Time of Conversion. Each conversion of Series C Preferred Stock
pursuant to Sections 1.6.1 and 1.6.2 shall be deemed to have been effected
immediately prior to the close of
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business on the Business Day on which such Series C Preferred Stock shall have
been surrendered to the corporation as provided herein (except that, in the case
of a conversion subject to Section 1.6.7 below, the conversion shall be deemed
to be effective upon the expiration of the Deferral Period referred to therein).
Each conversion pursuant to Section 1.6.3 shall be deemed to have been effected
as of the record date specified in the notice therefor, and such conversion
shall be at the Conversion Price in effect at such time (except that, in the
case of a conversion subject to Section 1.6.7 below, the conversion shall be
deemed to be effective upon the expiration of the Deferral Period referred to
therein). On each such day that the conversion of shares of Series C Preferred
Stock is deemed effected, the Person or Persons in whose name or names any
certificate or certificates for shares of stock are issuable upon such
conversion shall be deemed to have become the holder or holders of record
thereof.
1.6.7. Notice of Conversion to Regulated Stockholders. The corporation
shall not convert or directly or indirectly redeem, purchase or otherwise
acquire any shares of any class of capital stock of the corporation or take any
other action affecting the voting rights of such shares, if such action will
increase the percentage of any class of outstanding voting securities owned or
controlled by any Regulated Stockholder (other than any such stockholder which
requested that the corporation take such action, or which otherwise waives in
writing its rights under this Section 1.6.7), unless the corporation gives
written notice (the "Deferral Notice") of such action to each Regulated
Stockholder. The corporation will defer making any such conversion, redemption,
purchase or other acquisition, or taking any such other action for a period of
twenty (20) days (the "Deferral Period") after giving the Deferral Notice in
order to allow each Regulated Stockholder to determine whether it wishes to
convert or take another action with respect to the stock it owns, controls or
has the power to vote, and if any such Regulated Stockholder then elects to
convert any shares of its stock, it shall notify the corporation in writing
within ten (10) days of the issuance of the Deferral Notice, in which case the
corporation shall (i) promptly notify from time to time prior to the end of such
20-day period each other Regulated Stockholder holding shares of each proposed
conversion, and (ii) effect the conversions requested by all Regulated
Stockholders in response to the notices issued pursuant to this Section 1.6.7 at
the end of the Deferral Period. Upon complying with the procedures herein above
set forth in this Section 1.6.7, the corporation may so convert or directly or
indirectly redeem, purchase or otherwise acquire any shares of any other class
of capital stock of the corporation or take any other action affecting the
voting rights of such shares.
1.6.8. Issuance of Certificate for Common Stock. As promptly as practical
after the conversion of shares of Series C Preferred Stock, in whole or in part,
and in any event within five (5) Business Days thereafter, the corporation at
its expense (including the payment by it of any applicable issue, stamp or other
taxes, other than any income taxes and other than any taxes arising by reason of
issuance of shares of stock to any Person other than such holder) will cause to
be issued in the name of and delivered to the holder thereof or as such holder
may direct, a certificate or certificates for the number of shares of stock to
which such holder shall be entitled upon such conversion; provided, however,
that if such conversion is subject to Section 1.6.7 above, the corporation shall
not issue such certificate or certificates until the expiration of the Deferral
Period referred to therein. In case fewer than all the shares of Series C
Preferred Stock represented by any surrendered certificate are converted, a new
certificate representing the shares of Series C Preferred Stock not converted
shall be issued without cost to the holder thereof.
1.6.9. Books of Corporation. The corporation will not close its books
against the transfer of Series C Preferred Stock or of stock issued or issuable
upon conversion of Series C Preferred Stock in any manner which interferes with
the timely conversion of Series C Preferred Stock. The corporation shall at all
times reserve and keep available out of its authorized but unissued shares of
Common Stock and Series C-1 Preferred Stock, solely for the purpose of issuance
upon the conversion of the Series C Preferred Stock, such number of shares of
Common Stock issuable
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upon the conversion of all outstanding Series C Preferred Stock and such number
of shares of Series C-1 Preferred Stock issuable upon the conversion of all
outstanding Series C-2 Preferred Stock. All shares of Common Stock which are so
issuable shall, when issued, be duly and validly issued, fully paid and
nonassessable and free from all taxes, liens and charges. The corporation shall
take all such actions as may be necessary to assure that all such shares of
Common Stock and Series C-1 Preferred Stock may be so issued without violation
of any applicable law or governmental regulation or any requirements of any
domestic securities exchange upon which shares of Common Stock and Series C-1
Preferred Stock may be listed (except for official notice of issuance which
shall be immediately delivered by the corporation upon each such issuance).
1.6.10. Series D Preferred Stock. In the application of this Section 1.6,
Series C and Series D Preferred Stock shall be treated equally, pari passu.
1.7. Anti-Dilution Adjustments. The number of shares of Common Stock
issuable upon any conversion provided for in Section 1.6 shall be subject to
adjustment, from time to time, in accordance with the following provisions:
1.7.1. Issuance of Additional Shares of Common Stock. In case the
corporation at any time or from time to time after the date hereof shall issue
or sell Additional Shares of Common Stock (including Additional Shares of Common
Stock deemed to be issued pursuant to Section 1.7.2 or 1.7.3) without
consideration or for a consideration per share less than the Conversion Price in
effect immediately prior to such issue or sale, then, in each such case, subject
to Section 1.7.7, such Conversion Price shall be reduced, concurrently with such
issue or sale, to a price (calculated to the nearest .001 of a cent) determined
by multiplying such Conversion Price by a fraction
(a) the numerator which shall be (i) the number of shares of Common
Stock into which the outstanding Series C Preferred Stock is convertible
immediately prior to such issue or sale plus (ii) the number of shares of
Common Stock which the aggregate consideration received by the corporation
for the total number of such Additional Shares of Common Stock so issued or
sold would purchase at such Conversion Price, and
(b) the denominator of which shall be (i) the number of shares of
Common Stock into which the outstanding Series C Preferred Stock is
convertible immediately prior to such issue or sale plus (ii) the number of
Additional Shares so issued or sold immediately after such issue or sale,
provided that, for the purposes of this Section 1.7.1, (x) immediately
after any Additional Shares of Common Stock are deemed to have been issued
pursuant to Section 1.7.2 or 1.7.3, such Additional Shares shall be deemed
to be outstanding and (y) treasury shares shall not be deemed to be
outstanding.
1.7.2. Treatment of Options and Convertible Securities. In case the
corporation at any time or from time to time after the date hereof shall issue,
sell, grant or assume, or shall fix a record date for the determination of
holders of any class of securities entitled to receive, any Options or
Convertible Securities, then and in each such case, the maximum number of
Additional Shares of Common Stock (as set forth in the instrument relating
thereto, without regard to any provisions contained therein for a subsequent
adjustment of such number) issuable upon the exercise of such Options or, in the
case of Convertible Securities and Options therefor, the conversion or exchange
of such Convertible Securities, shall be deemed to be additional Shares of
Common Stock issued as of the time of such issue, sale, grant or assumption or,
in case such a record date shall have been fixed, as of the close of business on
such record date (or, if the Common Stock trades on an ex-dividend basis, on the
date prior to the commencement of ex-dividend trading), provided that such
Additional Shares of Common Stock shall not be deemed to have been issued unless
the consideration per share (determined pursuant to Section 1.7.4) of such
shares would be less than the Conversion Price in effect on the date of and
immediately prior to such issue, sale, grant or assumption or immediately prior
to the close of business on such record date (or, if the Common Stock trades on
an ex-dividend basis, on the date prior to the
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commencement of ex-dividend trading), as the case may be, and provided, further,
that in any such case in which Additional Shares of Common Stock are deemed to
be issued
(a) no further adjustment of the Conversion Price shall be made upon
the subsequent issue or sale of Convertible Securities or shares of Common
Stock upon the exercise of such Options or the conversion or exchange of
such Convertible Securities;
(b) if such Options or Convertible Securities by their terms provide,
with the passage of time or otherwise, for any increase in the
consideration payable to the corporation, or decrease in the number of
Additional Shares of Common Stock issuable, upon the exercise, conversion
or exchange thereof (by change of rate or otherwise), the Conversion Price
computed upon the original issue, sale, grant or assumption thereof (or
upon the occurrence of the record date, or date prior to the commencement
of ex-dividend trading, as the case may be, with respect thereto), and any
subsequent adjustments based thereon, shall, upon any such increase or
decrease becoming effective, be recomputed to reflect such increase or
decrease insofar as it affects such Options, or the rights of conversion or
exchange under such Convertible Securities, which are outstanding at such
time;
(c) upon the expiration (or purchase by the corporation and
cancellation or retirement) of any such Options which shall not have been
exercised or the expiration of any rights of conversion or exchange under
any such Convertible Securities which shall not have been exercised (or
purchase by the corporation and cancellation or retirement of any such
Convertible Securities the rights of conversion or exchange under which
shall not have been exercised), the Conversion Price computed upon the
original issue, sale, grant or assumption (or upon the occurrence of the
record date, or date prior to the commencement of ex-dividend trading, as
the case may be, with respect thereto), and any subsequent adjustments
based thereon, shall, upon such expiration (or such cancellation or
retirement, as the case may be), be recomputed as if:
(i) in the case of Options for Common Stock or Convertible
Securities, the only Additional Shares of Common Stock issued or sold
were the Additional Shares of Common Stock, if any, actually issued or
sold upon the exercise of such Options or the conversion or exchange of
such Convertible Securities and the consideration received therefor was
the consideration actually received by the corporation for the issue,
sale, grant or assumption of all such options, whether or not exercised,
plus the consideration actually received by the corporation upon such
exercise, or for the issue or sale of all such Convertible Securities
which were actually converted or exchanged plus the additional
consideration, if any, actually received by the corporation upon such
conversion or exchange, and
(ii) in the case of Options for Convertible Securities, only the
Convertible Securities, if any, actually issued or sold upon the
exercise of such Options were issued at the time of the issue, sale,
grant or assumption of such Options, and the consideration received by
the corporation for the Additional Shares of Common Stock deemed to have
then been issued was the consideration actually received by the
corporation for the issue, sale, grant or assumption of all such
Options, whether or not exercised, plus the consideration deemed to have
been received by the corporation (pursuant to Section 1.7.4) upon the
issue or sale of such Convertible Securities with respect to which such
Options were actually exercised;
(d) no readjustment pursuant to subdivision (b) or (c) above shall
have the effect of increasing the Conversion Price by an amount in excess
of the amount of the adjustment thereof originally made in respect of the
issue, sale, grant or assumption of such Options or Convertible Securities;
and
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(e) in the case of any such Options which expire by their terms not
more than thirty (30) days after the date of issue, sale, grant or
assumption thereof, no adjustment of the Conversion Price shall be made
until the expiration or exercise of all such Options, whereupon such
adjustment shall be made in the manner provided in subdivision (c) above.
1.7.3. Treatment of Stock Dividends, Stock Splits, etc. In case the
corporation at any time or from time to time after the date hereof shall declare
or pay any dividend on the Common Stock payable in Common Stock, or shall effect
a subdivision of the outstanding shares of Common Stock into a greater number of
shares of Common Stock (by reclassification or otherwise than by payment of a
dividend in Common Stock), then, and in each such case, Additional Shares of
Common Stock shall be deemed to have been issued (a) in the case of any such
dividend, immediately after the close of business on the record date for the
determination of holders of any class of securities entitled to receive such
dividend, or (b) in the case of any such subdivision, at the close of business
on the date immediately prior to the day upon which such corporate action
becomes effective.
1.7.4. Computation of Consideration. For the purposes of this Section
1.7,
(a) the consideration for the issue or sale of any Additional Shares
of Common Stock shall, irrespective of the accounting treatment of such
consideration,
(i) insofar as it consists of cash, be computed at the net amount
of cash received by the corporation, without deducting any expenses paid
or incurred by the corporation or any commissions or compensation paid
or concessions or discounts allowed to underwriters, dealers or others
performing similar services in connection with such issue or sale,
(ii) insofar as it consists of property (including securities)
other than cash, be computed at the fair value thereof at the time of
each issue or sale, as determined in good faith by the Board of
Directors of the corporation (subject to confirmation by a firm of
independent certified public accountants of recognized national standing
approved by either the holders of a majority of the Series C Preferred
Stock or the Series C Director), and
(iii) in case Additional Shares of Common Stock are issued or sold
together with other stock or securities or other assets of the
corporation for a consideration which covers both, be the portion of
such consideration so received, computed as provided in clauses (i) and
(ii) above, allocable to such Additional Shares of Common Stock, all as
determined in good faith by the Board of Directors of the corporation
(subject to confirmation by a firm of independent certified public
accountants of recognized national standing approved by either the
holders of a majority of the Series C Preferred Stock or the Series C
Director);
(b) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.2, relating to Options and Convertible Securities,
shall be deemed to have been issued for a consideration per share
determined by dividing
(i) the total amount, if any, received and receivable by the
corporation as consideration for the issue, sale, grant or assumption of
the Options or Convertible Securities in question, plus the minimum
aggregate amount of additional consideration (as set forth in the
instruments relating thereto, without regard to any provision contained
therein for a subsequent adjustment of such consideration to protect
against dilution) payable to the corporation upon the exercise in full
of such Options or the conversion or exchange of such Convertible
Securities or, in the case of Options for Convertible Securities, the
exercise of such Options for Convertible Securities and the conversion
or exchange of such Convertible Securities, in each case computing such
consideration as provided in the foregoing subdivision (a),
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by
(ii) the maximum number of shares of Common Stock (as set forth in
the instruments relating thereto, without regard to any provision
contained therein for a subsequent adjustment of such number to protect
against dilution) issuable upon the exercise of such Options or the
conversion or exchange of such Convertible Securities; and
(c) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.3, relating to stock dividends, stock splits, etc.,
shall be deemed to have been issued for no consideration.
1.7.5. Adjustments for Combinations, etc. In case the outstanding shares
of Common Stock shall be combined or consolidated, by reclassification or
otherwise, into a lesser number of shares of Common Stock, the Conversion Price
in effect immediately prior to such combination or consolidation shall,
concurrently with the effectiveness of such combination or consolidation, be
proportionately increased.
1.7.6. Dilution in Case of Other Securities. In case any Other Securities
shall be issued or sold or shall become subject to issue or sale upon the
conversion or exchange of any stock (or Other Securities) of the corporation (or
any issuer of Other Securities or any other Person referred to in Section 1.9)
or to subscription, purchase or other acquisition pursuant to any Options issued
or granted by the corporation (or any such other issuer or Person) for a
consideration such as to dilute, on a basis consistent with the standards
established in the other provisions of this Section 1.7, the conversion rights
granted to holders of Series C Preferred Stock, then, and in each such case, the
computations, adjustments and readjustments provided for in this Section 1.7
with respect to the Conversion Price shall be made as nearly as possible in the
manner so provided and applied to determine the amount of Common Stock from time
to time receivable upon the conversion of the shares of Series C Preferred
Stock, so as to protect the holders of the Series C Preferred Stock against the
effect of such dilution.
1.7.7. Minimum Adjustment of Conversion Price. If the amount of any
adjustment of the Conversion Price required pursuant to this Section 1.7 would
be less than five percent (5%) of the Conversion Price in effect at the time
such adjustment is otherwise so required to be made, such adjustment shall not
then be made and such amount shall be carried forward and adjustment with
respect thereto made at the time of and together with any subsequent adjustment
which, together with such amount and any other amount or amounts so carried
forward, shall aggregate at least five percent (5%) of such Conversion Price.
Notwithstanding the foregoing, the Conversion Price shall be adjusted at the
time of, and be effective with respect to, any conversion or redemption of any
shares of Series C Preferred Stock.
1.7.8. Reorganization, Reclassification, Consolidation, Merger or Sale.
(a) Corporation Survives. Upon the consummation of an Organic Change
(other than a transaction in which the corporation is not the surviving
entity) the terms of the Series C Preferred Stock shall be deemed modified,
without payment of any additional consideration therefor, so as to provide
that upon the conversion of shares of Series C Preferred Stock following
the consummation of such Organic Change, the holder of such shares of
Series C Preferred Stock shall have the right to acquire and receive (in
lieu of or in addition to the shares of Common Stock acquirable and
receivable prior to the Organic Change) such shares of stock, securities or
assets as such holder would have received if such holder had converted its
shares of Series C Preferred Stock into Common Stock immediately prior to
such Organic Change, in each case giving effect to any adjustment of the
Conversion Price made after the date of consummation of the Organic Change.
All other terms of the Series C Preferred Stock shall remain in full force
and effect following such an Organic Change. The provisions of this Section
1.7.8(a) shall similarly apply to successive Organic Changes.
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(b) Corporation Does Not Survive. No Organic Change that is a
transaction in which the corporation is not the surviving entity shall
become effective unless the surviving entity shall have issued new
securities to the holders of shares of Series C Preferred Stock, without
payment of any additional consideration therefor, with terms that provide
that upon the conversion of such securities following the consummation of
such Organic Change, the holder of such securities shall have the right to
acquire and receive (in lieu of or in addition to the shares of Common
Stock acquirable and receivable prior to the Organic Change) such shares of
stock, securities or assets as such holder would have received if such
holder had converted its shares of Series C Preferred Stock into Common
Stock immediately prior to such Organic Change, in each case giving effect
to any adjustment of the Conversion Price of such new securities made after
the date of consummation of the Organic Change on an equivalent basis to
the adjustments provided for the Conversion Price herein. All other terms
of the new securities shall be equivalent to the terms of the Series C
Preferred Stock provided for herein. The provisions of this Section
1.7.8(b) shall similarly apply to successive Organic Changes.
1.7.9. Series D Preferred Stock. In the application of this Section 1.7,
Series C and Series D Preferred Stock shall be treated equally, pari passu.
1.8. Restrictions on Redemptions, Purchases and Acquisitions. The
corporation shall not redeem, purchase, acquire or take any other action
affecting outstanding shares of stock if, after giving effect to such
redemption, purchase, acquisition or other action, a Regulated Stockholder would
own more than 4.99% of any class of voting securities of the corporation (other
than any class of voting securities which is (or is made prior to any such
redemption, purchase, acquisition or other action) convertible into a class of
non-voting securities which are otherwise identical to the voting securities and
convertible into such voting securities on terms reasonably acceptable to such
Regulated Stockholder) or more than 24.99% of the total equity of the
corporation or more than 24.99% of the total value of all capital stock and
subordinated debt of the corporation (in each case determined by assuming such
Regulated Stockholder (but no other holder) has exercised, converted or
exchanged all of its options, warrants and other convertible or exchangeable
securities). The corporation shall not be a party to a merger, consolidation,
recapitalization, reorganization or other transaction pursuant to which a
Regulated Stockholder would be required to take any securities or subordinated
debt which might reasonably be expected to cause such person to have a
Regulatory Problem. In the application of this Section 1.8, the Series C and
Series D Preferred Stock shall be treated equally, pari passu.
1.9. Notices.
(a) Immediately upon any adjustment of the Conversion Price, the
corporation will give written notice thereof to all holders of Series C
Preferred Stock.
(b) The corporation will give written notice to all holders of Series C
Preferred Stock at least twenty (20) days prior to the date on which the
corporation closes its books or takes a record (1) with respect to any dividend
or distribution upon Common Stock, (2) with respect to any pro rata subscription
offer to holders of Common Stock or (3) for determining rights to vote with
respect to any Organic Change, dissolution or liquidation.
(c) The corporation will also give written notice to the holders of Series
C Preferred Stock at least twenty (20) days prior to the date on which any
Organic Change will take place.
(d) All notices which are required or may be given pursuant to the terms of
this Article shall be in writing and shall be delivered personally (and
receipted for) or by facsimile (provided receipt is acknowledged in writing),
certified mail, return receipt requested, postage prepaid, or by Federal Express
or other recognized overnight courier, and any such notice shall be deemed
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effective when delivered. In the application of this Section 1.9, the Series C
and Series D Preferred Stock shall be treated equally, pari passu.
