<PAGE> 1
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 JUNE 30, 2000
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 the Registrant's Common Stock as of
July 31, 2000 was 46,737,173.
<PAGE> 2
UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I - FINANCIAL INFORMATION
Consolidated Balance Sheets at June 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations for the six months ended June 30, 2000
and June 30, 1999
4
Consolidated Statements of Operations for the three months ended June 30, 2000
and June 30, 1999 5
Consolidated Statements of Cash Flows for the six months ended June 30, 2000
and June 30, 1999 6
Notes to Consolidated Financial Statements 7-16
Management's Discussion and Analysis of Financial Condition and Results of Operations 17-33
PART II - OTHER INFORMATION 34
Signature 34
</TABLE>
2
<PAGE> 3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS June 30, 2000 Dec. 31, 1999
------------- -------------
Investments: (unaudited)
<S> <C> <C>
Fixed maturities available for sale, at fair value
(amortized cost: 2000, $ 743,048; 1999, $734,466) $ 725,636 $ 717,560
Equity securities, at fair value (cost: 2000, $5,009; 1999, $5,120) 4,670 4,838
Policy loans 25,352 25,640
Other invested assets 2,551 2,763
Mortgage loans 2,550 2,743
----------- -----------
Total investments 760,759 753,544
Cash and cash equivalents 48,126 58,753
Accrued investment income 11,652 11,506
Deferred policy acquisition costs 42,795 34,943
Amounts due from reinsurers 208,061 196,960
Due and unpaid premiums 3,926 3,578
Deferred income tax asset 64,933 70,968
Goodwill 5,548 4,201
Present value of future profits 8,157 1,226
Other assets 18,760 17,742
----------- -----------
Total assets 1,172,717 1,153,421
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 232,035 238,665
Reserves for future policy benefits 563,606 560,777
Policy and contract claims - life 6,294 5,644
Policy and contract claims - health 76,080 72,261
Loan payable 70,000 70,000
Amounts due to reinsurers 956 85
Restructuring accrual 7,921 9,980
Negative goodwill 8,784 9,622
Other liabilities 59,166 52,422
----------- -----------
Total liabilities 1,024,842 1,019,456
----------- -----------
STOCKHOLDERS' EQUITY
Common stock (Authorized, 80,000, issued and outstanding: 2000, 46,737,
1999, 45,914) 467 459
Additional paid-in capital 127,255 122,924
Accumulated other comprehensive income (8,603) (6,887)
Retained earnings 28,756 17,469
----------- -----------
Total stockholders' equity 147,875 133,965
----------- -----------
Total liabilities and stockholders' equity $ 1,172,717 $ 1,153,421
=========== ===========
</TABLE>
See notes to unaudited consolidated financial statements.
3
<PAGE> 4
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
2000 1999
---- ----
Revenues: (in thousands, per share
amounts in dollars)
<S> <C> <C>
Gross premium and policyholder fees earned $ 221,189 $ 66,817
Reinsurance premiums assumed 1,398 980
Reinsurance premiums ceded (111,966) (46,049)
--------- ---------
Net premium and policyholder fees earned 110,621 21,748
Net investment income 28,716 5,669
Net realized gains/(losses) on investments 147 (15)
Fee income 3,112 1,161
--------- ---------
Total revenues 142,596 28,563
--------- ---------
Benefits, claims and expenses:
Increase in future policy benefits 1,230 843
Claims and other benefits 75,136 14,478
Interest credited to policyholders 5,091 3,662
Increase in deferred acquisition costs (8,027) (1,420)
Amortization of present value of future profits 1,515 87
Amortization of goodwill/negative goodwill (347) 77
Commissions 40,356 13,413
Interest expense 3,401 184
Other operating costs and expenses 38,802 10,703
Commission and expense allowances on reinsurance ceded (32,211) (15,604)
--------- ---------
Total benefits, claims and other deductions 124,946 26,423
--------- ---------
Operating income before taxes 17,650 2,140
Federal and foreign income tax expense 6,363 727
--------- ---------
Net income 11,287 1,413
Redemption accrual on Series C and Series D Preferred Stock -- 180
--------- ---------
Net income applicable to common shareholders $ 11,287 $ 1,233
========= =========
Earnings per common share:
Basic $ 0.24 $ 0.14
========= =========
Diluted $ 0.24 $ 0.10
========= =========
</TABLE>
See notes to unaudited consolidated financial statements
4
<PAGE> 5
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
2000 1999
---- ----
Revenues: (in thousands, per share
amounts in dollars)
<S> <C> <C>
Gross premium and policyholder fees earned $ 111,848 $ 34,751
Reinsurance premiums assumed 381 730
Reinsurance premiums ceded (56,747) (24,157)
--------- ---------
Net premium and policyholder fees earned 55,482 11,324
Net investment income 14,565 2,870
Net realized gains/(losses) on investments 107 (62)
Fee income 1,672 581
--------- ---------
Total revenues 71,826 14,713
--------- ---------
Benefits, claims and expenses:
Increase in future policy benefits 1,174 526
Claims and other benefits 38,032 7,541
Interest credited to policyholders 2,529 1,744
Increase in deferred acquisition costs (5,021) (564)
Amortization of present value of future profits 703 44
Amortization of goodwill/negative goodwill (178) 39
Commissions 20,382 7,160
Interest expense 1,721 91
Other operating costs and expenses 20,134 5,250
Commission and expense allowances on reinsurance ceded (16,486) (8,191)
---------- ---------
Total benefits, claims and other deductions 62,990 13,640
--------- ---------
Operating income before taxes 8,836 1,073
Federal and foreign income tax expense 3,207 371
--------- ---------
Net income 5,629 702
Redemption accrual on Series C and Series D Preferred Stock -- --
--------- ---------
Net income applicable to common shareholders $ 5,629 $ 702
========= =========
Earnings per common share:
Basic $ 0.12 $ 0.07
========= =========
Diluted $ 0.12 $ 0.05
========= =========
</TABLE>
See notes to unaudited consolidated financial statements
5
<PAGE> 6
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
2000 1999
---- ----
(In thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 11,287 $ 1,413
Adjustments to reconcile net income to net cash used by operating activities:
Deferred income taxes 3,217 728
Change in reserves for future policy benefits 2,829 3,785
Change in policy and contract claims 4,470 (1,096)
Change in deferred policy acquisition costs (7,833) (1,420)
Change in deferred revenue (16) (17)
Amortization of present value of future profits 1,515 87
Amortization of goodwill/negative goodwill (347) 77
Change in policy loans 288 36
Change in accrued investment income (146) 344
Change in reinsurance balances (7,864) (4,293)
Change in due and unpaid premium (348) (220)
Realized (gains)/losses on investments (147) 22
Change in income taxes payable 2,202
Other, net 2,932 (2,224)
-------- --------
Net cash provided by/(used in) operating activities 12,039 (2,778)
-------- --------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for sale 35,744 5,122
Proceeds from redemption of fixed maturities available for sale 4,385 5,996
Cost of fixed maturities purchased available for sale (50,467) (16,732)
Change in amounts held in trust by reinsurer (1,140) (350)
Proceeds from sale of equity securities 98 374
Cost of equity securities purchased -- (104)
Change in other invested assets 376 1,909
Purchase of business, net of cash held (3,852) --
-------- --------
Net cash used in investing activities (14,856) (3,785)
-------- --------
Cash flows from financing activities:
Prepaid acquisition costs -- (857)
Net proceeds from issuance of common stock 46 485
Net proceeds from issuance of Series D Preferred Stock -- 1,750
Increase in policyholder account balances (6,630) 636
Change in reinsurance balances related to policyholder account balances (1,226) (1,063)
Principal payment on notes payable -- (500)
-------- --------
Net cash provided by/(used in) financing activities (7,810) 451
-------- --------
Net decrease in cash and cash equivalents (10,627) (6,112)
Cash and cash equivalents at beginning of period 58,753 17,093
-------- --------
Cash and cash equivalents at end of period $ 48,126 $ 10,981
======== ========
Supplemental cash flow information:
Cash paid during the period for interest $ 3,401 $ 184
======== ========
Cash paid during the period for income taxes $ 251 $ 25
======== ========
</TABLE>
See notes to unaudited consolidated financial statements
6
<PAGE> 7
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 six months ended
June 30, 2000 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, 1999. Certain
reclassifications have been made to prior year's financial statements to conform
with current period classifications.
