UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Period Ended September 30, 1999
Commission File #0-11321
UNIVERSAL AMERICAN FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2580136
(State of Incorporation) (I.R.S. Employer I.E. No.)
Six International Drive, Suite 190, Rye Brook, NY 10573
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 934-5200
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
The number of shares outstanding of each of the Registrant's Common
Stock and Common Stock Warrants as of November 1, 1999 were 43,102,304 and
595,427, respectively.
<PAGE>
2
UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
<TABLE>
<S> <C>
Page No.
PART I - FINANCIAL INFORMATION
Consolidated Balance Sheets at September 30, 1999 and December 31, 1998 3
Consolidated Statements of Operations for the nine months ended
September 30, 1999 and September 30, 1998
4
Consolidated Statements of Operations for the three months ended September 30, 1999
and September 30, 1998 5
Consolidated Statements of Cash Flows for the nine months ended September 30, 1999
and September 30, 1998 6
Notes to Consolidated Financial Statements 7-19
Management's Discussion and Analysis of Financial Condition and Results of Operations 20-34
PART II - OTHER INFORMATION 35
Signature 35
</TABLE>
<PAGE>
6
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<S> <C> <C>
ASSETS Sept. 30, 1999 Dec. 31, 1998
------------------- -------------------
Investments: (unaudited)
Fixed maturities available for sale, at fair value
(amortized cost $649,297,518 and $132,227,114, respectively) $ 644,556,826 $ 134,797,634
Equity securities,at fair value (cost $5,015,099 and $1,063,186, respectively) 4,873,397 1,019,780
Policy loans 25,756,546 7,276,163
Other invested assets 2,642,255 30,696
Mortgage loans 2,978,757 4,456,516
------------------- -------------------
Total investments 680,807,781 147,580,789
Cash and cash equivalents 138,561,195 17,092,938
Accrued investment income 10,596,283 3,538,573
Deferred policy acquisition costs 30,342,384 24,282,771
Amounts due from reinsurers 193,927,547 77,393,653
Due and unpaid premiums 5,086,034 525,909
Goodwill 4,239,075 4,354,584
Present value of future profits 1,438,800 1,569,601
Deferred income tax asset 63,091,946 -
Other assets 21,239,837 6,963,481
------------------- -------------------
Total assets 1,149,330,882 283,302,299
=================== ===================
LIABILITIES, SERIES C AND D PREFERRED STOCK AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 188,495,212 154,886,059
Reserves for future policy benefits 593,920,308 47,442,966
Policy and contract claims - life 5,347,723 2,297,446
Policy and contract claims - health 75,347,643 24,332,141
Loan payable 70,000,000 4,750,000
Amounts due to reinsurers 2,445,171 1,810,696
Negative goodwill 19,590,077 -
Deferred revenues 161,102 201,389
Deferred income tax liability - 1,218,547
Other liabilities 62,254,659 9,943,970
------------------- -------------------
Total liabilities 1,017,561,895 246,883,214
------------------- -------------------
Preferred Stock, including redemption accrual (Issued and outstanding
74,180 at December 31, 1998) - 8,101,214
------------------- -------------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Series B Preferred Stock (Issued and outstanding 400 at December 31, 1998) - 4,000,000
Common stock (Authorized 80,000,000 and 20,000,000, respectively; issued
and outstanding 43,101,304 and 7,638,057, respectively) 431,013 76,381
Common stock warrants (Authorized, issued and outstanding 596,427
and 658,231, respectively) - -
Additional paid-in capital 119,552,355 16,410,412
Accumulated other comprehensive income (516,279) 857,872
Retained earnings 12,301,898 6,973,206
------------------- -------------------
Total stockholders' equity 131,768,987 28,317,871
------------------- -------------------
Total liabilities, Series C and D Preferred Stock and stockholders' equity $ 1,149,330,882 $ 283,302,299
=================== ===================
</TABLE>
See notes to consolidated financial statements
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
Nine Months Ended September 30,
1999 1998
------------------- ---------------
<S> <C> <C>
Revenues:
Gross premium and policyholder fees earned $147,737,344 $95,945,350
Reinsurance premiums assumed 1,524,094 657,519
Reinsurance premiums ceded (87,234,561) (64,763,193)
---------------- ---------------
Net premium and policyholder fees earned 62,026,877 31,839,676
Net investment income 15,102,719 8,056,325
Net realized gains on investments 17,827 280,548
Fee income 1,570,243 1,989,789
Amortization of deferred revenue 33,474 47,517
---------------- ---------------
Total revenues 78,751,140 42,213,855
---------------- ---------------
Benefits, claims and expenses:
Increase in future policy benefits 1,191,812 2,069,093
Claims and other benefits 40,115,174 20,656,621
Interest credited to policyholders 5,845,901 5,426,434
Increase in deferred acquisition costs (2,591,879) (2,813,933)
Amortization of present value of future profits 130,801 130,801
Amortization of goodwill, net (216,526) 115,509
Commissions 26,282,974 19,530,706
Commission and expense allowances on reinsurance ceded (24,659,079) (21,489,576)
Other operating costs and expenses 25,325,663 15,535,725
--------------- ---------------
Total benefits, claims and other deductions 71,424,841 39,161,380
--------------- ---------------
Operating income before taxes 7,326,299 3,052,475
Federal income tax expense 2,680,815 1,037,842
--------------- --------------
Net income 4,645,484 2,014,633
Redemption accrual on Series C and Series D Preferred Stock 179,524 325,068
--------------- --------------
Net income applicable to common shareholders $ 4,465,960 $ 1,689,565
=============== ==============
Earnings per common share:
Basic $ 0.27 $ 0.23
=============== ==============
Diluted $ 0.22 $ 0.15
=============== ==============
</TABLE>
See notes to unaudited consolidated financial statements
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
Three Months Ended September 30,
1999 1998
----------------- ----------------
<S> <C> <C>
Revenues:
Gross premium and policyholder fees earned $ 80,920,538 $ 32,265,182
Reinsurance premiums assumed 543,852 217,523
Reinsurance premiums ceded (41,185,885) (21,954,983)
-------------- ----------------
Net premium and policyholder fees earned 40,278,505 10,527,722
Net investment income 9,433,474 2,686,850
Net realized gains on investments 32,705 63,773
Fee income 432,377 774,130
Amortization of deferred revenue 11,158 15,839
-------------- ----------------
Total revenues 50,188,219 14,068,314
-------------- ----------------
Benefits, claims and expenses:
Increase in future policy benefits 348,898 1,304,143
Claims and other benefits 25,637,304 6,134,060
Interest credited to policyholders 2,183,538 1,892,820
Increase in deferred acquisition costs (1,171,508) (1,174,305)
Amortization of present value of future profits 43,601 17,383
Amortization of goodwill, net (293,531) 38,503
Commissions 12,870,175 6,514,724
Commission and expense allowances on reinsurance ceded (9,054,915) (6,899,143)
Other operating costs and expenses 14,438,443 5,221,979
---------------- ---------------
Total benefits, claims and other deductions 45,002,005 13,050,164
----------------- ---------------
Operating income before taxes 5,186,214 1,018,150
Federal income tax expense 1,953,186 346,172
---------------- ----------------
Net income 3,233,028 671,978
Redemption accrual on Series C and Series D Preferred Stock - 108,356
================ ================
Net income applicable to common shareholders $ 3,233,028 $ 563,622
================ ================
Earnings per common share:
Basic $ 0.10 $ 0.07
================ ================
Diluted $ 0.09 $ 0.05
================ ================
</TABLE>
See notes to unaudited consolidated financial statements
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
Nine Months Ended Sept. 30,
1999 1998
--------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 4,645,484 $2,014,633
Adjustments to reconcile net income to net cash used by operating activities,
net of balances acquired:
Deferred income taxes 1,058,673 1,037,842
Change in reserves for future policy benefits 4,423,865 (798,147)
Change in policy and contract claims 679,478 (2,889,043)
Change in deferred policy acquisition costs (2,591,879) (2,813,933)
Change in deferred revenue (40,287) (47,517)
Amortization of present value of future profits 130,801 130,801
Amortization of goodwill, net (216,526) 115,509
Change in policy loans 147,436 (20,578)
Change in accrued investment income 573,810 (658,036)
Change in reinsurance balances (4,360,010) (935,097)
Change in due and unpaid premium (477,159) (63,433)
Realized (gains)/losses on investments (17,827) (280,548)
Change in income taxes payable 8,516,756 -
Other, net (7,142,557) (4,476,836)
--------------- --------------
Net cash provided by/(used in) operating activities 5,330,058 (9,684,383)
--------------- --------------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for sale 12,270,537 19,428,930
Proceeds from redemption of fixed maturities available for sale 14,675,246 3,108,323
Cost of fixed maturities purchased available for sale (72,385,183) (29,622,727)
Change in amounts held in trust by reinsurer (910,069) (3,413,068)
Change in amounts held for reinsurer - (1,769,221)
Proceeds from sale of equity securities 373,803 343,102
Cost of equity securities purchased (144,105) (532,922)
Change in other invested assets 2,587,972 1,515,382
Change in amounts due to/(from) broker 7,604,472 (1,751,523)
Purchase of business, net of cash held (5,348,323) (2,562,824)
--------------- --------------
Net cash used in investing activities (41,275,650) (15,256,548)
--------------- --------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 89,600,469 570,288
Net proceeds from issuance of Series D Preferred Stock 1,750,000 -
Increase in policyholder account balances 1,876,771 11,829,794
Change in reinsurance balances on policyholder account balances (1,063,391) (2,278,689)
Increase in loan payable 70,000,000 1,850,000
Principal payment on notes payable (4,750,000) (350,000)
--------------- --------------
Net cash provided by financing activities 157,413,849 11,621,393
--------------- --------------
Net increase/(decrease) in cash and cash equivalents 121,468,257 (13,319,538)
Cash and cash equivalents at beginning of period 17,092,938 25,014,019
--------------- --------------
Cash and cash equivalents at end of period $138,561,195 $ 11,694,481
=============== ==============
Supplemental cash flow information:
Cash paid during the period for interest $ 1,265,270 $ 200,523
=============== ==============
Cash paid during the period for income taxes $ 25,000 $ -
=============== ==============
</TABLE>
See notes to unaudited consolidated financial statements
<PAGE>
8
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
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, 1999 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, 1998. Certain
reclassifications have been made to prior year's financial statements to conform
with current period classifications.
