<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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.D. Number)
Six International Drive, Suite 190, Rye Brook, NY 10573
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (914) 934-5200
Securities registered pursuant to Section 12 (b) of the Act:
Name of Each Exchange
Title of Class on which Registered
Common Stock, par value $.01 per share NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of March 1, 1999 was approximately $41,575,000.
The number of shares outstanding of the Registrant's Common Stock as of
March 1, 1999 was 46,646,792.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document
is incorporated:
(1) Proxy Statement for the 2000 Annual Meeting incorporated by
reference into Part III.
(2) Exhibits listed in Item 14 (b), Part IV, incorporated by
reference to Proxy Statement dated July 12, 1999, Form 8-K
dated August 13, 1999, Form 10-Q dated November 15, 1999 and
Form 10-K for 1996.
<PAGE> 2
PART I
ITEM 1 - BUSINESS
GENERAL DESCRIPTION
Universal American Financial Corp. ("the Company" or "Universal"),
incorporated in the State of New York in 1981, is a life and accident & health
insurance holding company.
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"). In addition to the Insurance Subsidiaries, Universal
owns two third party administrators: American Insurance Administration Group,
Inc. ("AIAG"), which was purchased January 2, 2000 and WorldNet Services Corp.
("WorldNet") that processes the Company's brokerage senior market policies, as
well as business for unaffiliated insurance companies.
Universal manages its insurance business through three operating
segments, reflecting its major distribution channels: (i) senior market
brokerage, (ii) career agents and (iii) special markets. The Company develops,
markets and administers its products through its nine Insurance Subsidiaries,
which are collectively licensed to do business throughout all the fifty states
and all the provinces of Canada. The primary products offered by the Insurance
Subsidiaries are supplemental senior health insurance, senior life insurance,
fixed benefit accident and sickness insurance, individual life insurance and
annuity products.
The Company's strategy has been, and continues to be, growth through
both internal and external methods. Universal has grown internally through the
development and expansion of competitive and profitable insurance products
particularly geared for the senior market and the development of general agent
relationships. Its external growth has been achieved through the acquisitions of
nine insurance companies and three acquisitions of blocks of business since
1991. The Company successfully integrated the acquisitions completed prior to
the Penn Union Acquisition (See - "Penn Union Acquisition" below) into its own
operations and has formulated a plan to integrate the Penn Union Companies over
the next year.
The references below to the insurance operations of the Company are to
be understood as references to the activities of the Insurance Subsidiaries.
Financial items are reported on accounting principles generally accepted in the
United States ("GAAP"), except where otherwise noted.
RECENT ACQUISITIONS AND CHANGE IN CONTROL
Penn Union Acquisition
On July 30, 1999, Universal acquired all of the outstanding shares of
common stock of certain subsidiaries of PennCorp Financial Group ("PFG"),
including six insurance companies (the "Penn Union Companies") and certain other
assets as follows (the "Penn Union Acquisition"). The Penn Union Acquisition
received the approvals of the Pennsylvania, North Carolina and Texas Insurance
Departments (the states in which the U.S. Penn Union Companies are domiciled)
and the approval of the Office of the Superintendent of Financial Institutions
of Canada ("OSFI"), the regulatory body for the Canadian operations of the Penn
Union Companies. The Penn Union Companies are:
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<TABLE>
<CAPTION>
Name of Insurance Company State or Province of Domicile
------------------------- -----------------------------
<S> <C>
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
</TABLE>
The aggregate purchase price for the Penn Union Acquisition was $130.5
million in cash. It was financed with $92.8 million of proceeds from the sale of
common stock (See - "Share Purchase Agreement with Capital Z Financial Services
Fund II, L.P." below) and from the $70 million term loan portion of an $80
million credit facility entered into on July 30, 1999. None of the $10 million
revolving loan facility included in this credit facility was drawn at closing
nor has been drawn upon to date. The proceeds of the financing in excess of the
$130.5 million purchase price were used to retire an existing Universal bank
loan, to contribute to the surplus Pennsylvania Life, for transaction expenses
and for working capital.
The Company believes that the Penn Union Acquisition has greatly
enhanced its prospects for future internal growth through geographic expansion,
since the Company's Insurance Subsidiaries are now licensed, in varying
combinations, to do business in all States and Canadian provinces, and through
the addition, as discussed below, of a career agent marketing channel to
supplement the brokerage marketing channel.
The Company is in the process of consolidating the operations of the
Penn Union Companies, currently located in Raleigh, North Carolina, into
existing Universal locations in Toronto (Canada), Pensacola (Florida) and
Orlando (Florida). The Company expects this consolidation to be completed in
early 2001.
The Penn Union Acquisition 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 (See Note 4 to Notes to Consolidated Financial Statements).
Share Purchase Agreement with Capital Z Financial Services Fund II,
L.P.
On December 31, 1998, the Company entered into a Share Purchase
Agreement with Capital Z Financial Services Fund II, L.P. ("Capital Z"), which
was amended on July 2, 1999 (as amended, the "Share Purchase Agreement"). Under
the Share Purchase 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"). The Share Purchase Agreement received the
approvals of the Insurance Departments of all of the jurisdictions in which the
Insurance Subsidiaries owned by the Company prior to the Penn Union Acquisition
are domiciled. The stockholder approvals required for the closing of the Share
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).
As contemplated in the Share Purchase Agreement, certain members of management
and agents of Universal and the Penn Union Companies and holders of Universal's
Series C Preferred Stock preemptive rights purchased 3,753,189 shares of common
stock for $11,822,545, all at $3.15 per share. A total of 29,460,741 shares were
issued for total proceeds of $92,801,334. The transaction expenses incurred with
the Share Purchase Agreement amounted to $6,963,662 and were charged to paid-in
capital. These included a transaction fee and expense reimbursement of
$5,120,896 paid to an affiliate of Capital Z, $1,375,000 of which was paid by
issuing 436,508 shares of common stock of the Company.
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MARKETING AND DISTRIBUTION
Historically, Universal has marketed its senior market and special
market products through a traditional general agency system. However, as a
result of the Penn Union acquisition, the Company now also distributes its
products through an additional career agency system.
Senior Market Brokerage
Universal has placed its emphasis on the sale of products that
particularly appeal to the senior market, largely through marketing
organizations with concentrations in this segment. The Company currently sells
these products primarily in the states of Florida, Texas, New York, and North
Carolina. These marketing organizations typically recruit and train their
agents, bearing most of the costs incurred in connection with developing their
organization. This distribution channel consists of a general agency system and
insurance brokerage system with approximately 7,900 independently licensed
agents. In 1999, this segment accounted for $29.6 million, or 25.7%, of net
premiums earned.
Career Agency System
As a result of the Penn Union Acquisition, the Company has acquired a
viable career agency force, consisting mainly of Pennsylvania Life and PennCorp
Canada agents, which distributes fixed benefit accident and sickness, life
insurance and supplemental senior health insurance plans. This career field
force of approximately 900 agents in the United States and 400 agents in Canada,
are located in 79 branch offices throughout the United States and 15 in Canada.
Sales are made primarily through individual contact with the potential
policyholders. The agents seek to develop strong personal relationships with the
policyholders that may result in follow-up sales of additional policies and/or
riders that meet the needs of the insureds. Career agents also serve as a
contact person for policyholder questions, claim assistance and other insurance
needs. From August 1, 1999 to December 31, 1999, this segment accounted for
$55.6 million, or 48.1%, of net premiums earned.
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. The Company continues to sell some of these products through general
agency relationships, primarily in the states of Florida, Texas, Mississippi and
Alabama. As in the senior market brokerage segment, these marketing
organizations also typically recruit and train their agents, bearing most of the
costs incurred in connection with developing their organization. This general
agency and insurance brokerage system was composed of approximately 360
independently licensed agents and in 1999 accounted for $30.3 million, or 26.2%,
of net premiums earned.
PRODUCTS
The Company offers the following products through its various
distribution systems. Currently, the Senior Market Brokerage segment focuses on
the senior market products (Medicare Supplement, long-term care and senior life
insurance), whereas the Career Agents segment focuses on fixed benefit accident
and health. It is the Company's intention to leverage the alternative
distribution systems through cross-selling of its products.
SUPPLEMENTAL HEALTH INSURANCE
Universal's core supplemental health insurance products include
Medicare Supplement, Medicare
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Select, long-term care and fixed benefit accident and sickness products. These
products are designed for people who already have Medicare or other major
medical or primary insurance coverage. Typically they are guaranteed renewable
for the lifetime of the policyholder, which means that the Company cannot cancel
the policy, but can increase premium rates on existing and future policies
issued based upon the Company's claims experience being higher than originally
expected. These rate increases are applied on a uniform, nondiscriminatory basis
and are subject to state regulatory approval, which are subject to federal and
state loss-ratio requirements.
The following describes the core supplemental health insurance
products:
Medicare Supplement
The Medicare Supplement policies offered by the Insurance Subsidiaries
are primarily on standardized plans A, B, C and F, underwritten on a simplified
issue basis, except in New York where they are sold are on a guaranteed issue
basis, as required by the community rating law of that state. These policies
provide supplemental coverage for many of the medical expenses that the Medicare
program does not cover, such as deductibles, coinsurance and specified losses
that exceed the federal program's maximum benefits. The Company also sells
Medicare Select policies in some areas, in conjunction with hospitals that
contract with the insurer to waive the Medicare Part A deductible. The Company
monitors the claim experience on its Medicare Supplement and select products
and, when necessary, applies for rate increases in the states in which the
products are sold. The Company began selling Medicare Supplement products in
1994. Medicare Supplement and Medicare select issued premium amounted to $4.8
million, $13.6 million and $38.4 million in 1997, 1998 and 1999, respectively,
produced through the general agency system. Since the acquisition of the Penn
Union companies on July 30, 1999 and through December 31, 1999, the senior
market brokerage segment of the Penn Union Companies issued $2.9 million of
premium. It is anticipated that in 2000, the career agency system will also
begin to sell these products.
Long-Term Care (Home Health Care and Nursing Home)
Long-term care products provide coverage, within prescribed limits, for
nursing home care, home health care, or a combination of both nursing homecare
and home health care, and are typically sold to retirees. The nursing home
product covers the cost of nursing home care, subject to daily fixed-dollar
limits, to elimination periods ranging between 0 and 90 days, and to a maximum
benefit. The home health care product covers the usual and customary charges of
home care visit(s) and are subject to a daily or weekly maximum dollar amount
and an overall maximum benefit. The Company also has a managed care home health
care product in Florida that uses preferred provider organization ("PPO")
discounts and capitation with a home health care network. A new integrated
long-term car product, combining nursing home and home health care benefits, was
introduced in late 1999. Issued premium for these long-term care products in
1997, 1998 and 1999 amounted to $2.4 million, $3.9 million and $4.1 million,
respectively, and were produced through the general agency system. During 1999,
the career agency system sold these products with an unaffiliated third party
insurer since the Company did not have these products available for sale in the
necessary states. It is anticipated that in 2000, the career agents will begin
to sell these products on behalf of the Company.
Fixed Benefit Accident and Health
Fixed benefit accident and health products provide coverage for three
principal types of benefits: (i) fixed periodic payments to an insured who
becomes disabled and unable to work because of an accident and/or sickness
("disability income"), (ii) fixed periodic payments to an insured who becomes
hospitalized ("hospital income") and (iii) fixed single payments that vary in
amount generally for specified surgical or diagnostic procedures ("surgical").
Because the benefits are fixed in amount at the time of policy issuance and are
not intended to provide reimbursement for medical and hospital expenses,
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<PAGE> 6
payment amounts are not affected by inflation or the rising cost of health care
services. The disability income product is typically sold to individuals that,
when combined with other similar coverages, do not provide monthly benefits in
excess of $2,000, or 50% of the insured's monthly income if less. The hospital
income product is typically sold to individuals to provide the insured with a
means of paying supplemental expenses during a hospitalization stay and provides
benefits of not more than $250 per day ($1,000 if the insured is in intensive
care). The surgical product is typically sold as a rider to an accident policy
and the Company's practice is to provide benefits of not more than $5,000
($2,500 if the procedure is performed on an out-patient basis). These fixed
benefit accident and health products are sold through the career agency system
of which $9.1 million of premium was issued after the July 30, 1999 closing of
the Penn Union Acquisition. Issued premium for all of 1999 by the Career Agents
Segment was $22 million.
SENIOR LIFE INSURANCE
Senior Life (SL2000 and Peace of Mind)
This series of low-face value, simplified issue whole life products is
sold by Senior Market Brokerage segment. The Company issued $0.7 million, $1.0
million and $1.0 million in 1997, 1998 and 1999, respectively. It is anticipated
that in 2000, the career agents will begin to sell these products on behalf of
the Company.
One, Five, Six and Seven Pay Interest Sensitive Whole Life ("Asset
Enhancer")
This product is a simplified issue interest-sensitive whole life
product with one, five, six or seven year payment options. It is designed as an
interest-sensitive whole life vehicle for seniors to facilitate estate planning
and transfer assets to heirs in an income tax-advantaged manner. In many states,
the product offers an optional nursing care and home care rider.
In addition to American Pioneer's own sales of this product, in 1996,
American Pioneer entered into an arrangement with West Coast Life Insurance
Company ("West Coast Life"), an unaffiliated "A+" rated carrier, under which
West Coast issues this product and, through an unaffiliated reinsurer, reinsures
one-third of the risk to American Pioneer. Under its contract with West Coast
Life, American Pioneer administers the product and the relationships with the
producers on a fee basis.
Statutory premium production of five, six and seven pay life insurance
amounted to $3.8 million, $1.6 million and $0.5 million in 1997, 1998 and 1999,
respectively. The single pay plan was introduced in 1995 and statutory premium
production amounted to $17.6 million, $5.1 million and $1.6 million in 1997,
1998 and 1999, respectively. These figures include the entire premium generated
by American Pioneer sales and the portion assumed by American Pioneer on West
Coast Life's sales.
OTHER PRODUCTS
Annuities
The Company markets Single and Flexible Premium Deferred Annuities
primarily focusing on the senior and retirement markets. The Company's currently
marketed annuity products have a minimum guaranteed interest rate of 4.0%
annually and a current credited interest rates which range from 3.0% to 7.0%,
with the Company having the right to change the crediting rates. In exercising
its right to change the interest rate the Company takes into account the current
interest rate environment, the profitability of its annuity business and its
relative competitive position. Statutory premium production of new annuities
amounted to $10.8 million, $10.4 million and $6.3 million in 1997, 1998, and
1999, respectively, and was primarily produced through the general agency
system. It is anticipated that in 2000, the career agency system will begin to
sell these products.