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP") 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") and WorldNet
Services Corp. ("WorldNet"). 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"). On
January 6, 2000, Universal acquired American Insurance Administration Group
("AIAG").
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 BUSINESS COMBINATION
Penn Union Acquisition
On July 30, 1999, Universal acquired all of the outstanding shares of
common stock of the Penn Union Companies and other related assets.
The purchase price of $130.5 million in cash was financed with $92.8
million of proceeds generated from the sale of 29.5 million shares of common
stock 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 has been drawn to
date. 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 acquisition of the Penn Union Companies 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. In addition to the purchase price, the Company incurred
7
<PAGE> 8
costs totaling $17.2 million including a restructuring accrual of $10.0 million
and $3.0 million in stock compensation expense related to shares purchased by
agents and certain members of management at prices discounted from the market.
At the time of closing, the fair value of net assets of the acquired companies
amounted to $157.8 million resulting in a negative goodwill amount of $10.1
million, which will be amortized on a straight line basis over a ten year
period.
The consolidated pro forma results of operations for the six months
ended June, 1999, as if the companies described above had been purchased on
January 1, 1999, are as follows:
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1999
(In thousands)
<S> <C>
Total revenue $138,058
Operating income before taxes $ 15,511
Net income $ 9,260
Earnings per common share:
Basic $ 0.22
Diluted $ 0.21
</TABLE>
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired with the Penn Union Companies into its
locations in Toronto (Canada), Pensacola (Florida), and Orlando (Florida) in
order to improve operating efficiencies and capabilities. The plan to
consolidate this location was being formulated at the date of acquisition.
Accordingly, the Company recorded a $10.0 million restructuring liability in its
accounting for the Penn Union acquisition.
This liability was accounted for under EITF No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3").
The liability consisted of employee separation costs ($3.2 million), employee
relocation costs ($2.6 million), and other relocation and exit costs. During the
six months ended June 30, 2000, the Company paid $2.1 million in restructuring
charges.
In accordance with EITF 95-3, the Company's Board of Directors has
approved the plan and the Company will finalize any changes to the restructuring
plans no later than one year from the date of the Penn Union Acquisition. The
Company will report changes to the accrued acquisition expenses as adjustments
to the cost of the acquisition of the Penn Union companies in future financial
statements. The Company expects the consolidation to be completed in early 2001.
Acquisition of American Insurance Administration Group ("AIAG")
In January 2000, Universal acquired all of the outstanding shares of
AIAG, a privately held third party administrator located in Clearwater, Florida,
for $2.875 million in cash, 809,860 shares on Universal common stock and certain
contingent future cash payments. AIAG is the third party administrator of
approximately $123 million of senior supplemental health insurance,
approximately $97 million of which is administered for Union Bankers. Total
revenue for the six months ended June, 2000 totaled $5.2 million of which $3.7
million related to Union Bankers and Constitution and was eliminated in the
accompanying consolidated financial statements
3. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the
six-month periods ended June 30, 2000 and 1999 are as follows:
8
<PAGE> 9
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------
2000 1999
---- ----
(In thousands)
<S> <C> <C>
Net income $ 11,287 $ 1,413
-------- --------
Other comprehensive income:
Unrealized gain/(loss) on securities (422) (2,016)
Foreign currency translation adjustment (1,294) --
-------- --------
Other comprehensive income/(loss) (1,716) (2,016)
-------- --------
Comprehensive income/(loss) $ 9,571 $ (603)
======== ========
</TABLE>
The components of comprehensive income, net of related tax, for the
three-month periods ended June 30, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED JUNE 30,
--------------
2000 1999
---- ----
(In thousands)
<S> <C> <C>
Net income $ 5,629 $ 702
------- -------
Other comprehensive income:
Unrealized gain/(loss) on securities (827) (1,223)
Foreign currency translation adjustment (1,211) --
------- -------
Other comprehensive income/(loss) (2,038) (1,223)
------- -------
Comprehensive income/(loss) $ 3,591 $ (521)
======= =======
</TABLE>
4 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. A reconciliation of
the numerators and the denominators of the basic and diluted EPS for the six
months ended June 30, 2000 and 1999 is as follows:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30, 2000
--------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
Basic EPS
<S> <C> <C> <C>
Net income applicable to common shareholders $11,287 46,721 $0.24
Effect of Dilutive Securities
Incentive stock options 961
Director stock options 106
Agents and others stock options 561
Treasury stock assumed from proceeds of
options and warrants (1,227)
--------------- -----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $11,287 47,122 $0.24
=============== ================= =============
</TABLE>
9
<PAGE> 10
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30, 1999
--------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Net income $1,413
Less: Redemption accrual on Series C Preferred
Stock (180)
---------------
Basic EPS
Net income applicable to common shareholders 1,233 8,838 $0.14
=============
Effect of Dilutive Securities
Series B Preferred Stock 1,778
Series C Preferred Stock 180 1,088
Series D Preferred Stock 1,256
Non-registered warrants 2,016
Registered warrants 631
Incentive stock options 270
Director stock options 38
Agents and others stock options 73
Treasury stock assumed from proceeds of
options and warrants (1,241)
--------------- -----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $1,413 14,747 $0.10
=============== ================= =============
</TABLE>
A reconciliation of the numerators and the denominators of the basic
and diluted EPS for the three months ended June 30, 2000 and 1999 is as follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JUNE 30, 2000
----------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Basic EPS
Net income applicable to common shareholders $5,629 46,736 $0.12
Effect of Dilutive Securities
Incentive stock options 961
Director stock options 88
Agents and others stock options 555
Treasury stock assumed from proceeds of
options and warrants (1,237)
--------------- -----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $5,629 47,103 $0.12
=============== ================= =============
</TABLE>
10
<PAGE> 11
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JUNE 30, 1999
----------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Net income $702
Basic EPS
Net income applicable to common shareholders 702 9,971 $0.07
=============
Effect of Dilutive Securities
Series B Preferred Stock 1,778
Series C Preferred Stock -
Series D Preferred Stock 1,389
Non-registered warrants 2,016
Registered warrants 631
Incentive stock options 541
Director stock options 77
Agents and others stock options 73
Treasury stock assumed from proceeds of
options and warrants (1,261)
--------------- -----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $702 15,215 $0.05
=============== ================= =============
</TABLE>
5. INVESTMENTS
As of June 30, 2000 and December 31, 1999, 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>
<CAPTION>
JUNE 30, 2000
--------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
-------------- ---------- ---------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
US Treasury securities
and obligations of
US government $ 47,943 $ 31 $ (420) $ 47,554
Foreign government debt securities
131,573 487 (2,164) 129,896
Corporate debt securities 309,301 819 (9,812) 300,308
Mortgage-backed securities 254,231 228 (6,581) 247,878
--------- --------- --------- ---------
$ 743,048 $ 1,565 $ (18,977) $ 725,636
========= ========= ========= =========
</TABLE>
11
<PAGE> 12
<TABLE>
<CAPTION>
DECEMBER 31, 1999
--------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
-------------- --------- ---------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
US Treasury securities
and obligations of
US government $ 63,968 $ 10 $ (587) $ 63,391
Corporate debt securities 446,630 420 (10,693) 436,357
Mortgage-backed securities 223,868 190 (6,246) 217,812
--------- --------- --------- ---------
$ 734,466 $ 620 $ (17,526) $ 717,560
========= ========= ========= =========
</TABLE>
The amortized cost and fair value of fixed maturities at June 30, 2000
by contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
--------- -----
(In thousands)
<S> <C> <C>
Due in 1 year or less $ 26,526 $ 26,364
Due after 1 year through 5 years 165,200 162,073
Due after 5 years through 10 years 214,967 208,563
Due after 10 years 70,928 69,719
Mortgage-backed securities 265,427 258,917
-------- --------
$743,048 $725,636
======== ========
</TABLE>
6. STOCKHOLDERS' EQUITY
Common Stock
The par value of common stock is $.01 per share with 80,000,000 shares
authorized for issuance. The shares issued and outstanding at June 30, 2000 and
December 31, 1999 were 46,736,928 and 45,914,327, respectively. Changes in the
number of shares of common stock outstanding were as follows:
<TABLE>
<S> <C>
Balance at December 31, 1999 45,914,327
Stock issued for purchase of AIAG 809,860
Stock options exercised 5,000
Stock purchases pursuant to Agents' Stock Purchase Plan 7,281
Stock issued under employee benefit plans 460
===============
Balance at June 30, 2000 46,736,928
===============
</TABLE>
7. IMPACT OF THE YEAR 2000
The Year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information in years subsequent to 1999. Prior to 2000,
the Company underwent a corporate-wide program to address the Year 2000 issue,
as it relates to its own computer systems, as well as to instances in which
computer systems of third parties may have a significant impact on the Company's
operations, such as suppliers, business partners, customers, facilities and
telecommunications. In addressing the Year 2000 issue, the Company did not incur
any significant expenses other than the allocation of internal resources to test
and monitor this issue. The Company has not experienced any significant
disruptions of business operations related to the Year 2000 issue to date and
believes that the risk of such disruption in the future is low, although no
assurance can be given in this regard. It is possible that Year 2000 problems
that are not
12
<PAGE> 13
currently apparent may arise in the future. Accordingly, the Company will
continue to monitor its systems for the Year 2000 issue.
8. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS
American Progressive, American Pioneer, American Exchange, Constitution
Life, Marquette, Peninsular Life, 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. However, substantially more than such minimum
amounts are needed to meet statutory and administrative requirements of adequate
capital and surplus to support the current level of the Insurance Subsidiaries'
operations. At June 30, 2000 and December 31, 1999 the statutory capital and
surplus, including asset valuation reserve, of the U.S. insurance subsidiaries
totaled $89.3 and $89.2 million, respectively.
Beginning in 1993, the National Association of Insurance Commissioners
("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life
insurance enterprises. At December 31, 1999 all of the Insurance Subsidiaries
maintained ratios of total adjusted capital to RBC in excess of the Authorized
Control Level.
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
$63.2 and $63.9 million as of June 30, 2000 and December 31, 1999, respectively.
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 June 30, 2000 and
December 31, 1999.
9. 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 insurance businesses are reviewed by management of the Company
along distribution lines, and decisions regarding the operation of the Company
are made accordingly. In addition, due to the vast difference in the nature of
the operations from the insurance businesses, management reviews and evaluates
the results of the Insurance Services and Corporate Segment separately.
Under the new segment structure, the Company considers itself to have
four distinct business segments: Career Agents, Senior Market Brokerage, Special
Markets and Insurance Services and Corporate Segment. Products distributed
through the Career Agents segment are sold through a network of regional
managers who 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. Total revenue and
operating income before taxes generated by Canadian operations through PennCorp
Canada and Pennsylvania Life's Canadian branch totaled $28.4 million and $5.7
million, respectively, for the six month period ended June 30, 2000. The career
agents began to offer Universal's senior market products discussed below in
2000. Business in the Senior Market Brokerage Segment is sold through a
traditional general agency system which focuses on the sale of various senior
market products including Medicare supplement, home health care, nursing home
and hospital indemnity products. Agents in this segment do not sell exclusively
for the Company. The Special Markets segment consists of blocks of business that
were acquired through the acquisitions of various companies or are not currently
produced through the career or Senior Market brokerage agency distribution
channels as well as some specialty life insurance and accident and health
products. The information previously reported under "Life Insurance Segment" and
"Other Accident and Health Insurance Segment" has been combined under the
Special
13
<PAGE> 14
Markets Segment. The Insurance Services and Corporate Segment consists mainly of
the Parent Company, WorldNet and AIAG operations. Prior year segment information
has been restated to conform with the current segment structure.
Financial data by segment as of and for the six months ended June 30,
2000 and 1999 is as follows:
<TABLE>
<CAPTION>
June 30, 2000
-----------------------------------------------------------------------------------
(In thousands)
Insurance
Career Senior Market Special Services and
Agents Brokerage Markets Corporate Total
------ --------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Net premiums and policyholder
fees earned $ 66,184 $ 20,752 $ 23,685 $ -- $ 110,621
Net investment income 15,703 553 12,366 94 28,716
Realized gains 80 4 63 -- 147
Fee and other income 273 -- 227 2,612 3,112
----------- ----------- ----------- ----------- -----------
82,240 21,309 36,341 2,706 142,596
Policyholder benefits 41,589 16,174 23,694 -- 81,457
Increase in deferred acquisition costs (6,224) (1,627) (176) -- (8,027)
Commissions and general expenses 31,836 4,526 10,257 4,897 51,516
----------- ----------- ----------- ----------- -----------
Total benefits, claims and other
deductions 67,201 19,073 33,775 4,897 124,946
Operating income before taxes $ 15,039 $ 2,236 $ 2,566 $ (2,191) $ 17,650
=========== =========== =========== =========== ===========
ASSETS
Cash and investments $ 448,639 $ 11,744 $ 347,900 $ 602 $ 808,885
Deferred policy acquisition costs 9,119 12,878 20,798 -- 42,795
Accrued investment income 6,372 225 5,055 -- 11,652
Goodwill -- 3,601 522 1,425 5,548
Present value of future profits -- 779 354 7,024 8,157
Due and unpaid premiums 2,636 338 952 -- 3,926
Reinsurance recoverable 5,356 46,647 156,058 -- 208,061
Deferred income tax asset -- -- -- 64,933 64,933
Other assets 4,616 -- 568 13,576 18,760
----------- ----------- ----------- ----------- -----------
Total assets $ 476,738 $ 76,212 $ 532,207 $ 87,560 $ 1,172,717
=========== =========== =========== =========== ===========
</TABLE>
14
<PAGE> 15
<TABLE>
<CAPTION>
June 30, 1999
--------------------------------------------------------------------------
Insurance
Career Senior Market Special Services and
Agents Brokerage Markets Corporate Total
------ --------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Net premiums and policyholder fees $ -- $ 13,413 $ 8,335 $ -- $ 21,748
earned
Net investment income -- 399 5,236 34 5,669
Realized gains -- (1) (14) -- (15)
Fee and other income -- -- 24 1,137 1,161
--------- --------- --------- --------- ---------
-- 13,811 13,581 1,171 28,563
Policyholder benefits -- 9,963 9,020 -- 18,983
Increase in deferred acquisition costs -- (1,631) 211 -- (1,420)
Commissions and general expenses -- 4,403 3,724 733 8,860
--------- --------- --------- --------- ---------
Total benefits, claims and other -- 12,735 12,955 733 26,423
deductions
Operating income before taxes $ -- $ 1,076 $ 626 $ 438 $ 2,140
========= ========= ========= ========= =========
ASSETS
Cash and investments $ -- $ 10,960 $ 143,851 $ 3,045 $ 157,856
Deferred policy acquisition costs -- 9,066 19,285 -- 28,351
Accrued investment income -- 225 2,950 19 3,194
Goodwill -- 3,677 601 -- 4,278
Present value of future profits -- 938 544 -- 1,482
Due and unpaid premiums -- 436 310 -- 746
Reinsurance recoverable -- 36,962 44,618 -- 81,580
Other assets -- -- -- 7,147 7,147
========= ========= ========= ========= =========
Total assets $ -- $ 62,264 $ 212,159 $ 10,211 $ 284,634
========= ========= ========= ========= =========
</TABLE>
Financial data by segment for the three months ended June 30, 2000 and
1999 is as follows:
<TABLE>
<CAPTION>
June 30, 2000
------------------------------------------------------------------
(In thousands)
Insurance
Career Senior Market Special Services and
Agents Brokerage Markets Corporate Total
------ --------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Net premiums and policyholder fees
earned $ 32,870 $ 10,884 $ 11,728 $ -- $ 55,482
Net investment income 7,843 240 6,378 104 14,565
Realized gains 79 3 25 -- 107
Fee and other income 107 -- 100 1,465 1,672
-------- -------- -------- -------- --------
40,899 11,127 18,231 1,569 71,826
Policyholder benefits 20,818 8,492 12,425 -- 41,735
Increase in deferred acquisition costs (3,921) (880) (220) -- (5,021)
Commissions and general expenses 16,472 2,238 4,911 2,655 26,276