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"). On July 30, 1999, Universal acquired all of the outstanding
shares of common stock of certain direct and indirect subsidiaries of PennCorp
Financial Group ("PFG"), including the following six insurance companies (the
"Penn Union Companies"): Pennsylvania Life Insurance Company ("Pennsylvania
Life"), Peninsular Life Insurance Company ("Peninsular"), Union Bankers
Insurance Company ("Union Bankers"), Constitution Life Insurance Company
("Constitution"), Marquette National Life Insurance Company ("Marquette") and
PennCorp Life Insurance Company, a Canadian company ("PennCorp Canada").
Universal is a life and accident and health insurance holding company
whose principal insurance subsidiaries noted above traditionally, through a
general agency system, marketed and underwrote products aimed at the senior
market, including Medicare supplement, long-term care, home health care, life
insurance and annuities. With the acquisition of the Penn Union Companies, the
Company has expanded its issuance of fixed benefit accident and health insurance
products. The acquisition expanded the Company's general agency system and
generated a new distribution system consisting of career agents. The career
agent distribution system operates through a network of regional managers that
operate branch offices throughout the United States and Canada. These career
agents focus only on sales for Pennsylvania Life and PennCorp Canada.
2. EQUITY TRANSACTIONS
Universal American Financial Corp. Share Purchase Agreement with
Capital Z Financial Services Fund II, L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement
("UA Purchase Agreement") with Capital Z Financial Services Fund II, L.P.
("Capital Z"), which was amended on July 2, 1999. Under the amended agreement,
Capital Z agreed to purchase up to 28,888,888 shares of Universal common stock
for a purchase price of up to $91.0 million (the "Capital Z Transaction")
subject to adjustment as outlined in the UA Purchase Agreement. The UA Purchase
Agreement received the approvals of the Florida, New York and Texas Insurance
Departments (the states in which Universal's insurance subsidiaries are
domiciled). The stockholder approvals required for the closing of the UA
Purchase Agreement were given on July 27, 1999.
On July 30, 1999, the Capital Z Transaction closed with Capital Z
purchasing 25,707,552 shares of common stock for $80,978,790 ($3.15 per share).
In connection with the closing of the UA Purchase Agreement, certain managers
and agents of Universal and the Penn Union Companies and holders of Series C
Preferred Stock preemptive rights purchased 3,753,189 shares of common stock for
$11,822,545 ($3.15 per share). The total number of shares issued amounted to
29,460,741 for total proceeds of $92,801,334. The transaction expenses incurred
with the UA Purchase Agreement amounted to $6,963,662 and were charged to
paid-in capital. Included in these transaction expenses was $5,120,896 paid to
an affiliate of Capital Z, of which $1,375,000 was paid by issuing 436,508
shares of common stock of the Company ($3.15 per share).
Shareholders' Agreement
Universal, Capital Z, UAFC L.P. ("AAM") (an unaffiliated investment
firm), Richard Barasch (the Chairman and Chief Executive Officer of the Company)
and several other shareholders of Universal entered into a shareholders'
agreement on July 30, 1999 (the "Shareholders' Agreement"). 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
Barasch and Capital Z, including its affiliates. However, pledges and some other
transfers by any party to the Shareholders' Agreement of less than 2% of
Universal's outstanding common stock at any one time, or 2.5% when aggregated
with the other transfers by the shareholder and his, her or its permitted
transferees of Universal's outstanding common stock, are permitted. In addition,
Richard Barasch is not permitted to sell more than 2% of his holdings for a
three-year period beginning July 30, 1999. 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's board of directors, certain shareholders are permitted to nominate
directors as follows: Capital Z: four, Richard Barasch: two, AAM: one and
Universal: two. Capital Z, Richard Barasch and AAM are each required to vote for
the director(s) nominated by the others. The ability of Richard Barasch to
nominate directors is also conditioned upon his continued employment with
Universal. 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 from Capital Z.
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's shareholders would receive consideration other than in the form of
shares of the surviving entity.
Grant of Incentive Stock Options
On July 30, 1999, the Company granted incentive stock options to
certain of its management and employees totaling 2,230,000 options. These
options were granted at prices below the fair market value on the date of the
grant and, therefore, an expense was recorded for the difference between the
exercise price and the fair market price of the stock for those options vested.
3. BUSINESS COMBINATION
Penn Union Acquisition
On July 30, 1999, Universal acquired all of the outstanding shares of
common stock of certain direct and indirect subsidiaries of PennCorp Financial
Group ("PFG"), including six insurance companies (the "Penn Union Companies")
and certain other assets as follows (the "Penn Union Transaction"). The Penn
Union Companies are:
Name of Insurance Company State or Province of Domicile
Pennsylvania Life Insurance Company Pennsylvania
Peninsular Life Insurance Company North Carolina
Union Bankers Insurance Company Texas
Constitution Life Insurance Company Texas
Marquette National Life Insurance Company Texas
PennCorp Life Insurance Company Ontario, Canada
The purchase price of $130.5 million in cash was financed with $92.8
million of proceeds generated from the UA Purchase Agreement described in Note 2
and from the term loan portion of an $80 million credit facility entered into on
July 30, 1999 consisting of a $70 million term loan and a $10 million revolving
loan facility (see Note 4). None of the revolving loan facility was drawn at
closing. The proceeds of the financing in excess of the $130.5 million purchase
price were used to pay transaction costs of the acquisition and the financing,
to retire an existing Universal bank loan, to contribute to the surplus of
Pennsylvania Life and for working capital.
The Penn Union Transaction was accounted for using the purchase method
and, accordingly, the operating results generated by the acquired companies
after July 30, 1999 are included in Universal's consolidated financial
statements. At the time of closing, the fair value of net assets of the acquired
companies amounted to $157.9 million resulting in a negative goodwill amount of
$19.9 million, which will be amortized on a straight line basis over a ten year
period.
The consolidated pro forma results of operations, assuming that the
companies described above were purchased on January 1, 1999 and 1998,
respectively, are as follows:
Nine Months Ended September 30,
------------------------------------------
1999 1998 (a)
------------------- ------------------
Total revenue $ 205,420,000 $ 219,356,000
Operating income before taxes $ 24,245,000 $ (2,118,000)
Net income $ 14,291,000 $ (1,165,000)
Earnings per common share:
Basic $ 0.36 $ (0.03)
Diluted $ 0.32 $ (0.03)
(a) The results of the Penn Union Companies for the nine months ended
September 30, 1998 included reserve strengthenings which resulted in a
reduction of $17.4 million in net income after tax, or $0.41 per basic
share and $0.39 per diluted share.
4. LOAN AGREEMENTS
As of July 30, 1999 the Company had a loan outstanding of $4.3 million
pursuant to a credit agreement with Chase Manhattan Bank executed in 1998.
During the seven months ended July 30, 1999, the Company repaid $0.5 million in
principal and $0.2 million in interest. In connection with the Penn Union
Transaction discussed in Note 3, the $4.3 million amount outstanding on the 1998
credit agreement was repaid in full on July 30, 1999. As a result of this
repayment, the Company paid $25 thousand to terminate an interest rate swap
agreement that was in place with this credit agreement. In addition, the Company
expensed $87 thousand of unamortized loan origination expenses related to the
1998 credit agreement.
In connection with the Penn Union Transaction on July 30, 1999, the
Company entered into an $80 million credit facility consisting of a $70 million
term loan and a $10 million revolving loan facility. The term loan calls for
interest at the London Interbank Offering Rate ("LIBOR") plus 350 basis points
(currently 9.01%) and the principal repays over a seven year period with a final
maturity date of July 31, 2006. The term loan is secured by a first priority
interest in 100% of the outstanding common stock of American Exchange, American
Progressive, PFI, Inc. (an immaterial subsidiary), Quincy (an immaterial
subsidiary), WorldNet and 65% of the outstanding common stock of UAFC (Canada)
Inc. (the 100% parent of PennCorp Canada). The Company has not drawn down any of
the revolving loan facility and pays a commitment fee of 50 basis points on the
unutilized facility. For the two months ended September 30, 1999, the Company
paid $1.054 million in interest on the term loan.
5. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the
nine-month periods ended September 30, 1999 and 1998 are as follows:
For the Nine Months
Ended September 30,
---------------------------------
1999 1998
------------- -----------
Net income $ 4,645,484 $ 2,014,633
------------- -------------
Other comprehensive income:
Unrealized gain/(loss) on securities (2,428,136) 1,243,910
Foreign currency translation adjustment 1,053,985 -
------------- -------------
Other comprehensive income/(loss) (1,374,151) 1,243,910
------------- -------------
Comprehensive income $ 3,271,333 $ 3,258,543
============= =============
The components of comprehensive income, net of related tax, for the
three-month periods ended September 30, 1999 and 1998 are as follows:
For the Three Months
Ended September 30,
---------------------------------
1999 1998
---------------- -----------
Net income $ 3,233,028 $ 671,978
--------------- -----------
Other comprehensive income:
Unrealized gain/(loss) on securities (412,602) 1,057,791
Foreign currency translation adjustment 1,053,985 -
--------------- -----------
Other comprehensive income 641,383 1,057,791
--------------- -----------
Comprehensive income $ 3,874,411 $ 1,729,769
=============== ===========
6. FEDERAL INCOME TAXES
Universal files a consolidated U.S. income tax return that includes its
non-insurance company subsidiaries as well as American Pioneer and American
Progressive. Due to Internal Revenue Code restrictions, the remaining insurance
companies file a consolidated U.S. life insurance company income tax return that
includes the Penn Union Companies with American Exchange as the parent. For
periods ending prior to their acquisition, the Penn Union Companies are included
in the consolidated U.S. tax returns of their former parents. Additionally, both
PennCorp Canada and Pennsylvania Life's Canadian branch file separate income tax
returns in Canada.
<PAGE>
7. EARNINGS PER SHARE
Per share amounts for net income from operations are shown in the
income statement using i) an earnings per common share basic calculation and ii)
an earnings per common share-assuming dilution calculation. Due to the use of
weighted average shares outstanding when determining the denominator for
earnings per share, the sum of the quarterly per common share amounts may not
equal the per common share amounts for the nine months ended September 30, 1999.