Individual Medical
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The Company has approximately $44.5 million of annual premium in force
of individual medical business as of December 31, 1999, of which $17.9 million,
or 40%, is reinsured on a quota share basis ranging from 50% to 75% to
unaffiliated third party reinsurers. The Company also maintains additional
excess of loss reinsurance on the Major Medical block of business reinsurers
(See - "Reinsurance - Ceded" below"). Issued premium for the individual medical
products in 1997, 1998 and 1999 amounted to $5.7 million, $9.6 million and $16.3
million, respectively, and were produced through the general agency system. The
individual medical products are reinsured under various coinsurance and excess
of loss reinsurance agreements with unaffiliated third party reinsurers.
Group Life Insurance
Through an arrangement with Alabama Blue Cross that has existed since
1989, an American Pioneer group life insurance information package, including a
premium quotation, goes out with a large number of Alabama Blue Cross small
group major medical insurance premium quotations. This program had premium
revenue of $3.4 million in each of the years 1997, 1998 and 1999.
BUSINESS IN FORCE
As of December 31, 1999, the Company has $438.3 million of annualized
premium in force generated by 735 thousand policyholders. In addition, the
Company also has $238.7 million in account values with 39 thousand policyholders
for a total policyholder base of 774 thousand as of December 31, 1999.
The Company's growth in direct, acquired and assumed annualized premium
in force, is shown in the following tables as of December 31, 1999, 1998 and
1997.
<TABLE>
<CAPTION>
ANNUALIZED PREMIUM IN FORCE As of December 31,
---------------------------------------------
1999 1998 1997
---------------------------------------------
(In thousands)
<S> <C> <C> <C>
SENIOR MARKET BROKERAGE
Accident & Health
Medicare Supplement and Select (1) $204,579 $ 85,128 $ 68,404
Long-term Care 11,167 7,658 4,546
Hospital Indemnity 1,456 1,722 1,888
---------------------------------------------
TOTAL ACCIDENT & HEALTH 217,202 94,508 74,838
---------------------------------------------
Life
Asset Enhancer (3)
7,248 7,333 6,108
SL 2000
2,479 2,051 1,466
---------------------------------------------
TOTAL LIFE
9,727 9,384 7,574
---------------------------------------------
TOTAL SENIOR MARKET 226,929 103,892 82,412
---------------------------------------------
CAREER AGENCY
Accident & Health
Disability Income 75,080 -- --
Hospital 21,614 -- --
Long-term Care 12,011 -- --
Other Accident & Health 10,440 -- --
Surgical 5,600 -- --
</TABLE>
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<TABLE>
<S> <C> <C> <C>
-------------------------------------------
TOTAL ACCIDENT & HEALTH 124,745 -- --
-------------------------------------------
LIFE 15,800 -- --
-------------------------------------------
TOTAL CAREER AGENCY 140,545 -- --
-------------------------------------------
SPECIAL MARKETS
Accident & Health
Individual Medical (1) 50,442 23,835 17,682
Other Accident & Health (2) 9,518 2,928 3,475
-------------------------------------------
TOTAL ACCIDENT & HEALTH 59,960 26,763 21,157
Life
Group Life 3,542 3,520 3,889
Brokerage (3) 7,311 8,294 9,434
-------------------------------------------
TOTAL LIFE 10,853 11,814 13,323
-------------------------------------------
TOTAL SPECIAL MARKET 70,813 38,577 34,480
-------------------------------------------
CONSOLIDATED
ACCIDENT & HEALTH 401,907 121,271 95,995
LIFE 36,380 21,198 20,897
===========================================
TOTAL CONSOLIDATED $438,287 $142,469 $116,892
===========================================
</TABLE>
(1) Includes $93,371 and $24,318 of Medicare Supplement and individual
medical insurance premium, respectively, acquired in connection with
the Penn Union acquisition.
(2) Business acquired by the Company that is not actively marketed.
(3) Included in the amounts shown are premiums for interest-sensitive
products. These amounts represent the portion of premium applied to the
cost of insurance (i.e. deposit premiums have been excluded).
The following table shows all outstanding account values for
interest-sensitive products as of December 31, 1999, 1998 and 1997. For these
products, the Company earns income on the spread between investment income on
the Company's invested assets and interest credited to these account balances.
<TABLE>
<CAPTION>
ACCOUNT VALUES As of December 31,
----------------------------------------------
1999 (1) 1998 1997
----------------------------------------------
(In thousands)
<S> <C> <C> <C>
Annuities $107,169 $ 89,262 $ 88,032
Universal Life 97,845 36,543 35,640
Asset Enhancer 33,651 29,081 21,414
----------------------------------------------
Grand Total $238,665 $154,886 $145,086
==============================================
</TABLE>
(1) The 1999 figures include $20.2 million and $60.9 million of Annuity and
Universal Life account values, respectively, acquired in connection with
the Penn Union acquisition.
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Accident & Health Insurance
The following table sets forth a summary of accident & health premium
revenues for the three years ended December 31, 1999:
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1999 (1) 1998 1997 (2)
------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Premium received on new policies
Written in current year $ 44,222 $ 22,470 $ 12,285
Premium received on policies
Written in prior years 189,104 96,225 62,803
------------------------------------------------
Total Accident & Health Premium $233,326 $118,695 $ 75,088
================================================
</TABLE>
(1) The 1999 figures include the premium revenues of the Penn Union
Companies from July 30, 1999, the date of its acquisition, which
amounted to $9,487 and $88,384 current year and renewal year,
respectively.
(2) The 1997 figures include the premium revenues of American Exchange from
December 4, 1997, the date of its acquisition, which amounted to $474
and $941 current year and renewal year, respectively.
Life Insurance and Annuities
The following table sets forth a summary of life premium revenues and
annuity considerations on first year and renewal basis for the three years ended
December 31, 1999, as determined in accordance with statutory accounting
principles ("SAP"). These amounts differ from the premiums reported in the
accompanying consolidated statement of operations, since under GAAP, the annuity
and universal life insurance policies are reported under the retrospective
deposit method prescribed by the Financial Accounting Standards Board ("FASB")
Statement No. 97 "Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the Sales of
Investments" ("Statement No. 97"). (i.e. under GAAP, amounts attributable to
asset accumulation and components of interest-sensitive products are excluded
from premiums. See Note 2e of Notes to Consolidated Financial Statements for
further information).
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1999 (1) (2) 1998 (2) 1997 (2) (3)
---------------------------------------------
(Amounts in thousands in accordance with statutory
accounting principles)
<S> <C> <C> <C>
Life Insurance
Premium received,
Policies written in current year $ 5,311 $ 9,013 $11,038
Premium received,
Policies written in prior year 26,202 14,627 14,280
-----------------------------------------
Total Life Premium 31,513 23,640 25,318
-----------------------------------------
Annuities
Consideration received,
Policies written in current year 6,261 10,353 10,817
Consideration received,
Policies written in prior years 874 1,032 988
-----------------------------------------
Total Annuity Consideration 7,135 11,385 11,805
-----------------------------------------
Total Consideration and Premium $38,648 $35,025 $37,123
=========================================
</TABLE>
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(1) The 1999 figures include the premium revenues of the Penn Union
Companies from July 30, 1999, the date of their acquisition, which
amounted to life insurance premiums and annuity considerations of
$1,219 for current year and $9,975 for renewal years.
(2) The life insurance amount includes premiums received on asset enhancer
business assumed from West Coast Life, which amounts to $2,317, $5,195
and $5,585 in 1999, 1998 and 1997, respectively.
(3) The 1997 figures include the premium revenues of American Exchange from
December 4, 1997, the date of its acquisition, which amounted to $23.
In 1999, no agent produced as much as 5% of the Company's accident &
health insurance premiums, life insurance or annuity premiums collected.
The Company, through its nine Insurance Subsidiaries, is licensed to
market its products, in varying combinations, in all fifty states, in the
District of Columbia and in all the provinces of Canada. The following table
highlights (by direct cash premium collected as reported to the regulatory
authorities for the full year of 1999) the principal marketing regions in which
the Company collects its premiums collected:
<TABLE>
<CAPTION>
State/Region Collected % Total
Premium
(In thousands)
<S> <C> <C>
Florida $ 66,159 15.5%
Texas 50,899 11.9%
Canada 47,690 11.2%
Indiana 30,202 7.1%
New York 26,309 6.2%
Wisconsin 21,707 5.1%
Ohio 17,893 4.2%
Pennsylvania 15,011 3.5%
North Carolina 12,576 2.9%
Missouri 10,117 2.4%
California 9,779 2.3%
Illinois 8,544 2.0%
Georgia 8,376 2.0%
-------- ------
Subtotal 325,262 76.1%
All other 101,906 23.9%
-------- ------
Total $427,168 100.0%
======== ======
</TABLE>
COMPETITION
The life and accident and health insurance industry in the United
States is highly competitive. The Company competes with other insurance and
financial services companies, including large multi-line organizations, both in
connection with the sale of insurance and asset accumulation products and in
acquiring blocks of business. Many of these organizations have been in business
for a longer period of time and have substantially greater capital and surplus,
larger and more diversified portfolios of life and health insurance policies,
larger agency sales operations and higher ratings. In addition, it has become
increasingly difficult for mid-size companies to compete effectively with their
larger competitors for insurance product sales in part as a result of heightened
consumer and agent awareness of the financial size of companies.
The Company believes it meets these competitive pressures by offering a
high level of service and accessibility to its field force and by developing
specialized products and marketing approaches. The Company also believes its
policies and premium rates are generally competitive with those offered by other
companies selling similar types of products in the same jurisdictions.
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Increased public and regulatory concerns regarding the financial
stability of insurance companies have resulted in policyholders placing greater
emphasis upon company ratings and have created some measure of competitive
advantage for insurance carriers with higher ratings. A. M. Best & Co. is
considered to be a leading insurance company rating agency. In evaluating a
company's financial and operating performance, A.M. Best reviews profitability,
leverage and liquidity as well as the quality of the book of business, the
adequacy and soundness of reinsurance programs, the quality and estimated market
value of assets, reserve adequacy and the experience and competence of
management. A.M. Best's ratings are based upon factors relevant to
policyholders, agents, insurance brokers and intermediaries and are not directed
to the protection of investors. A. M. Best has assigned a "B+" rating to
American Pioneer, American Progressive, Constitution Life, Pennsylvania Life and
Union Bankers. This rating means that in A. M. Best's opinion, these companies
have demonstrated "very good" overall performance when compared to standards it
has established and "B+" rated companies have a "good" ability to meet their
obligations to policyholders and are in the "Secure" category of all companies
rated by A. M. Best. A. M. Best has rated Peninsular Life "FPR5", which means
the company has a "good" ability to meet its obligations to policyholders, based
primarily on a quantitative evaluation of Peninsular Life's financial strength
and operating performance. A. M. Best does not rate the other Insurance
Subsidiaries.
The Insurance Subsidiaries are not known to be currently rated by the
Standard & Poors, Duff and Phelps or Moody's rating organizations. Although a
higher rating by A.M. Best or another insurance rating organization could have a
favorable effect on the Company's business, management believes that its
marketing has enabled, and will continue to enable, the Insurance Subsidiaries
to compete effectively.
UNDERWRITING PROCEDURES
Premiums charged on insurance products are based, in part, on
assumptions about expected mortality and morbidity experience. The Company has
adopted and follows detailed uniform underwriting procedures designed to assess
and quantify certain insurance risks before issuing individual life insurance,
certain health insurance policies and certain annuity policies to individuals.
These procedures are generally based on industry practices, reinsurer
underwriting manuals and the Company's prior underwriting experience. To
implement these procedures, the Insurance Subsidiaries employ an experienced
professional underwriting staff.
Applications for insurance are reviewed on the basis of the answers to
the application questions. Where appropriate to the type and amount of insurance
applied for and the applicant's age and medical history, additional information
is required, such as medical examinations, statements from doctors who have
treated the applicant in the past and, where indicated, special medical tests.
If deemed necessary, the Company uses investigative services to supplement and
substantiate information. For certain coverages, the Company may verify
information with the applicant by telephone. After reviewing the information
collected, the Company either issues the policy as applied for; issues the
policy with an extra premium charge due to unfavorable factors, issues the
policy excluding benefits for certain conditions, either permanently or for a
period of time, or rejects the application. For certain of its coverages, the
Company has adopted simplified policy issue procedures in which the applicant
submits an application for coverage typically containing only a few
health-related questions instead of a complete medical history. In New York and
some other states, certain of the Company's products, including Medicare
Supplement, are subject to "Community Rating" laws that severely limit or
prevent underwriting of individual applications. See "Regulation - Health Care
Reform".
INVESTMENTS
The following table summarizes the Company's investment portfolio as of
December 31, 1999 and 1998:
INVESTMENT PORTFOLIO
11
<PAGE> 12
<TABLE>
<CAPTION>
December 31,1999 December 31,1998
----------------------------------- -----------------------------------
Percent of Percent of
Carrying Value Total Carrying Value Total
(Fair Value) Carrying Value (Fair Value) Carrying Value
---------------- ---------------- ---------------- -----------------
(In thousands)
<S> <C> <C> <C> <C>
Fixed Maturity Securities:
U.S. Government and
Government agencies (1) $63,391 7.80% $ 6,598 4.01%
Mortgage backed (1) 153,316 18.87% 48,989 29.75%
Asset backed 64,496 7.94% 14,499 8.80%
Investment grade corporates 428,317 52.73% 61,355 37.26%
Non-investment grade corporates 8,040 0.99% 3,357 2.04%
-------- ------ -------- ------
Total fixed maturity securities 717,560 88.33% 134,798 81.86%
Cash and cash equivalents 58,753 7.23% 17,093 10.38%
Other Investments:
Policy loans 25,640 3.16% 7,276 4.42%
Equity securities 4,838 0.60% 1,020 0.61%
Mortgage loans 2,743 0.34% 4,457 2.71%
Other invested assets 2,763 0.34% 30 0.02%
-------- ------ -------- ------
Total invested assets $812,297 100.00% $164,674 100.00%
======== ====== ======== ======
</TABLE>
- ----------
(1) US Government and government agencies include GNMA Mortgage backed
securities.