-------- -------- -------- -------- --------
Total benefits, claims and other 33,369 9,850 17,116 2,655 62,990
deductions
Operating income before taxes $ 7,530 $ 1,277 $ 1,115 $ (1,086) $ 8,836
======== ======== ======== ======== ========
</TABLE>
15
<PAGE> 16
<TABLE>
<CAPTION>
June 30, 1999
-----------------------------------------------------------------
(In thousands)
Insurance
Career Senior Market Special Services and
Agents Brokerage Markets Corporate Total
------ --------- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Net premiums and policyholder fees
earned $ -- $ 7,074 $ 4,250 $ -- $ 11,324
Net investment income -- 141 2,724 5 2,870
Realized gains -- (3) (59) -- (62)
Fee and other income -- -- 11 570 581
-------- -------- -------- -------- --------
-- 7,212 6,926 575 14,713
Policyholder benefits -- 4,897 4,914 -- 9,811
Increase in deferred acquisition costs -- (692) 128 -- (564)
Commissions and general expenses -- 2,310 1,602 481 4,393
-------- -------- -------- -------- --------
Total benefits, claims and other -- 6,515 6,644 481 13,640
deductions
Operating income before taxes $ -- $ 697 $ 282 $ 94 $ 1,073
======== ======== ======== ======== ========
</TABLE>
16
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
The following analysis of the consolidated results of operations and
financial condition of the Company should be read in conjunction with the
Consolidated Financial Statements and related consolidated footnotes included
elsewhere.
The Company owns nine insurance companies (collectively, the "Insurance
Subsidiaries"): 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"),
Constitution Life Insurance Company ("Constitution Life"), Marquette National
Life Insurance Company ("Marquette"), Peninsular Life Insurance Company
("Peninsular Life"), Pennsylvania Life Insurance Company ("Pennsylvania Life"),
PennCorp Life Insurance Company ("PennCorp Canada") and Union Bankers Insurance
Company ("Union Bankers"). Six of these companies, Pennsylvania Life, PennCorp
Canada, Peninsular, Union Bankers, Constitution and Marquette, as well as
certain other related assets, were acquired on July 30, 1999. In addition to the
Insurance Subsidiaries, Universal owns two third party administrators: American
Insurance Administration Group, Inc. ("AIAG"), which was purchased January 6,
2000 and WorldNet Services Corp. ("WorldNet") that process the Company's
brokerage senior market policies, as well as business for unaffiliated insurance
companies.
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired on July 30, 1999 into its locations in
Toronto (Canada), Pensacola (Florida), and Orlando (Florida) in order to improve
operating efficiencies and capabilities. The plan to consolidate this location
was being formulated at the date of acquisition. Accordingly, the Company
recorded a $10.0 million restructuring liability in its accounting for the
acquisition.
This liability was accounted for under EITF No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3").
The liability consisted of employee separation costs ($3.2 million), employee
relocation costs ($2.6 million), and other relocation and exit costs. During the
six months ended June 30, 2000, the Company paid $2.1 million in restructuring
charges.
Subsequent to the acquisition of the Penn Union Companies, the Company
redefined its operating segments with primary emphasis on its distribution
channels. Currently, the Company manages its
17
<PAGE> 18
business through four operating segments, Senior Market Brokerage, Career
Agency, Special Markets and Insurance Services and Corporate.
SENIOR MARKET BROKERAGE - This distribution channel consists of a general agency
system and insurance brokerage system that focus on the sale of products in the
senior market segment, including Medicare Supplement, Medicare Select and
Long-term Care.
CAREER AGENCY SYSTEM - The Career Agency segment is comprised of a career agency
field force, which distributes fixed benefit accident and sickness, life
insurance and supplemental senior health insurance in the United States and
Canada. The Career Agents are under exclusive contract with Pennsylvania Life
and PennCorp Canada.
SPECIAL MARKETS - Through its own operating history and through prior
acquisitions, Universal has accumulated various lines of business that it
manages in its Special Markets segments. These products include annuities,
interest-sensitive and group life insurance, individual medical and other
accident and health insurance.
INSURANCE SERVICES AND CORPORATE - This segment is primarily made up of the
insurance administrative service companies that process certain business for the
Insurance Subsidiaries, as well as unaffiliated insurers. It also includes the
corporate operations of the holding company, including interest on debt.
Prior to the Penn Union Transaction, the Company reported its results
through four segments, with primary emphasis on major product lines. These
segments were Senior Market Accident and Health Insurance, Other Accident and
Health Insurance, Life Insurance and Non-insurance Business.
The new Senior Market Brokerage Segment includes substantially all of
the former Senior Market Accident and Health Insurance Segment business.
The Career Agency segment includes only business which is new to the
Company as a result of the acquisition of Pennsylvania Life and PennCorp Canada.
The Special Markets segment includes a combination of existing
Universal business from the Other Accident and Health and Life Insurance
segments, as well as new business resulting from the acquisition of the
Peninsular, Marquette, Union Bankers and Constitution.
The Insurance Services and Corporate Segment includes all businesses
previously included in the Non-insurance Business Segment. Results of operations
for the six months ended June 30, 2000 include the results of AIAG.
RESULTS OF OPERATIONS
Six Months Ended June 30, 2000 and 1999
Consolidated net income after Federal income taxes increased by $10.1
million to $11.3 million ($0.24 per diluted share) in 2000, compared to $1.2
million ($0.10) in 1999. Operating income before income tax increased by $15.6
million to $17.7 million in 2000 compared to $2.1 million in 1999.
The Senior Market Brokerage segment more than doubled its operating
results, increasing by $1.2 million in addition to the $15.0 million added by
the acquisition of the Career Agency segment. The Special Markets segment
improved its results by $1.9 million primarily as a result of the business
acquired in the Penn Union Acquisition. These increases are offset by a
reduction of $2.6 million in the results from the Non-insurance segment.
Discussion of the details by segment follows.
18
<PAGE> 19
SENIOR MARKET BROKERAGE SEGMENT
The Senior Market Brokerage Segment focuses on the sale of senior
market products through a network of independent agents. The results of
operations for the six months ended June 30, 2000 and 1999 include the results
of the sales of products such as Medicare Supplement, Medicare Select and Long
Term Care products through this distribution channel.
REVENUES. Total revenues for the Senior Market Brokerage Segment
increased approximately $7.5 million to approximately $21.3 million for the six
months ended June 30, 2000, compared to total revenues of approximately $13.8
million in the prior year. This increase results from the increase in internally
generated production and not from the acquisition of the Penn Union Companies.