1.10. Other Rights.
1.10.1. Purchase Rights. If at any time the corporation distributes,
grants or sells any Options, Convertible Securities or rights to purchase stock,
warrants, securities or other property to all record holders of any class of
Common Stock (the "Purchase Rights"), then each holder of Series C Preferred
Stock will be entitled to acquire, upon the terms applicable to such Purchase
Rights, the aggregate Purchase Rights which such holder could have acquired if
such holder had held the number of shares of Common Stock acquirable upon
conversion of such holder's Series C Preferred Stock immediately before the date
on which a record is taken for the grant, issuance or sale of such Purchase
Rights, or, if no such record is taken, the date as of which the record holders
of Common Stock are to be determined for the distribution, issue or sale of such
Purchase Rights. In the application of this Section 1.10.1, Series C and Series
D Preferred Stock shall be treated equally, pari passu.
1.10.2. Pre-Emptive Rights. If the corporation authorizes the issuance
and sale of any Additional Shares of Common Stock, other than a sale to the
public, the corporation will offer to sell to the holders of Series C Preferred
Stock, and each holder of Series C Preferred Stock may elect to purchase, up to
that number of Additional Shares of Common Stock such that following such
purchase, the holder is able to maintain the same percentage ownership (on a
fully-diluted basis) of the outstanding shares of Common Stock of the
corporation which such holder possessed by virtue of its ownership of shares of
Series C Preferred Stock (or Common Stock issued upon the conversion thereof)
immediately prior to the issuance and sale of the Additional Shares of Common
Stock. Holders of Series C Preferred Stock will be entitled to purchase the
Additional Shares of Common Stock at the same price and upon the same terms as
such shares of Common Stock are being offered to any other Persons; provided
that, if such Persons are to pay for such Additional Securities in whole or in
part with consideration other than cash, then the Board of Directors shall make
a good faith determination of the fair market value of such non-cash
consideration and the holders of the Series C Preferred Stock will be entitled
to pay cash equal to the fair market value of the non-cash consideration such
holders would otherwise pay hereunder in the purchase of such Additional Shares
of Common Stock. Notwithstanding the foregoing, a holder of Series C Preferred
Stock will not be permitted to exercise its rights under this Section 1.10.2
unless such holder agrees to purchase all securities offered as a package or
unit in the issuance of the Additional Shares of Common Stock. The corporation
must give written notice of the issuance of Additional Shares of Common Stock,
which notice shall set forth the price and other terms of such issuance, to the
holders of Series C Preferred Stock no later than thirty (30) days following the
issuance date of the Additional Shares of Common Stock (the "Issuance Date").
Upon receipt of such notice, the holders may exercise the right granted by this
Section 1.10.2 by giving written notice to the Company within thirty (30) days
following receipt of the aforesaid notice, which written notice from a holder
shall specify the number of Additional Shares of Common Stock being purchased by
such holder, and be accompanied by a cashier's or certified check in the full
amount of the price for the Additional Shares of Common Stack being purchased.
The corporation shall promptly make delivery to such holders of certificates for
the Additional Shares of Common Stock or other securities upon execution of such
documents and instruments as shall govern the issuance of such Additional Shares
of Common Stock or other Securities. Notwithstanding the foregoing, if a holder
of Series C Preferred Stock shall exercise its rights under this Section 1.10.2
such holder shall not be required to pay for the Additional Shares of Common
Stock purchased by it unless and until all other parties have paid for their
Additional Shares of Common Stock. In addition, if a holder of Series C
Preferred Stock shall exercise its rights under this Section 1.10.2 following
the Issuance Date, then such holder shall be deemed to have owned the Additional
Shares of Common Stock purchased by it as of the Issuance Date for the purpose
of any benefits of ownership relating to
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such Additional Shares of Common Stock, including the right to receive cash or
stock dividends declared or other distributions, to participate in a merger or
reorganization or to reflect any reclassification of Additional Shares of Common
Stock between the Issuance Date and the date upon which such holder purchases
the Additional Shares of Common Stock.
1.11. Registration of Transfer. The corporation will keep at its
principal office or at the principal office of its transfer agent a register for
the registration of the Series C Preferred Stock. Upon the surrender of any
certificate representing Series C Preferred Stock at such place, the corporation
will, at the request of the record holder of such certificate, execute and
deliver (at the corporation's expense) a new certificate or certificates in
exchange therefor representing in the aggregate the number of shares of Series C
Preferred Stock represented by the surrendered certificate. Each such new
certificate will be registered in such name and will represent such number of
shares of Series C Preferred Stock as is requested by the holder of the
surrendered certificate and will be substantially identical in form to the
surrendered certificate; provided, however, that any transfer shall be subject
to any applicable restrictions on the transfer of such shares and the payment of
any applicable transfer taxes, if any, by the holder thereof.
1.12. Replacement. Upon receipt of evidence reasonably satisfactory to
the corporation (an affidavit of the registered holder will be satisfactory) of
the ownership and the loss, theft, destruction or mutilation of any certificate
evidencing shares of Series C Preferred Stock, and in the case of any such loss,
theft or destruction, upon receipt of indemnity reasonably satisfactory to the
corporation (provided that if the holder is an institutional investor its own
agreement will be satisfactory), or, in the case of any such mutilation, upon
surrender of such certificate, the corporation will (at its expense) execute and
deliver in lieu of such certificate a new certificate of like kind representing
the number of shares of Series C Preferred Stock represented by such lost,
stolen, destroyed or mutilated certificate and dated the date of such lost,
stolen, destroyed or mutilated certificate.
1.13. Retirement of Converted or Redeemed Shares. No share or shares of
Series C Preferred Stock acquired by the corporation by reason of redemption,
purchase, conversion or otherwise shall be re-issued and all such shares shall
be canceled, retired and eliminated from the shares which the corporation shall
be authorized to issue. The corporation may from time to time take such
appropriate corporate action as may be necessary to reduce the authorized number
of shares of Series C Preferred Stock accordingly.
FIFTH C: DESIGNATIONS, PREFERENCES AND SPECIAL RIGHTS OF SERIES D PREFERRED
STOCK.((3))
Designation, Amount and Rank. Forty Thousand (40,000) shares of a preferred
stock, $1.00 par value per share, shall constitute a series of such preferred
stock designated as "Series D Convertible Preferred Stock" (the "Series D
Preferred Stock"). The Series D Preferred Stock will be issued as one or more
subseries of preferred stock: Series D-1 Preferred Stock (the "Series D-1
Preferred Stock"), and Series D-2 Preferred Stock (the "Series D-2 Preferred
Stock"), provided that the Board of Directors of the Company may hereafter
provide for additional shares of Preferred Stock in this series or different
sub-series. The respective rights and preferences of the Series D Preferred
Stock, with respect to dividend rights, redemption rights and rights on
liquidation, winding up and dissolution, shall be as set forth herein. The
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(3)Since the Series D Preferred Stock will be converted at the closing of
the Capital Z Issuance, after the closing, a second amended and restated
certificate of incorporation will be filed deleting references to the Series D
Preferred Stock.
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Series D Preferred Stock shall be issued pursuant to the following additional
terms and conditions:
1. Series D Convertible Preferred Stock.
1.1. Definitions. As used herein, unless the context otherwise requires,
the terms defined in Section 1.1 of Article Fifth-B, as in effect on December
30, 1998, (the "Effective Date") except that (a) Sections 1.1.17, 1.1.18 and
1.1.19, shall not apply to this Article Fifth-C, and (b) the terms defined
below, shall have the following meanings:
1.1.1 "Additional Shares of Common Stock" means all shares (including
treasury shares) of Common Stock issued or sold (or, pursuant to Sections 1.7.2
or 1.7.31 deemed to be issued) by the Company after the Effective Date, whether
or not subsequently reacquired or retired by the Company other than (i) the
issuance of shares upon conversion of the Series B Preferred Stock; (ii) shares
issued upon the exercise of the Common Stock Purchase Warrants outstanding on
the Effective Date; (iii) shares to be issued to directors, employees, agents
and others, pursuant to the Company's Incentive Stock Option Plan for Employees,
Stock Option Plan for Directors and Stock Option Plan for Agents and Others, as
in effect on January 8, 1997; and (iv) such additional number of shares, if any,
as may become issuable upon the conversion or exercise of any of the securities
referred to in the foregoing clauses (i) through (iii) pursuant to the terms of
the instruments governing such securities as in effect on the Effective Date.
1.1.2 "Conversion Price" as to Series D-1 means $2.70, subject to
adjustment from time to time pursuant to Section 1.7, and as to Series D-2 means
$2.70, subject to adjustment from time to time pursuant to Section 1.7, provided
that if there is a "Change of Control" (as defined below) of this Corporation as
a result of a sale by the Corporation of Common Stock pursuant to a contract or
contracts, entered into on or prior to December 31, 1999 ("the Change of Control
Common"), the Series D-2 Preferred Stock shall be mandatorily converted to
Common Stock at a conversion price equal to the price per share at which the
Change of Control Common is issued by the Corporation. As used herein, "Change
of Control" shall mean the issuance, in a transaction or series of transactions,
of Common Stock, or securities convertible into Common Stock, having voting
power equal to or exceeding 30% of the voting power of all Common Stock, or
securities convertible into Common Stock, outstanding immediately after such
transaction or series of transactions.
1.1.3. "Junior Securities" means any of the Company's equity securities
other than the Series C or Series D Preferred Stock (including the Series B
Preferred Stock and the Common Stock) whether now outstanding or hereafter
issued.
1.2. Dividends. The Company shall not, without the prior written consent
of the holders of a majority of the shares of Series C and D Preferred Stock
then outstanding, pay or declare any dividend or distribution on any Junior
Securities (other than on Common Stock, and on Series B Preferred Stock to the
extent of participation in dividends declared on the Common Stock). In the event
that the Company declares a dividend or distribution on the Common Stock, the
holders of the Series C and D Preferred Stock and the holders of the Series B
Preferred Stock and the Common Stock shall share pro rata (based, in the case of
holders of Series C, D and Series B Preferred Stock, on the number of shares of
Common Stock which each holder of Series D, Series C and Series B Preferred
Stock would be entitled to receive upon conversion of its Series D, Series C and
Series B Preferred Stock into Common Stock, respectively) in such dividend or
distribution.
1.3. Rights on Liquidation. In the event of any Liquidation, the holders
of shares of the Series D Preferred Stock then issued and outstanding shall be
entitled to be paid pari passu on the same basis as the holders of the Series C
Preferred Stock.
1.4. Voting Power. For purposes of Section 1.4 of Article Fifth-B, shares
of Series D Preferred Stock can be treated as if it were Series C-2 Preferred
Stock.
D-34
<PAGE> 235
1.5. Redemption. The provisions of Section 1.5 of Article Fifth-B shall
apply to the Series D Preferred Stock, pari passu with the Series C Preferred
Stock.
1.6. Conversion Rights. The provisions of Section 1.6 of Article Fifth-B
shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock, subject (i) to the mandatory conversion of the Series D-2
Preferred Stock as provided in Section 1.1.2, above, and (ii) except that Series
D Preferred Stock shall not be converted into voting stock unless and until (A)
any applicable requirements of the insurance law of each state in which an
insurance company subsidiary of the Corporation is domiciled or deemed to be
domiciled relating to acquisition of control of an insurance company have been
complied with and (B) any applicable bank regulatory laws have been complied
with.
1.7. Anti-Dilution Adjustments. The provisions of Section 1.7 of Article
Fifth-B shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock, except that if such provisions are inapplicable to any shares
of Series D Preferred Stock because they were converted immediately before the
closing of a transaction which would have resulted in an adjustment under the
anti-dilution provisions of Section 1.7, but for such conversation, such
antidilution provisions shall be applied in connection with such conversion as
if such conversion had occurred immediately after such closing.
1.8. Restrictions on Redemptions, Purchases and Acquisitions. The
provisions of Section 1.8 of Article Fifth-B shall apply to the Series D
Preferred Stock pari passu with the Series C Preferred Stock.
1.9. Notices. The provisions of Section 1.9 of Article Fifth-B shall
apply to the Series D Preferred Stock pari passu with the Series C Preferred
Stock.
1.10. Other Rights.
1.10.1. Purchase Rights. The provisions of Section 1.10.1 of Article
Fifth-B shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock.
1.10.2. Preemptive Rights. The provisions of Section 1.10.1 shall apply
to the Series D Preferred Stock pari passu, but shall not apply to stock issued
pursuant an agreement between the Corporation and Capital Z Financial Services
Fund II L.P., dated December 31, 1998.
1.11. Registration of Transfer. The provisions of Section 1.11 of Article
Fifth-B shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock.
1.12. Replacement. The provisions of Section 1.12 of Article Fifth-B
shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock.
1.13. Retirement of Converted or Redeemed Shares. The provisions of
Section 1.13 of Article Fifth-B shall apply to the Series D Preferred Stock pari
passu with the Series C Preferred Stock.
SIXTH: The Secretary of State is designated as the agent of the corporation
upon whom process against the corporation may be served. The post office address
to which the Secretary of State shall mail a copy of any process against the
corporation served on the Secretary of State is: c/o Harnett Lesnick & Ripps
P.A., NationsBank Tower 150, East Palmetto Park Road, Suite 500, Boca Raton,
Florida, 33432.
SEVENTH: Except to the extent required by the New York Business Corporation
Law, no director of the corporation shall have any personal liability of
directors to the corporation or its stockholders for damages for any breach of
duty as such director, provided that this provision shall not eliminate or
limit:
(1) the liability of any director if a judgment or other final
adjudication adverse to him establishes that his acts or omissions were in
bad faith, involved intentional misconduct or a
D-35
<PAGE> 236
knowing violation of law or that he personally gained in fact a financial
profit or other advantage to which he was not legally entitled or that his
acts violated Section 719 of the New York Business Corporation Law, or
(2) the liability of any director for any act or omission prior to the
adoption of this Article.
Neither the amendment nor repeal of this Article, nor the adoption of any
provision of the Certificate of Incorporation inconsistent with this Article,
shall eliminate or reduce the effect of this Article in respect of any matter
occurring, or any cause of action, suit or claim that, but for this Article
would accrue or arise, prior to such amendment, repeal or adoption of an
inconsistent provision.
EIGHTH: The number of directors of the corporation shall be not less than
three (3), and the number to be chosen shall be determined in the manner
prescribed by the by-laws of this corporation. No director need be a stockholder
of the corporation. Any director may be removed with cause at any time by a vote
of the majority of the directors then in office or the affirmative vote of
stockholders of record holding a majority of the outstanding shares of stock of
the Corporation entitled to vote, given at a meeting of the stockholders called
for that purpose.
The terms of office of the directors shall be until the next annual
meeting. The foregoing notwithstanding, each director shall serve until his
successor shall have been duly elected and qualified, unless he shall resign,
become disqualified, disabled or shall otherwise be removed. Whenever a vacancy
occurs on the Board of Directors, a majority of the remaining directors have the
power to fill the vacancy by electing a successor director to fill that portion
of the unexpired term resulting from the vacancy.
NINTH: In furtherance and not in limitation of the powers conferred by
statute, the Board of Directors is expressly authorized:
To make, alter or repeal the By-Laws of the corporation.
To authorize and cause to be executed mortgages and liens upon the real and
personal property for the corporation.
To set apart out of any of the funds of the corporation available for
dividends a reserve or reserves for any proper purpose and to abolish any such
reserve in the manner in which it was created.
By a majority of the whole Board, to designate one or more committees, such
committee to consist of one or more of the directors of the corporation. The
Board may designate one or more directors as alternate members of any committee,
who may replace any absent or disqualified member at any meeting of the
committee. The By-Laws may provide that in the absence or disqualification of a
member of a committee, the member or members thereof present at any meeting and
not disqualified from voting, whether or not he or they constitute a quorum, may
unanimously appoint another member of the Board of Directors to act at the
meeting in the place of any such absent or disqualified member. Any such
committee, to the extent provided in the resolution of the Board of Directors,
or in the By-Laws of the corporation, shall have and may exercise all the powers
and authority of the Board of Directors in the management of the business and
affairs of the corporation and may authorize the seal of the corporation to be
affixed to all papers which may require it; but no such committee shall have the
power or authority in reference to amending the Certificate of Incorporation,
adopting an agreement of merger or consolidation, recommending to the
stockholders, the sale, lease or exchange of all or substantially all of the
corporation's property and assets, recommending to the stockholders a
dissolution of the corporation of a revocation or a dissolution, or amending the
By-Laws for the corporation; and, unless the resolution or By-Laws expressly so
provide, no such committee shall have the power or authority to declare a
dividend or to authorize the issuance of stock.
D-36
<PAGE> 237
When and as authorized by the stockholders in accordance with statute, to
sell, lease or exchange all or substantially all of the property and assets of
the corporation, including its goodwill and its corporate franchises, upon such
terms and conditions and for such consideration, which may consist in whole or
in part of money or property, including shares of stock in, and/or other
securities of, any other corporation or corporations as its Board of Directors
shall deem expedient and for the best interests of the corporation.
TENTH: Action required to be taken or which may be taken at any annual or
special meeting of stockholders of the corporation may be taken by written
consent of the stockholders in lieu of a meeting, setting forth the action so
taken, signed by the stockholders holding a sufficient amount of outstanding
shares to approve such action at any annual or special meeting.
ELEVENTH: Supermajority Approvals. The corporation shall not take, cause to
be taken, or approve any of the following actions unless such action has been
specifically approved or ratified at a meeting of the Board of Directors by the
affirmative vote of not less than 66 2/3% of the total number of directors:
(a)(i) entering into any merger or consolidation in which either the corporation
or a material Subsidiary is a constituent corporation or its securities are
being issued and the stockholders following such transaction do not own,
directly or indirectly, in the aggregate a majority of the shares or equity
securities of the surviving corporation of any such merger or consolidation
entitled to elect members of the Board of Directors, (ii) the sale of all or
substantially all of the corporation's assets or properties in a single
transaction or in a series of related transactions, or (iii) the sale, lease,
exchange or other disposition of any shares of a material Subsidiary or all or
substantially all assets of any material Subsidiary; (b) changing the authorized
number of directors; (c) amending or modifying the Certificate of Incorporation
or By-laws; (d) electing or removing any of the President, Chief Financial
Officer or other executive officers and amending or modifying the employment
agreement to be entered into between the Corporation and the Chief Executive
Officer of the Corporation on the closing date of the acquisition of certain
assets and subsidiaries of PennCorp Financial Group, Inc.; (e) voluntarily
dissolving or winding-up the corporation or any material Subsidiary or filing
with respect to the corporation or any material Subsidiary a voluntary petition
in bankruptcy or for reorganization or for the adoption of any plan or
arrangement with creditors or an admission seeking the relief therein provided
under any existing future law of any jurisdiction relating to bankruptcy,
insolvency, reorganization or relief of debtors; and (f) approving any dividend
or other distribution in respect of the Common Stock.
TWELFTH: In the event that it is proposed that the corporation enter into a
merger or consolidation with any other corporation and such other corporation or
its affiliates singly or in the aggregate own or control directly or indirectly
five percent (5%) or more of the outstanding voting power of the capital stock
of this corporation, or that the corporation shall sell substantially all of its
assets or business to such other corporation, the affirmative vote of the
holders of not less than sixty-six and two-thirds percent (66 2/3%) of the total
voting power of all outstanding shares of capital stock of this corporation
shall be required for the approval of any such proposal; provided, however, that
the foregoing shall not apply to any such merger, consolidation or sale of
assets or business which was approved by resolutions of the Board of Directors
of this corporation prior to the acquisition of the ownership or control of five
percent (5%) of the outstanding shares of this corporation by such other
corporation or its affiliates, nor shall it apply to any such merger,
consolidation or sale of assets or business between this corporation and another
corporation fifty percent (50%) or more of the total voting power of which is
owned by this corporation. For the purposes hereof, an "affiliate" is any person
(including a corporation, partnership, trust, estate or individual) who directly
or indirectly, through one or more intermediaries, controls, or is controlled
by, or is under common control with, the person specified; and "control" means
the possession, directly or indirectly, of the power to direct or cause the
direction of management and policies of a person, whether through the ownership
of voting securities, by contract or otherwise.