The following table shows the distribution of the contractual
maturities of the Company's portfolio of fixed maturity securities by carrying
value as of December 31, 1999. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties:
CONTRACTUAL MATURITIES OF FIXED MATURITY SECURITIES
<TABLE>
<CAPTION>
Percent of
Carrying Total Fixed
Available for Sale Value Maturities
----------------- -----------------
(In thousands)
<S> <C> <C>
Due in 1 year or less $23,648 3.30%
Due after 1 year through 5 years 153,986 21.46%
Due after 5 years through 10 years 224,548 31.29%
Due after 10 years 67,146 9.36%
Asset backed securities 64,496 8.99%
Mortgage backed securities 183,736 25.60%
-------- ------
$717,560 100.00%
======== ======
</TABLE>
The following table shows the distribution by carrying value (which is
the estimate of fair value) of the Company's fixed maturity securities portfolio
according to the ratings assigned by Standard & Poor's Corporation, as of
December 31, 1999 and 1998:
12
<PAGE> 13
DISTRIBUTION OF FIXED MATURITY SECURITIES BY RATING
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
---------------------------------- ----------------------------------
(In thousands)
Carrying % of Carrying % of
Standard & Value Total Value Total
Poor's (Estimated Fixed (Estimated Fixed
Rating Fair Value) Investment Fair Value) Investment
--------------- ----------------- -------------- ------------------ -------------
<S> <C> <C> <C> <C>
AAA $ 260,911 36.36% $ 57,518 42.67%
AA 94,482 13.17% 14,782 10.97%
A 257,702 35.92% 32,444 24.07%
BBB 96,425 13.44% 26,698 19.80%
BB 5,390 0.75% 2,346 1.74%
B 2,255 0.31% - -
CCC 395 0.05% 1,010 0.75%
-------- ------ -------- ------
Total $717,560 100.00% $134,798 100.00%
======== ====== ======== ======
</TABLE>
At December 31, 1999 and 1998, 98.9% and 97.5%, respectively, of the
Company's fixed maturity investments were investment grade corporate fixed
maturity securities (i.e., those rated "BBB-" or higher by Standard & Poor's
Corporation or "Baa3" or higher by Moody's Investors Service). This included
approximately $153.3 million, at December 31, 1999 and $46.8 million, at
December 31, 1998, of collateralized mortgage obligations secured by residential
mortgages, representing approximately 21% and 35% of the Company's fixed
maturity portfolio at December 31, 1999 and 1998, respectively. Certain classes
of mortgage-backed securities are subject to significant prepayment risk,
because in periods of declining interest rates, mortgages may be repaid more
rapidly than scheduled, as individuals refinance higher rate mortgages to take
advantage of the lower rates. As a result, holders of mortgage-backed securities
may receive higher prepayments on their investments, which they may not be able
to reinvest at an interest rate comparable to the rate paid on such
mortgage-backed securities.
At December 31, 1999 and 1998, less than investment grade fixed
maturity securities had aggregate carrying values (held at fair value) of $8.0
million and $3.3 million, respectively, amounting to 1.1% and 2.5%,
respectively, of total investments and 0.9% and 1.2%, respectively, of total
assets. The Company's holdings of less than investment grade corporate fixed
maturity securities are diversified and the largest investment in any one such
security at December 31, 1999 was $2.0 million and at December 31,1998 was less
than $1.0 million, which was less than 0.2% and 0.4% of total assets as of
December 31, 1999 and 1998, respectively. The Company wrote down the value of
certain securities, considered to have been subject to an-other-than temporary
decline in value, by $0.6 million in both 1999 and 1998, which was included in
net realized gains (losses) on investments in the consolidated statements of
operations.
INVESTMENT INCOME
Investment income is an important part of the Company's total revenues
and profitability. Management cannot predict the impact that changes in future
interest rates will have on the Company's financial statements.
The following table shows the investment results of the Company's total
invested asset portfolio, for the three years ended December 31, 1999 (excluding
the $0.6 million realized gain on the sale of a
13
<PAGE> 14
non-operating subsidiary in 1997):
INVESTMENT RESULTS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------
1999 1998 1997
------------------------------------------
(In thousands)
<S> <C> <C> <C>
Total invested assets, end of period $ 812,297 $ 164,724 $ 159,429
Net investment income $ 29,313 $ 10,721 $ 10,023
Yield on average cash and investments 6.79% 6.67% 6.81%
Net realized investment gains (losses) on the sale of securities
(including other than temporary declines in market value) $ (241) $ 256 $ 563
</TABLE>
RESERVES
In accordance with applicable insurance regulations, the Company has
established, and carries as liabilities in its statutory financial statements,
actuarially determined reserves that are calculated to satisfy its policy and
contract obligations. Reserves, together with premiums to be received on
outstanding policies and contracts and interest thereon at certain assumed
rates, are calculated to be sufficient to satisfy policy and contract
obligations. The actuarial factors used in determining such reserves are based
on statutorily prescribed mortality tables and interest rates. Reserves are also
maintained for unearned premiums, for premium deposits, for claims that have
been reported and are in the process of being paid or contested and for
management's estimate for claims that have been incurred but have not yet been
reported.
The reserves reflected in the Company's consolidated financial
statements are calculated in accordance with GAAP. These reserves are determined
based upon the Company's best estimates of mortality and morbidity, persistency,
expenses and investment income. The Company uses the net level premium method
for all non-interest-sensitive products and the retrospective deposit method for
interest-sensitive products. GAAP reserves differ from statutory reserves due to
the use of different assumptions regarding mortality and morbidity, interest
rates and the introduction of lapse assumptions into the GAAP reserve
calculation.
(See Notes 2e and 2f to the Notes to the Consolidated Financial Statements).
REINSURANCE
Consistent with the general practice of the life insurance industry,
the Company reinsures portions of the coverage provided by its life insurance
products to unaffiliated insurance companies under various reinsurance
agreements. Such agreements allow the Company to write policies in amounts
larger than the risk it is willing to retain on any one life, to continue
writing a larger volume of new business and to limit or eliminate risk on
non-core or underperforming blocks of business. The mortality risk retention
limit on each policy varies generally between $25,000 and $250,000. The Company
cedes insurance primarily on an "automatic" basis and receives allowances from
its reinsurers ranging from 100% to 142% of the reinsurers' premium in the first
policy year and at varying rates up to 51% in renewal years.
In addition, the Company reinsures, to unaffiliated reinsurers, on a
quota share basis ranging between 25% and 100%, certain of its health business.
Under these various treaties, the Company performs all the underwriting and
administration and receives various allowances for commission and
14
<PAGE> 15
expenses. The Company has "excess of loss" reinsurance agreements with
unaffiliated insurance companies on its medical insurance policies to reduce the
liability on individual risks to amounts ranging between $50,000 and $250,000.
The Company is contingently liable to pay claims in the unlikely event
that a reinsurer fails to meet its obligations under the reinsurance agreement.
The Company's primary reinsurers are currently rated A+ (Superior) and A
(Excellent) by A.M. Best. In conjunction with the Penn Union Acquisition,
Peninsular entered into a coinsurance agreement with Occidental Life Insurance
Company of North Carolina ("Occidental"), a former affiliate, to cede 100% of
its direct business (primarily life and annuity business). Currently, Occidental
is rated B+ by A.M. Best. It is the intent of the parties to this agreement to
replace the coinsurance agreement with a full assumption agreement and
effectively transfer the business to Occidental. To the Company's knowledge,
none of the Company's reinsurers have been unable to pay any policy claims on
any reinsured business. The reinsurance agreements are subject to cancellation
on 90 days notice as to future business, but policies reinsured prior to such
cancellation remain reinsured as long as they remain in force. Management
believes that if its reinsurance agreements were canceled it would be able to
obtain other reinsurance arrangements on satisfactory terms to enable it to
continue writing new business.
INSURANCE SERVICES
WorldNet is a fee-based company whose primary services are to act as a
third party administrator and service provider on the health insurance products
of American Progressive, American Pioneer, American Exchange and other
unaffiliated insurance companies. WorldNet also provides valuable support to the
Company's underwriters, making telephone contact with potential insureds and
verifying potential insureds' information on life and accident & health
applications.
WorldNet's revenues for three years ended December 31, 1999 were as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1999 (2) 1998 1997
------- ---- ----
(In thousands)
<S> <C> <C> <C>
Pensacola administrative revenue (1) $7,444 $6,916 $5,318
Managed care and claims adjudication - 1,270 1,584
Travel and other assistance - 354 356
------ ------ ------
$7,444 $8,540 $7,258
====== ====== ======
</TABLE>
(1) Included in the 1999, 1998 and 1997 Pensacola revenue amount is $7,189,
$6,451 and $5,231, respectively, of fees earned from the Insurance
Subsidiaries, which fees were eliminated in the consolidated financial
statements.
(2) In November 1998, WorldNet entered into a joint venture with Security
Health Care Providers, Inc. contributing the managed care, claim
adjudication and travel assistance business. See below for further
discussion.
In November 1998, WorldNet transferred its managed care, claims
adjudication and travelers assistance business conducted at its Bay Harbor
Islands location to Security Health Care Providers, Inc. ("SHP"), a Delaware
corporation, in exchange for SHP common and preferred stock constituting 50% of
SHP's common and preferred stock outstanding after the closing of the
transaction and $574,800 in 14% convertible demand notes of SHP.
15
<PAGE> 16
SHP is in the business of providing information services to senior
citizens regarding, among other things, long-term care, assisted living
facilities nursing homes, medical care providers, and other services. SHP offers
group rate discounts for such services to persons who join various membership
programs of SHP.
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, which
generated administrative fees of $11.3 million in 1999. This acquisition is
expected to generate cost savings and strengthen the Company's administrative
capabilities while it expands its presence in the senior market and initiates
cross-selling opportunities between the Company's Brokerage and Career Agents
Segments.
REGULATION
General
The Insurance Subsidiaries, like other insurance companies, are subject
to the laws, regulations and supervision of the states in which they are
domiciled (New York in the case of American Progressive, Florida in the case of
American Pioneer, North Carolina in the case of Peninsular Life, Pennsylvania in
the case of Pennsylvania Life, Texas in the case of American Exchange,
Constitution Life, Marquette and Union Bankers and provincial and federal law of
Canada in the case of PennCorp Canada). Each company is also subject to
regulation and supervision in the Insurance Department in each of the other
states in which they are admitted and authorized to transact business. The
purpose of such laws and regulations is primarily to provide safeguards for
policyholders rather than to protect the interest of shareholders.
Such regulations and supervision by the Insurance Departments extend,
among other things, to the declaration and payment of dividends, the setting of
premium rates on health insurance policy forms, the form and content of policies
which may be offered, the granting and revocation of licenses to transact
business, establishment of reserve and capitalization requirements, permissible
investments, and the form and content of statutorily-mandated financial
statements.
Most states have enacted legislation or adopted administrative
regulations covering such matters as the acquisition of control of insurance
companies and transactions between insurance companies and the persons
controlling them. Additional requirements are often imposed as a condition of
approval of the acquisition of an insurance company. The nature and extent of
the legislation and administrative regulations now in effect vary from state to
state and most states require administrative approval of the acquisition of
control of an insurance company incorporated in the state, whether by tender
offer, exchange of securities, merger or otherwise, and require the filing of
detailed information regarding the acquiring parties and the plan of
acquisition. The approval of the domiciliary insurance department is also
required before a controlling interest (10% as to New York, North Carolina,
Pennsylvania and Texas, 5% as to Florida and 10% under Canadian law) of an
insurance company, or of a holding company that owns such an insurance company,
can be acquired or transferred. Because the administrative offices of
Constitution Life, Marquette and Union Bankers after the Penn Union Acquisition
would no longer be located in Texas, the Texas Insurance Department required
that these companies transfer their domicile to another state as a condition of
its approval of the Penn Union Acquisition. The Company is in the process of
complying with this requirement. Every insurance company that is authorized to
do business in the state and is a member of an "insurance holding company
system" is generally required to register as such with the insurance regulatory
authorities and file periodic reports concerning its relationships with the
insurance holding company. Material transactions between registered insurance
companies and members of the holding company system are required to be "fair and
reasonable" and in some cases are
16
<PAGE> 17
subject to administrative approval, and the books, accounts and records of each
party are required to be so maintained as to clearly and accurately disclose the
precise nature and details of the transactions.
Each Insurance Subsidiary is required to file detailed reports with the
insurance department of each state in which it is licensed to conduct business
and its books and records are subject to examination by each such insurance
department. In accordance with the insurance codes of their domiciliary states
and the rules and practices of the National Association of Insurance
Commissioners ("NAIC"), the Insurance Subsidiaries are examined periodically by
examiners of the companies' domiciliary states and by representatives (on an
"association" or "zone" basis) of the other states in which they are licensed to
do business. American Progressive was examined in 1999 for the three years ended
December 31, 1997 by the New York State Insurance Department and has received a
draft examination report. American Pioneer was examined in 1997 for the year
ended December 31, 1995 by the Florida Insurance Department, which examination
resulted in a final report with no material issues, and is currently under
examination for the four years ended December 31, 1999. American Exchange was
examined in 1999 for the year ended December 31, 1997 by the Texas Insurance
Department, which examination resulted in a final report with no material
issues. None of these reports contain any issues that management believes will
have a material impact on the Company.
The North Carolina Department of Insurance examined Peninsular during
1996 and 1997 for the three years ended December 31, 1995, which examination
resulted in a final report. All recommendations contained in the report were
resolved prior to Peninsular's acquisition by the Company.
The Pennsylvania Department of Insurance examined Pennsylvania Life in
1997 and 1998 for the three years ended December 31, 1996. The examination
report has not been issued to the Company. The Department issued written
recommendations at the completion of the field examination work. Management
believes that all of these recommendations were resolved prior to Pennsylvania
Life's acquisition by the Company.
The Texas Department of Insurance examined Union Bankers, Constitution
Life and Marquette during 1998 for the three years ended December 31, 1997.
Drafts of the examination reports were recently received and are under review
and discussion with the Department. The draft report raises a number of issues,
including a statutory reserve issue, all of which issues Company management
believes will be resolved without a material adverse effect on the Company.
Many states require deposits of assets for the protection of
policyholders either in those states or for all policyholders. At December 31,
1999 and 1998, securities totaling $32.5 million and $7.7 million, respectively
(approximately 4.6% and 4.7%, respectively, of the carrying value of the
Company's invested assets), were on deposit with various state treasurers or
custodians. Such deposits must consist of securities that comply with the
standards established by the particular state.