Gross premium and policyholder fees earned and reinsurance assumed
In the six months ended June 30, 2000, the Senior Market Brokerage
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $116.2 million, a $68.9 million increase over the $47.3
million amount in 1999. The gross earned premiums on the Company's senior market
products increased as follows:
<TABLE>
<CAPTION>
PREMIUM INCREASE/ 2000 TOTAL
DESCRIPTION (DECREASE) PREMIUM EARNED
---------------------------------------- ------------------- ------------------
(in millions) (in millions)
<S> <C> <C>
Medicare Supplement/Select $22.27 $38.60
Freedom Care 1.59 4.31
Hospital Indemnity, Home Health Care and
Nursing Home 0.52 2.70
First National business acquired 1.25 22.76
Union Bankers Medicare Supplement 34.01 34.01
Constitution Medicare Supplement 9.71 9.71
Other (0.45) 4.08
------------------- ------------------
Totals $68.90 $116.17
=================== ==================
</TABLE>
The Medicare Supplement insurance issued by Union Bankers and
Constitution is 100% reinsured with an unaffiliated reinsurer.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the six months ended
June 30, 2000 for the Senior Market Brokerage Segment amounted to $95.4 million,
a $61.5 million increase from the 1999 amount of $33.9 million. Details of the
changes in reinsurance premiums ceded are as follows:
19
<PAGE> 20
<TABLE>
<CAPTION>
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE/ (DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------------ --------------------
(in millions) (in millions)
<S> <C> <C>
Business acquired:
First National $1.47 $18.13
Dallas General (0.57) 3.60
Medicare Supplement 16.08 27.08
Union Bankers Medicare Supplement 34.01 34.01
Constitution Medicare Supplement 9.71 9.71
Freedom Care 0.59 1.41
Hospital Indemnity, Home Health Care and
Nursing Home 0.24 1.22
Other lines 0.01 0.26
------------------------ --------------------
Totals $61.54 $95.42
======================== ====================
</TABLE>
Investment related revenue
Net investment income of the Senior Market Brokerage Segment increased
$0.2 million to $0.6 million for the six months ended June 30, 2000, compared to
1999. Realized gains on investments increased slightly from the prior year.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Senior Market Brokerage Segment increased approximately $6.4
million to $19.1 million for the six months ended June 30, 2000, compared to
$12.7 million for the six months ended June 30, 1999.
Claims and other benefits increased $5.0 million to $13.6 million for
the six months ended June 30, 2000 compared to $8.6 million in the prior year.
The change in reserves for the six months ended June 30, 2000 amounted to an
increase of $2.6 million compared to an increase of $1.4 million in 1999
generating a variance of $1.2 million. These increases in claims and change in
reserves are the result of the $7.3 million increase in net premiums earned for
the six months ended June 30, 2000 discussed above.
The change in deferred acquisition costs decreased slightly for the six
months ended June 30, 2000 compared to 1999. The amount of acquisition costs
capitalized decreased $45 thousand from the prior year. The amortization of
deferred acquisition costs decreased $49 thousand from the prior year.
Commissions in the Senior Market Brokerage Segment increased $11.0
million in the six months ended June 30, 2000 to $19.2 million, compared to $8.2
million in 1999. This increase is the direct result of the $68.9 million
increase in gross premium discussed above. Commissions and expense allowances on
reinsurance ceded increased $16.2 million in the six months ended June 30, 2000
to $26.6 million, compared to $10.4 million in 1999. This increase is the direct
result of the $61.5 million increase in reinsurance premium ceded discussed
above.
Other operating costs and expenses increased $5.3 million in the six
months ended June 30, 2000 to $11.9 million, compared to $6.6 million in 1999
due in part to the increase in expenses incurred in generating new business as
well as the increase in premium taxes associated with the growth in new business
in this segment.
CAREER AGENTS SEGMENT
The Career Agent Segment was acquired in the Penn Union Acquisition and
comprises the operations of Pennsylvania Life Insurance Company ("Pennsylvania
Life") and PennCorp Life Insurance Company of Canada ("PennCorp Canada"). The
Career Agents market life and health insurance products
20
<PAGE> 21
focusing primarily on fixed benefit accident and sickness products. Penn Corp
Canada operates exclusively in Canada, while Pennsylvania Life operates in both
the U.S. ("Pennsylvania Life U.S.") and Canada.
REVENUES. Total net revenues for the Career Agent segment amounted to
$82.2 million of which $54.0 million was generated by Pennsylvania Life U.S. and
$28.2 million was generated by the Canadian operations. Gross premium totaled
$68.0 million, $43.9 million derived from Pennsylvania Life U.S. and $24.1
million derived from the Canadian operations. The Company reinsures a portion of
these premiums to outside parties. Total ceded premiums for the six months ended
June 30, 2000 were $0.3 million at the Canadian operations and $1.5 million at
Pennsylvania Life U.S. Investment income of $15.7 million consists mostly of
interest on bonds held by the company.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Career Agent Segment totaled $67.2 million for the six months
ended June 30, 2000.
Claims and other benefits amounted to $36.3 million for the six months
ended June 30, 2000. Of this amount, $28.4 million related to claims incurred at
Pennsylvania Life U.S. and $7.9 million related to the Canadian operations. The
change in reserves for the six months ended June 30, 2000 amounted to $5.3
million.
Deferred acquisition costs increased $6.2 million for the six months
ended June 30, 2000. Acquisition costs capitalized at Pennsylvania Life U.S.
totaled $4.1 million net of amortization. Canadian costs capitalized, net of
amortization amounted to $2.1 million.
Commissions in the Career Agent Segment for the six months ended June
30, 2000 amounted to $15.2 million, of which $11.2 million related to
Pennsylvania Life U.S. Commissions and expense allowances on reinsurance ceded
totaled $0.4 million in the six months ended June 30, 2000. Other operating
costs and expenses totaled $17.0 million for the six months ended June 30, 2000.
SPECIAL MARKETS SEGMENT
The Special Markets Segment consists of blocks of business that were
acquired through the acquisitions of various companies or are not currently
produced through the career or brokerage agency distribution systems as well as
some specialty life and accidental insurance products. The results of operations
for the six months ended June 30, 2000 and 1999 include the results of the sales
of such products.
REVENUES. Total revenues for the Special Markets Segment increased
approximately $22.7 million to approximately $36.3 million for the six months
ended June 30, 2000, compared to total revenues of approximately $13.6 million
in the prior year. $20.8 million of this increase is attributable to the Penn
Union Transaction.
Gross premium and policyholder fees earned and reinsurance assumed
In the six months ended June 30, 2000, the Special Markets Segment
gross premium and policyholder fees earned (including reinsurance assumed)
amounted to $38.4 million, a $17.9 million increase over the $20.5 million
amount in 1999. The gross earned premiums on the Company's special market
products increased as follows:
21
<PAGE> 22
<TABLE>
<CAPTION>
2000 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
--------------------------------------------- ---------------------- ---------------------
Acquired Businesses: (in millions) (in millions)
<S> <C> <C>
Constitution $1.96 $1.96
Union Bankers 13.35 13.35
International Medical 0.05 2.71
Major Medical 0.16 6.48
Life and annuity products 0.78 8.20
Other Health Products 1.57 5.69
---------------------- ---------------------
Totals $17.87 $38.39
====================== =====================
</TABLE>
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the six months ended
June 30, 2000 for the Special Markets Segment amounted to $14.7 million, a $2.5
million increase from the 1999 amount of $12.2 million. Details of the changes
in reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE /(DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------------- ----------------------
(in millions) (in millions)
<S> <C> <C>
Business acquired
Constitution $0.88 $0.88
Union Bankers 0.26 0.26
Life and annuity products (0.30) 3.62
Major Medical 0.08 4.09
International Medical 0.12 2.60
Other lines 1.45 3.26
------------------------- ----------------------
Totals $2.49 $14.71
========================= ======================
</TABLE>
Investment related revenue
Net investment income of the Special Markets Segment increased $7.2
million to $12.4 million for the six months ended June 30, 2000, compared to
$5.2 million in 1999. This increase is attributable to the increase in invested
assets outstanding in this segment during 2000 compared to 1999 as a result of
the Penn Union Transaction.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Special Markets Segment increased approximately $20.8 million
to $33.8 million for the six months ended June 30, 2000, compared to $13.0
million for the six months ended June 30, 1999.