A reconciliation of the numerators and the denominators of the basic and diluted
EPS for the nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
For the Nine Months Ended Sept. 30, 1999
-----------------------------------------------------
<S> <C> <C> <C>
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ----------------- -------------
Net income $ 4,645,484
Less: Redemption accrual on Series C and Series D
Preferred Stock (179,524)
---------------
Basic EPS
Net income applicable to common shareholders 4,465,960 16,580,623 $ 0.27
=============
Effect of Dilutive Securities:
Series B Preferred Stock 1,382,715
Series C Preferred Stock 179,524 725,333
Series D Preferred Stock 991,770
Non-registered warrants 2,015,760
Registered warrants 641,521
Incentive stock options 1,407,556
Director stock options 51,500
Agents and others stock options 262,786
Treasury stock purchased from proceeds of
Options and warrants (2,418,805)
--------------- -----------------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 4,645,484 21,640,759 $ 0.22
=============== ================= =============
</TABLE>
<TABLE>
For the Nine Months Ended Sept. 30, 1998
-----------------------------------------------------
<S> <C> <C> <C>
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ----------------- -------------
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 option 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>
A reconciliation of the numerators and the denominators of the basic
and diluted EPS for the three months ended September 30, 1999 and 1998 are as
follows:
<TABLE>
For the Three Months Ended Sept. 30, 1999
-----------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------------- ------------- -------------
<S> <C> <C> <C>
Basic EPS
Net income applicable to common shareholders 3,233,028 32,065,773 $ 0.10
=============
Effect of Dilutive Securities:
Series B Preferred Stock 592,592
Series C Preferred Stock -
Series D Preferred Stock 462,963
Non-registered warrants 2,015,760
Registered warrants 620,562
Incentive stock options 2,639,167
Director stock options 51,500
Agents and others stock options 262,786
Treasury stock purchased from proceeds of
Options and warrants (2,700,605)
--------------- -----------------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 3,233,028 36,010,498 $ 0.09
=============== ================= =============
</TABLE>
<TABLE>
For the Three Months Ended Sept. 30, 1998
-----------------------------------------------------
<S> <C> <C> <C>
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ----------------- -------------
Net income $671,978
Less: Redemption accrual on Series C Preferred
Stock (108,356)
---------------
Basic EPS
Net income applicable to common shareholders 563,622 7,610,901 $ 0.07
=============
Effect of Dilutive Securities:
Series B Preferred Stock 1,777,777
Series C Preferred Stock 108,356 2,176,000
Non-registered warrants 2,015,760
Registered warrants 658,281
Incentive stock options 221,789
Director stock option 15,300
Treasury stock purchased from proceeds of
Options and warrants (1,267,535)
--------------- -----------------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $671,978 13,208,273 $ 0.05
=============== ================= =============
</TABLE>
8. INVESTMENTS
As of September 30, 1999 and December 31, 1998, 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.
<TABLE>
September 30, 1999
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------- ---------------------- -------------------- ---------------- ------------------
US Treasury securities
and obligations of
US government $ 60,089,441 $ 206,912 $ (127,839) $ 60,168,514
Foreign government debt
securities 114,957,681 530,600 (320,606) 115,167,675
Corporate debt securities 265,689,258 801,065 (3,138,461) 263,351,862
Mortgage-backed securities 208,561,138 642,028 (3,334,391) 205,868,775
---------------------- -------------------- ---------------- ------------------
$ 649,297,518 $ 2,180,605 $ (6,921,297) $ 644,556,826
====================== ==================== ================ ==================
</TABLE>
<TABLE>
December 31, 1998
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------- ---------------------- -------------------- ----------------- -----------------
US Treasury securities
and obligations of
US government $ 6,444,302 $ 181,694 $ (28,440) $ 6,597,556
Corporate debt securities 63,502,687 1,680,539 (472,027) 64,711,199
Mortgage-backed securities 62,280,125 1,821,084 (612,330) 63,488,879
---------------------- -------------------- ----------------- -----------------
$ 132,227,114 $ 3,683,317 $ (1,112,797) $ 134,797,634
====================== ==================== ================= =================
</TABLE>
The amortized cost and fair value of fixed maturities at September 30,
1999 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.
Amortized Fair
Cost Value
------------------ -------------
Due in 1 year or less $ 26,884,101 $ 27,150,915
Due after 1 year through 5 years 153,025,962 152,768,752
Due after 5 years through 10 years 176,484,113 175,110,904
Due after 10 years 52,379,579 51,609,825
Mortgage-backed securities 240,523,763 237,916,430
------------------ ---------------
$ 649,297,518 $ 644,556,826
================== ===============
9. SERIES C PREFERRED STOCK
During 1997, the Company issued 51,680 shares (par value $100) of
Series C Preferred Stock for $5.2 million, of which $2.4 million was purchased
by AAM, an unaffiliated investment firm, $0.6 million by Chase Equity Partners,
L.P., $1.4 million by Richard Barasch, members of his family, and members and
associates of the Company's management and $0.8 million by owners and employees
of Ameri-Life & Health Services, a general agency that sells the Company's
senior market products. This transaction received the approval of the Florida
Insurance Department.
Under the terms of the Series C Preferred Stock, the Company had the
right to require conversion of the Series C Preferred Stock into the Company's
common stock at a conversion price of $2.375 per common share if the average
reported bid price of its common stock for any 60 day period in which such bid
prices are reported exceeded $3.45 per common share. This condition was
satisfied on March 5, 1999. On March 11, 1999 the Company gave notice of the
conversion of the Series C Preferred Stock, and all of the 51,680 outstanding
shares of Series C Preferred Stock were converted to 2,175,986 shares of common
stock on April 1, 1999. As a result of this conversion, the redemption accrual
of $0.8 million was eliminated and credited to retained earnings.
The Company, AAM, the holders of the Series C Preferred Stock, Barasch
Associates Limited Partnership ("BALP") and Richard Barasch entered into a
stockholders' agreement at the closing of the 1997 transaction. The
stockholders' agreement was superceded by the new shareholders' agreement
executed upon the closing of the Capital Z Transaction. (See Note 2).
The Series C Preferred Stock had preemptive rights, which were
triggered by the execution of the UA Purchase Agreement on December 31, 1998,
subject to the closing of the sale pursuant to that agreement. 1,159,243 shares
of common stock were purchased pursuant to these preemptive rights at a price of
$3.15 per share.
10. SERIES D PREFERRED STOCK
On December 31, 1998, the Company contracted to sell 40,000 shares (par
value $100) of Series D Preferred Stock to UAFC, L.P. for $4.0 million. The
Series D Preferred Stock was divided into two sub-series, Series D-1 and Series
D-2. The 22,500 Series D-1 Shares were issued on December 31, 1998 and the
17,500 Series D-2 shares were issued on February 12, 1999. The Series D
Preferred Stock has the same provisions as the Series C Preferred Stock, except
(i) that the Series D has no voting rights except as required by law, (ii) the
conversion price on the Series D-1 was $2.70 rather than $2.375 per share, (iii)
the conversion price of the Series D-2 was $2.70 or, if a "change of control"
transaction, as defined, occurs in 1999, the conversion price will be equal to
the per share price at which common stock is issued in the change of control
transaction, and (iv) if the issuance of voting shares to a Series D shareholder
pursuant to a conversion requires regulatory approval, the conversion will be
postponed until such approval is obtained or ceases to be required. The Capital
Z Transaction, which closed on July 30, 1999, was a "change of control" within
the meaning of the terms of the Series D Preferred Stock and, therefore, the
conversion price on the Series D-2 was $3.15. Under the sale of the Series D
Preferred Stock, preemptive rights of the Series C-1 Preferred Stock held by
UAFC, L.P. and the Series C-2 Preferred Stock were waived.
On March 11, 1999, the Company gave notice of conversion of the Series
D-1 and D-2 Preferred Stock. Since the conversion of the Series D-1 and D-2
Preferred Stock held by UAFC, L.P. to common stock would result in its owning
more than 10% of the Company's voting stock, implementation of the conversion
required that the New York Insurance Department either (i) approve of UAFC, L.P.
becoming a controlling stockholder of the Company or (ii) determine that such
conversion would not result in UAFC, L.P. becoming a controlling person of
Universal. The completion of the conversion of the Series D Preferred Stock was
therefore deferred until July 30, 1999 when such conditions became no longer
applicable because the shares of UAFC, L.P., after conversion of the Series D
Preferred Stock, became less than 10% of Universal's then outstanding stock and
thus AAM was not a controlling person. Thus, on July 30, 1999, the outstanding
Series D-1 and Series D-2 Preferred Stock were converted into 1,388,889 shares
of common stock. As a result of this conversion, the redemption accrual of $62.5
thousand was eliminated and credited to retained earnings.
11. STOCKHOLDERS' EQUITY
Preferred Stock
The Company has 2,000,000 authorized, but unissued, shares of preferred
stock.
Series B Preferred Stock
At December 31, 1998, the Company had 400 shares of Series B Preferred
Stock issued and outstanding, with a par value of $10,000 per share, which were
held by Wand/Universal Investments L.P. I and II ("Wand"). The Series B
Preferred Stock was convertible into common stock at $2.25 per share (subject to
adjustment) and was entitled to dividends as if already converted, only when and
if dividends were declared on the common stock. The holders of the Series B
Preferred Stock could not require the Company to redeem it unless the Company
engaged in certain defined transactions. The Company had the right to require a
conversion if it raised additional equity from the public on pricing terms that
met certain criteria.
The Series B Preferred Stock was converted into 1,777,777 shares of
common stock on July 30, 1999 at the time of the closing of the Capital Z
Transaction.
Common Stock
At the Special Meeting of Shareholders held on July 27, 1999, the
shareholders voted in favor of increasing the number of authorized shares for
issuance from 20,000,000 to 80,000,000. (See Note 2 for further information of
shares issued pursuant to the closing of the Capital Z Transaction).
The par value of common stock is $.01 per share with 80,000,000 shares
authorized for issuance. The shares issued and outstanding at September 30, 1999
and December 31, 1998 were 43,101,304 and 7,638,057, respectively.
Changes in the number of shares of common stock outstanding were as follows:
Balance at December 31, 1998 7,638,057
Stock options exercised 17,000
Stock warrants exercised 61,804
Stock purchases pursuant to Agents' Stock Purchase Plan 30,432
Stock issued under employee benefit plans 114,110
Conversion of the Series B Preferred Stock 1,777,777
Conversion of the Series C Preferred Stock 2,175,986
Conversion of the Series D Preferred Stock 1,388,889
Stock issued pursuant to UA Purchase Agreement 29,897,249
----------
Balance at September 30, 1999 43,101,304
==========
Common Stock Warrants
The Company had 596,427 common stock warrants issued and outstanding at
September 30, 1999 and 658,231 issued and outstanding at December 1998, which
are registered under the Securities Exchange Act of 1934. At September 30, 1999
and December 31, 1998, 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.
12. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS
American Progressive, American Pioneer, American Exchange,
Constitution, Marquette, Peninsular, PennCorp Canada, Pennsylvania Life and
Union Bankers (collectively, the "Insurance Subsidiaries") are required to
maintain minimum amounts of capital and surplus as determined by statutory
accounting. Each of the Insurance Subsidiaries' statutory capital and surplus
exceeds its respective minimum requirements. At September 30, 1999 the statutory
capital and surplus, including asset valuation reserve, of the Insurance
Subsidiaries was $90.7 million.
Beginning in 1993, the National Association of Insurance Commissioners
("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life
insurance enterprises. At December 31, 1998 all of the Insurance Subsidiaries
except Pennsylvania Life maintained ratios of total adjusted capital to RBC in
excess of the Authorized Control Level. Pennsylvania Life received capital
contributions from its former parent PFG and from Universal of $13.2 and $10
million, respectively, in conjunction with the close of the Penn Union
Transaction. Additionally, Pennsylvania Life's invested assets improved as a
result of the sale of PennCorp Canada and certain non-performing assets being
replaced with higher quality assets.
Also associated with the closing, Pennsylvania Life recorded additional
claims and active life reserves of $26.7 million in its statutory financial
statements during the three months ended September 30, 1999. This was primarily
the result of a change in its statutory accounting policy for claim reserves to
a prescribed methodology from a practice permitted by the Pennsylvania
Department of Insurance ("PA DOI"). In 1998, the PA DOI permitted Pennsylvania
Life to use its own termination rate experience in claim reserves rather
than the full statutory tables as required by the PA DOI. As a result of these
transactions, management believes that Pennsylvania Life is in compliance with
the regulatory RBC requirements.
PennCorp Canada and Pennsylvania Life's Canadian branch reports 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
$61.6 million as of September 30, 1999. PennCorp Canada maintained a Minimum
Continuing Capital and Surplus Requirement Ratio ("MCCSR") in excess of the
minimum requirement and Pennsylvania Life's Canadian branch maintained a Test of
Adequacy of Assets in Canada and Margin Ratio ("TAAM") in excess of the minimum
requirement at September 30, 1999.
13. BUSINESS SEGMENT INFORMATION
During the third quarter of 1999 and with the acquisition of the Penn
Union companies, Universal changed its segment structure. Under the new
structure, the information previously reported under "Life Insurance Segment"
and "Other Accident and Health Insurance Segment" has been combined under the
Retained Inforce Segment. In addition, the Career Agents Segment acquired with
the acquisition is reported as a separate segment. Under the new segment
structure, Universal considers itself to have four business segments: Career
Agents, Brokerage Agents, Retained In Force and Non-Insurance Businesses.
Products distributed through the Career Agents segment are through a network of
regional managers that operate branch offices throughout the U.S. and Canada.
The career agents focus only on sales for Pennsylvania Life and PennCorp Canada
and sell primarily fixed benefit accident and health insurance. The career
agents will begin to offer Universal's senior market products discussed below.
The Brokerage Agents segment focuses on the sale of various senior market
products including Medicare supplement, home health care, nursing home, hospital
indemnity products, life insurance and annuities. These brokerage agents do not
sell exclusively for Universal. The Retained In Force segment represents those
blocks of insurance policies that were acquired through the acquisition of
various companies or are not currently produced through the career or brokerage
agency distribution systems. The Non-Insurance segment consists mainly of the
Parent Company and WorldNet operations. The information below reflects the
change in Universal's segment structure for 1999 as well as 1998.
<PAGE>
Financial data by segment as of and for the nine months ended September
30, 1999 and 1998 is as follows:
<TABLE>
September 30, 1999
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Career Brokerage Retained Non-Insurance
Agents Agents In force Businesses Total
----------------- -------------- ----------------- ---------------- ----------------
Net premiums and policyholder fees earned $ 21,664,390 $21,382,204 $ 18,980,283 $ - $ 62,026,877
Net investment income 4,565,110 546,059 10,021,534 (29,984) 15,102,719
Realized gains 18,062 645 29,104 (29,984) 17,827
Fee and other income (58,780) - (93,325) 1,755,822 1,603,717
----------------- -------------- --------------- -------------- --------------
26,188,782 21,928,908 28,937,596 1,695,854 78,751,140
----------------- -------------- --------------- -------------- --------------
Policyholder benefits 12,594,335 15,939,004 18,619,548 - 47,152,887
Change in deferred acquisition costs (405,698) (2,454,402) 268,221 - (2,591,879)
Commissions and general expenses 10,179,573 6,470,924 6,885,231 3,328,105 26,863,833
----------------- -------------- ---------------- ---------------- ----------------
Total benefits, claims and other
deductions 22,368,210 19,955,526 25,773,000 3,328,105 71,424,841
----------------- -------------- ---------------- ---------------- ----------------
Operating income/(loss) before taxes $ 3,820,572 $1,973,382 $ 3,164,596 $ (1,632,251) $ 7,326,299
================= ============== =============== ================ ================
ASSETS
Cash and investments $ 443,680,628 $ 9,870,976 $357,920,180 $ 7,897,192 $ 819,368,976
Deferred policy acquisition costs 406,528 9,692,545 20,243,311 - 30,342,384
Accrued investment income 4,447,298 223,331 5,925,654 - 10,596,283
Goodwill - 3,702,664 536,411 - 4,239,075
Present value of future profits - 962,929 475,871 - 1,438,800
Due and unpaid premiums 3,543,639 436,185 1,106,210 - 5,086,034
Reinsurance recoverable 4,889,979 35,922,370 153,115,198 - 193,927,547
Other assets 52,546,457 - 20,885,860 10,899,466 84,331,783
================= ============== ================ ================ ================
Total assets $ 509,514,529 $60,811,000 $560,208,695 $ 18,796,658 $1,149,330,882
================= ============== ================ ================ ================
</TABLE>
<TABLE>
September 30, 1998
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Career Brokerage Retained Non-Insurance
Agents Agents In force Businesses Total
----------------- -------------- ----------------- --------------- ----------------
Net premiums and policyholder fees earned $ - $ 17,306,052 $ 14,533,624 $ - $ 31,839,676
Net investment income - 740,104 7,255,638 60,583 8,056,325
Realized gains - 25,773 252,665 2,110 280,548
Fee and other income - - 47,517 1,989,789 2,037,306
----------------- -------------- ----------------- --------------- ----------------
Total revenues - 18,071,929 22,089,444 2,052,482 42,213,855
----------------- -------------- ----------------- --------------- ----------------
Policyholder benefits - 13,296,534 14,855,614 - 28,152,148
Change in deferred acquisition costs - (1,918,049) (895,884) - (2,813,933)
Commissions and general expenses - 6,004,621 6,390,755 1,427,789 13,823,165
----------------- -------------- ----------------- --------------- ----------------
Total benefits, claims and other
deductions - 17,383,106 20,350,485 1,427,789 39,161,380
----------------- -------------- ----------------- --------------- ----------------
Operating income before taxes $ - $ 688,823 $ 1,738,959 $ 624,693 $ 3,052,475
================= ============== ================= =============== ================
ASSETS
Cash and investments $ - $14,665,685 $ 143,775,579 $ 777,730 $159,218,994
Deferred policy acquisition costs - 6,311,718 15,615,463 - 21,927,181
Accrued investment income - 368,904 3,616,559 30,197 4,015,660
Goodwill - 3,775,977 617,110 - 4,393,087
Present value of future profits - 1,020,365 592,835 - 1,613,200
Due and unpaid premiums - 385,981 225,723 - 611,704
Reinsurance recoverable - 30,440,643 56,378,376 - 86,819,019
Other assets - - - 10,383,797 10,383,797
================= ============== ================= =============== ================
Total assets $ - $ 56,969,273 $ 220,821,645 $ 11,191,724 $288,982,642
================= ============== ================= =============== ================
</TABLE>
Financial data by segment as of and for the three months ended
September 30, 1999 and 1998 is as follows:
<TABLE>
September 30, 1999
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Career Brokerage Retained Non-Insurance
Agents Agents In force Businesses Total
----------------- -------------- ----------------- ---------------- ----------------
Net premiums and policyholder fees earned $21,664,390 $ 7,969,296 $ 10,644,819 $ - $ 40,278,505
Net investment income 4,565,110 147,068 4,784,899 (63,603) 9,433,474
Realized gains/(losses) 18,062 1,692 42,847 (29,896) 32,705
Fee and other income (58,780) - (115,641) 617,956 443,535
----------------- -------------- ----------------- ---------------- ----------------
26,188,782 8,118,056 15,356,924 524,457 50,188,219
----------------- -------------- ----------------- ---------------- ----------------
Policyholder benefits 12,594,335 5,976,356 9,599,049 - 28,169,740
Change in deferred acquisition costs (405,698) (823,628) 57,818 - (1,171,508)
Commissions and general expenses 10,179,573 2,067,706 3,161,431 2,595,063 18,003,773
----------------- -------------- ----------------- ---------------- ----------------
Total benefits, claims and other
deductions 22,368,210 7,220,434 12,818,298 2,595,063 45,002,005
----------------- -------------- ----------------- ---------------- ----------------
Operating income/(loss) before taxes $ 3,820,572 $ 897,622 $ 2,538,626 $ (2,070,606) $ 5,186,214
================= ============== ================= ================ ================
</TABLE>
<TABLE>
September 30, 1998
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Career Brokerage Retained Non-Insurance
Agents Agents In force Businesses Total
----------------- -------------- ----------------- ---------------- ----------------
Net premiums and policyholder fees earned $ - $ 6,021,497 $ 4,506,225 $ - $ 10,527,722
Net investment income - 317,447 2,367,051 2,352 2,686,850
Realized gains - 7,535 56,182 56 63,773
Fee and other income - - 15,839 774,130 789,969
----------------- -------------- ----------------- ---------------- ----------------
Total revenues - 6,346,479 6,945,297 776,538 14,068,314
----------------- -------------- ----------------- ---------------- ----------------
Policyholder benefits - 4,631,736 4,699,287 - 9,331,023
Change in deferred acquisition costs - (732,096) (442,209) - (1,174,305)
Commissions and general expenses - 2,052,583 2,260,551 580,312 4,893,446
----------------- -------------- ----------------- ---------------- ----------------
Total benefits, claims and other
deductions - 5,952,223 6,517,629 580,312 13,050,164
----------------- -------------- ----------------- ---------------- ----------------
Operating income before taxes $ - $ 394,256 $ $ 427,668 $ 196,226 $ 1,018,150
================= ============== ================= ================ ================
</TABLE>
14. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued,
as amended, 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, 2000. This Statement
requires all derivative instruments to be recorded on the balance sheet at
estimated fair value. Changes in the fair value of derivative instruments are to
be recorded each period either in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, on the type of hedge transaction. 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.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this section is to discuss and analyze the Company's
consolidated results of operations and liquidity and capital resources. This
analysis should be read in conjunction with the consolidated financial
statements and related notes, which appear elsewhere in this report and are also
contained in the 1998 Form 10-K.