D-37
<PAGE> 238
THIRTEENTH: The corporation reserves the right to amend, alter, change or
repeal any provisions contained in this Certificate of Incorporation, in the
manner now or hereafter prescribed by statute, and all rights conferred upon
stockholders herein are granted subject to this reservation.
FOURTEENTH: The provisions set forth in Article TWELFTH above may not be
altered, amended or repealed in any respect unless such alteration, amendment or
repeal is approved by the affirmative vote of the holders of not less than
sixty-six and two-thirds (66 2/3%) of the total voting power of all outstanding
shares of capital stock of the corporation.
IN WITNESS WHEREOF, we have signed this Restated Certificate of
Incorporation on the day of , 1999, and we affirm that the
statements made herein are true under penalties of perjury.
By:
------------------------------------
Richard A. Barasch
President
By:
------------------------------------
Joan Ferrarone
Secretary
D-38
<PAGE> 239
ANNEX E
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
<TABLE>
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS (AUDITED)
AND FINANCIAL STATEMENT SCHEDULES:
Independent Auditors' Reports............................. E-2 & E-3
Consolidated Balance Sheets as of December 31, 1996 and
1997................................................... E-4
Consolidated Statements of Operations for the Three Years
Ended December 31, 1997................................ E-5
Consolidated Statements of Stockholders' Equity for the
Three Years Ended December 31, 1997.................... E-6
Consolidated Statements of Cash Flows for the Three Years
Ended December 31, 1997................................ E-7
Notes to Consolidated Financial Statements................ E-8
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............................................. E-34
Schedule III -- Supplementary Insurance Information....... E-37
Schedule IV -- Reinsurance (incorporated in Note 8 of
Notes to Consolidated Financial Statements)
Other schedules were omitted because they were not
applicable
CONSOLIDATED FINANCIAL STATEMENTS (unaudited):
Consolidated Balance Sheets as of September 30, 1998
(unaudited)
and December 31, 1997.................................. E-38
Consolidated Statements of Operations for the nine months
ended September 30, 1998 (unaudited) and September 30,
1997................................................... E-39
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 (unaudited) and September 30,
1997................................................... E-40
Notes to Consolidated Financial Statements................ E-41
</TABLE>
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
<TABLE>
<S> <C>
COMBINED FINANCIAL STATEMENTS:
Independent Auditors' Report.............................. E-47
Combined Balance Sheets as of September 30, 1998
(unaudited) December 31, 1997 and 1996................. E-48
Combined Statements of Income for the nine moths ended
September 30, 1998 (unaudited) and the years ended
December 31, 1997, 1996 and 1995....................... E-49
Combined Statements of Changes in Business Equity for the
nine months ended September 30, 1998 (unaudited) and
the years ended December 31, 1997, 1996 and 1995....... E-50
Combined Statements of Comprehensive Income for the nine
months ended September 30, 1998 (unaudited) and the
years ended December 31, 1997, 1996 and 1995........... E-51
Combined Statements of Cash Flows for the nine months
ended September 30, 1998 (unaudited) and the years
ended December 31, 1997, 1996 and 1995................. E-52
Notes to Combined Financial Statements.................... E-54
</TABLE>
<PAGE> 240
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
E-2
<PAGE> 241
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 statements schedules
for the period indicated above as listed in the accompanying index. The
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 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 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
E-3
<PAGE> 242
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
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.......................... 1,186,702 1,167,213
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........................................... 357,957 264,745
Other liabilities........................................... 7,361,163 12,743,775
------------ ------------
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.
E-4
<PAGE> 243
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
1995 1996 1997
REVENUE: (Notes 2e and f) ----------- ----------- -----------
<S> <C> <C> <C>
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.
E-5
<PAGE> 244
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
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.
E-6
<PAGE> 245
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
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) 677,167 (2,713,062)
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.................................................. 2,205,013 1,125,463 4,336,972
------------ ------------ ------------
Net cash used by operating activities....................... (6,081,246) (9,908,865) (6,873,290)
------------ ------------ ------------
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 sale of fixed maturities held to maturity..... 928,180 -- --
Proceeds from redemption of fixed maturities available for
sale...................................................... 8,049,240 25,436,976 9,029,804
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............................. 76,571 269,702 (1,367,882)
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
============ ============ ============
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
Implementation of Statement 115 (Note 2c):
Transfer of securities held to maturity to available for
sale...................................................... $ 36,098,026 $ -- $ --
============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
E-7
<PAGE> 246
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 consolidated
financial 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.
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
E-8
<PAGE> 247
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
E-9
<PAGE> 248
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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:
<TABLE>
<S> <C>
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
===========
</TABLE>
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. 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
E-10
<PAGE> 249
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
health insurance products. Activity in the accident and health policy and
contract claim liability is as follows:
<TABLE>
<CAPTION>
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 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
E-11
<PAGE> 250
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
<CAPTION>
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 exercise of
options and warrants............................... (1,118,755)
---------- ----------
Diluted EPS
Net income applicable to common shareholders plus
assumed conversions................................ 2,641,822 10,666,039 $0.25
========== ========== =====
</TABLE>
E-12
<PAGE> 251
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
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>
<CAPTION>
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
stock.............................................. (249,790)
----------
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 exercise of
options and warrants............................... (1,331,515)
---------- ----------
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.
E-13
<PAGE> 252
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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:
<TABLE>
<S> <C>
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
==========
</TABLE>
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.
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
E-14
<PAGE> 253
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
4. INVESTMENTS:
As of December 31, 1996 and 1997, investments consisted of the following:
<TABLE>
<CAPTION>
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.......... 131,729 131,729
Policy loans................ 6,421,251 6,421,251
Mortgage loans.............. 1,199,110 1,199,110
------------ ------------
Total
investments...... $145,712,686 $144,681,269
============ ============
</TABLE>
E-15
<PAGE> 254
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
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>
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>
<CAPTION>
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...... 36,348,884 414,210 (1,391,551) 35,371,543
------------ ---------- ----------- ------------
$122,511,012 $1,702,907 $(2,721,752) $121,492,167
============ ========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
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 $ (20,088) $ 11,026,445
Corporate debt securities........ 52,427,251 1,668,511 (261,644) 53,834,118
Mortgage-backed securities....... 57,870,114 1,506,116 (651,085) 58,725,145
------------ ---------- --------- ------------
$121,119,346 $3,399,179 $(932,817) $123,585,708
============ ========== ========= ============
</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.
E-16
<PAGE> 255
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
------------ ------------
<S> <C> <C>
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........... 18,648,243 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
============ ============
</TABLE>
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.
Gross unrealized gains and gross unrealized losses of equity securities as
of December 31, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Gross unrealized gains............................... $ -- $ 29,392
Gross unrealized losses.............................. (12,572) (71,357)
-------- --------
Net unrealized losses................................ $(12,572) $(41,965)
======== ========
</TABLE>
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>
<CAPTION>
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>
E-17
<PAGE> 256
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The details of net investment income for the three years ended December 31,
1997 are as follows:
<TABLE>
<CAPTION>
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>
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>
<CAPTION>
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:
<TABLE>
<CAPTION>
1995 1996 1997
------ -------- ----------
<S> <C> <C> <C>
Current.................................. $9,032 $ -- $ --
Deferred................................. -- 269,017 1,091,818
------ -------- ----------
Total tax expense.............. $9,032 $269,017 $1,091,818
====== ======== ==========
</TABLE>
E-18
<PAGE> 257
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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>
<CAPTION>
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.
E-19
<PAGE> 258
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
<CAPTION>
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>
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
E-20
<PAGE> 259
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
E-21
<PAGE> 260
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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
E-22
<PAGE> 261
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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:
<TABLE>
<CAPTION>
SHARES UNDER
OPTIONS EXERCISE
OUTSTANDING PRICE
------------ -----------
<S> <C> <C>
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
======== ===========
</TABLE>
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.
E-23
<PAGE> 262
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- -----------
<S> <C> <C>
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
====== ===========
</TABLE>
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 underlying
stock 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.
E-24
<PAGE> 263
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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>
<CAPTION>
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>
<CAPTION>
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>
<CAPTION>
WEIGHTED-
NUMBER WEIGHTED-AVERAGE WEIGHTED- NUMBER AVERAGE
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AT EXERCISE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE 12/31/97 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>
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
E-25
<PAGE> 264
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
American Pioneer............................... $12,733,151 $10,490,353
American Progressive........................... $ 7,464,004 $ 9,345,050
American Exchange.............................. $ 4,218,871
</TABLE>
The insurance companies statutory gain (loss) for the years ended December
31, 1995, 1996 and 1997 were as follows:
<TABLE>
<CAPTION>
1995 1996 1997
---------- --------- ----------
<S> <C> <C> <C>
American Pioneer.................... $1,694,711 $ 955,714 $ 439,330
American Progressive................ $ (262,049) $(672,127) $1,810,710
American Exchange................... $ (538,120)
</TABLE>
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.
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.
E-26
<PAGE> 265
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
<CAPTION>
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>
E-27
<PAGE> 266
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
----------- ------------ -----------
<S> <C> <C> <C>
Premium
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................................. 386,254 391,456 997,836
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 7,443,937 8,072,694
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>
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.
E-28
<PAGE> 267
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth summary information with respect to total
borrowings of the Company for the three years ended December 31, 1997:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------
WEIGHTED AVERAGE
MAXIMUM AVERAGE(A) INTEREST
AMOUNT INTEREST AMOUNT AMOUNT RATE
OUTSTANDING RATE OUTSTANDING OUTSTANDING (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%
========== ===== ========== ======== =====
</TABLE>
- ---------------
(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.
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:
<TABLE>
<CAPTION>
TOTAL
----------
<S> <C>
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
==========
</TABLE>
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.
E-29
<PAGE> 268
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
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%
========== ==========
</TABLE>
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.
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.
E-30
<PAGE> 269
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The estimated fair values of the Company's financial instruments as of
December 31, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
1996
----------------------------
CARRYING
AMOUNT FAIR VALUE
------------ ------------
<S> <C> <C>
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
</TABLE>
<TABLE>
<CAPTION>
1997
----------------------------
CARRYING
AMOUNT FAIR VALUE
------------ ------------
<S> <C> <C>
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
</TABLE>
- ---------------
(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.
E-31
<PAGE> 270
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The quarterly results of operations for the three years ended December 31,
1997 are presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------
1995 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>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------
1996 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>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------
1997 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
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
E-32
<PAGE> 271
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
E-33
<PAGE> 272
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
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.
E-34
<PAGE> 273
Schedule II -- continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
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.
E-35
<PAGE> 274
Schedule II -- continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
1995 1996 1997
---------- -------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income......................................... $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
E-36
<PAGE> 275
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
<TABLE>
<CAPTION>
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>
E-37
<PAGE> 276
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Investments
Cash and cash equivalents................................. $ 11,694,481 $ 25,014,019
Fixed maturities available for sale, at fair value
(amortized cost $128,501,955 and $121,119,346,
respectively)........................................... 134,607,174 123,585,708
Equity securities, at fair value (cost $1,163,842 and
$987,081, respectively)................................. 1,095,926 945,116
Policy loans.............................................. 7,205,592 7,185,014
Property tax liens........................................ 70,963 136,713
Mortgage loans............................................ 4,544,858 2,562,008
------------ ------------
Total investments.................................. 159,218,994 159,428,578
Accrued investment income................................... 4,015,660 3,357,624
Deferred policy acquisition costs........................... 21,927,181 20,832,060
Amounts due from reinsurers................................. 86,819,019 76,576,040
Due and unpaid premiums..................................... 611,704 548,271
Deferred income tax asset................................... -- 105,413
Goodwill.................................................... 4,393,087 4,508,596
Present value of future profits............................. 1,613,200 1,281,807
Other assets................................................ 10,383,797 5,936,947
------------ ------------
Total assets....................................... 288,982,642 272,575,336
============ ============
LIABILITIES, SERIES C PREFERRED STOCK, REDEMPTION ACCRUAL ON
SERIES C
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances............................... 156,915,481 145,085,687
Reserves for future policy benefits......................... 39,716,874 38,327,612
Policy and contract claims -- life.......................... 2,248,296 1,167,213
Policy and contract claims -- health........................ 21,762,315 22,592,441
Loan payable................................................ 5,000,000 3,500,000
Amounts due to reinsurers................................... 15,621,042 17,769,695
Deferred income tax liability............................... 1,582,604 --
Deferred revenues........................................... 217,228 264,745
Other liabilities........................................... 10,965,798 12,743,775
------------ ------------
Total liabilities.................................. 254,029,638 241,451,168
------------ ------------
Series C Preferred Stock (Issued and outstanding, 51,680 and
51,680, respectively)..................................... 5,168,000 5,168,000
------------ ------------
Redemption accrual on Series C Preferred Stock.............. 574,858 249,790
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
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
7,633,507 and 7,325,860 respectively)..................... 76,335 73,259
Common stock warrants (Authorized, issued and outstanding
658,281 and 668,481, respectively)........................ -- --
Additional paid-in capital.................................. 16,559,709 15,992,497
Accumulated other comprehensive income...................... 2,085,534 841,620
Retained earnings........................................... 6,488,568 4,799,002
------------ ------------
Total stockholders' equity......................... 29,210,146 25,706,378
------------ ------------
Total liabilities, Series C preferred stock,
redemption accrual on Series C preferred stock
and stockholders' equity........................ $288,982,642 $272,575,336
============ ============
</TABLE>
See notes to unaudited consolidated financial statements
E-38
<PAGE> 277
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPT. 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Revenues:
Gross premium and policyholder fees earned................ $95,945,350 $73,773,391
Reinsurance premiums assumed.............................. 657,519 266,158
Reinsurance premiums ceded................................ (64,763,193) (44,196,036)
----------- -----------
Net premium and policyholder fees earned.......... 31,839,676 29,843,513
Net investment income..................................... 8,056,325 7,511,045
Net realized gains on investments......................... 280,548 914,859
Fee income................................................ 1,989,789 1,850,043
Amortization of deferred revenue.......................... 47,517 69,909
----------- -----------
Total revenues.................................... 42,213,855 40,189,369
----------- -----------
Benefits, claims and expenses:
Increase in future policy benefits........................ 2,069,093 439,466
Claims and other benefits................................. 20,656,621 19,143,562
Interest credited to policyholders........................ 5,426,434 4,527,720
Increase in deferred acquisition costs.................... (2,813,933) (2,106,368)
Amortization of present value of future profits........... 130,801 --
Amortization of goodwill.................................. 115,509 83,864
Commissions............................................... 19,530,706 14,156,831
Commission and expense allowances on reinsurance ceded.... (21,489,576) (13,240,477)
Other operating costs and expenses........................ 15,535,725 14,678,173
----------- -----------
Total benefits, claims and other deductions....... 39,161,380 37,682,771
----------- -----------
Operating income before taxes............................... 3,052,475 2,506,598
Federal income tax expense.................................. 1,037,842 852,243
----------- -----------
Net income.................................................. 2,014,633 1,654,355
Redemption accrual on Series C Preferred Stock.............. 325,068 146,430
Net income applicable to common shareholders................ $ 1,689,565 $ 1,507,925
=========== ===========
Earnings per common share:
Basic..................................................... $ 0.23 $ 0.21
=========== ===========
Diluted................................................... $ 0.15 $ 0.14
=========== ===========
</TABLE>
See notes to unaudited consolidated financial statements
E-39
<PAGE> 278
UNIVERSAL AMERICAN FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPT. 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................. $ 2,014,633 $ 1,654,355
Adjustments to reconcile net income to net cash used by
operating activities:
Deferred income taxes..................................... 1,037,842 852,243
Change in reserves for future policy benefits............. (798,147) (1,886,540)
Change in policy and contract claims...................... (2,889,043) (5,365,445)
Change in deferred policy acquisition costs............... (2,813,933) (2,106,368)
Change in deferred revenue................................ (47,517) (69,909)
Amortization of present value of future profits........... 130,801 --
Amortization of goodwill.................................. 115,509 83,862
Change in policy loans.................................... (20,578) (299,436)
Change in accrued investment income....................... (658,036) (390,376)
Change in reinsurance balances............................ (935,097) 2,604,443
Change in due and unpaid premium.......................... (63,433) 1,259,103
Realized gains on investments............................. (280,548) (914,860)
Other, net................................................ (4,476,836) 4,534,259
------------ ------------
Net cash used by operating activities....................... (9,684,383) (44,669)
------------ ------------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for
sale.................................................... 19,428,930 26,008,608
Proceeds from redemption of fixed maturities available for
sale.................................................... 3,108,323 7,043,732
Cost of fixed maturities purchased available for sale..... (29,622,727) (31,434,282)
Change in amounts held in trust by reinsurer.............. (3,413,068) (4,112,556)
Change in amounts held for reinsurer...................... (1,769,221) (2,788,769)
Proceeds from sale of equity securities................... 343,102 290,572
Cost of equity securities purchased....................... (532,922) (876,207)
Change in other invested assets........................... 1,515,382 (1,289,809)
Change in amounts due from broker......................... (1,751,523) 29,532
(Purchase)/sale of business, net of cash
(acquired)/held......................................... (2,562,824) 2,020,496
------------ ------------
Net cash used by investing activities....................... (15,256,548) (5,108,683)
------------ ------------
Cash flows from financing activities:
Net proceeds from issuance of common stock................ 570,288 211,345
Net proceeds from issuance of Series C Preferred Stock.... -- 4,618,356
Increase in policyholder account balances................. 11,829,794 5,058,610
Change in reinsurance balances on policyholder account
balances................................................ (2,278,689) (2,477,857)
Increase in loan payable.................................. 1,850,000 --
Principal payment on notes payable........................ (350,000) --
------------ ------------
Net cash provided from financing activities................. 11,621,393 7,410,454
------------ ------------
Net (decrease)/increase in cash and cash equivalents........ (13,319,538) 2,257,102
Cash and cash equivalents at beginning of period............ 25,014,019 15,403,450
------------ ------------
Cash and cash equivalents at end of period.................. $ 11,694,481 $ 17,660,552
============ ============
Supplemental cash flow information:
Cash paid during the period for interest.................. $ 200,523 $ 56,557
============ ============
Cash paid during the period for income taxes.............. $ - $ 61,515
============ ============
</TABLE>
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
E-40
<PAGE> 279
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements have been prepared on the basis of
generally accepted accounting principles and consolidate the accounts of
Universal American Financial Corp. ("Universal" or the "Parent Company") and its
subsidiaries (collectively the "Company"), American Progressive Life & Health
Insurance Company of New York ("American Progressive"), American Pioneer Life
Insurance Company ("American Pioneer"), American Exchange Life Insurance Company
("American Exchange"), WorldNet Services Corp. ("WorldNet") and Quincy Coverage
Corp. ("Quincy").
The interim financial information herein is unaudited, but in the opinion
of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results of operations for the nine months ended
September 30, 1998 are not necessarily indicative of the results to be expected
for the full year. The consolidated financial statements should be read in
conjunction with the Form 10-K for the year ended December 31, 1997. Certain
reclassifications have been made to prior year's financial statements to conform
with current period classifications.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 1999. Because of the Company's minimal use of
derivatives, management does not anticipate that the adoption of the new
Statement will have a significant effect on earnings or the financial position
of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("Statement 131"), effective for years
beginning after December 15, 1997. Statement 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 and will be implemented by the Company starting with
December, 1998 financial statements. 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 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 131 will not affect results of
operations or financial position.