Claims and other benefits increased $19.4 million to $25.2 million for
the six months ended June 30, 2000 compared to $5.8 million in 1999. $18.7
million of this increase is attributable to the Penn Union Transaction. The
change in reserves for the six months ended June 30, 2000 amounted to a decrease
of $6.6 million compared to a decrease of $0.5 million in 1999 generating a
variance of $6.1 million. The change in reserves for Penn Union Companies for
the six months ended June 30, 2000 amounted to a decrease of $6.7 million.
Interest credited to policyholders increased $1.4 million from $3.7 million in
1999 to $5.1 million in 2000. Approximately $1.6 million of the increase relates
to the acquired companies which
22
<PAGE> 23
is offset by a slight decrease in the core businesses.
The change in deferred acquisition costs increased by $0.4 million for
the six months ended June 30, 2000 compared to the same period in 1999. The
amount of acquisition costs capitalized increased $0.2 million from $1.2 million
for the six months ended June 30, 1999 to $1.3 million for the six months ended
June 30, 2000. The deferred acquisition costs decreased in relation to the
increase in net earned premium primarily due to the fact that the increase in
net earned premium related mainly to renewal business of the Penn Union
companies. New business production is the main driver of deferred acquisition
costs. The amortization of deferred acquisition costs decreased $0.2 million
from $1.3 million for the six months ended June 30, 1999 to $1.2 million for the
six months ended June 30, 2000
Commissions in the Special Markets Segment increased $0.7 million in
the six months ended June 30, 2000 to $5.9 million, compared to $5.2 million in
1999. This increase is due largely to the acquisition of the Penn Union
Companies which increase of $0.8 million was offset by a decrease of $0.1
million in some of the life products no longer marketed. Premiums on products in
this segment are generally renewal premiums as little new business is being
written. Commissions on renewal business are at lower rates than new business.
Commissions and expense allowances on reinsurance ceded remained flat at $5.2
million for the six months ended June 30, 2000 and 1999. This is largely due to
runoff of the life business.
Other operating costs and expenses increased $5.9 million in the six
months ended June 30, 2000 to $9.6 million, compared to $3.7 million in 1999.
This increase is due mainly to expenses related to the newly acquired Penn Union
lines of business. This increase is offset by a decrease in the cost of
generating new business as some of the lines of business in this segment run
off.
INSURANCE SERVICES AND CORPORATE
The Non Insurance Businesses Segment consists of WorldNet, PFI, Inc
("PFI")(an internal servicing company acquired in July, 1999), the Parent
Company, AIAG which was acquired in January, 2000 as well as a minority interest
in Security Health.
Fees and other income increased $1.5 million due to revenue generated
at AIAG of $1.5 million. General expenses increased $4.2 million from $0.7
million in 1999 to $4.9 million in 2000. This increase is due to an increase in
interest expense of $3.2 million related to a loan with Chase Manhattan to
finance the purchase of the Penn Union Companies. In addition, the Parent
Company incurred compensation expenses of approximately $0.4 million related to
the issue of stock options and bonuses to employees and members of management
related to the acquisition of the Penn Union Companies.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2000 and 1999
Consolidated net income after Federal income taxes increased by $4.9
million to $5.6 million ($0.12 per diluted share) in 2000, compared to $0.7
million ($0.05) in 1999. Operating income before income tax increased by $7.7
million to $8.8 million in 2000 compared to $1.1 million in 1999.
The Senior Market Brokerage segment almost doubled its operating
results, increasing by $0.6 million in addition to the $7.5 million added by the
acquisition of the Career Agency segment. The Special Markets segment improved
its results by $0.8 million primarily as a result of the business acquired in
the Penn Union Acquisition. These increases are offset by a reduction of $1.2
million in the results from the Non-insurance segment. Discussion of the details
by segment follows.
23
<PAGE> 24
SENIOR MARKET BROKERAGE SEGMENT
The Senior Market Brokerage Segment focuses on the sale of senior
market products through a network of independent agents. The results of
operations for the three months ended June 30, 2000 and 1999 include the results
of the sales of products such as Medicare Supplement, Medicare Select and Long
Term Care products through this distribution channel.
REVENUES. Total revenues for the Senior Market Brokerage Segment
increased approximately $3.9 million to approximately $11.1 million for the
three months ended June 30, 2000, compared to total revenues of approximately
$7.2 million in the prior year. This increase results from the increase in
internally generated production and not from the acquisition of the Penn Union
Companies.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended June 30, 2000, the Senior Market Brokerage
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $58.6 million, a $33.8 million increase over the $24.8
million amount in 1999. The gross earned premiums on the Company's senior market
products increased as follows:
<TABLE>
<CAPTION>
PREMIUM INCREASE/ 2000 TOTAL
DESCRIPTION (DECREASE) PREMIUM EARNED
--------------------------------------------- ----------------------- ----------------------
(in millions) (in millions)
<S> <C> <C>
Medicare Supplement/Select $11.11 $19.96
Freedom Care 0.81 2.42
Hospital Indemnity, Home Health Care and
Nursing Home 0.28 1.55
First National business acquired 0.15 11.10
Union Bankers Medicare Supplement 16.48 16.48
Constitution Medicare Supplement 5.02 5.02
Other (0.03) 2.03
----------------------- ----------------------
Totals $33.82 $58.56
======================= ======================
</TABLE>
The Medicare Supplement insurance issued by Union Bankers and
Constitution is 100% reinsured with an unaffiliated reinsurer.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
June 30, 2000 for the Senior Market Brokerage Segment amounted to $47.7 million,
a $30.0 million increase from the 1999 amount of $17.7 million. Details of the
changes in reinsurance premiums ceded are as follows:
24
<PAGE> 25
<TABLE>
<CAPTION>
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE /(DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------------- --------------------
(in millions) (in millions)
<S> <C> <C>
Business acquired:
First National $0.30 $8.84
Dallas General (0.19) 1.80
Medicare Supplement 7.88 13.93
Union Bankers Medicare Supplement 16.48 16.48
Constitution Medicare Supplement 5.02 5.02
Freedom Care 0.32 0.78
Hospital Indemnity, Home Health Care and
Nursing Home 0.09 0.70
Other lines 0.03 0.12
------------------------- --------------------
Totals $29.93 $47.67
========================= ====================
</TABLE>
Investment related revenue
Net investment income of the Senior Market Brokerage Segment increased
$0.1 million to $0.2 million for the three months ended June 30, 2000, compared
to 1999. Realized gains on investments increased slightly from the prior year.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Senior Market Brokerage Segment increased approximately $3.4
million to $9.9 million for the three months ended June 30, 2000, compared to
$6.5 million for the three months ended June 30, 1999.
Claims and other benefits increased $3.2 million to $7.5 million for
the three months ended June 30, 2000 compared to $4.3 million in the prior year.
The change in reserves for the three months ended June 30, 2000 amounted to an
increase of $1.0 million compared to an increase of $0.6 million in 1999
generating a variance of $0.4 million. These increases in claims and change in
reserves are the result of the $3.8 million increase in net premiums earned for
the three months ended June 30, 2000 discussed above.
The change in deferred acquisition costs decreased by $0.2 million for
the three months ended June 30, 2000 compared to 1999. The amount of acquisition
costs capitalized decreased $27 thousand from the prior year. The amortization
of deferred acquisition costs decreased $0.2 million from $0.3 million for the
three months ended June 30, 1999 to $41 thousand for the three months ended
June 30, 2000.
Commissions in the Senior Market Brokerage Segment increased $5.7
million in the three months ended June 30, 2000 to $10.0 million, compared to
$4.3 million in 1999. This increase is the direct result of the $33.7 million
increase in gross premium discussed above. Commissions and expense allowances on
reinsurance ceded increased $8.0 million in the three months ended June 30, 2000
to $13.4 million, compared to $5.4 million in 1999. This increase is the direct
result of the $30.0 million increase in reinsurance premium ceded discussed
above.