The Company cautions readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this report
and in any other oral or written statements, either made by, or on behalf of the
Company, whether or not in future filings with the Securities and Exchange
Commission ("SEC"). Forward-looking statements are statements not based on
historical information. They relate to future operations, strategies, financial
results or other developments. In particular, statements using verbs such as
"expect," "anticipate," "believe" or similar words generally involve
forward-looking statements. Forward-looking statements include statements that
represent the Company's products, investment spreads or yields, or the earnings
or profitability of the Company's activities.
Forward-looking statements are based upon estimates and assumptions
that are subject to significant business, economic and competitive
uncertainties, many of which are beyond the Company's control and are subject to
change. These uncertainties can affect actual results and could cause actual
results to differ materially from those expressed in any forward-looking
statements made by, or on behalf of the Company. Whether or not actual results
differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable events or developments, some of which may be
national in scope, such as general economic conditions and interest rates. Some
of these events may be related to the insurance industry generally, such as
pricing competition, regulatory developments and industry consolidation. Others
may relate to Universal specifically, such as credit, volatility and other risks
associated with the Company's investment portfolio, and other factors. Universal
disclaims any obligation to update forward-looking information.
Penn Union Acquisition
On July 30, 1999, Universal acquired all of the outstanding shares of
common stock of certain direct and indirect subsidiaries of PennCorp Financial
Group ("PFG"), including six insurance companies (the "Penn Union Companies")
and certain other assets as follows (the "Penn Union Transaction"). The Penn
Union Companies are:
Name of Insurance Company State or Province of Domicile
Pennsylvania Life Insurance Company Pennsylvania
Peninsular Life Insurance Company North Carolina
Union Bankers Insurance Company Texas
Constitution Life Insurance Company Texas
Marquette National Life Insurance Company Texas
PennCorp Life Insurance Company Ontario, Canada
The purchase price of $130.5 million in cash was financed with $92.8
million of proceeds generated from the UA Purchase Agreement (See - Liquidity
and Capital Resources) and from the term loan portion of an $80 million credit
facility entered into on July 30, 1999 consisting of a $70 million term loan and
a $10 million revolving loan facility. None of the revolving loan facility was
drawn at closing. The proceeds of the financing in excess of the $130.5 million
purchase price were used to pay transaction costs of the acquisition and the
financing, to retire an existing Universal bank loan, to contribute to the
surplus Pennsylvania Life and for working capital.
The Penn Union Transaction was accounted for using the purchase method
and, accordingly, the operating results generated by the acquired companies
after July 30, 1999 are included in Universal's consolidated financial
statements.
General
Universal is a life and accident and health insurance holding
company whose principal insurance subsidiaries traditionally, through a general
agency system, marketed and underwrote products aimed at the senior market,
including Medicare supplement, long-term care, home health care, life insurance
and annuities. With the acquisition of the Penn Union Companies, the Company
has expanded its product portfolio to include fixed benefit accident and health
insurance products. The acquisition expanded the Company's general agency system
and generated a new distribution system consisting of career agents. The career
agent distribution system operates through a network of regional managers that
operate branch offices throughout the United States and Canada. These career
agents focus only on sales for Pennsylvania Life and PennCorp Canada.
Universal has four business segments which are aligned based on
distribution channels: Career Agents, Brokerage Agents, Retained In Force and
Non-Insurance Businesses. Products distributed through the Career Agents segment
are through a network of regional managers that operate branch offices
throughout the U.S. and Canada. The career agents focus only on sales for
Pennsylvania Life and PennCorp Canada and sell primarily fixed benefit accident
and health insurance. The career agents will begin to offer Universal's senior
market products discussed below. The Brokerage Agents segment focuses on the
sale of various senior market products including Medicare supplement, home
health care, nursing home, hospital indemnity products, life insurance and
annuities. These brokerage agents do not sell exclusively for Universal. The
Retained In force segment represents those blocks of insurance policies that
were acquired through the acquisition of various companies or are not currently
produced through the career or brokerage agency distribution systems. The
Non-Insurance segment consists mainly of the Parent Company and WorldNet
operations.
Results of Operations
Nine Months Ended September 30, 1999
For the nine months ended September 30, 1999, the Company earned net
income after Federal income taxes of $4.5 million ($0.22 per diluted share)
compared to $1.7 million ($0.15 per diluted share) in the prior year. Operating
income before Federal income taxes amounted to $7.3 million for the nine months
ended September 30, 1999 compared to $3.1 million in the prior year, which
amounts include net realized gains on investments of $18 thousand and $281
thousand, respectively.
Premiums. Total net premium increased approximately $30.2 million to
approximately $62.0 million for the nine months ended September 30, 1999,
compared to net premium of approximately $31.8 million in the prior year. In the
nine months ended September 30, 1999, the Company's gross premium and
policyholder fees earned (including reinsurance premiums assumed) amounted to
$149.2 million, a $52.7 million increase over the $96.6 million amount in 1998.
Of this increase, $22.3 million was attributable to the acquisition of the
Career Agents Segment and $21.1 million was attributable to the acquired
Retained In Force businesses. Total reinsurance premiums ceded for the nine
months ended September 30, 1999 amounted to $87.2 million, an increase of $22.4
over the 1998 amount of $64.8. Total reinsurance premium ceded from the
acquisition of the Career Agents Segment amounted to $0.6 million and the
acquired Retained In Force amounted to $15.1 million.
The Company's Brokerage Agents Segment consists mainly of Medicare
supplement and long term care products. For the nine months ended September 30,
1999 gross premiums increased approximately $9.6 million to $74.9 million over
the prior year as follows:
Premium Premium
Product Increase/(Decrease) Earned
------------------------------------ ------------------------ --------------
(in millions) (in millions)
Medicare Supplement $ 11.3 $ 27.2
Freedom Care 1.8 4.2
Hospital Indemnity, Home Health Care
and Nursing Home 0.2 3.4
First National assumed business (1.7) 33.4
Dallas General assumed business (2.1) 6.2
Group Health 0.1 0.5
---------- -----------
Totals $ 9.6 $ 74.9
========== ===========
While the Company was able to increase its gross premium revenue from
its senior market products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the nine months ended
September 30, 1999 amounted to $53.5 million, a $5.4 million increase from the
1998 amount of $48.1 million.
Ceded Premium Total Premium
Product Increase/(Decrease) Ceded
------------------------------------ ------------------- ---------------
(in millions) (in millions)
Medicare Supplement $ 7.2 $ 18.4
Freedom Care 0.5 1.3
Hospital Indemnity, Home Health Care
and Nursing Home 0.3 1.5
First National assumed business (2.7) 25.7
Dallas General assumed business - 6.2
Group Health 0.1 0.4
------------ -----------
Totals $ 5.4 $ 53.5
============ ===========
The Company's Retained In force Segment consists mainly of life and
health insurance products that are not marketed by the brokerage or career
agents For the nine months ended September 30, 1999 gross premiums increased
approximately $20.7 million to $52.0 million over the prior year as follows:
Premium Premium
Product Increase/(Decrease) Earned
--------------------------------------- ---------------- ---------------
(in millions) (in millions)
Life products $ 0.2 $ 11.3
Major Medical (2.3) 9.6
International Medical 0.6 4.0
Concept Medical 0.7 1.9
Other Health 0.4 4.1
Constitution Life and Annuity Products 3.4 3.4
Union Bankers Major Medical 17.7 17.7
----------- -----------
Totals $ 20.7 $ 52.0
=========== ===========
<PAGE>
The Company continues to reinsure a portion of the risks associated with its
Retained In force products to unaffiliated reinsurers. Reinsurance premiums
ceded for the nine months ended September 30, 1999 amounted to $33.1 million, a
$16.5 million increase from the 1998 amount of $16.6 million.
Ceded Premium Total Premium
Product Increase/(Decrease) Ceded
-------------------------------------- ------------------ ---------------
(in millions) (in millions)
Life products $ 1.1 $ 5.6
Major Medical (1.9) 5.9
International Medical 0.7 3.7
Concept Medical 0.7 1.7
Other Health 0.5 0.8
Constitution Life and Annuity Products 2.9 2.9
Union Bankers Major Medical 12.5 12.5
----------- ----------
Totals $ 16.5 $ 33.1
=========== ==========
Net investment income of the Company increased $7.0 million to $15.1
million for the nine months ended September 30, 1999, compared to $8.1 million
in the prior year. Investment income of the acquired companies totaled $6.8
million. The remaining increase is attributable to the increase in invested
assets outstanding during the nine month period in 1999 compared to 1998.
Realized gains on investments amounted to $18 thousand for the nine months
ended September 30, 1999 compared to a gain of $281 thousand in the prior year.
During 1999 the Company wrote down a permanently impaired security by
$0.2 million.
Fee income amounted to $1.6 million for the nine months ended September
30, 1999, a decrease of $0.4 million over the $2.0 million amount for the prior
year which is attributable to a reduction in administrative services provided by
the administrative company's Miami facility. The amortization of deferred
revenue amounted to $33.4 thousand for the nine months ended September 30, 1999
compared to $47.5 thousand in the prior year.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions increased approximately $32.2 million to $71.4 million for the nine
months ended September 30, 1999, compared to $39.2 million in the prior year.
Claims and other benefits in the Career Agents Segment amounted to
$12.8 million while the change in reserves amounted to a decrease of $0.2
million.