Codification of Statutory Accounting Practices
In 1998, the NAIC approved a codification of statutory accounting
principles, effective January 1, 2001, which will serve as a comprehensive and
standardized guide to statutory accounting principles. The adoption of the
codification will change, to some extent, the accounting practices that the
Company's Insurance Subsidiaries use to prepare their statutory financial
statements. Although the Company has not completed its assessment of the effect
of codification, it does not believe that such changes will have a material
adverse impact on the reported statutory financial condition of any such
subsidiaries.
Other Insurance Regulatory Changes
The NAIC and state insurance regulators have recently become involved
in a process of re-examining existing laws and regulations and their application
to insurance companies. This re-
17
<PAGE> 18
examination has focused on insurance company investment and solvency issues,
risk-based capital guidelines, assumption reinsurance, interpretations of
existing laws, the development of new laws, the interpretation of nonstatutory
guidelines, and the circumstances under which dividends may be paid. The NAIC
has encouraged states to adopt model NAIC laws on specific topics such as
holding company regulations and the definition of extraordinary dividends.
Furthermore, while the Federal government currently does not directly regulate
the insurance business, Federal legislation and administrative policies in a
number of areas, such as employee benefits regulation, age, sex and
disability-based discrimination, financial services regulation and Federal
taxation, can significantly affect the insurance business. It is not possible to
predict the future impact of changing regulation on the operations of the
Company and its Insurance Subsidiaries.
Since 1993 New York State has required that all health insurance sold
to individuals and groups with less than 50 employees, be offered on an open
enrollment and community rated basis. Such insurance may continue to be sold to
groups with more than 50 employees on an underwritten basis, with premium set to
reflect expected or actual results. The community rating aspect of the law
prohibits the use of age, sex, health or occupational factors in rating and
requires that the same average rate be used for all persons with the same policy
residing in the same location. The Medicare Supplement policies actively
marketed by American Progressive in New York State and some of its in force
business is subject to the community rating rules. The extension of such
legislation to Florida, Texas and other states where significant medically
underwritten health insurance is offered, might cause a reconsideration of the
Company's existing health care coverage offerings.
Dividend and Distribution Restrictions
Under the New York State Insurance Law, the declaration or payment of a
dividend by American Progressive requires the approval of the New York
Superintendent of Insurance, who, as a matter of present policy, would not
approve such payment until American Progressive had generated sufficient
statutory profits to offset its entire negative unassigned surplus, which was
approximately $8.6 million at December 31, 1999.
Under current Florida State insurance law, a life insurer may pay a
dividend or make a distribution without the prior written approval of the
department when:
a) the dividend is paid from that portion of the
accumulated and available surplus of the Company as
is derived from the net operating profits of its
business and its net realized capital gains;
b) the dividend is no more than the greater of (i) 10%
of the insurer's surplus as to policyholders derived
from net operating profits on its business and net
realized capital gains; or (ii) the insurer's entire
net operating profits and realized net capital gains
derived during the immediately preceding calendar
year;
c) the insurer will have surplus as to policyholders
equal to or exceeding 115% of the minimum required
statutory surplus as to policyholders after the
dividend or distribution is made; and
d) the insurer has filed notice with the department at
least 10 business days prior to the dividend payment
or distribution.
Under current North Carolina, Pennsylvania and Texas insurance law, a
life insurer may pay dividends or make distributions without the prior approval
of the Insurance Department as long as the dividend distributions out of
accumulated earnings, provided they do not exceed the greater of (i) 10% of the
insurer's surplus as to policyholders as of the preceding December 31st; or (ii)
the insurer's net gain
18
<PAGE> 19
from operations for the immediately preceding calendar year.
During 1999, the Penn Union companies were not able to pay dividends
without prior approval from their respective insurance regulatory authorities.
For 2000, the Penn Union Companies are able to pay dividends in accordance with
the laws of the states of domicile.
Under current Canadian law, a life insurer may pay a dividend after
such dividend declaration has been approved by its board of directors and upon
at least 10 days prior notification to the Superintendent of Financial
Institutions. In considering approval of a dividend, the board of directors must
consider whether the payment of such dividend would be in contravention of the
Insurance Companies Act of Canada.
Risk-Based Capital Requirements
The NAIC's risk-based capital ("RBC") requirements for insurance
companies take into account asset risks, interest rate risks, mortality and
morbidity risks and other relevant risks with respect to the insurer's business
and specify varying degrees of regulatory action to occur to the extent that an
insurer does not meet the specified RBC thresholds, with increasing degrees of
regulatory scrutiny or intervention provided for companies in categories of
lesser RBC compliance. The Company believes that its Insurance Subsidiaries are
adequately capitalized under the RBC requirements and that the thresholds will
not have any significant regulatory effect on the Company. However, were the
Insurance Subsidiaries' RBC position decline in the future, the Insurance
Subsidiaries' continued ability to pay dividends and the degree of regulatory
supervision or control to which they are subjected might be affected.
Guaranty Association Assessments
The Company's Insurance Subsidiaries can be required, under solvency or
guaranty laws of most states in which they do business, to pay assessments to
fund policyholder losses or liabilities of unaffiliated insurance companies that
become insolvent. These assessments may be deferred or forgiven under most
solvency or guaranty laws if they would threaten an insurer's financial strength
and, in most instances, may be offset against future state premium taxes. None
of the Insurance Subsidiaries has ever incurred any significant costs of this
nature. The likelihood and amount of any other future assessments are now
unknown and are beyond the control of the Company.
Health Care Reform
From time to time, numerous proposals have been introduced in Congress
and the state legislatures to reform the current health care system. Proposals
have included, among other things, employer-based insurance systems, subsidized
premiums for lower income people, "managed competition" among health plans,
programs to regulate policy availability, affordability of public and private
programs and expansion of Medicare to provide prescription drug benefits and
coverage to persons under age 65. Changes in health care policy could
significantly affect the Company's health insurance business.
In 1996, Congress enacted the Kennedy-Kassenbaum Act, which, among
other changes, restricts the ability of insurers to utilize medical underwriting
and pre-existing condition provisions in certain health insurance policies
issued to persons who were previously insured under qualifying policies. These
changes, which became effective in stages, may have an effect on some of the
Company's policies.
Whether or not Congress passes any further health reform measures in
the foreseeable future cannot be determined at the present time; however, it is
likely that health reform will continue to reappear on the legislative agenda in
the future. Such additional healthcare reform proposals also could require
standardization of major medical or long-term care coverages, impose mandated or
target loss ratios or rate regulation, require the use of community rating or
other means that further limit the ability of insurers
19
<PAGE> 20
to differentiate among risks, or mandate utilization review or other managed
care concepts to determine what benefits would be paid by insurers. These or
other proposals could increase or decrease the level of competition among health
insurers. In addition, changes could be made in Medicare that could necessitate
revisions in the Company's Medicare Supplement products. Other potential
initiatives, designed to tax insurance premiums or shift medical care costs from
government to private insurers, could have effects on the Company's business,
some of them adverse. The Company is unable to predict what changes to the
country's health care system will be enacted, if any, or their effects on the
Company's business. (See "Regulation").
Other Possible Changes in Legislation
Since insurance is a regulated business, with a high public profile, it
is always possible that legislation may be enacted which would have an adverse
effect on the Company's business.
An important portion of the Company's insurance business is the sale of
deferred annuities and certain life insurance products, which are attractive to
purchasers in part because policyholders generally are not subject to federal
income tax on increases in the value of an annuity or life insurance contract
until some form of distribution is made from the contract. From time to time,
Congress has considered proposals to reduce or eliminate the tax advantages of
annuities and life insurance, which, if enacted, might have an adverse effect on
the ability of the Company to sell the affected products in the future. The
Company is not aware that Congress is actively considering any legislation that
would reduce or eliminate the tax advantages of annuities or life insurance;
however, it is possible that the tax treatment of annuities or life insurance
could change by legislation or other means (for example, by Internal Revenue
Service regulations or judicial decisions).
Certain changes in insurance and tax laws and regulations could have a
material adverse effect on the operations of insurance companies. Specific
regulatory developments which could have a material adverse effect on the
operation of the insurance industry include, but are not limited to, the
potential repeal of the McCarran-Ferguson Act (which exempts insurance companies
from a variety of federal regulatory requirements), and adoption of laws, such
as those already in force in New York, limiting an insurer's ability to
medically underwrite and rate health insurance policies or to exclude
pre-existing conditions from coverage. In addition, the administration of such
regulations is vested in state agencies that have broad powers and are concerned
primarily with the protection of policyholders.
EMPLOYEES
At January 31, 2000, the Company employed approximately 700 employees,
none of whom are represented by a labor union. The Company is in process of
restructuring its operations that will result in the relocating, hiring and
severing of various employees. It is anticipated that at the conclusion of the
restructuring, the Company will have approximately 640 employees. The Company
considers its relations with its employees to be satisfactory.
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
The following table sets forth certain information concerning the
Directors and Officers of the Company:
20
<PAGE> 21
<TABLE>
<CAPTION>
POSITION WITH THE COMPANY, PRESENT PRINCIPAL OCCUPATION OR
NAME AGE EMPLOYMENT AND PAST FIVE-YEAR EMPLOYMENT HISTORY
- ----------------------------------------- ------- -------------------------------------------------------------------
<S> <C> <C>
Richard A. Barasch 46 Director, Chairman of the Board (since December 1997), President
and Chief Executive Officer of the Company; Director and
President of American Progressive; and Chairman of the Board of
all the other Insurance Subsidiaries and of WorldNet. Mr.
Barasch has been a director and executive officer of the Company
since July 1988, President since April 1991 and Chief Executive
Officer since June 15, 1995. He has held his positions with the
Company's subsidiaries since their acquisition or organization by
the Company.
Robert A. Waegelein, C.P.A. 39 Senior Vice President and Chief Financial Officer of the Company
(since October 1990) and of the Company's subsidiaries since they
were acquired or organized. Prior to that, Mr. Waegelein, a
certified public accountant, was employed by KPMG Peat Marwick
LLP, the Company's then independent public accountants, in
positions of increasing responsibility, finally serving as Senior
Manager.
Gary W. Bryant, C.P.A. 50 President, Chief Executive Officer and Director of American
Pioneer since April 1983 and Senior Vice President of the Company
since June 15, 1995. President and a director of American
Exchange (since December 1997), Constitution Life, Marquette,
Peninsular Life and Union Bankers (since March 2000) and Chairman
of the Board of AIAG (since January 2000).
William E. Wehner, C.L.U. 56 Executive Vice President and Chief Operating Officer of American
Progressive since May 1991. Senior Vice President and Chief
Marketing Officer of American Pioneer since November 1997. Mr.
Wehner was employed for over twenty years by Mutual Life
Insurance Company of New York and its affiliates in positions of
increasing responsibility, finally serving as Vice President for
Group Insurance.
Bradley E. Cooper 33 Mr. Cooper is a Partner and co-founder of Capital Z. Prior to
joining Capital Z, Mr. Cooper served in similar roles at
Insurance Partners, L.P. ("Insurance Partners") and International
Insurance Investors, L.P. Prior to the formation of Insurance
Partners, Mr. Cooper was a Vice President of International
Insurance Advisors, Inc. and was an investment banker in the
Financial Institutions Group at Salomon Brothers, Inc. Mr.
Cooper currently serves on the board of directors of Superior
National Insurance Group, Highlands Insurance Group, CERES Group,
Inc. and American Capital Access Holdings.
Susan S. Fleming 29 Ms. Fleming is a Principal of Capital Z. Prior to joining
Capital Z, Ms. Fleming served as Vice President of Insurance
Partners and was an investment banker in the Mergers and
Acquisitions Financial Institutions Group at
</TABLE>
21
<PAGE> 22
<TABLE>
<S> <C> <C>
Morgan Stanley & Co.. Ms. Fleming currently serves on the Board of
Directors of CERES Group, Inc.
Mark M. Harmeling 47 Director of the Company since July 1990 and Director of American
Progressive since December 1992. Mr. Harmeling has been
President of Bay State Realty Advisors since January 1994 and
previously President of Intercontinental Real Estate
Corporation, a real estate management and development company
for more than the past five years. Mr. Harmeling is also a
Director of the following companies: Rochester Shoetree
Corporation (since 1988) and Applied Extrusion Technologies
(since 1987).
Bertram Harnett 76 Elected director of the Company and American Pioneer in June 1996
and had been a director of the Company previously (July 29, 1988
to February 9, 1989). Mr. Harnett is President of the law firm
of Harnett Lesnick & Ripps P.A., Boca Raton, Florida and its
predecessors since 1988 and a practicing lawyer since 1948. He
is the author of treatises on insurance law and is a former
Justice of New York State Supreme Court.
Patrick J. McLaughlin 41 Director of the Company since January 1995. Mr. McLaughlin has
been a Managing Director of Emerald Capital Group, Ltd., an asset
management and consulting firm specializing in the insurance
industry, since April 1993. Prior to that he was an Executive
Vice President and Chief Investment Officer of Life Partners
Group, Inc. (April 1990 to April 1993), Managing Director of
Conning & Company (August 1989 to April 1990) and Senior Vice
President and Chief Investment Officer of ICH Corporation (March
1987 to August 1989).
Robert A. Spass 43 Mr. Spass is a Partner and co-founder of Capital Z. Prior to
founding Capital Z, Mr. Spass was the Managing Partner and
co-founder of Insurance Partners. Prior to the formation of
Insurance Partners, Mr. Spass was President and CEO of
International Insurance Advisors Inc. Prior to that, Mr. Spass
was a Director of Investment Banking at Salomon Brothers and a
Senior Manager for Peat Marwick Main & Co Mr. Spass serves on
the board of directors of Highlands Insurance Group, Superior
National Insurance Group, CERES Group, Inc. and MMI Companies.
Richard Veed 47 Director of the Company since April 25, 1997. Mr. Veed has been
a Managing Partner of AAM Investment Banking Group, Ltd. Since
October 1993. Prior to that, he was President of Guaranty
Reassurance Corp. from September 1992 to May 1993 and a Partner
at Arthur Andersen & Co. from 1987 to August 1992. He is also a
Director of HomeVest Financial Group, Inc.
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C> <C>
Robert F. Wright 74 Director of the Company since June 1998. Mr. Wright has been
President of Robert F. Wright Associates, Inc. since 1988. Prior
to that Mr. Wright was a senior partner of the public accounting
firm of Arthur Andersen LLP from 1960 to 1988. Mr. Wright is
Director of Hanover Direct, Inc., Reliance Standard Life
Insurance Company and its affiliates, Deotexis, Inc., GVA
Williams, The Navigators Group, Inc., Quadlogic Controls Corp.,
and U.S. Timberlands Company, L.P.