Other operating costs and expenses increased $2.2 million in the three
months ended June 30, 2000 to $5.6 million, compared to $3.4 million in 1999 due
in part to the increase in expenses incurred in generating new business as well
as the increase in premium taxes associated with the growth in new business in
this segment.
25
<PAGE> 26
CAREER AGENTS SEGMENT
The Career Agent Segment was acquired in the Penn Union Acquisition and
comprises the operations of Pennsylvania Life Insurance Company ("Pennsylvania
Life") and PennCorp Life Insurance Company of Canada ("PennCorp Canada"). The
Career Agents market life and health insurance products focusing primarily on
fixed benefit accident and sickness products. Penn Corp Canada operates
exclusively in Canada, while Pennsylvania Life operates in both the U.S.
("Pennsylvania Life U.S.") and Canada.
REVENUES. Total net revenues for the Career Agent segment amounted to
$40.9 million of which $27.1 million was generated by Pennsylvania Life U.S. and
$13.8 million was generated by the Canadian operations. Gross premium totaled
$33.9 million, $22.0 million derived from Pennsylvania Life U.S. and $11.9
million derived from the Canadian operations. The Company reinsures a portion of
these premiums to outside parties. Total ceded premiums for the three months
ended June 30, 2000 were $0.1 million at the Canadian operations and $0.9
million at Pennsylvania Life U.S. Investment income of $7.8 million consists
mostly of interest on bonds held by the company.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Career Agent Segment totaled $33.4 million for the three
months ended June 30, 2000.
Claims and other benefits amounted to $17.6 million for the three
months ended June 30, 2000. Of this amount, $13.9 million related to claims
incurred at Pennsylvania Life U.S. and $3.7 million related to the Canadian
operations. The change in reserves for the three months ended June 30, 2000
amounted to $3.2 million.
Deferred acquisition costs increased $3.9 million for the three months
ended June 30, 2000. Acquisition costs capitalized at Pennsylvania Life U.S.
totaled $1.3 million net of amortization. Canadian costs capitalized, net of
amortization amounted to $1.0 million.
Commissions in the Career Agent Segment for the three months ended June
30, 2000 amounted to $7.1 million, of which $5.7 million related to Pennsylvania
Life U.S. Commissions and expense allowances on reinsurance ceded totaled $0.1
million in the three months ended June 30, 2000. Other operating costs and
expenses totaled $9.5 million for the three months ended June 30, 2000
SPECIAL MARKETS SEGMENT
The Special Markets Segment consists of blocks of business that were
acquired through the acquisitions of various companies or are not currently
produced through the career or brokerage agency distribution systems as well as
some specialty life and accidental insurance products. The results of operations
for the three months ended June 30, 2000 and 1999 include the results of the
sales of such products.
REVENUES. Total revenues for the Special Markets Segment increased
approximately $11.3 million to approximately $18.2 million for the three months
ended June 30, 2000, compared to total revenues of approximately $6.9 million in
the prior year. $10.2 million of this increase is attributable to the Penn Union
Transaction.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended June 30, 2000, the Special Markets Segment
gross premium and policyholder fees earned (including reinsurance assumed)
amounted to $19.7 million, a $9.3 million increase over the $10.7 million amount
in 1999. The gross earned premiums on the Company's special market products
increased as follows:
26
<PAGE> 27
<TABLE>
<CAPTION>
2000 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
--------------------------------------------- ---------------------- ---------------------
Acquired Businesses: (in millions) (in millions)
<S> <C> <C>
Constitution $0.61 $0.61
Union Bankers 6.49 6.49
International Medical 0.02 1.58
Major Medical 0.06 3.23
Life and annuity products 0.55 4.30
Other Health Products 1.52 3.49
---------------------- ---------------------
Totals $9.25 $19.70
====================== =====================
</TABLE>
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
June 30, 2000 for the Special Markets Segment amounted to $8.0 million, a $1.6
million increase from the 1999 amount of $6.4 million. Details of the changes in
reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE/ (DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------------- ----------------------
(in millions) (in millions)
<S> <C> <C>
Business acquired
Constitution $0.11 $0.11
Union Bankers 0.17 0.17
Life and annuity products (0.03) 1.90
Major Medical (0.01) 2.02
International Medical 0.03 1.51
Other lines 1.37 2.34
------------------------- ----------------------
Totals $1.64 $8.05
========================= ======================
</TABLE>
Investment related revenue
Net investment income of the Special Markets Segment increased $3.7
million to $6.4 million for the three months ended June 30, 2000, compared to
$2.7 million in 1999. This increase is attributable to the increase in invested
assets outstanding in this segment during 2000 compared to 1999 as a result of
the Penn Union Transaction.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Special Markets Segment increased approximately $10.5 million
to $17.1 million for the three months ended June 30, 2000, compared to $6.6
million for the three months ended June 30, 1999.
Claims and other benefits increased $9.7 million to $13.0 million for
the three months ended June 30, 2000 compared to $3.3 million in 1999. $9.7
million of this increase is attributable to the Penn Union Transaction. The
change in reserves for the three months ended June 30, 2000 amounted to a
decrease of $3.1 million compared to a decrease of $0.1 million in 1999
generating a variance of $3.0 million. The change in reserves for Penn Union
Companies for the three months ended June 30, 2000 amounted to a decrease of
$3.3 million. Interest credited to policyholders increased $0.8 million from
$1.7 million in 1999 to $2.5 million in 2000. Approximately $1.2 million of the
increase relates to the acquired companies with
27
<PAGE> 28
an offsetting decrease of $0.4 million in the core businesses.
The change in deferred acquisition costs increased by $0.3 million for
the three months ended June 30, 2000 compared to the same period in 1999. The
amount of acquisition costs capitalized increased $0.2 million from $0.6 million
for the three months ended June 30, 1999 to $0.8 million for the three months
ended June 30, 2000. The deferred acquisition costs decreased in relation to the
increase in net earned premium primarily due to the fact that the increase in
net earned premium related mainly to renewal business of the Penn Union
companies. New business production is the main driver of deferred acquisition
costs. The amortization of deferred acquisition costs decreased $0.1 million
from $0.6 million for the three months ended June 30, 1999 to $0.5 million for
the three months ended June 30, 2000
Commissions in the Special Markets Segment increased $0.5 million in
the three months ended June 30, 2000 to $3.3 million, compared to $2.8 million
in 1999. This increase is due largely to the acquisition of the Penn Union
Companies. Premiums on products in this segment are generally renewal premiums
as little new business is being written. Commissions on renewal business are at
lower rates than new business. Commissions and expense allowances on reinsurance
ceded increased $0.2 million in the three months ended June 30, 2000 to $3.0
million, compared to $2.8 million in 1999.
Other operating costs and expenses increased $3.0 million in the three
months ended June 30, 2000 to $4.6 million, compared to $1.6 million in 1999.
This increase is due mainly to expenses related to the newly acquired Penn Union
lines of business. This increase is offset by a decrease in the cost of
generating new business as some of the lines of business in this segment run
off.
INSURANCE SERVICES AND CORPORATE
The Non Insurance Businesses Segment consists of WorldNet, PFI, Inc
("PFI")(an internal servicing company acquired in July, 1999), the Parent
Company, AIAG which was acquired in January, 2000 as well as a minority interest
in Security Health.
Fees and other income increased $0.9 million due to revenue generated
at AIAG of $0.8 million. General expenses increased $2.2 million from $0.5
million in 1999 to $2.7 million in 1999. This increase is due to an increase in
interest expense of $1.6 million related to a loan with Chase Manhattan to
finance the purchase of the Penn Union Companies. In addition, the Parent
Company incurred compensation expenses of approximately $0.2 million related to
the issue of stock options and bonuses to employees and members of management
related to the acquisition of the 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, the
debentures outstanding with American Progressive and to fund the planned
reorganization of the Company being performed in connection with the acquisition
of the Penn Union Companies.
28
<PAGE> 29
Management believes that the current cash position, the availability of
the revolving loan facility, the expected cash flows of the non-insurance
companies (including AIAG), the surplus note interest payments from American
Exchange 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.