Claims and other benefits in the Brokerage Agents Segment increased
$2.5 million to $14.0 million for the nine months ended September 30, 1999
compared to the prior year. The change in reserves for the nine months ended
September 30, 1999 amounted to an increase of $1.9 million compared to an
increase of $1.7 million in the prior year.
Claims and other benefits in the Retained In Force Segment increased
$4.2 million to $13.3 million compared to $9.1 million in the prior year. Of
this increase $1.4 million is due to Constitution Life and $3.8 million is
due to Union Bankers. The increase is offset by a decrease in the Company's
life claims of $1.4 million. The change in reserves amounted to a decrease
of $0.5 million compared to an increase of $0.3 million in the prior year.
Constitution's reserves decreased $0.4 million and Union Bankers reserves
increased $1.0 million.
Interest credited to policyholders increased $0.4 million to $5.8
million, which increase is the result of more interest sensitive account values
in force.
The change in deferred acquisition costs amounted to an increase of
$2.6 million for the nine months ended September 30, 1999 compared to an
increase of $2.8 million in 1998. The change in deferred acquisition costs for
the Career Agents Segment amounted to an increase of $0.4 million. The change in
deferred acquisition costs in the Brokerage Agents Segment was an increase of
$2.5 million for the nine months ended September 30, 1999 compared to $1.9
million in the prior year. Deferred acquisition costs in the Retained In force
Segment decreased $1.2 million.
In the nine months ended September 30, 1999, the Company amortized
$115.5 thousand of goodwill generated in the acquisitions of First National
($83.9 thousand) and American Exchange ($31.6 thousand). The amortization of
negative goodwill for the Penn Union companies for the two months ended
September 30, 1999 totaled $0.3 million. In the nine months ended September 30,
1999, the Company amortized $0.1 million of present value of future profits
generated in the acquisitions of American Exchange ($96.1 thousand) and Dallas
General ($34.7 thousand).
Commissions increased $6.8 million in the nine months ended September
30, 1999 to $26.3 million, compared to $19.5 million in the prior year, of which
$5.6 million relates to the acquired companies. The remaining increase is a
direct result of the increase in premium discussed above. Commissions and
expense allowances on reinsurance ceded increased $3.2 million in the nine
months ended September 30, 1999 to $24.7 million, compared to $21.5 million in
the prior year. $0.2 million is attributable to the acquired companies. This
remainder is the direct result of the increase in reinsurance premium ceded
discussed above.
Other operating costs and expenses increased $10.0 million in the nine
months ended September 30, 1999 to $25.5 million, compared to $15.5 million in
the prior year. The insurance companies' expenses amounted to $22.4 for the nine
months ended September 30, 1999 compared to $13.2 million in the prior year, an
increase of $9.2 million, largely related to $6.5 million of expenses in the
acquired companies. The non-insurance companies' expenses of $3.3 million
increased $1.9 million compared to the prior period. Parent Company expenses
increased $2.0 million related to interest on the new loan agreement of $1.3
million and one time expenses of $0.7 million related to the acquisition of Penn
Union Companies.
Three Months Ended September 30, 1999
For the three months ended September 30, 1999, the Company earned net
income after Federal income taxes of $3.3 million ($0.09 per diluted share)
compared to $0.6 million ($0.05 per diluted share) in the prior year. Operating
income before Federal income taxes amounted to $5.2 million for the three months
ended September 30, 1999 compared to $1.0 million in the prior year, which
amounts include net realized gains on investments of $32.7 thousand and $63.8
thousand.
Premiums. Total net premium increased approximately $29.8 million to
approximately $40.3 million for the three months ended September 30, 1999,
compared to net premium of approximately $10.5 million in the prior year. In the
three months ended September 30, 1999, the Company's gross premium and
policyholder fees earned (including reinsurance premiums assumed) amounted to
$81.5 million, a $49.0 million increase over the $32.5 million amount in 1998.
Of this increase, $22.3 million was attributable to the acquisition of the
Career Agents Segment and $21.1 million was attributable to he acquired Retained
In Force businesses. Total reinsurance premiums ceded for the three months ended
September 30, 1999 amounted to $41.2 million, an increase of $19.2 million over
the 1998 amount of $22.0 million. Total reinsurance premium ceded from the
acquisition of the Career Agents Segment amounted to $0.6 million and the
acquired Retained In Force amounted to $15.4 million.
The Company's Brokerage Agents Segment consists mainly of Medicare
supplement and long-term care products. For the three months ended September 30,
1999 gross premiums increased approximately $5.5 million to $27.6 million over
the prior year as follows:
Premium Premium
Product Increase/(Decrease) Earned
----------------------------------------- ------------------ -----------
(in millions) (in millions)
Medicare Supplement $ 4.5 $ 10.9
Freedom Care 0.5 1.4
Hospital Indemnity, Home Health Care and 0.1 1.2
Nursing Home
First National assumed business 0.8 11.8
Dallas General assumed business (0.4) 2.0
Group Health - 0.3
----------- -----------
Totals $ 5.5 $ 27.6
=========== ===========
While the Company was able to increase its gross premium revenue from
its senior market products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
September 30, 1999 amounted to $19.6 million, a $3.5 million increase from the
1998 amount of $16.1 million.
Ceded Premium Total Premium
Product Increase/(Decrease) Ceded
----------------------------------------- ------------------ --------------
(in millions) (in millions)
Medicare Supplement $ 3.0 $ 7.5
Freedom Care 0.2 0.5
Hospital Indemnity, Home Health Care and 0.1 0.5
Nursing Home
First National assumed business - 9.0
Dallas General assumed business 0.2 2.0
Group Health - 0.1
------------ -----------
Totals $ 3.5 $ 19.6
============ ===========
The Company's Retained In force Segment consists mainly of life and
health insurance products that are not senior market related products marketed
by the brokerage division. For the three months ended September 30, 1999 gross
premiums increased approximately $21.2 million to $31.6 million over the prior
year as follows:
Premium Premium
Product Increase/(Decrease) Earned
------------------------------------- --------------------- -------------
(in millions) (in millions)
Life products $ 0.2 $ 3.8
Major Medical (0.5) 3.5
International Medical - 1.3
Concept Medical 0.2 0.6
Other Health 0.2 1.3
Constitution Life and Annuity Products 3.4 3.4
Union Bankers Major Medical 17.7 17.7
------------ -----------
Totals $ 21.2 $ 31.6
============ ===========
The Company continues to reinsure a portion of the risks associated
with its Retained In force products to unaffiliated reinsurers. Reinsurance
premiums ceded for the three months ended September 30, 1999 amounted to $21.0
million, a $15.1 million increase from the 1998 amount of $5.9 million.
Ceded Premium Total Premium
Product Increase/(Decrease) Ceded
-------------------------------------- ----------------- -----------------
(in millions) (in millions)
Life products $ 0.2 $ 1.6
Major Medical (0.9) 1.8
International Medical - 1.2
Concept Medical 0.2 0.5
Other Health 0.2 0.5
Constitution Life and Annuity Products 2.9 2.9
Union Bankers Major Medical 12.5 12.5
------------ -------------
Totals $ 15.1 $ 21.0
============ =============
Net investment income of the Company increased $6.7 million to $9.4
million for the three months endedSeptember 30, 1999, compared to $2.7 million
in the prior year. Investment income of the acquired companies totaled $6.8
million. Realized gains on investments amounted to $32.7 thousand for the three
months ended September 30, 1999 compared to a gain of $63.8 thousand in the
prior year.
Fee income amounted to $0.4 million for the three months ended
September 30, 1999, a decrease of $0.4 million over the $0.8 million amount for
the prior year which is attributable to a reduction in services provided by the
company's Miami facility. The amortization of deferred revenue amounted to $11.2
thousand for the three months ended September 30, 1999 compared to $15.8
thousand in the prior year.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions increased approximately $32.0 million to $45.0 million for the three
months ended September 30, 1999, compared to $13.0 million in the prior year.
Claims and other benefits in the Career Agents Segment amounted to
$12.8 million while the change in reserves amounted to a decrease of $0.2
million.
Claims and other benefits in the Brokerage Agents Segment increased
$1.9 million to $5.4 million for the three months ended September 30, 1999
compared to the prior year. The change in reserves for the three months ended
September 30, 1999 amounted to an increase of $0.5 million compared to an
increase of $1.1 million in the prior year.
Claims and other benefits in the Retained In force Segment increased
$5.0 million to $7.6 million compared to $2.6 million in the prior year. Of
this increase $1.4 million is due to Constitution Life and $3.8 million is
due to Union Bankers. The increase is offset by a decrease in the Company's
life claims of $0.6 million. The change in reserves amounted to an increase
of $1.0 million compared to an increase of $0.2 million in the prior year.
Constitution's reserves decreased $0.4 million and Union Bankers reserves
increased $1.0 million.
Interest credited to policyholders increased $0.3 million to $2.2
million, which is the result of more interest sensitive account values in force.
The change in deferred acquisition costs amounted to an increase of
$1.2 million for the three months ended September 30, 1999 compared to an
increase of $1.2 million in 1998. The change in deferred acquisition costs for
the Career Agents Segment amounted to an increase of $0.4 million. The change
in deferred acquisition costs in the Brokerage Agents Segment was an increase of
$0.8 million for the three months ended September 30, 1999 compared to $0.7
million in the prior year. Deferred acquisition costs in the Retained In force
Segment decreased $0.5 million.
In the three months ended September 30, 1999, the Company amortized
$38.5 thousand of goodwill generated in the acquisitions of First National
($28.0 thousand) and American Exchange ($10.5 thousand). The amortization of
negative goodwill for the acquired companies totaled $0.3 million. In the three
months ended September 30, 1999, the Company amortized $43.6 thousand of present
value of future profits generated in the acquisitions of American Exchange
($32.0 thousand) and Dallas General ($11.6 thousand).
Commissions increased $6.4 million in the three months ended September
30, 1999 to $12.9 million, compared to $6.5 million in the prior year, of which
$5.6 million relates to the acquired companies. The remaining increase is a
direct result of the increase in premium discussed above. Commissions and
expense allowances on reinsurance ceded increased $2.2 million in the three
months ended September 30, 1999 to $9.1 million, compared to $6.9 million in the
prior year. $0.2 million is attributable to the acquired companies. This
remainder is the direct result of the increase in reinsurance premium ceded
discussed above.