</TABLE>
All of the executive officers listed above devote their full business
time to the Company. All of the officers and directors of the Company and its
subsidiaries are elected annually for one-year terms. All officers and directors
hold office until their successors are duly elected and qualified.
The By-laws of the Company provide that the Board of Directors shall
set the number of directors. The Company's Board of Directors currently consists
of nine directors.
The Board of Directors has an Audit Committee, which also acts as a
Transactions Committee, consisting of Messrs. Harmeling, McLaughlin, Spass, Veed
and Wright; a Compensation Committee consisting of Ms. Fleming and Messrs.
Harmeling and Veed; and an Executive Committee consisting of Messrs. Barasch,
Cooper, Harnett, McLaughlin and Spass. The Audit Committee is empowered to
consult with the Company's independent auditors with respect to their audit
plans and to review their audit report and the accompanying management letters
and, as the Transactions Committee, reviews and makes recommendations to the
Board on certain capital transactions entertained by the Company. The
Compensation Committee reviews and recommends compensation, including incentive
stock option grants, of officers of the Company. The Executive Committee has the
authority to act between Board meetings on behalf of the Board, on all matters
allowed by law.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company and Wand Partners L.P., an affiliate of Wand/Universal
Investments L.P., I and II, the holders of all of the outstanding Series B
Preferred Stock (which was converted to common stock in 1999), entered into a
financial advisory agreement, dated December 30, 1994, under which such Wand
affiliate rendered advisory services to the Company and was paid a fee of
$100,000 per year for such services reduced by any director's fees paid to the
director designated by Wand. Such services and fees were to continue as long as
Wand owns 500,000 shares of Common Stock or common stock equivalent. In
connection with the Capital Z Transaction, Wand agreed to terminate this
advisory agreement as of December 31, 1999 and Wand was paid $100,000 in 1999.
Bertram Harnett, a director of the Company, is a shareholder in
Harnett, Lesnick & Ripps P.A. of Boca Raton, Florida, which was paid $524,257 in
1999 on account of its legal services to, as well as reimbursement for
disbursements made on behalf of, the Company.
Robert F. Wright, a director of the Company, was paid $25,661 on
account of his services as Chairman of the Audit Committee, as well as
reimbursement for disbursements made on behalf of the Company.
ITEM 2 - PROPERTIES
At December 31, 1999, the Company had the following leases from
unaffiliated parties: (i) approximately 9,000 square feet of office space in Rye
Brook, New York, under a lease expiring in October 2004; (ii) 18,000 square feet
in Orlando, Florida, under a lease expiring in February 2002; (iii)
23
<PAGE> 24
32,000 square feet in Pensacola, Florida, under a lease expiring in November
2002, with two renewals at the Company's option for a period of five years each;
(iv) 4,000 square feet in Bay Harbor, Florida, under a lease expiring August
2000; (v) 3,000 square feet in Richardson, Texas, under a lease expiring in
March 2004; (vi) 67,000 square feet in Raleigh, North Carolina, under a lease
expiring July 2003; (vii) 22,000 square feet in Mississauga, Ontario, Canada,
under a lease expiring April 2003. These leases represent the operating offices
of American Progressive, American Pioneer, WorldNet, American Exchange,
Pennsylvania Life, and PennCorp of Canada, respectively, and carry an aggregate
annual rental of approximately $1.8 million. The company also leases a smaller
office in Andalusia, Alabama, for an aggregate annual rental of approximately
$17,000.
ITEM 3 - LEGAL PROCEEDINGS
No reportable litigation was pending at December 31, 1999. The Company
is party to various lawsuits arising out of the ordinary conduct of its
business, none of which, the Company believes, would have a material adverse
effect upon the business of the Company if it were to be adversely determined.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted by the Company to a vote of
stockholders, through the solicitation of proxies or otherwise, during the
fourth quarter of the fiscal year for which this report is filed.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF PUBLICLY TRADED SECURITIES
The Company's Common Stock has been traded in the over-the-counter
market and quoted on the Nasdaq National Market under the symbol UHCO since May
12, 1983. The following table sets forth the high and low sales prices per share
of Common Stock as reported on the Nasdaq National Market for the periods
indicated.
<TABLE>
<CAPTION>
Common Stock
------------------
High Low
---- ---
<S> <C> <C>
1997
---------------------------------
First Quarter 2 31/64 1 3/4
Second Quarter 2 5/8 1 3/4
Third Quarter 2 5/8 1 7/8
Fourth Quarter 3 1/4 2
1998
---------------------------------
First Quarter 3 2 3/8
Second Quarter 2 15/16 2 5/16
Third Quarter 2 7/8 2 1/8
Fourth Quarter 2 7/8 2
1999
---------------------------------
First Quarter 4 3
Second Quarter 4 3 2/64
Third Quarter 5 3/16 3 3/38
Fourth Quarter 4 13/16 3 3/8
2000
---------------------------------
</TABLE>
24
<PAGE> 25
First Quarter (through March 1) 4 1/2 3 3/4
As of March 1, 2000, there were approximately 1,500 holders of record
of the Common Stock. On March 1, 1999, the bid and ask sales prices for the
Common Stock were $3 7/8 and $4.
DIVIDENDS
The Company has neither declared nor paid dividends on its Common Stock
and no such dividends are likely in the foreseeable future. Any future decision
to pay dividends will be made by the Board of Directors in light of conditions
then existing, including the Company's results of operations, financial
condition and requirements, loan covenants, insurance regulatory restrictions,
business conditions and other factors. In addition, the ability of the Company
to pay cash dividends, if and when it should wish to do so, may depend on the
ability of its subsidiaries to pay dividends to the Company. See "Regulation
Dividend and Distribution Restrictions".
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below should be read
in conjunction with the consolidated financial statements of the Company, the
related notes thereto and the auditors' report thereon and "Management's
Discussion and Analysis of Financial Condition and Results of Operations". The
selected consolidated financial data presented below as of, and for the year
ended December 31, 1995 are derived from the consolidated financial statements
of the Company, which have been audited and reported upon by KPMG LLP,
independent certified public accountants. The selected consolidated financial
data presented below as of and for each of the years ended December 31, 1996
through 1999, have been audited and reported upon by Ernst & Young LLP,
independent certified public accountants.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------------------------------------
INCOME STATEMENT DATA: 1999 (4) 1998 1997 (5) 1996 (6) 1995
--------- --------- --------- --------- ---------
(In thousands, except for per share data)
<S> <C> <C> <C> <C> <C>
Direct premium and policyholder fees $ 252,553 $ 131,044 $ 99,339 $ 55,287 $ 46,145
Reinsurance premium assumed 1,751 998 998 10,522 8,866
Reinsurance premium ceded (138,827) (89,546) (62,623) (25,664) (18,200)
--------- --------- --------- --------- ---------
Net premium and other policyholder fees
115,477 42,496 37,714 40,145 36,811
Net investment income 29,313 10,721 10,023 9,850 8,945
Realized gains (241) 256 1,133 240 674
Fee income 3,542 2,553 2,368 2,872 3,137
Other income 45 63 92 280 244
Total revenues 148,136 56,089 51,330 53,387 49,811
Total benefits, claims and other
Deductions 132,080 52,157 48,119 53,014 47,161
Operating income before taxes 16,056 3,932 3,211 373 2,650
Net income after taxes 9,813 2,608 2,119 104 2,642
Net income applicable to common
Shareholders (1) 9,633 2,174 1,870 104 2,642
Earnings per share:
Basic $ 0.42 $ 0.29 $ 0.26 $ 0.01 $ 0.42
Diluted $ 0.34 $ 0.20 $ 0.18 $ 0.18 $ 0.25
</TABLE>
25
<PAGE> 26
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------
BALANCE SHEET DATA: 1999 1998 1997 1996 1995
---------- -------------- -------------- -------------- -------------
(In thousands, except for per share data)
<S> <C> <C> <C> <C> <C>
Total cash and investments $ 812,297 $ 164,674 $ 159,429 $ 144,681 $ 135,603
Total assets 1,153,421 283,302 272,575 242,237 182,994
Policyholder account balances 238,665 154,886 145,085 134,539 118,609
Loan payable 70,000 4,750 3,500 -- --
Series C Preferred Stock -- 5,168 5,168 -- --
Series D Preferred Stock -- 2,250 -- -- --
Series B Preferred Stock -- 4,000 4,000 4,000 4,000
Stockholders' equity 133,965 28,318 25,706 22,079 24,114
Stockholders' equity per share of
Common Stock :
Basic (2) $ 2.92 $ 3.18 $ 2.96 $ 2.53 $ 2.89
Diluted (3) $ 2.91 $ 2.59 $ 2.39 $ 2.12 $ 2.30
</TABLE>
- ------------------------
(1) After provision for Series C Preferred Stock dividends of $180, $433
and $250 for the years ended December 31, 1999, 1998 and 1997,
respectively.
(2) Basic stockholders' equity per share of common stock represents
stockholders' equity less the statement value of Series B Preferred
Stock divided by outstanding shares of common stock.
(3) Diluted stockholders' equity per share of common stock represents
stockholders' equity plus the statement value of the Series C Preferred
Stock, redemption accrual on the Series C Preferred Stock, the Series D
Preferred Stock, the proceeds from the exercise of outstanding options
and warrants divided by outstanding shares of common stock plus the
stock issued pursuant to the conversion of the Series B, Series C and
Series D Preferred Stock and the exercise of the options and warrants
outstanding.
(4) Includes the results of the Penn Union Companies since its acquisition
on July 30, 1999. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
(5) Includes the results of American Exchange since its acquisition on
December 1, 1997. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
(6) Includes the results of the First National block of business since its
acquisition on October 1, 1996.
ITEM 7 - 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.
26
<PAGE> 27
Universal is a life and accident and health insurance holding company,
and consists of American Progressive, American Pioneer, American Exchange,
WorldNet and 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 six insurance companies (the "Penn Union
Companies"): Pennsylvania Life, PennCorp Canada, Peninsular, Union Bankers,
Constitution and Marquette as well as certain other assets (the "Penn Union
Acquisition").
The purchase price of $130.5 million in cash was financed with $92.8
million of proceeds from the sale of common stock (See - "Share Purchase
Agreement with Capital Z Financial Services Fund II, L.P." and Note 2 to Notes
to Consolidated Financial Statements) and from the $70 million term loan portion
of an $80 million credit facility entered into on July 30, 1999. None of the $10
million revolving loan facility included in this credit facility was drawn at
closing nor has been drawn upon 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 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. In addition to the purchase price, the Company incurred costs
totaling $17.5 million including a transition accrual of $10.0 million. 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 $10.0 million,
which will be amortized on a straight line basis over a ten year period.
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired in the Penn Union Transaction 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.
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 (July
31, 2000). The Company will report changes to the accrued acquisition expenses
in future financial statements. The Company expects the consolidation to be
completed in early 2001.
The consolidated results of operations include the results of the Penn
Union Companies from the date of acquisition.
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 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 and Long-term Care. The
agents in this segment also distribute universal life products.
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
27
<PAGE> 28
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 company that processes 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 Insurance Services and Corporate.
The new Senior Market Brokerage Segment includes substantially all of
the Senior Market Accident and Health Insurance business as well as a portion of
the business previously included in the Life Insurance segment that was produced
by the brokerage agents.
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 business included in the Insurance Services and Corporate Segment
has not changed significantly from the prior year.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999 AND 1998
Consolidated net income after Federal income taxes increased by $7.2
million to $9.8 million ($0.34 per share) in 1999, compared to $2.6 million
($0.20) in 1998. Operating income before income tax increased by $12.2 million
to $16.1 million in 1999 compared to $3.9 million in 1998.
The Senior Market Brokerage segment nearly doubled its results,
increasing by $1.5 million in addition to the $11.6 million added by the
acquisition of the Career Agency segment. The Special Markets segment improved
its results by $3.0 million primarily as a result of the business acquired in
the Penn Union Acquisition. These are offset by a reduction of $3.9 million in
the results from the Non-insurance segment. Discussion of the details by segment
follows.
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 years ended December 31, 1999 and 1998 include the results of
the sales of products such as Medicare Supplement, Long Term Care and Senior
Life products through this distribution channel.
REVENUES. Total revenues for the Senior Market Brokerage Segment
increased approximately $5.9 million to approximately $30.5 million for the year
ended December 31, 1999, compared to total revenues of approximately $24.6
million in the prior year.
28
<PAGE> 29
Gross premium and policyholder fees earned and reinsurance assumed
In the year ended December 31, 1999, the Senior Market Brokerage
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $104.0 million, a $17.3 million increase over the $86.7
million amount in 1998. The gross earned premiums on the Company's senior market
products increased as follows:
<TABLE>
<CAPTION>
1999 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
----------- ---------------- --------------
(in millions) (in millions)
<S> <C> <C>
Medicare Supplement $ 19.45 $ 40.21
Freedom Care 2.40 5.76
Hospital Indemnity, Home Health Care and 0.43 4.62
Nursing Home
Senior Life 0.16 0.79
-------- --------
Totals $ 22.44 $ 51.38
======== ========
</TABLE>
These increases totaled $22.44 million and were offset by the decrease
in premiums on the products acquired in connection with the acquisitions of the
business of First National and Dallas General, which products were terminated.
Premiums earned from these products decreased $5.16 million to $52.60 million.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December
31, 1999 for the Senior Market Brokerage Segment amounted to $74.4 million, a
$11.5 million increase from the 1998 amount of $62.9 million. Details of the
changes in reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM 1999 TOTAL
DESCRIPTION INCREASE (DECREASE) PREMIUM CEDED
----------- ------------------- -------------
(in millions) (in millions)
<S> <C> <C>
Business acquired:
First National $(3.76) $34.62
Dallas General (0.25) 8.16
Medicare Supplement 14.38 27.27
Freedom Care 0.72 1.85
Hospital Indemnity, Home Health Care and
Nursing Home 0.37 2.08
------ ------
Other lines 0.08 0.41
Totals $11.54 $74.39
====== ======
</TABLE>
Investment related revenue
Net investment income of the Brokerage Agent Segment increased $0.2
million to $0.9 million for the year ended December 31, 1999, compared to $0.7
million in 1998. This increase is attributable to the increase in invested
assets outstanding in this segment during 1999 compared to 1998. Realized gains
on investments decreased slightly from the prior year.