As of January 1, 1998, the Company adopted Statement 130, "Reporting
Comprehensive Income". Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or shareholders'
equity. Statement 130 requires unrealized gains or losses on the Company's
available-for-sale securities, which prior to adoption were reported separately
in shareholders' equity, to be included in other comprehensive income. Prior
year financial statements have been reclassified to conform to the requirements
of Statement 130.
E-41
<PAGE> 280
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of comprehensive income, net of related tax, for the
nine-month periods ended September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPT. 30,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
Net income.................................... $2,014,633 $1,654,355
Unrealized gain on securities................. 1,243,910 1,885,142
---------- ----------
Comprehensive income.......................... $3,258,543 $3,539,497
========== ==========
</TABLE>
2. RECENT REINSURANCE TRANSACTION
Dallas General Life Insurance Company
On March 19, 1998, the Company acquired a $12.6 million block of annual
premiums in force of Medicare Supplement business from Dallas General, effective
January 1, 1998. This business was assumed by American Pioneer, with the
approval of 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. In connection with this acquisition, American Pioneer
entered into a 75% quota share reinsurance agreement with an unaffiliated
reinsurer. For the nine months ended September 30, 1998, net premium earned on
this block amounted to $2,081,258.
3. FEDERAL 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.
4. EARNINGS PER SHARE
The Company adopted FASB Statement No. 128, "Earnings per Share",
("Statement No. 128") as of December 31, 1997 and restated the prior period
earnings per share ("EPS") amounts. Statement No. 128 replaced 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 denomina-
E-42
<PAGE> 281
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
tors of the basic and diluted EPS for the nine months ended September 30, 1998
and 1997 is as follows:
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED SEPT. 30, 1998
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Net income........................................... $2,014,633
Less: Redemption accrual on Series C Preferred
Stock.............................................. (325,068)
----------
Basic EPS
Net income applicable to common shareholders......... 1,689,565 7,497,878 $0.23
========== ========== =====
Effect of Dilutive Securities Series B Preferred
Stock.............................................. 1,777,777
Series C Preferred Stock............................. 325,068 2,176,000
Non-registered warrants.............................. 2,015,760
Registered warrants.................................. 658,281
Incentive stock options.............................. 173,262
Director stock options............................... 15,300
Treasury stock purchased from proceeds of options and
warrants........................................... (1,244,184)
---------- ----------
Diluted EPS
Net income applicable to common shareholders plus
assumed conversions................................ $2,014,633 13,070,074 $0.15
========== ========== =====
</TABLE>
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED SEPT. 30, 1997
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Net income........................................... $1,654,355
Less: Redemption accrual on Series C Preferred
Stock.............................................. (146,430)
----------
Basic EPS
Net income applicable to common shareholders......... 1,507,925 7,234,510 $0.21
========== ========== =====
Effect of Dilutive Securities Series B Preferred
Stock.............................................. 1,777,777
Series C Preferred Stock............................. 146,430 1,027,930
Non-registered warrants.............................. 2,015,760
Registered warrants.................................. 668,481
Incentive stock options.............................. 415,000
Director stock option................................ 9,000
Treasury stock purchased from proceeds of options and
warrants........................................... (1,479,194)
---------- ----------
Diluted EPS
Net income applicable to common shareholders plus
assumed conversions................................ $1,654,355 11,669,264 $0.14
========== ========== =====
</TABLE>
5. INVESTMENTS
As of September 30, 1998 and December 31, 1997, fixed maturity securities
are classified as investments available for sale and are carried at fair value,
with the unrealized gain or loss, net of tax and other adjustments (deferred
policy acquisition costs), included in accumulated other comprehensive income.
E-43
<PAGE> 282
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
--------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
CLASSIFICATION COST GAINS LOSSES VALUE
- -------------- ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
US Treasury securities and
obligations of
US government.................... $ 8,542,831 $ 473,962 $ (10,398) $ 9,006,395
Corporate debt securities........ 56,899,002 2,631,568 (413,769) 59,116,801
Mortgage-backed securities....... 63,060,122 3,885,314 (461,458) 66,483,978
------------ ---------- --------- ------------
$128,501,955 $6,990,844 $(885,625) $134,607,174
============ ========== ========= ============
</TABLE>
<TABLE>
<CAPTION>
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 $ (20,088) $ 11,026,445
Corporate debt securities........ 52,427,251 1,668,511 (261,644) 53,834,118
Mortgage-backed securities....... 57,870,114 1,506,116 (651,085) 58,725,145
------------ ---------- --------- ------------
$121,119,346 $3,399,179 $(932,817) $123,585,708
============ ========== ========= ============
</TABLE>
The amortized cost and fair value of fixed maturities at September 30, 1998
by contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
------------ ------------
<S> <C> <C>
Due in 1 year or less........................ $ 2,853,349 $ 2,865,386
Due after 1 year through 5 years............. 28,122,204 29,031,995
Due after 5 years through 10 years........... 17,951,556 19,095,342
Due after 10 years........................... 13,830,362 14,199,764
Mortgage-backed securities................... 65,744,484 69,414,687
------------ ------------
$128,501,955 $134,607,174
============ ============
</TABLE>
6. SERIES C PREFERRED STOCK
The Company has outstanding 51,680 shares (par value $100) of Series C
Preferred Stock. 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 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. For the nine months ended September 30, 1998 and
1997, $325,068 and $146,430 of redemption accruals was accumulated,
respectively, and cumulatively as of September 30, 1998, $574,858 of redemption
accruals has been accumulated.
E-44
<PAGE> 283
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 September 30, 1998 and
December 31, 1997, respectively, of which 400 shares are Series B and 51,680
shares are Series C (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. I and II ("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 holders 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.
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 September 30, 1998
and December 31, 1997 were 7,633,507, and 7,325,860, respectively. During the
nine months ended September 30, 1998, the Company issued 307,647 shares of its
common stock for $570,288.
Common Stock Warrants
The Company had 658,281 common stock warrants issued and outstanding at
September 30, 1998 and 668,481 issued and outstanding at December 1997, which
are registered under the Securities Exchange Act of 1934. At September 30, 1998
and December 31, 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.
8. INTERCOMPANY SALE OF AMERICAN PIONEER
When American Pioneer was acquired in 1993, it became a wholly-owned
subsidiary of American Progressive. Pursuant to an agreement, dated June, 1996,
between Universal and American Progressive, Universal was 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 agreement, the purchase was 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, The debentures are payable by Universal to
American Progressive with interest at 8.5% per annum.
The first segments of the unstacking were consummated in September and
December of 1997. In the aggregate for 1997, 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.
In May 1998, Universal purchased the remaining 25% of American Pioneer for
$3,950,000 consisting of $1,975,000 in cash and $1,975,000 in debentures.
E-45
<PAGE> 284
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. AMENDMENT TO BANK LOAN
On September 30, 1998, the Company executed the First Amendment to its
Credit Agreement with Chase Manhattan Bank, which Amendment refinanced the
current loan agreement with the bank. Under the Amendment, the Company executed
a new $5,000,000 five-year secured term loan. The principle amount outstanding
on the prior loan was $3,150,000 and was paid off with the proceeds of the new
loan. The new loan agreement calls for interest at the London Interbank Offered
Rate (LIBOR) plus 200 basis points. The Company's three-year interest rate swap
agreement with the Bank remains in effect. The effective interest rate as of
September 30, 1998 on the refinanced loan is 7.865%.
The loan remains to 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.
E-46
<PAGE> 285
[INDEPENDENT AUDITOR'S REPORT TO BE FILED
WITH THE DEFINITIVE PROXY STATEMENT]
E-47
<PAGE> 286
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30, AS OF DECEMBER 31,
1998 ----------------------
(UNAUDITED) 1997 1996
------------- --------- ---------
<S> <C> <C> <C>
ASSETS
Investments:
Fixed maturity securities:
Held for investment, at amortized cost (fair value
$7,377 in 1996)....................................... $ -- -- 7,377
Available for sale, at fair value (amortized cost
$562,866 as of September 30, 1998, $501,128 in 1997
and $467,129 in 1996)................................. 593,255 521,844 478,138
Equity securities available for sale, at fair value (cost
$6,872 as of September 30, 1998, $7,423 in 1997 and
$15,135 in 1996)........................................ 6,857 7,564 18,303
Trading securities, at fair value......................... -- -- 1,150
Mortgage loans on real estate............................. 1,884 7,335 8,241
Policy loans.............................................. 22,626 23,731 24,758
Short-term investments.................................... 45,542 48,366 44,382
Other investments......................................... 12,956 51,090 48,657
---------- --------- ---------
Total investments.................................. 683,120 659,930 631,006
Cash........................................................ 24,532 14,819 20,055
Due from reinsurers......................................... 78,307 86,051 119,820
Due from affiliates......................................... -- 70,511 20,197
Accrued investment income................................... 8,565 8,797 9,931
Accounts and notes receivable, net of allowance of $3,794 as
of September 30, 1998, $4,086 in 1997 and $4,802 in
1996...................................................... 14,177 21,747 20,479
Present value of insurance in force......................... 92,829 106,864 124,884
Deferred policy acquisition costs........................... 114,746 173,214 147,877
Other assets................................................ 22,083 14,714 16,240
Costs in excess of net assets acquired...................... 104,873 109,535 115,883
---------- --------- ---------
Total assets....................................... $1,143,232 1,266,182 1,226,372
========== ========= =========
LIABILITIES
Policy liabilities and accruals............................. $ 636,950 666,598 638,991
Payable to affiliates....................................... 5,600 -- --
Income taxes, primarily deferred............................ 11,957 41,962 33,551
Capital lease obligation.................................... 2,643 3,109 3,679
Deferred ceding allowance................................... 19,236 33,227 47,448
Accrued expenses and other liabilities...................... 24,951 22,446 19,524
---------- --------- ---------
Total liabilities.................................. 701,337 767,342 743,193
---------- --------- ---------
Business equity.................................... 441,895 498,840 483,179
---------- --------- ---------
Total liabilities and business equity.............. $1,143,232 1,266,182 1,226,372
========== ========= =========
</TABLE>
SEE ACCOMPANYING NOTES TO COMBINED FINANCIAL STATEMENTS.
E-48
<PAGE> 287
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Premiums................................... $158,995 223,283 293,509 166,040
Interest sensitive policy product
changes................................. 1,154 1,721 2,753 246
Net investment income...................... 36,720 47,405 48,113 30,572
Net gains (losses) from sale of
investments............................. 2,568 4,795 (616) (278)
Other income............................... 7,690 17,550 9,252 3,717
-------- ------- ------- -------
Total revenues..................... 207,127 294,754 353,011 200,297
-------- ------- ------- -------
Benefits and expenses:
Policyholder benefits incurred............. 103,754 147,055 175,173 79,281
Change in liability for future policy
benefits and other policy benefits...... 34,626 (2,604) (15,137) (12,729)
Amortization of present value of insurance
in force and deferred policy acquisition
costs................................... 95,565 39,666 38,497 24,392
Amortization of costs in excess of net
assets acquired......................... 4,167 5,594 5,613 3,052
Interest expense........................... 120 201 179 --
Underwriting and other administrative
expenses................................ 57,143 72,948 94,612 59,401
-------- ------- ------- -------
Total benefits and expenses........ 295,375 262,860 298,937 153,397
-------- ------- ------- -------
Operating (loss) income before income taxes.. (88,248) 31,894 54,074 46,900
Income tax (benefit) expense................. (30,856) 7,589 17,606 19,468
-------- ------- ------- -------
Operating (loss) income...................... $(57,392) 24,305 36,468 27,432
======== ======= ======= =======
</TABLE>
SEE ACCOMPANYING NOTES TO COMBINED FINANCIAL STATEMENTS.
E-49
<PAGE> 288
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CHANGES IN BUSINESS EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance at beginning of period............... $498,840 483,179 451,843 263,291
Net (loss) income............................ (57,392) 24,305 36,468 27,432
Capital contributions received............... 1,000 2,474 1,227 10,100
Dividends received from operations not
acquired................................... -- 10,000 7,400 2,801
Dividends paid............................... -- -- (7,000) (6,475)
Deemed (dividend) capital contribution
relating to suplus debentures, including
interest thereon........................... (15,516) (19,510) 26,967 79,605
Deemed capital contribution (dividend) in
connection with acquisitions and
dispositions of:
Marketing One........................... 10,270 -- (35) (14,103)
Occidental.............................. -- -- -- 43,992
PennCorp Occidental Corp................ -- -- 3,292 (348)
Southwestern Life....................... -- -- (40,000) --
Knightsbridge........................... 4,748 -- -- --
Union Bankers........................... -- -- -- (80,000)
Other................................... (102) -- -- --
Deemed (dividend) capital contribution from
reinsurance transactions with affiliates... (1,077) -- 2,465 --
Deemed capital contribution of Constitution,
Union Bankers, and Marquette............... 830 -- -- 102,640
Change in net unrealized foreign currency
translation................................ (5,463) (5,641) 568 2,344
Change in net unrealized investment gains.... 5,757 4,033 (16) 20,564
-------- ------- ------- -------
Balance at end of period..................... $441,895 498,840 483,179 451,843
======== ======= ======= =======
</TABLE>
SEE ACCOMPANYING NOTES TO COMBINED FINANCIAL STATEMENTS.
E-50
<PAGE> 289
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 --------------------------
(UNAUDITED) 1997 1996 1995
------------- ------ ------ ------
<S> <C> <C> <C> <C>
Net (loss) income............................... $(57,392) 24,305 36,468 27,432
-------- ------ ------ ------
Other comprehensive income:
Change in foreign currency translation
adjustment, net of taxes................... (5,463) (5,641) 568 2,344
Change in unrealized gains on securities
available for sale, net of taxes........... 5,757 4,033 (16) 20,564
-------- ------ ------ ------
Other comprehensive income (loss)............... 294 (1,608) 552 22,908
-------- ------ ------ ------
Comprehensive (loss) income..................... $(57,098) 22,697 37,020 50,340
======== ====== ====== ======
</TABLE>
SEE ACCOMPANYING NOTES TO COMBINED FINANCIAL STATEMENTS.
E-51
<PAGE> 290
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -------------------------------
(UNAUDITED) 1997 1996 1995
------------- -------- -------- -------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income......................................... $(57,392) 24,305 36,468 27,432
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Adjustments relating to universal life and investment
products:
Interest credited to account balances............... 2,105 2,280 4,121 --
Charges for mortality and administration............ (1,154) (2,612) (2,753) (134)
Capitalization of deferred policy acquisition costs..... (31,560) (49,491) (45,350) (38,099)
Amortization of intangibles, depreciation and accretion,
net................................................... 98,474 43,595 43,998 25,223
Change in due from reinsurers........................... 7,744 33,769 (117,089) (2,581)
Change in policy liabilities, accruals and other
policyholder funds.................................... 47,105 (36,195) (25,511) (21,927)
Reinsurance reserves assumed from affiliate............. (27,716) 67,368 -- --
Change in other assets.................................. (6,498) 2,553 (3,668) (965)
Change in accrued expenses and other liabilities........ 64,624 (61,614) 28,092 (6,543)
Change in notes and accounts receivable and accrued
investment income..................................... 7,802 (134) (2,748) (3,628)
Change in taxes payable................................. (3,422) 3,436 3,002 (1,522)
Change in deferred income taxes payable................. (28,759) 3,693 21,124 16,154
Net gains (losses) from sales of investments............ (2,568) (4,795) 616 278
Other, net.............................................. 355 2,254 1,468 (2,278)
-------- -------- -------- -------
Net cash provided (used) by operating activities.... 69,140 28,412 (58,230) (8,590)
-------- -------- -------- -------
Cash flows from investing activities:
Sales of fixed maturities available for sale.............. $ 23,388 40,338 169,902 55,618
Maturities and other redemptions of fixed maturities
available for sale...................................... 48,865 62,381 29,316 11,204
Sales of mortgages, real estate and other investments..... 2,400 -- -- --
Sales of equity securities................................ 279 20,436 8,972 10,370
Sales of other investments................................ 5,815 568 117 --
Sale of subsidiary to affiliate........................... 10,270 -- 3,292 15,454
Sale and maturities of obligations of affiliates.......... 30,662 -- 1,592 --
Partial liquidation of affiliated partnership interest.... 8,498 -- -- --
Acquisition and origination of mortgages.................. -- -- -- (76)
Principal collected on mortgage loans..................... 2,987 997 1,509 1,745
Change in short-term investments, net..................... 2,780 (4,046) (8,192) 7,170
Purchases of fixed maturities available for sale.......... (136,989) (132,955) (95,188) (52,792)
Purchases of other investments............................ -- (3,859) (4,196) (1,323)
Purchases of equity securities............................ -- (6,405) (8,209) (11,605)
Purchase of obligations of affiliates..................... -- -- -- (19,103)
Cash of Union Bankers, Constitution, and Marquette at date
acquired by PennCorp Financial Group, Inc............... -- -- -- 10,892
-------- -------- -------- -------
Net cash (used) provided by investing activities.... (1,045) (22,545) 98,915 27,554
-------- -------- -------- -------
(continued)
</TABLE>
SEE ACCOMPANYING NOTES TO COMBINED FINANCIAL STATEMENTS.
E-52
<PAGE> 291
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CASH FLOWS -- (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------- -------
<S> <C> <C> <C> <C>
Cash flows from financing activities:
Receipts from interest sensitive products
credited to policyholders' account
balances................................ $ 3,910 1,980 2,157 --
Return of policyholders' account balances
on interest sensitive products.......... (46,233) (5,477) (49,542) --
Capital contributions received............. 1,000 2,474 1,227 10,100
Deemed (dividend) capital contribution
relating to surplus debentures,
including interest thereon.............. (15,516) (19,510) (13,034) --
Dividends paid............................. -- -- (7,000) (6,475)
Dividends received from operations not
acquired................................ -- 10,000 7,400 2,801
Payments on capital lease obligation....... (466) (570) 3,409 --
Reductions in notes payable................ -- -- -- (271)
Deemed (dividend) capital contribution from
reinsurance transactions with
affiliates.............................. (1,077) -- 2,465 --
-------- ------- ------- -------
Net cash (used) provided by
financing activities............. (58,382) (11,103) (52,918) 6,155
-------- ------- ------- -------
Increase (decrease) in cash.................. 9,713 (5,236) (12,233) 25,119
Cash at beginning of year.................... 14,819 20,055 32,288 7,169
-------- ------- ------- -------
Cash at end of year.......................... $ 24,532 14,819 20,055 32,288
======== ======= ======= =======
Supplemental disclosures:
Income taxes paid.......................... $ 807 1,980 (6,552) 6,882
Interest paid.............................. 5,832 13,510 12,428 24
Non-cash financing activities:
Deemed capital contribution relating to
suplus debentures....................... $ -- -- 40,000 80,000
Deemed capital contribution (dividend) in
connection with acquisitions and
dispositions of:
Occidental............................ $ -- -- -- 28,538
Southwestern Life..................... -- -- (40,000) --
Union Bankers......................... -- -- -- (80,000)
Deemed capital contribution of
Constitution, Union Bankers, and
Marquette............................... $ 830 -- -- 102,640
</TABLE>
SEE ACCOMPANYING NOTES TO COMBINED FINANCIAL STATEMENTS.
E-53
<PAGE> 292
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Pursuant to a Stock Purchase Agreement, Universal American Financial Corp.
("Universal") has committed to acquire from PennCorp Financial Group, Inc.
("PennCorp" or the "Company") all of the outstanding shares of certain insurance
operations including: Pennsylvania Life Insurance Company ("PLIC") including its
wholly owned subsidiaries, Peninsular Life Insurance Company ("Peninsular") and
Penncorp Life Insurance Company ("Penncorp Life"), Constitution Life Insurance
Company ("Constitution") including its wholly owned subsidiary, Union Bankers
Insurance Company ("Union Bankers"), Union Bankers' wholly owned subsidiary,
Marquette National Life Insurance Company ("Marquette"), and PennCorp Financial,
Inc. ("PCFI"). The acquired operations are collectively referred to as the
Acquired Companies.