Other operating costs and expenses increased $9.4 million in the three
months ended September 30, 1999 to $14.6 million, compared to $5.2 million in
the prior year. The insurance companies' expenses amounted to $12.0 for the
three months ended September 30, 1999 compared to $4.6 million in the prior
year, an increase of $7.4 million, largely related to $6.5 million of expenses
in the acquired companies. The non-insurance companies' expenses of $2.6 million
increased $2.0 million compared to the prior period. Parent Company expenses
increased $2.0 million related to interest on the loan agreement of $1.3 million
and one time expenses of $0.7 million related to the acquisition of Penn Union
Companies.
Liquidity and Capital Resources
The Company's need for capital is primarily to maintain or
increase the surplus of its Insurance Subsidiaries and to support the Company as
an insurance holding company, including the maintenance of its status as a
public company. In addition, the Company requires capital to fund its
anticipated growth through acquisitions of other companies and blocks of
insurance business.
The Company
The Company requires cash to pay the operating expenses necessary to
function as an insurance holding company (which under applicable Insurance
Department regulations must bear its own expenses), and to meet the cost
involved in being a publicly-owned company. In addition, it requires cash to
meet Universal's obligations under the loan agreement discussed below and the
debentures outstanding with American Progressive.
Loan Agreements
As of July 30, 1999 the Company had outstanding a loan of $4.3 million
pursuant to a credit agreement with Chase Manhattan Bank executed in 1998.
During the seven months ended July 30, 1999, the Company repaid $0.5 million in
principal and $0.2 million in interest. In connection with the Penn Union
Transaction discussed above, the $4.3 million amount outstanding on the 1998
credit agreement was repaid in full on July 30, 1999. As a result of this
repayment, the Company paid $25 thousand to terminate an interest swap agreement
that was in place with this credit agreement. In addition, the Company expensed
$87 thousand of unamortized loan origination expenses related to the 1998 credit
agreement.
In connection with the Penn Union Transaction on July 30, 1999, the
Company entered into an $80 million credit facility consisting of a $70 million
term loan and a $10 million revolving loan facility. The term loan calls for
interest at the London Interbank Offering Rate ("LIBOR") plus 350 basis points
(currently 9.01%) and the principal repays over a seven year period with a final
maturity date of July 31, 2006. The term loan is secured by a first priority
interest in 100% of the outstanding common stock of American Exchange, American
Progressive, PFI, Inc. (an immaterial subsidiary), Quincy Coverage Corp. (an
immaterial subsidiary), and WorldNet and 65% of the outstanding common stock of
UAFC (Canada) Inc. (the 100% parent of PennCorp Canada). The Company has not
drawn down any of the revolving loan facility and pays a commitment fee of 50
basis points on the unutilized facility. For the two months ended September 30,
1999, the Company paid $1.054 million in interest.
In connection with an agreement entered into 1996 whereby American
Pioneer became a direct subsidiary of Universal, rather than an indirect
subsidiary owned through American Progressive, Universal has $7.9 million in
debentures outstanding to its subsidiary, American Progressive. The debentures
pay interest quarterly at 8.50% and are due between September 2002 and May 2003.
During the nine months ended September 30, 1999 the Company paid $0.5 million in
interest on these debentures to American Progressive which was eliminated in
consolidation.
Management believes that the current cash position and expected cash
flows of the non-insurance companies and the availability of dividends from its
insurance subsidiaries can support the obligations of Universal noted above for
the foreseeable future. However, there can be no assurance as to the expected
future cash flows or to the availability of dividends from the insurance
subsidiaries.
Universal American Financial Corp. Share Purchase Agreement with
Capital Z Financial Services Fund II, L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement
("UA Purchase Agreement") with Capital Z Financial Services Fund II, L.P.
("Capital Z"), which was amended on July 2, 1999. Under the amended agreement,
Capital Z agreed to purchase up to 28,888,888 shares of Universal common stock
for a purchase price of up to $91.0 million (the "Capital Z Transaction")
subject to adjustment as outlined in the UA Purchase Agreement. The UA Purchase
Agreement received the approvals of the Florida, New York and Texas Insurance
Departments (the states in which Universal's insurance subsidiaries are
domiciled). The stockholder approvals required for the closing of the UA
Purchase Agreement were given on July 27, 1999.
On July 30, 1999, the Capital Z Transaction closed with Capital Z
purchasing 25,707,552 shares of common stock for $80,978,790 ($3.15 per share).
In connection with the closing of the UA Purchase Agreement, certain managers
and agents of Universal and the Penn Union Companies and holders of Series C
Preferred Stock preemptive rights purchased 3,753,189 shares of common stock for
$11,822,545 ($3.15 per share). The total number of shares issued amounted to
29,460,741 for total proceeds of $92,801,334. The transaction expenses incurred
with the UA Purchase Agreement amounted to $6,963,662 and were charged to
paid-in capital. Included in these transaction expenses was $5,120,896 paid to
an affiliate of Capital Z, of which $1,375,000 was paid by issuing 436,508
shares of common stock of the Company ($3.15 per share).
Conversion of Preferred Stock
Under the terms of the Series C Preferred Stock, the Company had the
right to require conversion if certain conditions were met, which condition was
satisfied on March 5, 1999. All of the 51,680 outstanding shares of Series C
Preferred Stock were converted to 2,175,986 shares of common stock on April 1,
1999. As a result of this conversion, the redemption accrual of $0.8 million was
eliminated and credited to retained earnings.
The holders of the Series C Preferred Stock had preemptive rights,
which were triggered by the execution of the UA Purchase Agreement on December
31, 1998, subject to the closing of the sale pursuant to that agreement.
1,159,243 shares were purchased pursuant to these preemptive rights at a price
of $3.15 per share.
As a result of the closing of the Capital Z transaction on July 30,
1999, all of the Series B, D-1 and D-2 Preferred Stock was converted into
1,777,777, 833,333 and 555,556 shares of common stock, respectively.
Insurance Subsidiaries
American Progressive, American Pioneer, American Exchange,
Constitution, Marquette, Peninsular, PennCorp Canada, Pennsylvania Life and
Union Bankers (collectively, the "Insurance Subsidiaries") are required to
maintain minimum amounts of capital and surplus as determined by statutory
accounting. Each of the Insurance Subsidiaries` statutory capital and surplus
exceeds its respective minimum requirement. At September 30, 1999 the statutory
capital and surplus, including asset valuation reserve, of the Insurance
Subsidiaries was $90.7 million.
Beginning in 1993, the National Association of Insurance Commissioners
("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life
insurance enterprises. At December 31, 1998 all of the Insurance Subsidiaries
except Pennsylvania Life maintained ratios of total adjusted capital to RBC in
excess of the Authorized Control Level. Pennsylvania Life received capital
contributions from its former parent PFG and from Universal of $13.2 and $10
million, respectively, in conjunction with the close of the Penn Union
transaction. Additionally, Pennsylvania Life's invested assets improved as a
result of the sale of PennCorp Canada and certain non-performing assets being
replaced with higher quality assets.
Also associated with the closing, Pennsylvania Life recorded additional
claims and active life reserves of $26.7 million in its statutory financial
statements during the three months ended September 30, 1999. This was primarily
the result of a change in its statutory accounting policy for claim reserves to
prescribed methodology from a practice permitted by the Pennsylvania Department
of Insurance ("PA DOI"). In 1998, the PA DOI permitted Pennsylvania Life to use
its own termination rate experience in claim reserves rather than the full
statutory tables as required by the PA DOI. As a result of these transactions,
management believes that Pennsylvania Life is in compliance with the regulatory
RBC requirements.
PennCorp Canada and Pennsylvania Life's Canadian branch reports 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
$61.6 million as of September 30, 1999. PennCorp Canada maintained a Minimum
Continuing Capital and Surplus Requirement Ratio ("MCCSR") in excess of the
minimum requirement and Pennsylvania Life's Canadian branch maintained a Test of
Adequacy of Assets in Canada and Margin Ratio ("TAAM") in excess of the minimum
requirement at September 30, 1999.
Liquidity for the life insurance subsidiaries is measured by their
ability to pay scheduled contractual benefits, pay operating expenses, and fund
investment commitments. Sources of liquidity include scheduled and unscheduled
principal and interest payments on investments, premium payments and deposits
and the sale of liquid investments. These sources of liquidity for the Insurance
Subsidiaries significantly exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including
death benefits, benefits under accident & health policies and interest-sensitive
policy surrenders and withdrawals. The amount of surrenders and withdrawals is
affected by a variety of factors such as credited interest rates for similar
products, general economic conditions and events in the industry that affect
policyholders' confidence. Although the contractual terms of substantially all
of the Company's in force life insurance policies and annuities give the holders
the right to surrender the policies and annuities, the Company imposes penalties
for early surrenders.
Cash generated by the insurance subsidiaries will be made available to
Universal, the ultimate parent, principally through periodic payments of
principal and interest on surplus debentures, funded primarily by dividends from
the insurance companies.
Dividend payments by insurance companies are limited by, or subject to
the approval of the insurance regulatory authorities of each insurance company's
state of domicile. Such dividend requirements and approval processes vary
significantly from state to state. Currently, the surplus notes between
Universal and American Exchange will be primarily serviced by dividends from
Pennsylvania Life, a wholly owned subsidiary of American Exchange. The maximum
amount of dividends which can be paid to American Exchange without the prior
approval of the Pennsylvania Department of Insurance ("PA DOI") is restricted to
the greater of 10% of the company's surplus as regards policyholders as of the
preceding December 31 or the net gain from operations during the preceding year.
Pennsylvania Life is not able to pay dividends without prior approval from the
PA DOI. However, associated with the Penn Union Transaction, the PA DOI approved
a quasi reorganization of Pennsylvania Life's surplus, such that previously
negative surplus as regards to policyholders was reset to zero. Thus, future
earnings of the company would be available for dividends without prior approval,
subject to the restrictions noted above.
Investments
The Company'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 payment of policy benefits and claims. The Company invests in
assets permitted under the insurance laws of the various states in which it
operates. Such laws generally prescribe the nature, quality of and limitations
on various types of investments that may be made. The Company currently engages
the services of two investment advisors, Conning Asset Management Company and
Asset Allocation and Management Company, an affiliate of AAM, to manage the
Company's fixed maturity portfolio, under the direction of the management of the
insurance subsidiaries and in accordance with guidelines adopted by their
respective Boards of Directors. The Company does not invest in derivative
programs or other hybrid securities that may contain any off balance sheet risk.