29
<PAGE> 30
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Brokerage Agent Segment increased approximately $4.4 million
to $27.4 million for the year ended December 31, 1999, compared to $23.0 million
for the year ended December 31, 1998.
Claims and other benefits increased $5.3 million to $18.6 million for
the year ended December 31, 1999 compared to $13.3 million in 1998. The change
in reserves for the year ended December 31, 1999 amounted to an increase of $3.6
million compared to an increase of $4.3 million in 1998 generating a variance of
$0.7 million. These increases in claims and change in reserves are the result of
the $5.7 million increase in net premiums earned for the year ended December 31,
1999 discussed above.
The change in deferred acquisition costs increased by $1.0 million for
the year ended December 31, 1999 compared to 1998. The amount of acquisition
costs capitalized increased $1.4 million from $3.9 million in 1998 to $5.3
million in 1999. The overall increase in capitalized costs is the result of the
increase in new premium production in the year ended December 31, 1999 compared
to 1998. The amortization of deferred acquisition costs increased $0.4 million
from $1.0 million in 1998 to $1.4 million in 1998.
Commissions in the Brokerage Agent Segment increased $4.2 million in
the year ended December 31, 1999 to $18.3 million, compared to $14.1 million in
1998. This increase is the direct result of the $17.3 million increase in gross
premium discussed above. Commissions and expense allowances on reinsurance ceded
increased $4.4 million in the year ended December 31, 1999 to $23.2 million,
compared to $18.8 million in 1998. This increase is the direct result of the
$11.5 million increase in reinsurance premium ceded discussed above.
Other operating costs and expenses increased $1.8 million in the year
ended December 31, 1999 to $13.9 million, compared to $12.1 million in 1998 due
in part to the increase in expenses incurred in generating new business ($0.8
million) as well as the increase in taxes associated with the growth in new
business in this segment. The ratio of general expenses to gross premium has
remained at 13%.
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 revenues for the Career Agent segment amounted to $68.0
million of which $44.2 million was generated by Pennsylvania Life U.S. and $23.8
million was generated by the Canadian operations. Gross premium totaled $56.9
million, $36.6 million derived by Pennsylvania Life U.S. and $20.4 million
derived from the Canadian operations. The Company reinsures a portion of these
premiums to outside parties. Total ceded premiums for the five months since
acquisition were $0.2 million at the Canadian operations and $1.1 million at
Pennsylvania Life U.S.. Investment income of $12.1 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 $56.4 million for the five months
ended December 31, 1999.
Claims and other benefits amounted to $29.2 million for the five months
ended December 31, 1999. Of this amount, $23.0 million related to claims
incurred at Pennsylvania Life U.S. and $6.2 million related to the Canadian
operations. The change in reserves for the five months ended December 31, 1999
amounted to $1.2 million, representing an increase of 0.3% since the date of
acquisition.
30
<PAGE> 31
Deferred acquisition costs increased $2.9 million for the five months
ended December 31, 1999. Acquisition costs capitalized at Pennsylvania Life U.S.
totaled $1.6 million offset by amortization of $34 thousand. Canadian costs
capitalized amounted to $1.3 million.
Commissions in the Career Agent Segment for the five months ended
December 31, 1999 amounted to $15.0 million, of which $10.4 million related to
Pennsylvania Life U.S. Commissions and expense allowances on reinsurance ceded
totaled $0.8 million in the five months ended December 31, 1999.
Other operating costs and expenses totaled $14.7 million for the five
months ended December 31, 1999. The ratio of general expenses to gross premium
for the period was 26%.
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 years ended December 31, 1999 and 1998 include the results of the sales
of such products.
REVENUES. Total revenues for the Special Markets Segment increased
approximately $17.2 million to approximately $46.5 million for the year ended
December 31, 1999, compared to total revenues of approximately $29.3 million in
the prior year.
Gross premium and policyholder fees earned and reinsurance assumed
In the year ended December 31, 1999, the Special Markets Segment gross
premium and policyholder fees earned (including reinsurance assumed) amounted to
$93.4 million, a $48.1 million increase over the $45.3 million amount in 1998.
The gross earned premiums on the Company's special market products increased as
follows:
<TABLE>
<CAPTION>
1999 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
----------- ---------------- --------------
<S> <C> <C>
Acquired Businesses: (in millions) (in millions)
Constitution Life Insurance $ 6.93 $ 6.93
Union Bankers 43.78 43.78
Peninsular 1.26 1.26
International Medical 0.50 5.24
Group Health Products 1.98 4.75
-------- --------
Totals $ 54.45 $ 61.96
======== ========
</TABLE>
These increases totaled $54.5 million and were offset by the decrease
in premiums on the products terminated and not currently marketed by the Company
as follows:
<TABLE>
<CAPTION>
1999 TOTAL
DESCRIPTION PREMIUM DECREASE PREMIUM EARNED
----------- ---------------- --------------
(in millions) (in millions)
<S> <C> <C>
Life and annuity products $1.50 $14.75
Major Medical 4.25 12.83
Other health products 0.60 3.9
-------- --------
Totals $ 6.35 $ 31.39
======== ========
</TABLE>
31
<PAGE> 32
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December
31, 1999 for the Special Markets Segment amounted to $63.1 million, a $36.4
million increase from the 1998 amount of $26.7 million. Details of the changes
in reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM 1999 TOTAL
DESCRIPTION INCREASE (DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------ -------------
(in millions) (in millions)
<S> <C> <C>
Business acquired
Constitution $6.83 $6.83
Union Bankers 31.31 31.31
Peninsular 0.36 0.36
Life and annuity products 0.19 7.43
Major Medical (4.33) 8.27
International Medical 0.68 4.95
Other lines 1.34 3.96
------- -------
Totals $ 36.38 $ 63.11
======= =======
</TABLE>
Investment related revenue
Net investment income of the Special Markets Segment increased $6.2
million to $16.2 million for the year ended December 31, 1999, compared to $10.0
million in 1998. This increase is attributable to the increase in invested
assets outstanding in this segment during 1999 compared to 1998. Realized gains
on investments decreased $0.5 million from the prior year due to the write down
of a permanently impaired security of $0.6 million.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Special Markets Segment increased approximately $14.3 million
to $42.2 million for the year ended December 31, 1999, compared to $27.9 million
for the year ended December 31, 1998.
Claims and other benefits increased $12.8 million to $25.2 million for
the year ended December 31, 1999 compared to $12.4 million in 1998. The change
in reserves for the year ended December 31, 1999 amounted to a decrease of $4.5
million compared to an increase of $1.1 million in 1998 generating a variance of
$5.5 million. These increases in claims and change in reserves are the result of
the $11.7 million increase in net premiums earned for the year ended December
31, 1999 discussed above. Interest credited to policyholders increased $1.4
million from $7.2 million in 1998 to $8.6 million in 1999. Approximately $0.8
million of the increase relates to the acquired companies.
The change in deferred acquisition costs decreased by $0.6 million for
the year ended December 31, 1999 compared to 1998. The amount of acquisition
costs capitalized decreased $1.5 million from $4.7 million in 1998 to $3.2
million in 1999. The deferred acquisition costs decreased despite an 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 $0.3 million from $4.0
million in 1998 to $3.7 million in 1999. This decrease is the result of the
decrease in the asset balance.
32
<PAGE> 33
Commissions in the Special Markets Segment increased $0.3 million in
the year ended December 31, 1999 to $13.3 million, compared to $13.0 million in
1998. This increase is due largely to the acquisition of the Penn Union
Companies which increase was offset by a decrease in some of the life products
no longer marketed. Commissions and expense allowances on reinsurance ceded
increased $2.6 million in the year ended December 31, 1999 to $15.0 million,
compared to $12.4 million in 1998. This increase is largely due to the
acquisition of the Penn Union Companies.
Other operating costs and expenses increased $5.8 million in the year
ended December 31, 1999 to $14.0 million, compared to $8.2 million in 1998. 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. The ratio of general expenses to gross premium has decreased from
approximately 19% to approximately 15%.
INSURANCE SERVICES AND CORPORATE
The Non Insurance Businesses Segment consists of WorldNet, Quincy, PFI,
Inc ("PFI")(an internal servicing company acquired in July, 1999), a minority
interest in Security Health and the Parent Company.
Fees and other income increased $0.8 million due to increase in income
at WorldNet. General expenses increased $4.8 million from $1.3 million in 1998
to $6.1 million in 1999. This increase is due to an increase in interest expense
of $2.6 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 $1.0 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.
YEARS ENDED DECEMBER 31, 1998 AND 1997
The results of operations for the years ended December 31, 1998 and
1997 include the operations of American Progressive, American Pioneer and
WorldNet for the year ended December 31, 1997 and the operations of American
Exchange for the period December 4, 1997, the date of its acquisition, to
December 31, 1997. All references to per share amounts are on a diluted basis.
For the year ended December 31, 1998, the Company earned net income
after Federal income taxes of $2.6 million ($0.20 per share) compared to $2.1
million ($0.18 per share) in the prior year. Operating income before Federal
income taxes amounted to $3.9 million for the year ended December 31, 1998
compared to $3.2 million in the prior year. During 1997, the Company sold
Amerifirst Insurance Company, an inactive insurance company, for $3.4 million
and realized a pretax gain of $0.6 million ($0.4 million after tax or $0.03 per
share).
SENIOR MARKET BROKERAGE SEGMENT
REVENUES. Total revenues for the Senior Market Brokerage Segment
increased approximately $8.0 million to approximately $24.6 million for the year
ended December 31, 1998, compared to total revenues of approximately $16.6
million in the prior year.
Gross premium and policyholder fees earned and reinsurance assumed
In the year ended December 31, 1998, the Senior Market Brokerage
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $86.7 million, a $24.1 million increase over the $62.6
million amount in 1997. The gross earned premiums on the Company's senior market
products increased as follows:
33
<PAGE> 34
<TABLE>
<CAPTION>
1998 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
--------------------------------------------- ---------------- --------------
(in millions) (in millions)
<S> <C> <C>
Medicare Supplement $ 14.40 $ 20.76
Dallas General 10.44 10.44
Hospital Indemnity, Home Health Care and
Nursing Home 0.67 4.19
Freedom Care 2.27 3.37
Other products 0.23 0.63
-------- ---------
Totals $ 28.01 $ 39.39
======== =========
</TABLE>
These increases totaled $39.4 million and were offset by the decrease
in premiums on the products terminated and not currently marketed by the Company
as follows:
<TABLE>
<CAPTION>
1999 TOTAL
DESCRIPTION PREMIUM DECREASE PREMIUM EARNED
--------------------------------------------- ---------------- --------------
(in millions) (in millions)
<S> <C> <C>
First National assumed business $ 3.95 $ 47.32
--------- ----------
Totals $ 3.95 $ 47.32
========= ==========
</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 year ended December
31, 1998 for the Senior Market Brokerage Segment amounted to $62.9 million, a
$16.3 million increase from the 1997 amount of $46.6 million. Details of the
changes in reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM 1999 TOTAL
DESCRIPTION INCREASE (DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------ -------------
(in millions) (in millions)
<S> <C> <C>
Business acquired
First National $(3.37) $38.38
Dallas General 8.41 8.41
Medicare Supplement 9.71 12.89
Freedom Care 0.77 1.14
Hospital Indemnity, Home Health Care and
Nursing Home 0.59 1.71
Other lines 0.22 0.33
------ ------
Totals $16.33 $62.86
====== ======
</TABLE>
Investment related revenue
Net investment income of the Brokerage Agent Segment increased $0.1
million to $0.7 million for the year ended December 31, 1998, compared to $0.6
million in 1997. This increase is attributable to the increase in invested
assets outstanding in this segment during 1999 compared to 1998. Realized gains
on investments decreased slightly from the prior year.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Brokerage Agent Segment increased approximately $6.9 million
to $23.0 million for the year ended December 31, 1998, compared to $16.1 million
for the year ended December 31, 1997.
34
<PAGE> 35
Claims and other benefits increased $2.6 million to $13.3 million for
the year ended December 31, 1998 compared to $10.7 million in 1997. The change
in reserves for the year ended December 31, 1998 amounted to an increase of $4.3
million compared to an increase of $0.5 million in 1997 generating a variance of
$3.8 million. These increases in claims and change in reserves are the result of
the $7.7 million increase in net premiums earned for the year ended December 31,
1998 discussed above.
The change in deferred acquisition costs increased by $1.2 million for
the year ended December 31, 1998 compared to 1997. The amount of acquisition
costs capitalized increased $1.5 million from $2.4 million in 1997 to $3.9
million in 1998. The overall increase in capitalized costs is the result of the
increase in new premium production in the year ended December 31, 1998 compared
to 1997. The amortization of deferred acquisition costs increased $0.4 million
from $0.6 million in 1998 to $1.0 million in 1998. This increase is the result
of the increase in new premium production.
Commissions increased $3.8 million in the year ended December 31, 1998
to $14.1 million, compared to $10.3 million in 1997. This increase is the direct
result of the $24.1 million increase in gross premium discussed above.
Commissions and expense allowances on reinsurance ceded increased $6.7 million
in the year ended December 31, 1998 to $18.8 million, compared to $12.2 million
in 1997. This increase is the direct result of the $16.3 million increase in
reinsurance premium ceded discussed above.
Other operating costs and expenses increased $3.6 million in the year
ended December 31, 1998 to $12.1 million, compared to $8.5 million in 1997 due
in part to the increase in expenses incurred in generating new business ($1.5
million) as well as the increase in third party administration fees and taxes
associated with the growth in new business in this segment.
SPECIAL MARKETS SEGMENT
REVENUES. Total revenues for the Special Markets segment decreased
approximately $2.7 million to approximately $29.3 million for the year ended
December 31, 1998, compared to total revenues of approximately $32.0 million in
the prior year.
Gross premium and policyholder fees earned and reinsurance assumed
In the year ended December 31, 1998, the Special Markets Segment gross
premium and policyholder fees earned (including reinsurance assumed) amounted to
$45.3 million, a $7.6 million increase over the $37.7 million amount in 1997.