The Acquired Companies operate under a single segment, the Career Sales
Division, to offer a broad range of accident and sickness, life and accumulation
insurance products to individuals through both a contractually exclusive sales
force and general agents.
The accompanying combined financial statements include the combined assets
and liabilities and the related combined operations of the Acquired Companies.
This presentation represents the group of related companies likely to be
acquired by Universal, and therefore excludes the subsidiaries of the Acquired
Companies not being acquired. Purchases and dispositions of subsidiaries not
acquired have been reflected as deemed dividends or deemed capital contributions
to the extent they related to the exchange of net tangible assets to
subsidiaries of PennCorp. All significant intercompany accounts and transactions
have been eliminated. The issuance of surplus debentures to other PennCorp
entities have been reflected as deemed capital contributions in these financial
statements as they relate directly to subsidiaries not acquired. Repayments of
principal and interest on these surplus debentures are reflected as deemed
dividends. These financial statements have been presented at their historical
costs, in accordance with generally accepted accounting principles ("GAAP"). No
adjustments have been made to reflect any effects of the Universal purchase
discussed above. Accordingly, these financial statements are not necessarily
indicative of the financial position or the results of operations and cash flows
of the Acquired Companies which would have occurred or which will be obtained in
the future, had the effects of the proposed purchase been reflected. All dollar
amounts presented hereafter are presented in thousands, except per share
amounts.
On December 14, 1995, Constitution, Union Bankers and Marquette were
purchased by Southwestern Financial Corporation ("SWF"). Through direct and
indirect investments, PennCorp had a 78.0% economic interest in SWF. The
acquisition was accounted for as a purchase. As a result, the assets and
liabilities of those companies were marked to fair value at the date of
acquisition. The historical income statements of Constitution, Union Bankers and
Marquette for the period prior to the acquisition, from January 1, 1995 to
December 14, 1995, are not included in these combined financial statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities as well
as revenues and expenses. Accounts that the Acquired Companies deem to be
acutely sensitive to changes in estimates include deferred policy acquisition
costs, policy liabilities and accruals, present value of insurance in force and
deferred taxes. In addition, the Acquired Companies must determine requirements
for disclosure of contingent assets and liabilities as of the date of the
financial statements based upon estimates. As additional information becomes
available, or actual amounts are determinable, the recorded estimates may be
E-54
<PAGE> 293
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
revised and reflected in operating results. Although some variability is
inherent in these estimates, management believes the amounts provided are
adequate. In all instances, actual results could differ from estimates.
Historical reserves for certain Acquired Companies were, in some cases,
determined with entities that are not being acquired. For historical purposes
these reserves were segregated in 1997 and for the last six months of 1996,
following a valuation system conversion in June 1996. At the conversion date,
the reserve levels as determined by the new valuation system were lower than the
reserve levels then carried. At that time, the Acquired Companies developed a
schedule to grade in the difference from the original to the new valuation
system, which resulted in reserve releases of $2,369 and $5,965 in 1997 and
1996, respectively. For purposes of these combined statements, the historical
reserves have been allocated to the Acquired Companies utilizing and expanding
on the work related to the conversion. If allocated using another method, the
results for the Acquired Companies may be different than the results as
presented in the accompanying combined financial statements.
The historical combined financial statements as of and for the nine-months
ended September 30, 1998 are unaudited but, in management's opinion, reflect all
adjustments, consisting of normal recurring adjustments and other changes in
estimates necessary for a fair presentation of its financial position and
results of operations for such period. The results of operations for the nine-
months ended September 30, 1998 may not be indicative of results of operations
to be expected for a full year.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) INVESTMENTS
Fixed maturity securities may be classified as available for sale, trading
or held for investment. This classification is generally determined at the date
of purchase. Fixed maturity and equity securities classified as available for
sale are recorded at fair value, as they may be sold in response to changes in
interest rates, prepayment risk, liquidity needs, the need or desire to increase
income or capital or other economic factors. Changes in unrealized gains and
losses related to securities available for sale are recorded as a component of
business equity, net of applicable taxes and amounts attributable to deferred
policy acquisition costs and present value of insurance in force related to
universal life and investment-type products.
Securities classified as trading securities are reported at fair value with
realized gains and losses and unrealized gains and losses included in the
determination of net income as a component of other income.
Fixed maturities classified as held for investment are recorded at cost,
adjusted for amortization of premium or discount, as the Acquired Companies have
the intent and ability to hold them to maturity.
As a result of PennCorp's decision to exit the private placement bond
sector, the Acquired Companies transferred all of their remaining assets in the
fixed maturities held for investment portfolio aggregating $5,500 to its fixed
maturities available for sale portfolio as of April 1, 1997. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, the Acquired
Companies marked all assets subject to the transfer to fair value. At the date
of the transfer, the fair value of these assets approximated carrying value and
resulted in no change in business equity.
E-55
<PAGE> 294
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Mortgage-backed securities are amortized using the interest method
including anticipated prepayments at the date of purchase. Significant changes
in estimated cash flows from original assumptions are reflected in the period of
such change. Mortgage loans on real estate are recorded at cost, adjusted for
the provision for loan losses, if necessary. Policy loans and short-term
investments are recorded at cost which approximates fair value. Short-term
investments include securities purchased with maturities generally less than
three months.
Other investments include real estate, collateral loans and limited
partnerships. Real estate, substantially all of which was acquired through
foreclosures, is recorded at the lower of fair value, less estimated costs to
sell, or cost. If the fair value of the foreclosed real estate less estimated
costs to sell is less than cost, a valuation allowance is provided for the
deficiency. Increases in the valuation allowance are charged to net income.
Collateral loans are carried at their aggregate unpaid principal balances, net
of a valuation allowance. Limited partnerships are carried on the equity method.
The Acquired Companies regularly evaluate the carrying value of their
investments based on current economic conditions, past credit loss experience
and other circumstances. A decline in net realizable value that is other than
temporary is recognized as a realized investment loss and a reduction in the
cost basis of the investment in the period when such determination is made. The
Acquired Companies discount expected cash flows in the computation of net
realizable value of its investments, other than certain mortgage-backed
securities. In those circumstances where the expected cash flows of residual
interest and interest-only mortgage-backed securities, discounted at a risk-free
rate of return, result in an amount less than the carrying value, a realized
loss is reflected in an amount sufficient to adjust the carrying value of a
given security to its fair value.
Realized investment gains and losses, determined on the basis of specific
identification, are included in the determination of net income.
(B) INSURANCE REVENUE RECOGNITION
Accident and health insurance premiums are recognized as revenue ratably
over the time period to which premiums relate. Revenues from traditional life
insurance policies represent premiums, which are recognized as earned when due.
Benefits and expenses are associated with earned premiums so as to result in
recognition of profits over the lives of the policies. This association is
accomplished by means of the provision for liabilities for future policy
benefits and the deferral and amortization of policy acquisition costs.
Revenues for interest sensitive products such as universal life and annuity
contracts represent charges assessed against the policyholders' account balance
for the cost of insurance, surrenders and policy administration. Benefits
charged to expenses include benefit claims incurred during the period in excess
of policy account balances and interest credited to policy account balances.
(C) GENERAL EXPENSES
Operating expenses include those direct expenses paid by the Acquired
Companies to third parties as well as amounts paid to affiliates of PennCorp
which are not included in these combined financial statements (as disclosed in
Note 13).
PLIC has an agreement with the affiliates of PennCorp with respect to the
reimbursement of certain direct and joint costs for services and materials paid
by PLIC on behalf of the Acquired
E-56
<PAGE> 295
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Companies, in some cases and other affiliates. Joint costs are allocated to the
various affiliates primarily based on time studies. These reimbursements are
netted against the expenses paid.
(D) POLICY LIABILITIES
Liabilities for future policy benefits for traditional life products
generally have been computed on the net level premium method, based on estimated
future investment yield, mortality, morbidity and lapses. For accident and
health products, liabilities for future policy benefits are established equal to
the excess of the present value of future benefits to or on behalf of
policyholders over discounted net future premiums. Estimates used are based on
the Acquired Companies' experience adjusted to provide for possible adverse
deviation. These estimates are periodically reviewed and compared with actual
experience. Liabilities for future policy benefits for interest sensitive
products include the balance that accrues to the benefit of the policyholders
and amounts that have been assessed to compensate the life insurance
subsidiaries for services to be provided in the future.
Policy and contract claims represent estimates of reported claims and
claims incurred but not reported based on experience. For certain long-term
policies, the estimates are based on the Acquired Companies' experience applied
to industry tables.
(E) ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist primarily of agents' balances and
premium receivable from agents and policyholders. Agents' balances are partially
secured by commissions due to agents in the future and premiums receivable are
secured by policy liabilities. An allowance for doubtful accounts is
established, based upon specific identification and general provisions, for
amounts which the Acquired Companies estimate will not ultimately be collected.
(F) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE
Estimated costs of acquiring new business which vary with, and are
primarily related to, the production of new business, have been deferred to the
extent that such costs are deemed recoverable from future revenues. Such
estimated costs include commissions and certain costs of policy issuance,
underwriting, certain variable agency and marketing expenses and other costs
directly associated with these functions to the extent such costs are determined
to vary with and are primarily related to the production of new business. Costs
deferred on accident and health and traditional life policies are amortized,
with interest, over the anticipated premium-paying period of the related
policies in proportion to the ratio of annual premium revenue to expected total
premium revenue to be received over the life of the policies. Expected premium
revenue is estimated by using the same mortality, morbidity and lapse
assumptions used in computing liabilities for future policy benefits. For
interest sensitive products and limited pay life products, policy acquisition
costs are amortized in relation to the emergence of anticipated gross profits
over the life of the policies.
The present value of insurance in force represents the anticipated gross
profits to be realized from future revenues on insurance in force at the date
such insurance was purchased, discounted to provide an appropriate rate of
return and amortized, with interest, based upon the policy liability or contract
rate, over the years that such profits are anticipated to be received in
proportion to the estimated gross profits. Accumulated amortization was
$160,323, $146,288, and $128,268 as of September 30, 1998, December 31, 1997,
and 1996, respectively.
E-57
<PAGE> 296
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The Acquired Companies monitor deferred policy acquisition costs and
present value of insurance in force utilizing assumptions related to underlying
profitability. An impairment loss is recorded in the period in which the
carrying value exceeds the present value of these expected cash flows and is
included in the determination of net income. The period ended September 30, 1998
includes an impairment loss related to deferred policy acquisition costs (see
Note 9).
(G) COSTS IN EXCESS OF NET ASSETS ACQUIRED
Costs in excess of the fair value of net assets acquired are amortized on a
straight-line basis primarily over 20 to 30 years. Accumulated amortization was
$36,359, $31,697 and $25,349 as of September 30, 1998, December 31, 1997, and
1996, respectively.
The Acquired Companies monitor costs in excess of net assets acquired for
impairment. An impairment loss is recorded in the period in which the carrying
value exceeds the expected future gross cash flows and is included in the
determination of net income.
(H) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, and operating losses and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which the 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.
The Acquired Companies are parties to tax sharing agreements. Under these
agreements, each company pays the parent of its federal consolidated return
group an amount equal to the tax due on a separate company basis. Losses and
credits, if any, are reimbursed when the company is able to use the loss or
credit on its return calculated on a separate return basis.
(I) FOREIGN CURRENCY TRANSLATION
The financial statement accounts of the Acquired Companies' Canadian
operations, which are denominated in Canadian dollars, are translated into U.S.
dollars as follows: (i) Canadian currency assets and liabilities are translated
at the rates of exchange as of the balance sheet dates and the related
unrealized translation adjustments are included as a component of business
equity, and (ii) revenues, expenses and cash flows, expressed in Canadian
dollars, are translated using a weighted average of exchange rates for each
period presented.
(J) REINSURANCE
Financial reinsurance that does not transfer significant insurance risk is
accounted for as deposits and is reflected as a component of due from
reinsurers. The cost of reinsurance related to long-duration contracts is
accounted for over the life of the underlying reinsurance policies. Balances due
to, or from, reinsurers have been reflected as assets and liabilities rather
than being netted against the related account balances. Realized gains on
retroactive reinsurance arrangements are deferred and amortized into net income
over the estimated duration of the reinsured business.
E-58
<PAGE> 297
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(K) BUSINESS COMBINATIONS
Business combinations accounted for as a purchase result in the allocation
of the purchase consideration to the fair values of the assets and liabilities
acquired establishing such fair values as the new accounting bases. Purchase
consideration in excess of the fair value of net assets acquired is allocated to
"costs in excess of net assets acquired." Should the fair value of the net
assets acquired exceed the purchase consideration, such excess is utilized to
reduce certain intangible assets, primarily "present value of insurance in
force." Allocation of purchase price is performed in the period in which the
purchase is consummated and may be preliminary. Adjustments resulting from the
completion of the purchase allocation process affect the value of the assets and
liabilities acquired.
(L) BUSINESS EQUITY
Pursuant to the consummation of the proposed Stock Purchase Agreement
mentioned above, the historical values for the equity accounts will be reset
based upon the terms of the agreement, as well as the establishment of the final
holding company structure. Accordingly, for the purposes of balance sheet
presentation, total equity is presented in a single line item, Business Equity.
The changes in the Business Equity account reflects only the historical changes
of the individual companies on a combined basis.
(M) NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 defines derivative instruments and provides comprehensive accounting and
reporting standards for the recognition and measurement of derivative and
hedging activities (including certain instruments embedded in other contracts).
It requires derivatives to be recorded in the balance sheet at fair value and
establishes criteria for hedges of changes in the fair value of assets,
liabilities or firm commitments, hedges of variable cash flows of forecasted
transactions, and hedges of foreign currency exposures of net investments in
foreign operations. Changes in the fair value of derivatives not meeting
specific hedge accounting criteria would be recognized in the Combined Statement
of Income. SFAS No. 133 is effective for all fiscal quarters of all years
beginning after June 15 1999. The Acquired Companies are evaluating SFAS No. 133
and have not determined its effect on the combined financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." This SOP provides
guidance for determining whether cost of software developed or obtained for
internal use should be capitalized or expensed as incurred. In the past, the
Acquired Companies have expensed such costs as they were incurred. This SOP is
also effective for fiscal years beginning after December 15, 1998. The Acquired
Companies are currently evaluating the financial impact as well as the changes
to its related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures
about Pensions and other Postretirement Benefits." SFAS No. 132 is effective for
fiscal years beginning after December 31, 1997. Earlier application is
encouraged. Restatement of disclosures for earlier periods provided for
comparative purposes is required. SFAS No. 132 standardizes employers'
disclosures about pension and other post-retirement benefits, requires
additional information on changes in the benefit obligations and fair values of
plan assets to facilitate financial analysis, and
E-59
<PAGE> 298
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
eliminates certain irrelevant disclosures. The Acquired Companies are currently
evaluating the necessary changes to its related disclosures.
In December 1997, the AICPA issued SOP 97-3. SOP 97-3 provides: (1)
guidance for determining when an entity should recognize a liability for
guaranty-fund and other insurance-related assessments, (2) guidance on how to
measure the liability, (3) guidance on when an asset may be recognized for a
portion or all of the assessment liability or paid assessment that can be
recovered through premium tax offsets or policy surcharges, and (4) requirements
for disclosure of certain information. This SOP is effective for financial
statements for fiscal years beginning after December 15, 1998. Early adoption is
encouraged. Previously issued annual financial statements are not restated. The
Acquired Companies will report the effect of initially adopting this SOP in a
manner similar to the reporting of a cumulative effect of a change in accounting
principle. The Acquired Companies are currently evaluating the financial impact,
which is expected to be immaterial, as well as the changes to its related
disclosures which the Acquired Companies anticipate will be included in the
annual financial statements as of and for the twelve month period ended December
31, 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was issued in June 1997 by the FASB. This Statement requires that
companies disclose segment data on the basis that is used internally by
management for evaluating segment performance and allocating resources to
segments. This Statement requires that a company report a measure of segment
profit or loss, certain specific revenue and expense items, and segment assets.
It also requires various reconciliations of total segment information to amounts
in the combined financial statements. The Acquired Companies currently operate
under one segment. The footnote disclosure requirements of SFAS No. 131 are
effective for fiscal years beginning after December 15, 1997.
(3) ACQUISITIONS
Pursuant to a Stock Acquisition Agreement, effective December 14, 1995,
Constitution, and its affiliates, Union Bankers, Marquette and Southwestern Life
Insurance Company ("Southwestern Life") were acquired by SWF, a corporation
organized by PennCorp and Knightsbridge Capital Fund I, LP ("Knightsbridge").
Prior to December 14, 1995, Constitution, Union Bankers and Marquette were
wholly-owned subsidiaries of Southwestern Life, whose ultimate parent was I.C.H.
Corporation ("ICH"). Subsequently, on December 14, 1995, Constitution issued a
surplus debenture in the amount of $80,000 to its former immediate parent, in
exchange for all of the outstanding common stock of Union Bankers, including its
wholly-owned subsidiary, Marquette. The fair value of the net assets of
Constitution, Union Bankers and Marquette amounted to $25,967 resulting in
$76,673 of costs in excess of net assets acquired which will be amortized over
30 years. The acquisition was accounted for as a purchase in accordance with
generally accepted accounting principles and accordingly the purchase price was
allocated to the assets and liabilities acquired based on estimates of their
fair value as of the acquisition date, which became the new cost basis.
The following unaudited pro forma financial information represents the
Acquired Companies' combined results of operations as if the acquisition of
Constitution, Union Bankers and Marquette occurred as of January 1, 1995. This
unaudited pro forma information has been prepared for comparative purposes only
and does not purport to be indicative of what would have occurred had the
acquisition been made as of January 1, 1995, or results which may occur in the
future.
E-60
<PAGE> 299
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1995
(UNAUDITED)
------------
<S> <C>
Total revenues.............................................. $455,141
Income before taxes......................................... 62,025
Net income.................................................. 36,427
</TABLE>
On January 1, 1996, the common stock of Southwestern Life was contributed
to Constitution by SWF. Concurrently, Constitution issued to SWF a surplus
debenture in the amount of $40,000.
The surplus debentures issued by Constitution have been reflected as deemed
capital contributions in these financial statements.
Interest incurred on these surplus debentures was $8,266, $13,510, $12,033
and $395 for the periods ended September 30, 1998 and December 31, 1997, 1996
and 1995, respectively. Principal repayments were $7,250, $6,000 and $1,000 for
the period ended September 30, 1998 and the years ended December 1997 and 1996,
respectively. Repayments of principal and interest are reflected as deemed
dividends.
On January 2, 1998 PennCorp consummated the acquisition from Knightsbridge
and Messrs. Fickes and Stone, of their respective holdings of common stock and
common stock warrants of SWF for an aggregate purchase price of $73,777 (not
including acquisition expenses). The fair value of the net assets acquired
amounted to $46,350 resulting in $28,257 of costs in excess of net assets
acquired which will be amortized over 30 years. This acquisition of the
remaining interest in SWF was accounted for as a step purchase. As a result,
approximately 22% of the assets and liabilities of the acquired entities,
including Union Bankers, were marked to the fair value at the date of
acquisition. The net effect of adjusting Union Bankers assets and liabilities to
fair value as of the acquisition date was an increase in the business equity of
Union Bankers of $830. The net assets of Southwestern Life are excluded from all
periods as they are not part of the companies being acquired. The pro forma
combined total revenues, income before taxes and net income of the Acquired
Companies, as if this step purchase occurred as of January 1, 1997, would not
have been materially different from the historical amounts reported.