The following table shows the distribution by carrying value of the
Company's fixed maturity securities portfolio according to the ratings assigned
by Standard & Poor's Corporation, along with related estimated fair values, as
of September 30, 1999 and December 31, 1998:
<TABLE>
Distribution of Fixed Maturity Securities by Rating
September 30, 1999 December 31, 1998
---------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Carrying % of Carrying % of
Standard & Value Total Value Total
Poor's (Estimated Fixed (Estimated Fixed
Rating Fair Value) Investment Fair Value) Investment
-------------- ----------------- -------------- ------------------ -------------
AAA $ 240,478,316 37.30% $ 57,517,532 42.67%
AA 93,932,589 14.57% 14,781,849 10.97%
A 199,783,876 31.00% 32,444,179 24.07%
BBB 92,794,318 14.40% 26,697,497 19.80%
BB 10,254,328 1.59% 2,346,394 1.74%
B 6,492,500 1.01% - -
CCC 820,899 0.13% 1,010,183 0.75%
----------------- -------------- ------------------ -------------
Total $ 644,556,826 100.00% $134,797,634 100.00%
================= ============== ================== =============
</TABLE>
The Company invests primarily in fixed maturity securities of the U.S.
Government and its agencies and in corporate fixed maturity securities with
investment grade ratings of "Baa3" (Moody's), "BBB-" (Standard & Poor's) or
higher. However, the Company does own some investments that are rated "BB" or
below (together 2.7% and 2.3% of total fixed maturities as of September 30, 1999
and December 31, 1998, respectively). As of September 30, 1999 all securities
were current in the payment of principal and interest.
At September 30, 1999, the insurance subsidiaries held cash and cash
equivalents totaling $138.6 million, as well as fixed maturity and equity
securities that could readily be converted to cash with carrying values (and
fair values) of $644.6 million.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity, unanticipated
surrenders and withdrawals in a changed interest rate environment could
adversely affect earnings if the Company were required to sell investments at
reduced values in order to meet liquidity demands. The Company manages the asset
and liability portfolios in order to minimize the adverse earnings impact of
changing market rates. The Company seeks to invest in assets that have duration
and interest rate characteristics similar to the liabilities that they support.
Federal Income Taxation of the Company
At September 30, 1999, the Company had established a valuation
allowance of $16.3 million with respect to certain of its net operating loss
carryforwards (deferred tax assets). The Company determined the valuation
allowance based upon an analysis of projected taxable income, certain Internal
Revenue Code restrictions on the use of its net operating loss carryforwards and
built-in deductions of the acquired Penn Union Companies, and its ability to
implement prudent and feasible tax planning strategies. The tax planning
strategies include the Company's recent reorganization and the use of its
administration company, WorldNet, to generate taxable income. Management
believes it is more likely than not that the Company will realize the recorded
net deferred tax assets.
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.
The Company'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.
The Company has completed its assessment of the systems that could be
significantly affected by the Year 2000 issue. The completed assessment
indicated that the Company'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 the Company's
computer programs used to process portions of the Company's business outside of
the main policy administration system were written using two digits rather than
four to define the applicable year and therefore had to be modified or replaced.
As a result, the Company began a conversion process to bring all of the
Company's products onto its main policy administration system. All of the
Company's products were placed on this system by January 1, 1999.
In addition to its policy administration system, the Company performed
assessments of other processing systems and determined that a claims paying
system for a small block of business was not Year 2000 compliant. The Company
obtained the vendor upgrade for this system. The installation, testing and
implementation of this upgrade was completed in April 1999.
On July 30, 1999 the Company acquired the Penn Union Companies.
Management believes that the Penn Union Companies have substantially completed
their Year 2000 assessment and remediation efforts.
In addition to resolving the internal Year 2000 issue, the Company is
working with all external organizations, business partners and vendors to assess
Year 2000 issues associated with the exchange of electronic data. The Company is
in the process of testing the interfaces with these business partners. The
Company has also begun the process of obtaining Year 2000 readiness statements
from all its external business partners to determine the extent to which the
Company 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 Company's systems rely will be timely converted and will not have
an adverse effect on the Company's systems.
The Company's plan to resolve the Year 2000 issue has been completed
prior to any anticipated impact on its operating systems, and the Year 2000
issue should not pose significant operational problems for its computer systems.
However, if the Company's plan is not successfully implemented, the Year 2000
issue could have a material impact on the operations of the Company.
The Company's plan includes the development of contingency plans for
any significant risks that might result from the Year 2000 issue. As discussed
above, the Company is not presently aware of any specific significant business
risk that it believes it is exposed to regarding the Year 2000 issue. The
Company has developed contingency plans for unanticipated disruptions and will
continue to monitor and assess risks for which contingency plans will be
required.
A possible worst case scenario, although this is not considered likely,
would occur if the Federal government and its vendors were unable to continue to
process Medicare supplement claims electronically. In the event that this would
occur, the Company's current procedure of obtaining Medicare claim data through
an electronic interface would not occur and the Company would have to revert to
manually entering this data into the claims paying system. This would result in
the Company hiring approximately 20 additional employees to handle the increase
in this data entry function. The Company considers the clerical marketplace in
each of its primary office locations (Pensacola, Raleigh, Toronto, Orlando,
Miami and Rye Brook) capable of handling this situation in a satisfactory
manner.
Currently, the Company's Year 2000 project costs were limited to the
allocation of its data processing department resources, and significant external
expenses were not incurred. The recently acquired 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 estimate that they have incurred costs aggregating $2.1
million from 1998 through September 30, 1999. Management does not expect to
incur additional significant external expenses for Year 2000 issues.
Although the Company believes 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 Company's
business, there can be no assurance that there will not be material disruptions
to the business or an increase in the cost of doing business.
Quantitative and Qualitative Disclosures About Market Risk
Market risk relates, broadly, to changes in the value of financial
instruments that arise from adverse movements in interest rates, equity prices
and foreign exchange rates. The Company is exposed principally to changes in
interest rates that affect the market prices of its fixed income securities. To
a lesser extent, the Company is also exposed to changes in the exchange rate
between the U.S. dollar and the Canadian dollar due to its foreign operations in
Canada.
Interest Rate Risk Sensitivity
The Company could experience economic losses if it was required to
liquidate fixed income securities during periods of rising and/or volatile
interest rates. However, the Company attempts to mitigate its exposure to
adverse interest rate movements through a combination of active portfolio
management and by staggering the maturities of its fixed income investments to
assure sufficient liquidity to meet its obligations and to address reinvestment
risk considerations. The Company's insurance liabilities are generally long
tailed in nature, which generally permits ample time to prepare for their
settlement. To date, the Company has not utilized various financial risk
management tools on its investment securities, such as interest rate swaps,
forwards, futures and options to modify it exposure to changes in interest
rates. However, the Company may consider them in the future.
The Company is aware that certain classes of mortgage backed securities
are subject to significant prepayment risk due to the fact that in periods of
declining interest rates, individuals may refinance higher rate mortgages to
take advantage of the lower rates then available. The Company monitors
investment portfolio mix to mitigate this risk.
The Company regularly conducts various analyses to gauge the financial
impact of changes in interest rates on its financial condition. The ranges
selected in these analyses reflect management's assessment as being reasonably
possible over the succeeding twelve-month period. The magnitude of changes
modeled in the accompanying analyses should, in no manner, be construed as a
prediction of future economic events, but rather, be treated as a simple
illustration of the potential impact of such events on the Company's financial
results.
The sensitivity analysis of interest rate risk assumes an instantaneous
shift in a parallel fashion across the yield curve, with scenarios of interest
rates increasing and decreasing 100 and 200 basis points from their levels at
September 30, 1999, and with all other variables held constant. A 100 and 200
basis point increase in market interest rates would result in a pre-tax decrease
in the market value of the Company's fixed income investments of $27.9 million
and $54.6 million, respectively. Similarly, a 100 and 200 basis point decrease
in market interest rates would result in a pre-tax increase in the market value
of the Company's fixed income investments of $28.1 million and $56.2 million,
respectively.
Foreign Currency Sensitivity
Portions of Universal's operations are transacted utilizing the
Canadian dollar as the functional currency. Approximately 13.4%, 11.7% and 30.1%
of Universal's assets, revenues and operating income before taxes, as of and for
the nine months ended September 30, 1999, respectively, are derived from the
Canadian operations. Accordingly, Universal's earnings and business equity are
affected by fluctuations in the value of the U.S. dollar as compared to the
Canadian dollar. Although this risk is somewhat mitigated by the fact that both
the assets and liabilities for Universal's foreign operations are denominated in
Canadian dollars, Universal is still subject to translation losses.
Universal periodically conducts various analyses to gauge the financial
impact of changes in the foreign currency exchange rate on their financial
condition. The ranges selected in these analyses reflect management's assessment
as being reasonably possible over the succeeding twelve-month period. The
magnitude of changes modeled in the following analysis should, in no manner, be
construed as a prediction of future economic events, but rather as a simple
illustration of the potential impact of such events on Universal's financial
results.
At September 30, 1999, a 10% strengthening of the U.S. dollar relative
to the Canadian dollar would result in a decrease to the operating income before
taxes of approximately $200 thousand and a decrease in equity of $5.5 million.
Universal's sensitivity analysis of the effects of changes in foreign currency
exchange rates does not factor in any potential change in sales levels or local
prices.
<PAGE>
35
PART II - OTHER INFORMATION
ITEM 6(b). Exhibits and Reports on Form 8-K
On August 13, 1999, the Company filed a Form 8-K with the Securities
and Exchange Commission to report the following items:
Item 1 - Change in control of the Registrant - Refer to Note 2 for
information on this item.
Item 2 - Acquisition or Disposition of Assets - Refer to Note 3 for
information on this item.
Item 6 - Resignation of Registrant's Directors - Refer to Note 2 for
information on this item.
Item 7 - Financial Statements and Exhibits - Refer to Notes 2 and 3 for
information on this item.
This Form 8-K reported the UA Purchase Agreement discussed in
Note 2 and the Penn Union Transaction discussed in Note 3 and filed as Exhibits
the various agreements and financial statements required.
- --------------------------------------------------------------------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /S/ Robert A. Waegelein
Robert A. Waegelein
Senior Vice President
Chief Financial Officer
Date: November 15, 1999
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