Loan Agreements
As of June 30, 2000 and December 31, 1999, the Company had 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 9.8%) with
principal repayment over a seven-year period and a final maturity date of July
31, 2006. 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 six
months ended June 30, 2000, the Company paid $3.4 million in interest. The
Company paid $1.5 million in principal on July 31, 2000 and is due to repay an
additional $1.9 million in principal during 2000.
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 six months ended June 30, 2000 the Company paid $0.3 million in
interest on these debentures to American Progressive, which was eliminated in
consolidation.
Acquisition of American Insurance Administration Group ("AIAG")
In January 2000, Universal acquired all of the outstanding shares of
AIAG, a privately held third party administrator located in Clearwater, Florida,
for $2.875 million in cash, 809,860 shares on Universal common stock and certain
contingent future cash payments. AIAG is the third party administrator of
approximately $123 million of senior supplemental health insurance,
approximately $97 million of which is administered for Union Bankers. For the
six months ended June 30, 2000, AIAG, Inc. received administrative fees of $5.2
million of which $3.7 million related to Union Bankers and was eliminated in the
consolidated financial statements of the Company.
Insurance Subsidiaries
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 June 30, 2000 and December 31, 1999 the statutory capital and
surplus, including asset valuation reserves, of the U.S. Insurance Subsidiaries
totaled $89.3 million and $89.2 million, respectively.
Beginning in 1993, the National Association of Insurance Commissioners
("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life
insurance enterprises. At June 30, 2000 all of the Insurance Subsidiaries
maintained ratios of total adjusted capital to RBC in excess of the Authorized
Control Level.
PennCorp Canada and Pennsylvania Life's Canadian branch report to
Canadian regulatory authorities based upon Canadian statutory accounting
principles that vary in some respects from U.S. statutory accounting principles.
Canadian net assets based upon Canadian statutory accounting principles were
$63.2 million and $63.9 million as of June 30, 2000 and December 31, 1999,
respectively. 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 June
30, 2000.
29
<PAGE> 30
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. Currently, the surplus notes
between Universal and American Exchange total $70 million and it is anticipated
that it will be primarily serviced by dividends from Pennsylvania Life, a wholly
owned subsidiary of American Exchange, and by tax-sharing payments among the
insurance companies which are wholly owned by American Exchange and file a
consolidated Federal income tax return. During 2000, $4.8 million of taxes have
been paid to American Exchange pursuant to the tax-sharing agreement.
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. The maximum amount of dividends which can be
paid to American Exchange from Pennsylvania Life without the prior approval of
the Pennsylvania Department of Insurance is restricted to the greater of 10% of
Pennsylvania Life's surplus as regards to policyholders as of the preceding
December 31 or the net gain from operations during the preceding year, but such
dividends can be paid only out of unassigned surplus. As part of its approval of
the Penn Union Acquisition, the Pennsylvania Insurance Department approved a
quasi reorganization of Pennsylvania Life's surplus in which its previously
negative unassigned surplus was reset to zero. Thus, future earnings of the
company would be available for dividends without prior approval, subject to the
restrictions noted above. As of June 30, 2000, $5.4 million of dividends can be
paid by the insurance subsidiaries of American Exchange.
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. At June 30, 2000 the Company held reserves that exceeded
the underlying cash surrender values of its in force life insurance and
annuities by more than $25.5 million. The insurance companies, in management's
view, have not experienced any material changes in surrender and withdrawal
activity in recent years.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity, unanticipated
surrenders and withdrawals in a changed interest rate environment could
adversely affect earnings if the Company were required to sell investments at
reduced values in order to meet liquidity demands. The Company manages the asset
and liability portfolios in order to minimize the adverse earnings impact of
changing market rates. The Company seeks to invest in assets that have duration
and interest rate characteristics similar to the liabilities that they support.
At June 30, 2000, the Insurance Subsidiaries held cash and cash
equivalents totaling $37.3 million, as well as fixed maturity and equity
securities that could readily be converted to cash with carrying values (and
fair values) of $725.6 million. The fair values of these liquid holdings totaled
more than $762.9 million.
INVESTMENTS
The Company's investment policy is to balance the portfolio between
long-term and short-term investments so as to continue to achieve investment
returns consistent with the preservation of capital and maintenance of liquidity
adequate to meet payment of policy benefits and claims. The Company invests in
30
<PAGE> 31
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 and Asset
Allocation and Management Company, to manage the Company's U.S. fixed maturity
portfolio, and Elliot and Page, a Canadian investment advisor to manage the
Canadian portfolio, under the direction of the management of the Insurance
Subsidiaries and in accordance with guidelines adopted by their respective
Boards of Directors. The Company's policy is not to invest in derivative
programs or other hybrid securities, except for GNMA's, FNMA's and investment
grade corporate collateralized mortgage obligations. It invests primarily in
fixed maturity securities of the U.S. Government and its agencies and in
corporate fixed maturity securities with investment grade ratings of "Baa3"
(Moody's), "BBB-" (Standard & Poor's) or higher. However, the Company does own
some investments that are rated "BB" or below (together 1.9% and 1.1% of total
fixed maturities as of June 30, 2000 and December 31, 1999, respectively). As of
June 30, 2000 all of the Company's securities were current in the payment of
principal and interest.
FEDERAL AND FOREIGN INCOME TAXATION OF THE COMPANY
The provision for federal and foreign income taxes was $6.3 million
during the first half of 2000 compared to $0.7 million for the same period in
1999. These provisions resulted in effective tax rates of 36.1% and 34.0%,
respectively. The increase in the effective tax rate relates primarily to the
acquisition of the Penn Union companies since certain business of the acquired
companies is subject to income tax in Canada at a corporate tax rate of
approximately 42%.
At June 30, 2000 and December 31, 1999, the Company has established
valuation allowances of $11.3 million and $11.3 million, respectively, with
respect to net operating loss carryforwards. The Company determines a valuation
allowance based upon an analysis of projected taxable income and through its
ability to implement prudent and feasible tax planning strategies. The tax
planning strategies include the expense reductions anticipated from the
Company's recent reorganization and from the income generated by its
administration companies WorldNet and AIAG. 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 relates to whether computer systems will properly
recognize date-sensitive information in years subsequent to 1999. Prior to 2000,
the Company underwent a corporate-wide program to address the Year 2000 issue,
as it relates to its own computer systems, as well as to instances in which
computer systems of third parties may have a significant impact on the Company's
operations, such as suppliers, business partners, customers, facilities and
telecommunications. In addressing the Year 2000 issue, the Company did not incur
any significant expenses other than the allocation of internal resources to test
and monitor this issue. The Company has not experienced any significant
disruptions of business operations related to the Year 2000 issue to date and
believes that the risk of such disruption in the future is low, although no
assurance can be given in this regard. It is possible that Year 2000 problems
that are not currently apparent may arise in the future. Accordingly, the
Company will continue to monitor its systems for the Year 2000 issue.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 2000. Management does not anticipate that the
adoption of the new statement will have a significant impact on earnings or the
financial position of the Company.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relates, broadly, to changes in the value of financial
instruments that arise from adverse
31
<PAGE> 32
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.
Interest Rate Risk
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 its 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.
Sensitivity Analysis
The Company regularly conducts various analyses to gauge the financial
impact of changes in interest rates on it 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
June 30, 2000, 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 $48.9 million and
$88.9 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 $47.7 million and $88.9 million,
respectively.
Foreign Currency Sensitivity
Portions of Universal's operations are transacted utilizing the
Canadian dollar as the functional currency. Approximately 13.9%, 19.9% and 32.1%
of Universal's assets, revenues and operating income before taxes, as of and for
the six months ended June 30, 2000 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.
32
<PAGE> 33
At June 30, 2000, 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 $516 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.
33
<PAGE> 34
PART II-OTHER INFORMATION
NONE
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: August 14, 2000