On August 9, 1995, PLIC purchased an 87.3% interest in the common stock of
Marketing One for $9,603. In addition to the common stock, PLIC purchased a bond
from Marketing One in the amount of $4,500. In 1996, the bond matured with
accrued interest of $35. In lieu of repayment of the bond, PLIC was issued
additional shares, increasing its ownership to 90.8%. On January 1, 1998, PLIC
sold its interest in Marketing One to a related party for $121 of cash and
$10,149 of fixed maturities, which approximated its carrying values. These
transactions have been reflected as deemed dividends and deemed capital
contributions.
On September 29, 1995, PLIC transferred Occidental Life Insurance Company
of North Carolina ("Occidental") to a related party in exchange for cash of
$15,454 and a note receivable of $28,538 (the "AAH Note"). This transaction has
been reflected as a deemed capital contribution.
In 1996, PennCorp Occidental Corp. was sold by Peninsular to a related
party for $3,292, which approximated its carrying value. This transaction has
been reflected as a deemed capital contribution.
E-61
<PAGE> 300
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(4) FOREIGN INFORMATION AND BUSINESS SEGMENT INFORMATION
The Acquired Companies operate under a single segment, the Career Sales
Division, and the only significant foreign operations are conducted in Canada.
The components of operations were as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------- -------
<S> <C> <C> <C> <C>
Total revenues:
U.S. ................................... $166,811 241,100 300,626 153,271
Canada.................................. 40,316 53,654 52,385 47,026
-------- ------- ------- -------
$207,127 294,754 353,011 200,297
======== ======= ======= =======
Operating (loss) income before income taxes:
U.S. ................................... $(80,848) 21,752 37,997 28,881
Canada.................................. (7,400) 10,142 16,077 18,019
-------- ------- ------- -------
$(88,248) 31,894 54,074 46,900
======== ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, AS OF DECEMBER 31,
1998 ----------------------
(UNAUDITED) 1997 1996
------------- --------- ---------
<S> <C> <C> <C>
Total assets:
U.S. ........................................... $ 973,061 1,084,414 1,054,331
Canada.......................................... 170,171 181,768 172,041
---------- --------- ---------
$1,143,232 1,266,182 1,226,372
========== ========= =========
</TABLE>
(5) INVESTMENTS
The Acquired Companies held no investments in a single entity, other than
obligations of the U.S. Government or agencies thereof, totaling in excess of
10% of total business equity as of September 30, 1998, December 31, 1997, or
December 31, 1996.
E-62
<PAGE> 301
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and fair value of fixed maturities available for sale by
categories of securities are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
September 30, 1998 (unaudited):
Mortgage-backed securities.................. $200,007 9,029 (303) 208,733
U.S. Treasury securities and obligations of
U.S. Government corporations and
agencies................................. 29,741 1,437 -- 31,178
Debt securities issued by states of the
United States and political subdivisions
of the states............................ 925 45 -- 970
Debt securities issued by foreign
Governments.............................. 47,354 7,358 -- 54,712
Corporate debt securities................... 284,839 13,540 (717) 297,662
-------- ------ ------- -------
Total fixed maturities available for
sale.............................. $562,866 31,409 (1,020) 593,255
======== ====== ======= =======
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
December 31, 1997:
Mortgage-backed securities.................... $155,780 6,055 (659) 161,176
U.S. Treasury securities and obligations of
U.S.
Government corporations and agencies........ 29,277 719 (73) 29,923
Debt securities issued by states of the United
States and political subdivisions of the
states...................................... -- -- -- --
Debt securities issued by foreign
Governments................................. 53,522 6,792 (8) 60,306
Corporate debt securities..................... 262,549 8,517 (627) 270,439
-------- ------ ------- -------
Total fixed maturities available for
sale.............................. $501,128 22,083 (1,367) 521,844
======== ====== ======= =======
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
December 31, 1996:
Mortgage-backed securities.................. $150,936 2,520 (2,083) 151,373
U.S. Treasury securities and obligations of
U.S. Government corporations and
agencies................................. 38,235 572 (428) 38,379
Debt securities issued by states of the
United States and political subdivisions
of the states............................ -- -- -- --
Debt securities issued by foreign
Governments.............................. 64,217 7,465 (52) 71,630
Corporate debt securities................... 213,741 6,808 (3,793) 216,756
-------- ------ ------- -------
Total fixed maturities available for
sale.............................. $467,129 17,365 (6,356) 478,138
======== ====== ======= =======
</TABLE>
E-63
<PAGE> 302
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and fair value of fixed maturities available for sale,
by contractual maturity, are shown below:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
(UNAUDITED) DECEMBER 31, 1997
-------------------- --------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ------- --------- -------
<S> <C> <C> <C> <C>
Due in one year or less.................... $ 35,679 36,030 16,998 16,995
Due after one year through five years...... 135,671 142,541 65,547 66,239
Due after five years through ten years..... 137,818 147,399 159,118 168,299
Due after ten years........................ 53,691 58,552 56,587 59,245
Mortgage backed securities, principally
obligations of U.S. Government
agencies................................ 200,007 208,733 202,878 211,066
-------- ------- ------- -------
$562,866 593,255 501,128 521,844
======== ======= ======= =======
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
Investments with a fair value of $18,903, $19,509 and $22,403 were on
deposit with certain regulatory authorities as of September 30, 1998 and
December 31, 1997 and 1996, respectively.
Included in fixed maturities available for sale as of September 30, 1998
and December 31, 1997, are below investment-grade securities with amortized
costs of $12,661 and $19,227 respectively, and fair values of $13,244 and
$19,918, respectively. Included in fixed maturities available for sale as of
September 30, 1998 and December 31, 1997, are unrated securities with an
amortized cost and fair value of $8,313 and $5,750, respectively.
The Acquired Companies had non-income producing investments with an
amortized cost and fair value as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
(UNAUDITED) DECEMBER 31, 1997
------------------ ------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ----- --------- -----
<S> <C> <C> <C> <C>
Fixed maturities.................... $ 315 24 315 38
Equity securities................... 33 5 33 10
Other investments................... 1,900 1,900 1,900 1,900
------ ----- ----- -----
$2,248 1,929 2,248 1,948
====== ===== ===== =====
</TABLE>
At September 30, 1998, business equity included net unrealized depreciation
of equity securities of $15 consisting of gross unrealized gains of $173, less
unrealized losses of $188. At December 31, 1997 net unrealized appreciation of
equity securities of $141 consisted of gross unrealized gains of $234, less
unrealized losses of $93. At December 31, 1996 net unrealized appreciation of
$3,168 consisted of gross unrealized gains of $3,290, less unrealized losses of
$122.
E-64
<PAGE> 303
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Following is an analysis of realized gains and losses from sale of
investments:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 ----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------ -------
<S> <C> <C> <C> <C>
Fixed maturities:
Gross gains................................. $1,677 450 1,557 592
Gross losses................................ (1,322) (476) (2,005) (1,034)
Equity securities:
Gross gains................................. -- 5,247 699 734
Gross losses................................ -- (224) (203) (44)
Other investments:
Gross gains................................. 2,261 -- -- 256
Gross losses................................ (59) (200) -- (776)
Real estate................................... 75 (2) (135) --
Mortgage loans................................ (64) -- (529) --
Short-term investments........................ -- -- -- (6)
------ ------- ------ -------
$2,568 4,795 (616) (278)
====== ======= ====== =======
</TABLE>
Following are changes in net unrealized appreciation (depreciation) on
investments and foreign currency translation:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 ----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------ -------
<S> <C> <C> <C> <C>
Investments carried at fair value:
Fixed maturities............................ $9,673 9,707 (2,381) 30,539
Equity securities........................... (156) (3,027) 2,110 1,333
Other investments........................... (476) 16 460 --
------ ------- ------ -------
9,041 6,696 189 31,872
Less effect on other balance sheet accounts:
Value of business acquired and deferred
policy acquisition costs................. (184) (492) (213) (236)
Deferred income taxes....................... (3,100) (2,171) 8 (11,072)
Change in foreign currency translation...... (5,463) (5,641) 568 2,344
------ ------- ------ -------
Change in unrealized investment gains and
losses and foreign currency translation..... $ 294 (1,608) 552 22,908
====== ======= ====== =======
</TABLE>
E-65
<PAGE> 304
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Major categories of net investment income consist of the following:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 --------------------------
(UNAUDITED) 1997 1996 1995
------------- ------ ------ ------
<S> <C> <C> <C> <C>
Fixed maturities................................ $32,538 43,276 40,015 26,568
Equity securities............................... 16 121 303 538
Mortgage loans.................................. 406 748 1,218 473
Policy loans.................................... 964 1,367 1,404 647
Short-term investments.......................... 2,484 2,379 2,803 713
Collateral loans................................ 245 (220) 191 198
Real estate..................................... 40 66 68 13
Other investments............................... 775 1,185 3,454 2,123
------- ------ ------ ------
Gross investment income....................... 37,468 48,922 49,456 31,273
Less: investment expenses..................... 748 1,517 1,343 701
------- ------ ------ ------
Net investment income........................... $36,720 47,405 48,113 30,572
======= ====== ====== ======
</TABLE>
At September 30, 1998 and December 31, 1997 and 1996, the Acquired
Companies held mortgage loans principally involving commercial real estate with
carrying values of $1,884, $7,335 and $8,241, respectively. The average
outstanding loan balances were approximately $82, $198 and $175 at September 30,
1998, and December 31, 1997 and 1996, respectively. At September 30, 1998 and
December 31, 1997 mortgage loan investments were concentrated in the following
states:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
(UNAUDITED) DECEMBER 31, 1997
---------------------- ----------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
CARRYING CARRYING CARRYING CARRYING
VALUE TOTAL VALUE TOTAL
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
California....................................... $ 802 42.6% $3,518 48.0%
Texas............................................ -- -- 2,400 32.7
Canada........................................... 300 15.9 300 4.0
Florida.......................................... 423 22.5 724 9.9
New Jersey....................................... 207 11.0 219 3.0
All other........................................ 152 8.0 174 2.4
------ ----- ------ -----
Balance, end of period........................... $1,884 100.0% $7,335 100.0%
====== ===== ====== =====
</TABLE>
E-66
<PAGE> 305
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Included in other investments are the following investments in obligations
of affiliates:
<TABLE>
<CAPTION>
SEPTEMBER 30, AS OF DECEMBER 31,
1998 ------------------
(UNAUDITED) 1997 1996
------------- ------- -------
<S> <C> <C> <C>
American Amicable Holding Corporation promissory note..... $ -- 30,662 30,662
KB Investment Fund I, L.P.-SWF.......................... -- 3,750 3,750
KB Investment Fund I, L.P.-Acordia, Inc................. 3,252 3,228 --
SWF redeemable preferred stock.......................... 5,825 5,592 5,295
------ ------ ------
Total assets.................................... $9,077 43,232 39,707
====== ====== ======
</TABLE>
In September 1995, PLIC received the American Amicable Holding Corporation
promissory note as partial consideration for the common stock of Occidental. In
February 1998, PLIC sold the note to affiliates Southwestern Life and Security
Life and Trust Insurance Company, at carrying value.
In March 1995, PLIC purchased an interest in Knightsbridge with an
underlying investment in SWF for $3,750 (see Note 13). In January 1998, PLIC
liquidated its limited partnership investment in Knightsbridge related to SWF as
part of the purchase of the remaining interest in SWF by PennCorp. PLIC realized
a gain on this transaction totaling $4,748. This realized gain was reflected as
a deemed capital contribution to PLIC.
In August 1997, PLIC purchased an interest in Knightsbridge with an
underlying investment in the preferred stock of Acordia, Inc. ("Acordia") for
$3,228. At the time of the transaction, Acordia was 28.6% owned by
Knightsbridge.
Investment income earned on the above assets totaled $702, $4,130, and
$2,267 for the periods ended September 30, 1998, and December 31, 1997 and 1996,
respectively.
(6) POLICY LIABILITIES AND ACCRUALS
Policy liabilities and accruals consist of reserves for fixed benefit, life
and accumulation products.
For interest sensitive life products and annuity products, the liability
for future policy benefits is equal to the accumulated fund value. Fund values
are equal to the premium received and interest credited to the fund value less
deductions for mortality costs and expense charges. Current interest rates
credited range from 4.0 to 6.5 percent. Mortality costs and expense charges are
established by the Acquired Companies based upon their experience and cost
structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is
based primarily upon Commissioners' Standard Ordinary Tables with interest rates
ranging from 2.5 to 6.0 percent. Fixed benefit products establish a liability
for future policy benefits equal to the excess of the present value of future
benefits to or on behalf of the policyholder over the future net premium
discounted at interest rates ranging primarily from 4.5 to 8.0 percent.
Traditional life products and fixed benefit products future policy benefits may
also be determined using the Acquired Companies experience as to mortality,
morbidity and lapses with a provision for adverse deviation. The Acquired
Companies may vary assumptions by year of policy issue.
E-67
<PAGE> 306
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Policy liabilities and accruals also include provisions for reported claims
in process of settlement, valued in accordance with the terms of the related
policies and contracts, as well as provisions for claims incurred and unreported
based on the Acquired Companies' prior experience.
During 1998 the Acquired Companies refined their calculation of policy
benefit reserves for long term care products which resulted in an increase of
approximately $7,551.
While management believes the estimated amounts included in the financial
statements for policy liabilities and accruals are adequate, such estimates may
be more or less than the amounts ultimately paid when the claims are settled. In
addition, the Acquired Companies are involved in certain litigation regarding
policyholder benefits. The Acquired Companies intend to vigorously defend their
position relative to these claims; however, if unsuccessful, the level of
reserves currently provided could be adversely affected.
The following table presents information on changes in the liability for
policy and contract claims:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -------------------------------
(UNAUDITED) 1997 1996 1995
------------- -------- -------- -------
<S> <C> <C> <C> <C>
Policy and contract claims at beginning of
period................................... $144,504 148,931 161,807 118,187
Less reinsurance recoverables.............. (19,247) (18,452) (4,277) (4,174)
-------- -------- -------- -------
Net balance at beginning of period......... 125,257 130,479 157,530 114,013
-------- -------- -------- -------
Addition due to acquisition................ -- -- -- 50,753
-------- -------- -------- -------
Add claims incurred, net of reinsurance re-
lated to:
Current year............................. 83,458 107,662 143,311 46,196
Prior years.............................. 26,804 (936) 1,341 (639)
-------- -------- -------- -------
110,262 106,726 144,652 45,557
-------- -------- -------- -------
Deduct claims paid, net of reinsurance
related to:
Current year............................. (37,780) (57,083) (91,382) (15,190)
Prior years.............................. (44,269) (54,865) (80,321) (37,603)
-------- -------- -------- -------
(82,049) (111,948) (171,703) (52,793)
-------- -------- -------- -------
Policy and contract claims, net of related
reinsurance recoverables at end of
period................................... 153,470 125,257 130,479 157,530
Plus reinsurance recoverables.............. 22,482 19,247 18,452 4,277
-------- -------- -------- -------
Policy and contract claims at end of
period................................... $175,952 144,504 148,931 161,807
======== ======== ======== =======
</TABLE>
The Acquired Companies have been closely monitoring the development of
claims reserve experience. The methodology previously utilized has experienced,
what appears to be a deterioration of the adequacy of its claims reserves
associated with its disability income products underwritten prior to PennCorp's
ownership of PLIC. During the first quarter, 1998, PLIC recognized this trend
and strengthened the reserves by approximately $3,000. During the three-month
period ended June 30, 1998, PLIC began a process to change its methodology in
determining these
E-68
<PAGE> 307
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
reserves. As a result of the trends, PLIC increased its claims reserve estimate
by $20,000. The effect of the change in methodology is inseparable from the
effect of the change in accounting estimate and is accordingly reflected in
operations for the nine-month period ended September 30, 1998.
On February 5, 1999, management met with the Commonwealth of Pennsylvania
Insurance Department to discuss establishing the methodology to determine claim
reserves as of December 31, 1998. Management has requested permission to use
PLIC's own termination rate experience and other assumptions. Depending on the
level of PLIC'S experience considered as compared to reserves calculated with a
strict interpretation of certain model regulations, an additional reserve
increase in the range of $0 to $25,000 would be recorded. PLIC is awaiting the
results of the Commonwealth of Pennsylvania Insurance Department's review and
conclusion as to the permitted practice with respect to establishing the
methodology for claims reserves. Should PLIC need to substantially increase its
claims reserves, it is likely that PLIC's risk-based capital ratio would
materially decline, without further management action, to a level which could
require certain actions be taken by the Commonwealth of Pennsylvania Insurance
Department. Should the Commonwealth of Pennsylvania Insurance Department grant
the permitted practice as of December 31, 1998, there is no guarantee that the
permitted practice would be re-approved in future periods.
(7) LEASE OBLIGATIONS
The outstanding principal amounts of notes payable consist of the
following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 --------------
(UNAUDITED) 1997 1996
------------- ----- -----
<S> <C> <C> <C>
Capital lease obligations, expiring 2002.................... $2,643 3,109 3,679
====== ===== =====
</TABLE>
Interest costs for the capital lease obligations totaled $120, $201 and
$179 for the nine months ended September 30, 1998 and the years ended December
31, 1997 and 1996, respectively. The interest rate on the capital lease
obligations is fixed at 8.0 percent. The aggregate commitments for these capital
lease obligations during the three months after September 30, 1998 and each of
the five years after December 31, 1998 are as follows: 1998, $213; 1999, $673;
2000, $728; 2001, $917; 2002, $112; and 2003, $--.
E-69
<PAGE> 308
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The Acquired Companies are also obligated under operating leases, primarily
for office space. Rent expense was $3,916, $7,097, $5,977, and $6,315 for the
periods ended September 30, 1998, December 31, 1997, 1996 and 1995,
respectively.
Minimum operating lease commitments are:
<TABLE>
<S> <C>
For the period remaining in 1998............................ $ 406
1999........................................................ 1,276
2000........................................................ 1,039
2001........................................................ 656
2002........................................................ 311
2003 and thereafter......................................... 21
------
Total minimum payments required................... $3,709
======
</TABLE>
(8) INCOME TAXES
The total provisions for income tax (benefit) expense are as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -------------------------
(UNAUDITED) 1997 1996 1995
------------- ----- ------ ------
<S> <C> <C> <C> <C>
Current -- U.S. ................................. $ (3,945) 1,838 (5,837) (2,205)
Current -- foreign............................... 1,848 2,058 2,319 4,552
Deferred -- U.S. ................................ (24,650) 1,676 16,683 15,016
Deferred -- foreign.............................. (4,109) 2,017 4,441 2,105
-------- ----- ------ ------
Income tax (benefit) expense..................... $(30,856) 7,589 17,606 19,468
======== ===== ====== ======
</TABLE>
Income taxes computed using the prevailing corporate tax rate of 35% are
reconciled to the Acquired Companies' actual income tax expense attributable to
income as follows:
<TABLE>
<CAPTION>
NINE
MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 --------------------------
(UNAUDITED) 1997 1996 1995
------------- ------ ------ ------
<S> <C> <C> <C> <C>
Tax expense computed at statutory rate............. $(30,887) 11,163 18,926 16,415
Amortization of costs in excess of net assets
acquired......................................... 873 1,177 1,184 1,068
Change in deferred tax asset valuation allowance... 1,056 (525) 1,052 1,672
Interest paid to affiliate not acquired............ (2,893) (4,728) (4,212) (138)
Other.............................................. 995 502 656 451
-------- ------ ------ ------
Income tax (benefit) expense....................... $(30,856) 7,589 17,606 19,468
======== ====== ====== ======
</TABLE>
E-70
<PAGE> 309
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Temporary differences between the financial statement carrying amounts and
tax bases of assets and liabilities that give rise to the deferred tax assets
(liabilities) relate to the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 ------------------
(UNAUDITED) 1997 1996
------------- ------- -------
<S> <C> <C> <C>
Deferred tax assets:
Future policy benefits................................... $ 44,594 49,358 49,889
Invested assets, subject to capital gains treatment...... 6,472 7,442 5,897
Net operating loss....................................... -- 8,181 6,695
Foreign tax credits...................................... 22,632 20,783 21,252
Deferred ceding allowance................................ 13,732 11,629 16,608
Net unrealized loss...................................... -- -- 1,197
-------- ------- -------
87,430 97,393 101,538
-------- ------- -------
Deferred tax liabilities:
Deferred policy acquisition costs........................ $ 25,308 43,243 41,437
Present value of insurance in force...................... 32,491 37,004 43,300
Other assets and liabilities............................. 17,794 36,047 31,178
Net unrealized gain...................................... 10,237 7,137 6,162
-------- ------- -------
85,830 123,431 122,077
-------- ------- -------
1,600 (26,038) (20,539)
Valuation allowance........................................ (17,616) (16,560) (17,085)
-------- ------- -------
Net deferred tax liability................................. $(16,016) (42,598) (37,624)
======== ======= =======
</TABLE>
The valuation allowances at September 30, 1998 and December 31, 1997 and
1996 are attributable to deferred tax assets principally arising from
differences in the book and tax bases of invested assets subject to capital
gains treatment that existed as of the date of the acquisition of the insurance
subsidiaries ("acquisition capital gains") and foreign tax credits which could
potentially expire prior to utilization. To the extent that income tax benefits
relative to the acquisition capital gains are ultimately realized, the reduction
in the related valuation allowance of $8,507 at each period would be allocated
to reduce costs in excess of net assets acquired. Foreign tax credit carryovers
available at September 30, 1998, expire as follows: $3,309 in 1999, $1,754 in
2000, $3,674 in 2001, $2,058 in 2002 and $3,750 in 2003.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon those
considerations, management believes it is more likely than not that the Acquired
Companies will realize the benefits of these deductible differences, net of the
existing valuation allowance at September 30, 1998 or December 31, 1997.