The gross earned premiums on the Company's senior market products increased as
follows:
<TABLE>
<CAPTION>
1998 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
--------------------------------------------- ---------------- --------------
<S> <C> <C>
Life Insurance and Annuities $ 2.10 $ 16.24
Major Medical 10.84 17.11
International Medical 1.65 4.75
------- -------
Totals $ 14.59 $ 38.10
======= =======
</TABLE>
These increases totaled $38.1 million and were offset by the decrease
in premiums on the products terminated and not currently marketed by the Company
as follows:
<TABLE>
<CAPTION>
1998 TOTAL
DESCRIPTION PREMIUM DECREASE PREMIUM EARNED
--------------------------------------------- ---------------- --------------
(in millions) (in millions)
<S> <C> <C>
Group Health Products $ 5.63 $ 2.77
Other health products 1.33 4.47
------ ------
Totals $ 6.96 $ 7.24
====== ======
</TABLE>
35
<PAGE> 36
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December
31, 1998 for the Special Markets Segment amounted to $26.7 million, a $10.7
million increase from the 1997 amount of $16.0 million. Details of the changes
in reinsurance premiums ceded is as follows:
<TABLE>
<CAPTION>
CEDED PREMIUM 1998 TOTAL
DESCRIPTION INCREASE (DECREASE) PREMIUM CEDED
--------------------------------------------- ------------------ -------------
(in millions) (in millions)
<S> <C> <C>
Life and annuity products 1.67 7.24
Major Medical 9.23 12.56
International Medical 1.47 4.27
Other lines (1.67) 2.62
------ -------
Totals $ 10.7 $ 26.69
====== =======
</TABLE>
Investment related revenue
Net investment income of the Special Markets Segment increased $0.7
million to $10.0 million for the year ended December 31, 1998, compared to $9.3
million in 1997. This increase is attributable to the increase in invested
assets outstanding in this segment during 1998 compared to 1997. Realized gains
on investments decreased $0.3 million from the prior year due primarily to the
write down of a permanently impaired security of $0.5 million in 1998.
Interest credited to policyholders increased $0.6 million to $7.2
million, which is the result of more interest sensitive account values in force.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions in the Special Markets Segment decreased approximately $2.6 million
to $27.9 million for the year ended December 31, 1998, compared to $30.5 million
for the year ended December 31, 1997.
Claims and other benefits decreased $0.6 million to $12.4 million for
the year ended December 31, 1998 compared to $13.0 million in 1997. The change
in reserves for the year ended December 31, 1998 amounted to a increase of $1.1
million compared to a decrease of $22 thousand in 1997 generating a variance of
$1.1 million. Interest credited to policyholders amounted to $7.2 million in
1998, an increase of $0.6 million over the 1997 amount of $6.6 million.
The change in deferred acquisition costs decreased by $0.6 million for
the year ended December 31, 1998 compared to 1997. The amount of acquisition
costs capitalized increased $45 thousand from the prior year. The small increase
in capitalized costs is the result of relatively flat new premium production in
the year ended December 31, 1998 compared to 1997 as some of the lines of
business in this segment continue to run off. The amortization of deferred
acquisition costs increased $0.6 million from $3.4 million in 1997 to $4.0
million in 1998.
Commissions increased $2.2 million in the year ended December 31, 1998
to $13.0 million, compared to $10.8 million in 1997. This increase is the direct
result of the $7.6 million increase in total premium discussed above.
Commissions and expense allowances on reinsurance ceded increased $4.3 million
in the year ended December 31, 1998 to $12.4 million, compared to $8.1 million
in 1997. This increase is the direct result of the $10.7 million increase in
reinsurance premium ceded discussed above.
36
<PAGE> 37
Other operating costs and expenses increased $1.2 million in the year
ended December 31, 1998 to $8.2 million, compared to $9.4 million in 1997. The
ratio of general expenses to gross premium decreased from approximately 25% in
1997 to 18% in 1998.
INSURANCE SERVICES AND CORPORATE
The Non Insurance Businesses Segment consists of WorldNet, Quincy, a
minority interest in Security Health acquired in 1998 and the Parent Company.
Total revenue decreased $0.4 million from $2.7 million in 1997 to $2.3
million in 1998 due to a realized gain of $0.6 million in 1997 related to the
sale of Amerifirst Insurance Company, an inactive insurance company. This
decrease in realized gains was partially offset by an increase in fee income of
$0.2 million. General expenses decreased $0.2 million from $1.5 million in 1997
to $1.3 million in 1998. The decrease in expenses at WorldNet ($1.1 million) was
offset by an increase in expenses at the Parent Company ($0.6 million) related
to increased interest expense and activity in public company activities compared
to 1997.
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.
Loan Agreements
As of December 31, 1998, the Company had outstanding a loan of $4.8
million pursuant to a credit agreement with Chase Manhattan Bank, which it
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. At
the same time, the Company paid $25 thousand to terminate an interest rate swap
agreement and expensed $87 thousand of unamortized loan origination expenses,
both related to the 1998 credit agreement.
To help finance the Penn Union Acquisition 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 9.38%) with principal repayment over a seven-year period and 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 five months ended December 31,
1999, the Company paid $2.65 million in interest.
37
<PAGE> 38
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 year ended December 31, 1999 the Company paid $0.7 million in
interest on these debentures to American Progressive, which was eliminated in
consolidation.
Management believes that the current cash position, the availability of
the revolving loan facility, the expected cash flows of the non-insurance
companies, 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.
Share Purchase Agreement with Capital Z Financial Services Fund II,
L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement
with Capital Z Financial Services Fund II, L.P. ("Capital Z"), which was amended
on July 2, 1999 (as amended the "Share Purchase Agreement"). 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"). The Share Purchase Agreement received the approvals of the
Florida, New York and Texas Insurance Departments (the states in which
Universal's Insurance Subsidiaries prior to the Penn Union Acquisition 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 Share Purchase Agreement closed with Capital Z
purchasing 25,707,552 shares of common stock for $80,978,790. As contemplated by
the Share Purchase Agreement, certain members of management 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.
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 a transaction fee and expense reimbursements of
$5,120,896 paid to an affiliate of Capital Z, $1,375,000 of which was paid by
issuing 436,508 shares of common stock of the Company.
Conversion of Preferred Stock
Under the terms of the Series C Preferred Stock, the Company had the
right to require its conversion to common stock if certain conditions were met,
which conditions were 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 cumulative
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 Share 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.
Exercise of Outstanding Common Stock Warrants that Expired on December
31, 1999
At December 31, 1998, the Company had 658,231 common stock warrants
issued and outstanding which were registered under the Securities Act of 1933
and 2,015,760 warrants outstanding
38
<PAGE> 39
which were not registered under the Securities Act of 1933. The warrants had an
exercise price to purchase common stock on a one to one basis at $1.00 and
expired on December 31, 1999. During the year ended December 31, 1999, 650,410
of the registered common stock warrants and all of the unregistered common stock
warrants were exercised for $2,666,170 resulting in the issuance of 2,666,170
shares of the Company's common stock. 7,821 of the registered common stock
warrants expired unexercised.
Insurance Subsidiaries
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. At December 31, 1999 the statutory capital and
surplus, including asset valuation reserves, of the U.S. Insurance Subsidiaries
totaled $89.2 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, 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 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
$63.9 million as of December 31, 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 December 31, 1999.
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 anticipates 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 filing a
consolidated Federal income tax return.
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
the Pennsylvania Life's surplus as regards 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.
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
39
<PAGE> 40
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 December 31, 1999 the Company held reserves that exceeded the
underlying cash surrender values of its in force life insurance and annuities by
more than $22.8 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.
The net yield on the Company's cash and invested assets increased
slightly from 6.67% in 1998 to 6.79% in 1999. A significant portion of these
securities are held to support the liabilities for policyholder account
balances, which liabilities are subject to periodic adjustments to their
credited interest rates. The credited interest rates of the interest-sensitive
policyholder account balances are determined by management based upon factors
such as portfolio rates of return and prevailing market rates and typically
follow the pattern of yields on the assets supporting these liabilities.
At December 31, 1999, the Insurance Subsidiaries held cash and cash
equivalents totaling $45.6 million, as well as fixed maturity and equity
securities that could readily be converted to cash with carrying values (and
fair values) of $717.6 million.
The fair values of these liquid holdings totaled more than $763.2 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
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 fixed maturity
portfolio, under the direction of the management of the Insurance Subsidiaries
and in accordance with guidelines adopted by their respective Boards of
Directors. The Company's policy is not to invest in derivative programs or other
hybrid securities, except for GNMA's, FNMA's and investment grade corporate
collateralized mortgage obligations. It invests primarily in fixed maturity
securities of the U.S. Government and its agencies and in corporate fixed
maturity securities with investment grade ratings of "Baa3" (Moody's), "BBB-"
(Standard & Poor's) or higher. However, the Company does own some investments
that are rated "BB" or below (together 1.1% and 2.5% of total fixed maturities
as of December 31, 1999 and 1998, respectively). As of December 31, 1999 all of
the Company's securities were current in the payment of principal and interest.
During the year ended December 31, 1999 the Company wrote down the value of a
certain fixed maturity security by $0.6 million which represents management's
estimate of other than temporary declines in value and was included in net
realized gains (losses) on investments in the accompanying consolidated
statement of operations.
FEDERAL INCOME TAXATION OF THE COMPANY
40
<PAGE> 41
The Company files a consolidated return for federal income tax
purposes, in which American Exchange and the Penn Union life insurance companies
are not currently permitted to be included. At December 31, 1999, the Company
(exclusive of American Exchange and the Penn Union life insurance companies) had
a net operating tax loss carryforwards of approximately $9.7 million that expire
in the years 2001 to 2019. At December 31, 1999, the Company also had an
Alternative Minimum Tax (AMT) credit carryforward for Federal income tax
purposes of approximately $0.3 million that can be carried forward indefinitely.
As a result of the change in ownership of the Company in July 1999, use of most
of the loss carryforwards of the Company are subject to annual limitations.
American Exchange and the other U. S. Penn Union life insurance
companies file a separate consolidated federal income tax return. At December
31, 1999, these companies had net operating loss carryforwards, most of which
were incurred prior to their acquisition by the Company, of approximately $47.1
million that expire in the years 2007 to 2013. As a result of the change in
ownership of the Company in July 1999 and the Penn Union Acquisition, use of
most of the loss carryforwards are subject to annual limitations.
At December 31, 1999 and 1999, the Company has established valuation
allowances of $11.3 million and $1.3 million, respectively, with respect to
these net operating loss carryforwards (deferred tax assets). 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. The Company
increased the taxable income in the non-life companies by $0.4 million and $1.9
million in 1998 and 1999, respectively. Management believes it is more likely
than not that the Company will realize the recorded net deferred tax assets.
The United States Insurance Subsidiaries are taxed as life insurance
companies as provided in the Tax Code. The Omnibus Budget Reconciliation Act of
1990 amended the Tax Code to require a portion of the expenses incurred in
selling insurance products to be capitalized and amortized over a period of
years, as opposed to an immediate deduction in the year incurred. Instead of
measuring actual selling expenses, the amount capitalized for tax purposes is
based on a percentage of premiums. In general, the capitalized amounts are
subject to amortization over a ten-year period. Since this change only affects
the timing of the deductions, it does not, assuming stability of rates, affect
the provisions for taxes reflected in the Company's financial statements
prepared in accordance with GAAP. However, by deferring deductions, the change
does have the effect of increasing the current tax expense, thereby reducing
statutory surplus. Because of the Insurance Subsidiaries' net operating loss
carryforwards, there was no material increase in the Company's current income
tax provision for any of the three years in the period ended December 31, 1999
due to this provision.
The Clinton Administration has made two tax proposals relating to the
insurance industry that may have an impact on the Company. One proposal is to
require recapture of untaxed profits on policyholder surplus accounts. Between
1959 and 1983, stock life insurance companies deferred tax on a portion of their
profits. These untaxed profits were added to a policyholders surplus account
("PSA"). In 1984, Congress precluded life insurance companies from continuing to
defer taxes on any future profits. The Clinton Administration argues that there
is no continuing justification for permitting stock life companies to defer tax
on profits that were earned between 1959 and 1983. Peninsular has $8.4 million
and American Pioneer has $1.1 million of untaxed profits in its PSA. None of the
other life Insurance Subsidiaries owned by the Company have PSA balances.
A second proposal the Clinton Administration has made modifies the
rules for capitalizing policy acquisition costs of life insurance companies on
the grounds that life insurance companies generally only capitalize a fraction
of their actual policy acquisition costs. The proposed modifications to
capitalization percentages apply only to group or individual term life
insurance, non-pension annuity contracts, cash value life insurance, credit life
insurance and credit health insurance and are higher than the current
41
<PAGE> 42
capitalization percentages. For the 1999 tax year, the Company had $138.8
million of premium receipts subject to proposed modifications to capitalization
percentages.
The Company can not predict whether or not these proposals will pass or
pass in some modified form and, therefore, can not predict the impact caused by
these proposed tax changes.
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.
ITEM 7A - 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.
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 rate on it financial condition. The ranges
selected in these analyses reflect management's
42
<PAGE> 43
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
December 31, 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 $39.3 million
and $70.7 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 $32.2 million and $65.9 million,
respectively.
Foreign Currency Sensitivity
Portions of Universal's operations are transacted utilizing the
Canadian dollar as the functional currency. Approximately 13.7%, 16.1% and 23.7%
of Universal's assets, revenues and operating income before taxes, as of and for
the twelve months ended December 31, 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 December 31, 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 $346 thousand and a decrease in equity of $5.2 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.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary schedules are listed in the
accompanying Index to Consolidated Financial Statements and Financial Statement
Schedules on Page F - 1.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of the
Registrant is set forth in Part I, Item 1, under the caption "Executive Officers
and Directors".
ITEM 11 - EXECUTIVE COMPENSATION
43
<PAGE> 44
Information regarding executive compensation is incorporated by
reference to Universal American Financial Corp.'s definitive proxy statement to
be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934
within 120 days after the end of the Company's fiscal year ended December 31,
1999.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding beneficial ownership of Universal American
Financial Corp.'s voting securities by directors, officers and persons who, to
the best knowledge of the Company, are known to be the beneficial owners of more
than 5% of the Company's voting securities as of December 31, 1999, is
incorporated by reference to Universal American Financial Corp.'s definitive
proxy statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934 within 120 days after the end of the Company's fiscal year
ended December 31, 1999.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
incorporated by reference to Universal American Financial Corp.'s definitive
proxy statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934 within 120 days after the end of the Company's fiscal year
ended December 31, 1999.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) 1 AND 2 FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
See separate index to Financial Statements and Financial Statement
Schedules on Page F - 1.