The Acquired Companies' federal income tax returns are routinely examined
by the Internal Revenue Service ("IRS"). PLIC and Peninsular are included in the
consolidated tax return of Pacific Life and Accident Insurance Company ("PLAIC")
with other affiliates. Constitution, Union Bankers and Marquette are included in
the Constitution consolidated tax return along with Southwestern Life.
E-71
<PAGE> 310
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The IRS has examined the Constitution consolidated group's federal income tax
returns through December 14, 1995, and pursuant to a settlement agreement with
the IRS, all tax years through December 14, 1995, are closed. The examination of
the returns for the periods through December 31, 1996 has recently commenced.
The returns for the PLAIC consolidated group are not currently under
examination.
Under federal income tax laws which existed prior to 1984, certain earnings
of life insurance companies were accumulated in a special tax memorandum account
designated as the "policyholders' surplus" account. This account, with a balance
of $8,400, was frozen as of December 31, 1983. Under certain conditions, the
amount accumulated in the "policyholders' surplus" account can become taxable.
As is true for most life insurance companies, the possibility of tax becoming
due on any balance in the aforementioned "policyholders' surplus" account is not
likely. However, if such tax were to become payable, it would approximate
$2,900.
(9) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE
Deferred policy acquisition costs represent commissions and certain costs
of policy issuance and underwriting. Information relating to these costs is as
follows:
<TABLE>
<CAPTION>
NINE
MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance at beginning of period................. $173,214 147,877 118,588 92,513
Policy acquisition costs deferred:
Commissions.................................. 18,844 23,400 17,864 21,406
Underwriting and issue costs................. 12,715 26,091 27,486 16,693
Released by 80% coinsurance of Medicare
business (see Note 11)....................... -- -- (1,243) --
Write-down of unrecoverable costs.............. (65,376) -- -- --
Policy acquisition costs amortized............. (20,647) (22,314) (14,530) (12,395)
Change in unrealized investment (gain) loss
adjustment................................... (155) (359) (211) (118)
Change in foreign currency translation
adjustment................................... (1,332) (1,481) (77) 489
Union Bankers step purchase accounting
adjustment................................... (2,517) -- -- --
-------- ------- ------- -------
Balance at end of period....................... $114,746 173,214 147,877 118,588
======== ======= ======= =======
</TABLE>
During 1998, the Acquired Companies' assumptions as to future morbidity
have increased primarily as a result of adverse trends identified by the
Acquired Companies with respect to disability income claim reserves.
Additionally, effective in 1998, PLIC modified the commission structure and
related participation in agency profitability. Based on a recoverability
analysis, comparing future discounted cash flows from these blocks of business
to the unamortized deferred policy acquisition costs, it was determined that the
unamortized deferred policy acquisition costs for these blocks of business were
not fully recoverable. This resulted in a charge to income and a reduction of
unamortized deferred policy acquisition costs of $65,376.
E-72
<PAGE> 311
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
As part of purchase accounting for PennCorp's acquisitions of the Acquired
Companies, a present value of insurance in force asset was established which
represents the value of the right to receive future cash flows from insurance
contracts existing at the date of acquisition. Such value is the actuarially
determined present value of the projected cash flows from the acquired policies,
discounted to provide an appropriate rate of return.
The methods used by the Acquired Companies to value the health, life and
annuity products purchased are consistent with the valuation methods used most
commonly to value blocks of insurance business. It is also consistent with the
basic methodology generally used to value insurance assets. The method used by
the Acquired Companies includes identifying the future cash flows from the
acquired business, the risks inherent in realizing those cash flows, the rate of
return the Acquired Companies believe they must earn in order to accept the
risks inherent in realizing the cash flows, and determining the value of the
insurance asset by discounting the expected future cash flows by the discount
rate the Acquired Companies require.
The discount rate used to determine such values is the rate of return
required in order to invest in the business being acquired. In selecting the
rate of return, the Acquired Companies consider the magnitude of the risks
associated with actuarial factors described in the following paragraph, cost of
capital available to the Acquired Companies to fund the acquisition,
compatibility with other activities that may favorably affect future profits,
and the complexity of the acquired company.
Expected future cash flows used in determining such values are based on
actuarial determinations of future premium collection, mortality, morbidity,
surrenders, operating expenses and yields on assets held to back policy
liabilities as well as other factors. Variances from original projections,
whether positive or negative, are included in income as they occur and will
affect the present value of insurance inforce amortization rates for insurance
products accounted for under SFAS No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments." To the extent that these variances
indicate that future cash flows will differ from those included in the original
scheduled amortization of the present value of the insurance in force, current
and future amortization may be adjusted. Recoverability of the present value of
insurance in force is evaluated annually and appropriate adjustments are then
determined and reflected to the financial statements for the applicable period.
E-73
<PAGE> 312
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Information related to the present value of insurance in force is as
follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -----------------------------
(UNAUDITED) 1997 1996 1995
------------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance at beginning of year.................. $106,864 124,884 171,818 114,505
Released by 80% coinsurance of Medicare
business (see Note 11)...................... -- -- (22,936) --
Additions for acquisition of Constitution and
Union Bankers............................... -- -- -- 69,022
Union Bankers step purchase accounting
adjustment.................................. (3,965) -- -- --
Net amortization.............................. (9,542) (17,352) (23,967) (11,997)
Change in unrealized investment (gain) loss
adjustment.................................. (29) (133) (2) (118)
Change in foreign currency translation
adjustment.................................. (499) (535) (29) 406
-------- ------- ------- -------
Balance at end of year................. $ 92,829 106,864 124,884 171,818
======== ======= ======= =======
</TABLE>
Expected amortization of the present value of insurance in force, based
upon current assumptions and accretion of interest at a policy liability or
contract rate ranging from 5.5 to 9.2 percent for the period from October 1,
1998 to December 31, 1998 and the next five years is as follows:
<TABLE>
<CAPTION>
BEGINNING GROSS ACCRETION NET
BALANCE AMORTIZATION OF INTEREST AMORTIZATION
--------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
1998....................................... $92,829 9,391 7,620 1,771
1999....................................... 91,058 18,089 7,274 10,815
2000....................................... 80,243 15,827 6,424 9,403
2001....................................... 70,840 13,841 5,680 8,161
2002....................................... 62,679 12,111 5,030 7,081
2003....................................... 55,598 10,956 4,452 6,504
</TABLE>
(10) STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
Cash generated by the insurance companies included in the Acquired
Companies is made available to PennCorp, the ultimate parent, principally
through periodic payments of principal and interest on surplus debentures,
funded primarily by dividends from the insurance companies included in or owned
by the Acquired Companies.
Dividend payments by insurance companies are limited by, or subject to the
approval of the insurance regulatory authority of each insurance company's state
of domicile. Such dividend requirements and approval processes vary
significantly from state to state. In 1998, the insurance companies included in
the Acquired Companies are not able to pay dividends without prior approval from
their respective insurance regulatory authorities.
The surplus debentures in the amount of $105,750, $113,000, and $119,000,
respectively, are excluded from net assets in the combined statements (see Note
1 on the basis of presentation). However, pursuant to the terms of the surplus
debenture issued by Constitution to the benefit of
E-74
<PAGE> 313
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Southwestern Life Companies, Inc. ("SLC"), Constitution may make principal and
interest payments to the extent that Constitution's surplus, plus liabilities
relating to the surplus debentures, less the statutory carrying value of
Southwestern Life and Union Bankers, exceeds $1,200. Constitution's surplus at
September 30, 1998 was $154,799, of which $158,215 was attributable to its
ownership of Southwestern Life and Union Bankers. Liabilities relating to the
surplus debentures at September 30, 1998 were $6,059, representing accrued
principal and interest. At September 30, 1998, Constitution was restricted from
making the full payment on the surplus note and was in arrears with respect to
principal in the amount of $3,625 and interest in the amount of $990. At
December 31, 1997, Constitution's surplus was $174,715 of which $161,098 was
attributable to its ownership of Southwestern Life and Union Bankers.
The insurance subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by their respective
state insurance departments. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the National Association of Insurance Commissioners ("NAIC").
Permitted statutory accounting practices encompass all accounting practices that
are approved by insurance regulatory authorities; such practices differ from
state to state, and may differ from company to company within a state, and may
change in the future. Furthermore, the NAIC has a project to codify statutory
accounting practices, the result of which is expected to constitute the only
source of prescribed statutory accounting practices. Accordingly, that project
will likely change to some extent prescribed statutory accounting practices and
may result in changes to the accounting practices that insurance enterprises use
to prepare their statutory financial statements.
Statutory capital and surplus of the insurance companies as reported to
regulatory authorities at September 30, 1998 and December 31, 1997 and 1996
totaled $183,736, $226,312 and $220,653, respectively. Statutory net (loss)
income of the insurance companies as reported to regulatory authorities totaled
$(22,045) for the nine months ended September 30, 1998 and $9,469 $21,473 and
$(25,171) for the years ended December 31, 1997 and 1996 and 1995, respectively.
Beginning in 1993, the NAIC imposed regulatory risk-based capital ("RBC")
requirements on life insurance enterprises, including the insurance companies.
The RBC model serves as a benchmark for the regulation of life insurance
companies by state insurance regulators. RBC provides for targeted surplus
levels based on formulas which specify various weighting factors that are
applied to financial balances or various levels of activity based on the
perceived degree of risk, and are set forth in the RBC requirements. Such
formulas focus on four general types of risk: (a) the risk with respect to a
company's assets (asset or default risk); (b) the risk of adverse insurance
experience with respect to a company's liabilities and obligations (insurance or
underwriting risk); (c) the interest rate risk with respect to a company's
business (asset/liability matching); and, (d) all other business risk
(management, regulatory action, and contingencies). The amount determined under
such formulas is called the authorized control level RBC ("ACLC").
The RBC guidelines define specific capital levels based on a company's ACLC
that are determined by the ratio of a company's total adjusted capital ("TAC")
to its ACLC. TAC is equal to statutory capital, plus AVR and certain other
specified adjustments. The specified capital levels, in declining order, and
applicable ratios are generally as follows: "Company Action Level" where TAC is
less than or equal to 2.0 times ACLC or the TAC is less than or equal to 2.5
times ACLC with a negative trend; "Regulatory Action Level" where TAC is less
than or equal to 1.5 times ACLC; "Authorized Control Level" where TAC is less
than or equal to 1.0 times ACLC; and, "Mandatory Control Level" where TAC is
less than or equal to 0.7 times ACLC. Companies at the Company
E-75
<PAGE> 314
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Action Level are required to submit a comprehensive financial plan to the
insurance commissioner of the state of domicile. Companies at the Regulatory
Action Level are subject to mandatory examination or analysis by the
commissioner and possible required corrective actions. At the Authorized Control
Level, companies are subject to, among other things, the commissioner placing it
under regulatory control. At the Mandatory Control Level, the insurance
commissioner is required to place a company under regulatory control.
At December 31, 1997 PLIC's TAC was $44,224 with a negative trend, placing
it within the Company Action Level. Should PLIC need to substantially increase
its claims reserves, it is likely that PLIC's risk-based capital ratio would
materially decline, without further management action, to a level which could
require that certain actions be taken by the Commonwealth of Pennsylvania
Insurance Department (see note 6).
On September 30, 1998, PLIC entered into a reinsurance agreement with an
unaffiliated reinsurer to coinsure certain inforce individual life and health
business written or acquired by PLIC prior to January 1, 1998. In addition, as
part of the stock purchase agreement, PennCorp is required to deliver the
Acquired Companies, including PLIC, to Universal with a minimum TAC of 3.00
times ACLC. To achieve this, several actions are planned. These actions include
the sale of Penncorp Life by PLIC to PennCorp for fair value; the replacement,
by PennCorp, of certain non-performing assets held by the Acquired Companies
with investment grade bonds assigned an NAIC rating of 1 or 2; and the
reallocation of capital.
Attaining and maintaining the required RBC levels depends on future events
and circumstances, the outcome of which cannot be assured and the ultimate
outcome cannot be presently determined. Accordingly, no adjustments that may
result from the ultimate resolution of this uncertainty have been made in the
accompanying financial statements. Management presently believes that it will
implement its plan and meet and maintain RBC requirements.
At December 31, 1997, Union Bankers, Constitution, Peninsular, and
Marquette's total adjusted capital is in compliance with regulatory RBC
requirements.
PLIC's Canadian branch and Canadian subsidiary report to Canadian
regulatory authorities based upon Canadian statutory accounting principles that
vary in some respects from U.S. statutory accounting principles. Canadian net
assets based upon Canadian statutory accounting principles were $50,379, $51,428
and $51,567 as of September 30, 1998, and December 31, 1997 and 1996,
respectively.
Remittances to PLIC from the Canadian operations totaled $2,485 for the
year ended December 31, 1995. There were no remittances during 1998, 1997 or
1996.
(11) REINSURANCE
In the normal course of business, the Acquired Companies reinsure portions
of certain policies that it underwrites to limit disproportionate risks. The
Acquired Companies retain varying amounts of individual insurance up to a
maximum retention of $500 on any life. Amounts not retained are ceded to other
insurance enterprises or reinsurers on an automatic or facultative basis. The
Acquired Companies cede varying amounts of certain accident and sickness
policies up to a maximum cession of $800, as well as varying portions of certain
disability income products.
Reinsurance contracts do not relieve the Acquired Companies from their
obligations to policyholders. Therefore, the Acquired Companies are contingently
liable for recoverable unpaid
E-76
<PAGE> 315
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
claims and policyholder liabilities ceded to reinsurers in the unlikely event
that assuming reinsurers are unable to meet their obligations. The Acquired
Companies evaluate the financial condition of its reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies.
The effect of reinsurance on policy revenues earned and the related
benefits incurred by such reinsurers is as follows:
<TABLE>
<CAPTION>
NINE MONTHS
END
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 ------------------------------
(UNAUDITED) 1997 1996 1995
------------- -------- ------- -------
<S> <C> <C> <C> <C>
Direct policy revenues and amounts assessed
against policyholders..................... $223,672 324,375 327,118 160,942
Reinsurance assumed......................... 3,357 5,029 22,514 9,156
Reinsurance ceded........................... (68,034) (106,121) (56,123) (4,058)
-------- -------- ------- -------
Net premiums and amounts earned............. $158,995 223,283 293,509 166,040
======== ======== ======= =======
</TABLE>
Effective July 1, 1996, Union Bankers entered into reinsurance agreements
with Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its
Medicare supplement business in force on July 1, 1996 and to coinsure 80% of its
Medicare policies issued on or after July 1, 1996. Union Bankers recorded a
deferred gain on the transaction of $53,893 as of July 1, 1996, which is being
amortized into income over the life of the business. As a result of the step
purchase accounting adjustments at January 2, 1998, the deferred gain was
reduced by $7,310. For the nine months ended September 30, 1998, the year ended
December 31, 1997 and the period from July 1, 1996 to December 31, 1996, $6,681
$14,221 and $6,445, respectively, of the deferred gain has been recognized and
is included in other income. Union Bankers is not subject to any negative
experience adjustments if the ceded business is unprofitable; however, Union
Bankers may participate in a portion of future earnings from the ceded business
after Cologne recovers its initial ceding commission plus interest at a
specified rate. Union Bankers retained administration for the ceded block of
business and is reimbursed by Cologne for administrative costs at the rate of
8.5% of ceded renewal premiums and 11.5% of ceded first year premiums.
Peninsular has entered into three reinsurance agreements with an affiliate,
Occidental. The three agreements consist of a "Coinsurance of Individual and
Group Annuities" effective December 31, 1986, an "Indemnity Reinsurance"
effective July 1, 1991 and a "Coinsurance of Individual Universal Life
Insurance" effective October 1, 1992 whereby Peninsular is assuming the business
from Occidental.
The effect of this reinsurance on revenues earned and the related benefits
incurred is as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
1998 -------------------------
(UNAUDITED) 1997 1996 1995
------------- ----- ------ ------
<S> <C> <C> <C> <C>
Revenues assumed................................. $3,208 4,848 20,788 9,057
Policy benefits and expenses assumed............. $4,447 6,403 24,661 11,537
</TABLE>
Pursuant to the terms of the agreements, assets with a market value equal
to the statutory liabilities ceded were transferred to Peninsular on the
effective dates of the respective treaties.
E-77
<PAGE> 316
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
GAAP reserves for the business assumed from Occidental were $49,734,
$51,197 and $52,498 as of September 30, 1998, December 31, 1997 and 1996,
respectively.
Effective January 1, 1996, Union Bankers and Constitution ceded on a
coinsurance basis substantially all of their inforce annuity business to
Southwestern Life. Pursuant to the terms of the agreement, assets, with a market
value equal to the statutory reserves held by Union Bankers and Constitution
were transferred to Southwestern Life. Statutory and GAAP reserves at the date
of transfer were $34,827 and $37,291, respectively. This resulted in a deemed
capital contribution to Constitution of $2,465. These agreements were terminated
on September 30, 1998. Pursuant to the terms of the recapture provision, assets,
with a market value equal to the statutory reserves for the recaptured policies,
were transferred to Union Bankers and Constitution. Statutory and GAAP reserves
at the date of recapture were $27,337 and $28,414, respectively. This resulted
in a deemed dividend from Constitution of $1,077.
Effective December 31, 1997, Marquette assumed on a coinsurance basis a
specified block of flexible premium deferred annuity policies from Southwestern
Life. Marquette received assets equal to the statutory reserves with respect to
the assumed policies. At December 31, 1997, the statutory and GAAP reserves for
these policies were $67,630. This agreement was terminated on September 30,
1998. Assets with a market value equal to the statutory reserves on the
termination date were transferred back to Southwestern Life. Statutory and GAAP
reserves on the termination date were $27,716.
(12) RETIREMENT AND PROFIT SHARING PLAN
The Acquired Companies participate in defined contribution plans sponsored
by their respective ultimate parents, either PennCorp or SWF. All employees of
the Acquired Companies are eligible who have attained age 21, except for certain
employees whose commission earnings represent more than 50% of their income from
the Company. Matching contributions are made by PennCorp or SWF in the amount
equal to 50% of each participant's salary deferral up to a maximum of 3% of
annual compensation. The plans also provide for a discretionary employer profit
sharing contribution, which is determined annually by the parents' Boards of
Directors. Salary deferral contributions are at all times fully vested, while
matching contributions and profit sharing contributions vest ratably from one to
five years of service. All participant accounts are fully vested at death,
disability or attainment of age 65. Expenses related to this plan are charged to
each subsidiary or affiliate for its allocable share of such contributions based
on the percentage of payroll. The expenses allocated to the Acquired Companies
relating to this plan were $448 as of September 30, 1998 and $530, $534 and $649
for 1997, 1996, and 1995 respectively.
In addition, PennCorp has a bonus plan for certain key officers. The amount
available to pay awards for any year is determined by a committee of senior
executives of PennCorp and is subject to approval of the Board of Directors of
PennCorp. Awards are based on the performance of the Acquired Companies and the
performance of eligible participants. The Acquired Companies paid bonuses of
$634 through September 30, 1998 and $2,957 and $1,360 for the years ended 1997
and 1996 respectively.
PennCorp and SWF also provide certain health care and life insurance
benefits for retired employees. Employees meeting certain age and length of
service requirements become eligible for these benefits. The obligation for the
accrued postretirement health and welfare benefits is unfunded.
E-78
<PAGE> 317
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The combined total liability for PennCorp and SWF for the accrued
postretirement benefits include the following at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------- ------
<S> <C> <C>
Accumulated postretirement benefit obligations.............. $27,509 28,998
Unrecognized transition obligation.......................... (4,202) (5,187)
Unrecognized losses......................................... (816) (589)
------- ------
Total............................................. $22,491 23,222
======= ======
</TABLE>
The liabilities for the accrued postretirement benefit included at the
individual company level include company-specific programs and an allocated
portion of the service companies liability. The liability for the accrued
postretirement benefit for the Acquired Companies includes the following at
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Accumulated postretirement benefit obligations.............. $7,977 8,395
Unrecognized transition obligations......................... (3,204) (4,066)
Unrecognized losses......................................... (589) (367)
------ ------
Total............................................. $4,184 3,962
====== ======
</TABLE>
For measurement purposes, a 5.5% annual rate increase in the health care
cost trend rate was assumed for 1998; the rate was assumed to decrease gradually
to 4.0% by the year 2015 and remain at that level thereafter. The health care
cost trend rate assumption has a significant effect on the amounts reported. To
illustrate, increasing the assumed health care cost trend rates by one
percentage point in each year would increase the accumulated postretirement
health care benefit obligation as of December 31, 1997 by $767 and the aggregate
of the service and interest components of net periodic postretirement health
care benefit cost for 1997 by $127. The weighted average discount rate used in
determining the accumulated postretirement benefit obligation was 7.0%.
(13) RELATED PARTY TRANSACTIONS
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Combined Financial Statements.
During 1995, two of PennCorp's officers and directors, Messrs. Stone and
Fickes, formed a fund, Knightsbridge, for the purpose of making equity and
equity linked investments in companies engaged primarily in the life insurance
industry. Knightsbridge has received subscriptions for approximately $92,000 in
limited partnership interests, including a $15,000 subscription from PennCorp.
The general partner of Knightsbridge is Knightsbridge Capital L.L.C.
("Knightsbridge Capital"), the members of which are David J. Stone and Steven W.
Fickes. Allan D. Greenberg, a member of the Company's Board of Directors,
formerly owned a 5% interest in Knightsbridge Capital which was purchased by
Messrs. Stone and Fickes. The general partner of Knightsbridge cannot be removed
by the limited partners, unless a court has finally determined that the general
partner has committed a willful and material breach of the limited partnership
agreement.
The Acquired Companies have management and services agreements with
entities affiliated with Knightsbridge, a shareholder and a director of
PennCorp. In connection with an Advisory and Management Services Agreement with
Knightsbridge Management, L.L.C., the Acquired Companies
E-79
<PAGE> 318
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
have paid $1,545 through September 30, 1998. Fees of $243 and $326 were paid in
1997 and 1996 respectively. Each insurance company has an Investment Management
Agreement with Knightsbridge Consultants, L.L.C. For the periods ended September
30,1998 and December 31, 1997, 1996, and 1995 fees incurred totaled $785, $371,
$377, and $313 respectively.
PLIC has an agreement with its affiliates with respect to the reimbursement
of direct and joint costs for services or material paid on behalf of the
Acquired Companies, in some cases, and other affiliates. Pursuant to this
agreement, PLIC received $23,249 through September 30, 1998 and $30,522,
$32,093, and $18,547 for 1997, 1996, and 1995, respectively.
Pursuant to a service agreement, PennCorp Financial Services, Inc.,
provides data processing services for the Acquired Companies. The Acquired
Companies incurred expenses of $5,473 through September 30, 1998, and $9,523,
$8,392, and $6,109 for 1997, 1996, and 1995, respectively.
A corporation whose principal owners are shareholders, directors or
officers of PennCorp, provides actuarial and tax advisory services to the
Acquired Companies. Advisory fees of $222 were paid in 1997, $210 was paid in
1996 and 1995. As of September 30, 1998, no advisory fees have been paid in
1998.
Constitution, Union Bankers, and Marquette were parties to a management and
services agreement with Southwestern Financial Services Corporation ("SFSC"), a
subsidiary of SWF. SFSC provided substantially all administrative, management,
investment, personnel, data processing, facilities and certain other services
for SWF, its subsidiaries and affiliates and certain other unrelated parties.
Under the management and services agreement with SFSC, those companies paid fees
for personnel, data processing, and other services equal to the cost of such
services to SFSC. The amount of fees incurred in accordance with the agreement
was $12,129 through September 30, 1998. For the years ended 1997, 1996, and for
the period from December 15, 1995 through December 31, 1995, the fees were
$20,810, $22,664, and $800, respectively.
(14) OTHER COMMITMENTS AND CONTINGENCIES
PennCorp, the parent of the Acquired Companies, and a number of current or
former PennCorp directors and officers have been named as defendants in ten
class-action securities complaints (collectively, the "Complaints") that were
filed in the United States District Court for the Southern District of New York.
Nine of the Complaints are brought on behalf of certain purchasers of the
PennCorp's common stock; the other on behalf of the purchasers of PennCorp's
subordinated notes. The Complaints charge PennCorp and certain of its officers
and directors with violations of federal securities laws. Plaintiffs seek to
recover damages in unspecified amounts on behalf of themselves and all other
purchasers of the PennCorp's common stock and subordinated notes during various
periods. During a pre-trial conference on November 9, 1998, all parties agreed
to the consolidation of all of the above actions and the Court appointed lead
plaintiffs on behalf of the shareholders and noteholders. Additional information
with respect to the Complaints is included in PennCorp's 10Q, for the period
ended September 30, 1998, on file with the SEC.
Presently, none of the Acquired Companies have been specifically named in
the above complaints.
While it is not feasible to predict or determine the final outcome of these
proceedings or to estimate the amount or potential range of loss with respect to
these matters, management believes that an adverse outcome with respect to such
proceedings would have a material adverse impact on the financial condition,
results of operations and cash flows of the Company.
E-80
<PAGE> 319
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
On July 30, 1998, the Securities and Exchange Commission (the "SEC")
notified PennCorp that it had commenced a formal investigation into possible
violations of the federal securities laws including matters relating to
PennCorp's restatement of its financial statements for the first nine months of
1997, and for the years ended December 31, 1994, 1995, and 1996. PennCorp and
its management are fully cooperating with the SEC in its investigation.
Certain lawsuits have been brought against the Acquired Companies in the
normal course of the insurance business involving the settlement of various
matters and seeking compensatory and in some cases punitive damages. Management
believes that the ultimate settlement of all such litigations will not have a
materially adverse effect on the Acquired Companies combined financial position
or results of operations.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered through a reduction in future premium taxes. The insurance
subsidiaries paid assessments of $292 through September 30, 1998, and $787, $541
and $435 for the years ended December 31, 1997, 1996 and 1995, respectively.
Based on information currently available, the insurance subsidiaries have
determined that no accrual is necessary at September 30, 1998 for future
assessments, net of future premium tax reductions.
(15) FINANCIAL INSTRUMENTS
The following is a summary of the carrying value and fair value of the
Acquired Companies' financial instruments as of September 30, 1998, December 31,
1997 and 1996:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31;
1998 ---------------------------------------
(UNAUDITED) 1997 1996
------------------ ------------------ ------------------
CARRYING FAIR CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE VALUE VALUE
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Cash and short-term
investments................. $ 70,073 70,073 63,186 63,186 64,438 64,438
Fixed maturities.............. 593,255 593,255 521,844 521,844 485,515 485,515
Equity securities............. 6,856 6,856 7,564 7,564 19,453 19,453
Mortgage loans................ 1,884 1,884 7,335 7,335 8,241 8,241
Policy loans.................. 22,626 22,626 23,731 23,731 24,758 24,758
Other investments............. 7,130 6,879 14,836 14,582 12,700 12,438
Agent and premium
receivables................. 701,825 701,575 638,496 638,242 615,106 614,844
LIABILITIES:
Capital lease obligations..... $ 2,643 2,643 3,109 3,109 3,679 3,679
Universal life and investment
contract liabilities........ 35,278 35,278 104,753 104,753 40,950 40,950
</TABLE>
E-81
<PAGE> 320
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The following methods and assumptions were used by the Acquired Companies
in estimating their fair value disclosures for financial instruments:
Cash and Short-term Investments, Agent and Premium Receivables: The
carrying value of short-term investments and amounts receivable approximate
their fair value due to the short-term maturity of these instruments.
Fixed Maturities and Equities Available for Sale: Fair values for fixed
maturities available for sale are based on quoted market prices, where
available. For fixed maturities not actively traded, fair values are estimated
using values obtained from independent pricing services or are estimated based
on expected future cash flows using a current market rate applicable to the
yield, credit quality, and maturity of the investments. The fair values for
equity securities are based on quoted market prices.
Mortgage and Collateral Loans: The fair value for mortgage and collateral
loans are estimated using discounted cash flow analyses, based on interest rates
currently being offered for similar loans to borrowers with similar credit
ratings. Loans with similar characteristics are aggregated for purposes of the
calculation.
Other Investments: The fair value of Acquired Companies' investment in
residual interests in mortgage-backed securities was obtained from an
independent broker-dealer. The fair values of other miscellaneous invested
assets have not been estimated due to their relative immateriality.
Policy Loans: Policy loans are an integral part of life insurance policies
which the insurance companies have in force and, in the Acquired Companies'
opinion, cannot be valued separately. These loans typically carry an interest
rate that is tied to the crediting rate applied to the related policy and
contract reserves.
Capitalized Lease Obligations: Fair values of the Acquired Companies'
capitalized lease obligations approximate carrying values.
Universal Life and Investment Contract Liabilities: The carrying value and
fair values for the insurance companies' liabilities under universal life and
investment-type insurance contracts are the same as the interest rates credited
to these products are periodically adjusted by the Acquired Companies to reflect
market conditions. The fair values of liabilities under all insurance contracts
are taken into consideration in the overall management of investment maturities
with amounts due under insurance contracts.
(16) RESTRUCTURING CHARGES
As a result of the Acquired Companies initiative to transfer administration
of its comprehensive and medicare supplement blocks of business to third party
administrators, the Acquired Companies recorded a pre-tax restructuring charge
of $1,834 during 1998. The restructuring charge recognized primarily severance
and related benefits incurred due to staff reductions. Through September 30,
1998, the Acquired Companies have charged against the accrual $1,308. As of
September 30, 1998, the Acquired Companies re-evaluated such charge and reduced
accruals by $269.
During 1995, the Acquired Companies recorded a restructuring charge of
$1,272 relating to the relocation of operations.
E-82
<PAGE> 321
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(17) YEAR 2000 COMPLIANCE
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g., "98" represents 1998). It is
highly likely that such systems will not be able to accurately process data
containing date information for the year 2000 and beyond. The year 2000 issue
has the potential to affect the Acquired Companies through the disruption of the
processing of business both internally and between the Acquired Companies and
other businesses with which it interacts.
Although the Acquired Companies believe that their operating divisions,
outside vendors and most critical business partners will be sufficiently
compliant that the year 2000 issue should not cause a material disruption in the
Acquired Companies' business, there can be no assurance that there will not be
material disruptions to the Acquired Companies' business or an increase in the
cost of doing business. Although the Acquired Companies believe that the year
2000 issues should not cause a material disruption in business, they are
currently evaluating various contingency plans associated with remediation tasks
which management believes are at a higher risk for failure.
(18) SUBSEQUENT EVENT -- PENDING SALE OF THE CAREER DIVISION (UNAUDITED)
On December 31, 1999, PennCorp entered into a definitive agreement to sell
its Career Sales Division and related assets to Universal, in conjunction with
Capital Z Financial Services Fund II, L.P. ("Capital Z"). The purchase price is
$175,000, consisting of $136,000 of cash and $39,000 of Subordinated Notes. The
purchase price may be increased or decreased under the terms of the agreement.
To finance part of the transaction, Universal will issue approximately
$82,000 of new equity in the form of common stock to Capital Z and some agents
and members of the management of the Acquired Companies. Of that amount, Capital
Z will invest $76,500 to acquire 24.3 million common shares of Universal at a
price of $3.15 per share. Capital Z is a $1.8 billion global private equity fund
that focuses exclusively on investments in the insurance, financial services and
healthcare services industries.
Universal also intends to fund the transaction by borrowing $70,000 which
has been committed by a syndicate of lenders arranged by Chase Securities, Inc.
The lenders will make an additional $10,000 available to Universal on a
revolving credit basis. In addition, Universal will issue $39,000 in
Subordinated Notes to PennCorp (the "Notes"). The Notes will have an 8.0 percent
coupon and a maturity of ten years. Interest on the Notes may be paid in
additional Subordinated Notes or in cash, at Universal's option. The accreted
value of the Notes will be subject to offset in the event of adverse development
in PLIC's disability income claim reserve and for other indemnification issues.
The closing of the transaction is subject to certain closing conditions,
including receipt of all required regulatory approvals and the approval of the
transactions by Universal's shareholders. Shareholders holding a majority of the
outstanding voting shares of Universal have already agreed to vote their shares
in favor of the related transactions. The parties expect the closing of the
transaction to occur in the second quarter of 1999.
The stock purchase agreement contains other pre-closing restructuring
provisions, including the termination of the current reinsurance agreements
between Peninsular and Occidental relating to the assumption by Peninsular of
Occidental's reserves and the establishment of a new reinsurance agreement,
whereby Peninsular will cede 100 percent of its existing direct business to
Occidental. These transactions will be settled at amounts equal to the statutory
reserves at the date
E-83
<PAGE> 322
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
the new agreements become effective. At September 30, 1998, Peninsular's net
GAAP reserves, including the amounts assumed from Occidental, were approximately
$60,000 and the related statutory reserves were approximately $70,000.
Accordingly, it is anticipated that Peninsular will recognize a net loss of
approximately $10,000, as a result of the above transactions.
(19) SUBSEQUENT EVENTS -- REINSURANCE (UNAUDITED)
In December 1998, Union Bankers signed a letter of intent to ceded the
remaining 20 percent of its medicare supplement business to Cologne. The letter
of intent also amends certain provisions of the existing contract. The Acquired
Companies have, at their option, the ability to recapture the additional 20
percent. This option expires on January 29, 1999. Management does not expect
this transaction to have a material effect on the financial position of the
Acquired Companies.
E-84
<PAGE> 323
UNIVERSAL AMERICAN FINANCIAL CORP.
PROXY
THIS PROXY IS SOLICITED BY
THE BOARD OF DIRECTORS OF UNIVERSAL AMERICAN FINANCIAL CORP.
FOR THE SPECIAL MEETING OF SHAREHOLDERS TO BE HELD ON , 1999
The undersigned hereby (i) acknowledge(s) receipt of the notice of special
meeting of shareholders and the proxy statement dated , 1999, relating
to the special meeting of shareholders of UNIVERSAL AMERICAN FINANCIAL CORP. to
be held , 1999 and (ii) appoints , as proxies, with full
power of substitution, and authorizes them, or either of them, to vote all
shares of capital stock of Universal American entitled to vote standing in the
name of the undersigned at said meeting or any adjournment or postponement
thereof upon the matters specified on the reverse side of this card and upon
such other matters as may be properly brought before the meeting, conferring
discretionary authority upon such proxies as to such other matters. THIS PROXY,
WHEN PROPERLY EXECUTED, WILL BE VOTED AS DIRECTED BY THE SHAREHOLDER. IF NO
DIRECTION IS MADE, A PROPERLY EXECUTED PROXY WILL BE TREATED AS A VOTE IN FAVOR
OF ALL OF THE PROPOSALS.
The proxies are authorized to vote upon such other business as may properly come
before the meeting as recommended by the board of directors.
SHAREHOLDERS WHO ATTEND THE MEETING MAY VOTE IN PERSON EVEN THOUGH THEY HAVE
PREVIOUSLY MAILED THIS PROXY CARD.
[X] PLEASE MARK YOUR VOTES AS IN THIS EXAMPLE.
Proposal No. 1 -- Capital Z issuance
<TABLE>
<S> <C> <C> <C>
Approval of the issuance and sale to Capital Z Financial
Services Fund II, L.P. and some agents and members of
management of the Penn Union Companies of up to 26,031,746
shares of common stock of Universal American and the payment
of a part of a transaction fee to an affiliate of Capital Z
in Universal American common stock, which will result in a
change of control of Universal American. The number of
shares issued and purchased and the price paid for the
shares may be adjusted under the share purchase agreement. FOR [ ] AGAINST [ ] ABSTAIN [ ]
</TABLE>
(CONTINUED ON REVERSE SIDE)
<PAGE> 324
PROPOSAL NO. 2 -- AMENDMENTS TO CERTIFICATE OF INCORPORATION
Approval to amend Universal American's certificate of incorporation to:
<TABLE>
<S> <C> <C> <C>
(a) Increase the number of authorized shares of common stock FOR [ ] AGAINST [ ] ABSTAIN [ ]
from 20 million shares to 80 million shares.
(b) Provide for shareholder action by written consent
instead of a meeting of shareholders. Written consent
would only need to be executed by shareholders holding
the number of shares required to approve the action FOR [ ] AGAINST [ ] ABSTAIN [ ]
taken by written consent.
(c) Eliminate the requirement that holders of 66 2/3% of the
Universal American's outstanding voting capital stock
approve amendments to certain provisions of the
certificate of incorporation, which means only majority FOR [ ] AGAINST [ ] ABSTAIN [ ]
approval will be necessary for those amendments.
(d) Remove the provision which requires the vote of holders
of 66 2/3% of the outstanding voting capital stock to
call a special meeting of the shareholders. The board
will amend the by-laws to allow special meetings of the
shareholders to be called at the request of 50% of the FOR [ ] AGAINST [ ] ABSTAIN [ ]
outstanding voting capital stock.
(e) Replace the present method of electing directors and the
length of the term each director serves with a system in
which all directors are elected at one time each for a
term expiring at the next annual meeting. Directors are FOR [ ] AGAINST [ ] ABSTAIN [ ]
currently elected to three-year staggered terms.
(f) Require 66 2/3% of Universal American's board of FOR [ ] AGAINST [ ] ABSTAIN [ ]
directors approve certain important corporate actions.
</TABLE>
Please check this box if you plan to attend the meeting. [ ]
Please mark, date, sign and mail this proxy card in the envelope provided. No
postage is required for domestic mailing.
<TABLE>
<S> <C>
Signature(s) Date
</TABLE>
Note: Please sign exactly as name appears hereon. When shares are held by joint
tenants, both should sign. When signing as executor, administrator,
trustee or guardian, please give full title as such. If a corporation,
please sign in full corporate name by President or other authorized
officer. If a partnership, please sign in partnership name by authorized
person.