3 EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
3(a) Restated Certificate of Incorporation filed July 29, 1999,
incorporated by reference to Exhibit A of Form 8-K dated
August 13, 1999.
3(b) By-Laws, as amended, are hereby incorporated by reference to
Exhibit A to Form 8-K dated August 13, 1999.
10(a) Amended and Restated Purchase Agreement among the Company,
dated December 31, 1999, as amended and restated on July 2,
1999, between Universal American, PennCorp Financial Group,
Inc. and several of PFG's subsidiaries, incorporated by
reference to Annex B of Proxy Statement dated July12, 1999.
10(b) Share Purchase Agreement, as of December 31, 1998, between the
Company and Capital Z Financial Services Fund II, L.P. as
amended by Amendment, dated as of July 2, 1999, incorporated
by reference to Annex A of Proxy Statement dated July 12,
1999.
10(c) Shareholders Agreement dated July 30, 1999, among the Company,
Capital Z Financial Services Fund II, L.P., UAFC, L.P., AAM
Capital Partners, L.P., Chase Equity Associates, L.P., Richard
A. Barasch and others, incorporated by reference to Exhibit A
of Form 8-K dated August 13, 1999.
10(d) Registration Rights Agreement, dated July 30, 1999, among the
Company, Capital Z
44
<PAGE> 45
Financial Services Fund II, L.P., Wand/Universal Investments
L.P.I., Wand/Universal Investments L.P. II, Chase Equity
Associates, L.P., Richard A. Barasch and others, incorporated
by reference to Exhibit A to Form 8-K dated August 13, 1999.
10(d) Special Commitments to the Superintendent of Insurance of the
State of New York, dated January 6, 1995, signed by:
(i) the Registrant, American Progressive, BALP
and NMRB Corp. and
(ii) WAND, Wand (Universal) Inc., David S.
Callard and Bruce W. Schnitzer are
incorporated by reference to Exhibit 10(e)
to Form 10-K for 1994.
11 Computation of basic and diluted earnings per share,
incorporated by reference to Note 2j of Notes to Consolidated
Financial Statements for 1999, included in this Form 10-K.
12 List of Subsidiaries:
<TABLE>
<CAPTION>
State of Percentage
Name Incorporation Owned
---- ------------- -----
<S> <C> <C>
American Progressive Life & Health Insurance Company New York 100%
American Pioneer Life Insurance Company Florida 100%
American Exchange Life Insurance Company Texas 100%
Pennsylvania Life Insurance Company Pennsylvania 100%
Peninsular Life Insurance Company North Carolina 100%
Union Bankers Insurance Company Texas 100%
Constitution Life Insurance Company Texas 100%
Marquette National Life Insurance Company Texas 100%
PennCorp Life Insurance Company Ontario, Canada 100%
PFI, Inc. Delaware 100%
Quincy Coverage Corporation Delaware 100%
WorldNet Service Corp. Florida 100%
Security Health Providers, Inc. Delaware 50%
</TABLE>
23(a) Consent of Ernst & Young LLP
(B) REPORTS ON FORM 8-K
None
45
<PAGE> 46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 28th day of
March 2000.
UNIVERSAL AMERICAN FINANCIAL CORP.
(Registrant)
By: /s/ Richard A. Barasch
Richard A. Barasch
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on March 28, 2000 by the following persons in
the capacities indicated:
<TABLE>
<CAPTION>
Signatures Title
- ---------- -----
<S> <C>
/s/ Richard A. Barasch Chairman of the Board, President,
- ------------------------------ Chief Executive Officer and Director
Richard A. Barasch (Principal Executive Officer)
/s/ Robert A. Waegelein Senior Vice President and Chief
- ------------------------------ Financial Officer
Robert A. Waegelein (Principal Accounting Officer)
/s/ Bradley E. Cooper Director
- ------------------------------
Bradley E. Cooper
/s/ Susan S. Fleming Director
- ------------------------------
Susan S. Fleming
/s/ Mark M. Harmeling Director
- ------------------------------
Mark M. Harmeling
/s/ Bertram Harnett Director
- ------------------------------
Bertram Harnett
/s/ Patrick J. McLaughlin Director
- ------------------------------
Patrick J. McLaughlin
/s/ Robert A. Spass Director
- ------------------------------
Robert A. Spass
/s/ Richard Veed Director
- ------------------------------
Richard Veed
/s/ Robert F. Wright Director
- ------------------------------
Robert Wright
</TABLE>
46
<PAGE> 47
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULES OF THE REGISTRANT:
<TABLE>
<S> <C>
Independent Auditors' Reports F-2
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-3
Consolidated Statements of Operations
for the Three Years Ended December 31, 1999 F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income
for the Three Years Ended December 31, 1999 F-5
Consolidated Statements of Cash Flows
for the Three Years Ended December 31, 1999 F-6
Notes to Consolidated Financial Statements F-7
Schedule I -- Summary of Investments - other than investments in related parties
(incorporated in Note 5 to Consolidated Financial Statements)
Schedule II -- Condensed Financial Information of Registrant F-38
Schedule III -- Supplementary Insurance Information F-41
</TABLE>
Schedule IV -- Reinsurance (incorporated in Note 11 of Notes to Consolidated
Financial Statements)
Other schedules were omitted because they were not applicable
<PAGE> 48
Independent Auditors' Report
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated balance sheets of Universal
American Financial Corp. and subsidiaries as of December 31, 1999 and 1998 and
the related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the three years in the period
ended December 31, 1999. Our audits also included the financial statement
schedules as listed in the Index at Item 14(a). These consolidated financial
statements and schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Universal American Financial Corp. and subsidiaries at December 31, 1999 and
1998 and the consolidated results of their operations and their cash flows for
each of the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
Ernst & Young LLP
New York, New York
March 6, 2000
F-2
<PAGE> 49
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS 1999 1998
----------- -----------
<S> <C> <C>
Investments (Notes 2c and 5):
Fixed maturities available for sale, at fair value
(amortized cost: 1999, $734,466; 1998, $132,227) $ 717,560 $ 134,798
Equity securities, at fair value (cost: 1999, $5,120; 1998, $1,063) 4,838 1,020
Policy loans 25,640 7,276
Other invested assets 2,763 30
Mortgage loans 2,743 4,457
---------- -----------
Total investments 753,544 147,581
Cash and cash equivalents 58,753 17,093
Accrued investment income 11,506 3,539
Deferred policy acquisition costs (Note 2d) 34,943 24,283
Amounts due from reinsurers (Note 11) 196,960 77,394
Due and unpaid premiums 3,578 526
Deferred income tax asset (Note 6) 70,968 -
Goodwill (Note 2o) 4,201 4,354
Present value of future profits 1,226 1,569
Other assets 17,742 6,963
---------- -----------
Total assets 1,153,421 283,302
========== ===========
LIABILITIES, SERIES C PREFERRED STOCK, REDEMPTION ACCRUAL ON SERIES C PREFERRED
STOCK, SERIES D PREFERRED STOCK AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances (Note 2e) 238,665 154,886
Reserves for future policy benefits 560,777 47,443
Policy and contract claims - life 5,644 2,297
Policy and contract claims - health 72,261 24,332
Loan payable (Note 12) 70,000 4,750
Amounts due to reinsurers 85 1,811
Restructuring liability (Note 4) 9,980 -
Negative goodwill (Note 2o and 4) 9,622 -
Deferred income tax liability (Note 6) - 1,219
Other liabilities 52,422 10,145
---------- -----------
Total liabilities 1,019,456 246,883
---------- -----------
Series C preferred stock (Note 7) - 5,168
---------- -----------
Redemption accrual on Series C preferred stock - 683
---------- -----------
Series D preferred stock (Note 7) - 2,250
---------- -----------
Commitments and contingencies (Note 13)
STOCKHOLDERS' EQUITY (Note 8)
Series B preferred stock (Note 7) - 4,000
Common stock (Authorized: 1999, 80,000; 1998, 20,000, issued and outstanding:
1999, 45,914; 1998, 7,638) 459 76
Additional paid-in capital 122,924 16,411
Accumulated other comprehensive income/(loss) (6,887) 858
Retained earnings 17,469 6,973
---------- -----------
Total stockholders' equity 133,965 28,318
---------- -----------
Total liabilities, Series C preferred stock, redemption accrual on Series C
Preferred stock, Series D preferred stock and stockholders' equity $1,153,421 $ 283,302
========== ===========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 50
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
REVENUE: 1999 1998 1997
--------- --------- ----------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Gross premiums and policyholder fees earned $252,553 $131,044 $ 99,339
Reinsurance premiums assumed 1,751 998 998
Reinsurance premiums ceded (138,827) (89,546) (62,623)
---------- ---------- ----------
Net premiums and policyholder fees earned (Note 11) 115,477 42,496 37,714
Net investment income (Note 5) 29,313 10,721 10,023
Realized gains/(losses) on investments (Note 5) (241) 256 1,133
Fee income 3,587 2,616 2,460
---------- ---------- ----------
Total revenues 148,136 56,089 51,330
---------- ---------- ----------
BENEFITS, CLAIMS AND OTHER DEDUCTIONS:
Net increase/(decrease) in future policy benefits 357 5,356 441
Claims and other benefits 72,898 25,638 23,719
Interest credited to policyholders 8,668 7,240 6,646
Net increase in deferred acquisition costs (6,229) (3,530) (2,946)
Amortization of present value of future profits 343 174 -
Amortization of goodwill/negative goodwill (273) 171 112
Commissions 46,624 27,147 21,089
Other operating costs and expenses 48,658 21,181 19,358
Commission and expense allowances
on reinsurance ceded (38,966) (31,220) (20,300)
---------- ---------- ----------
Total benefits, claims and other deductions 132,080 52,157 48,119
---------- ---------- ----------
Operating income before taxes 16,056 3,932 3,211
Federal income tax expense (Note 6) 6,243 1,324 1,092
---------- ---------- ----------
Net income 9,813 2,608 2,119
Redemption accrual on Series C and Series D Preferred
Stock (Note 7) 180 434 249
---------- ---------- ----------
Net Income applicable to common shareholders $ 9,633 $ 2,174 $ 1,870
========== ========== ==========
Earnings per common share (Note 2k):
Basic $0.42 $0.29 $0.26
========== ========== ==========
Diluted $0.34 $0.20 $0.18
========== ========== ==========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 51
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE YEARS ENDED DECEMBER 31, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
Accumulated
Series B Additional Other
Preferred Common Paid-In Comprehensive Retained
Stock Stock Capital Income/(Loss) Earnings Total
----- ----- ------- ------------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 $ 4,000 $ 71 $ 16,050 $ (972) $ 2,929 $ 22,078
Net income -- -- -- -- 2,119 2,119
Change in net unrealized
Investment gain (loss) -- -- -- 1,814 -- 1,814
---------
Comprehensive income 3,933
---------
Issuance of common stock -- 2 272 -- -- 274
Issuance of Series C
Preferred Stock -- -- (329) -- -- (329)
Redemption accrual on
Series C Preferred Stock -- -- -- -- (250) (250)
--------- --------- --------- --------- --------- ---------
Balance, December 31,1997 $ 4,000 $ 73 $ 15,993 $ 842 $ 4,798 $ 25,706
--------- --------- --------- --------- --------- ---------
Net income -- -- -- -- 2,608 2,608
Change in net unrealized
Investment gain (loss) -- -- -- 16 -- 16
---------
Comprehensive income 2,624
---------
Issuance of common stock -- 3 525 -- -- 528
Issuance of Series D
Preferred Stock -- -- (107) -- -- (107)
Redemption accrual on
Series C Preferred Stock -- -- -- -- (433) (433)
--------- --------- --------- --------- --------- ---------
Balance, December 31,1998 $ 4,000 $ 76 $ 16,411 $ 858 $ 6,973 $ 28,318
--------- --------- --------- --------- --------- ---------
Net income -- -- -- -- 9,813 9,813
Currency translation adjustments -- -- -- 1,294 -- 1,294
Change in net unrealized
Investment gain (loss) -- -- -- (9,039) -- (9,039)
---------
Comprehensive income 2,068
---------
Issuance of common stock -- 383 89,927 -- -- 90,310
Preferred Stock Conversion (4,000) -- 13,142 -- 863 10,005
Stock compensation (Note 4 and 9) -- -- 4,411 -- -- 4,411
Loans to officers (Note 4) -- -- (967) -- -- (967)
Redemption accrual on
Series C Preferred Stock -- -- -- -- (180) (180)
--------- --------- --------- --------- --------- ---------
Balance, December 31,1999 $ -- $ 459 $ 122,924 $ (6,887) $ 17,469 $ 133,965
========= ========= ========= ========= ========= =========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 52
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Years Ended December 31, 1999
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 9,813 $ 2,608 $ 2,119
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Deferred income taxes 996 1,324 1,092
Change in reserves for future policy benefits (net of balances 5,136 6,928 (3,997)
acquired)
Change in policy and contract claims (net of balances acquired) (2,229) (270) (2,713)
Change in deferred policy acquisition costs (net of balances acquired) (6,253) (3,530) (2,946)
Change in deferred revenue (net of balances acquired) (45) (63) (93)
Amortization of present value of future profits 343 175 --
Amortization of goodwill (273) 154 112
Change in policy loans (net of balances acquired) 264 (91) (589)
Change in accrued investment income (net of balances acquired) (336) (181) (369)
Change in reinsurance balances (net of balances acquired) (5,571) (5,320) (4,963)
Change in due and unpaid premium (net of balances acquired) 187 22 2,270
Realized loss/(gain) on investments 241 (256) (1,133)
Change in income taxes payable (net of balances acquired) 11,565 -- --
Other, net 4,830 (1,874) 4,337
--------- --------- ---------
Net cash provided by/(used in) operating activities 18,668 (374) (6,873)
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for sale 41,039 26,887 35,963
Proceeds from redemption of fixed maturities available for sale 12,405 7,941 9,030
Cost of fixed maturities purchased available for sale (182,843) (45,886) (37,933)
Change in amounts held in trust for reinsurer (2,403) (5,182) (5,155)
Proceeds from sale of equity securities 374 512 337
Cost of equity securities purchased (144) (591) (690)
Change in mortgage loans 2,870 -- --
Change in other invested assets 2,079 (108) (1,368)
Proceeds from sale of subsidiary, net of cash held -- -- 2,020
Purchase of business, net of cash acquired (9,620) (2,563) (4,079)
--------- --------- ---------
Net cash used by investing activities (136,243) (18,990) (1,875)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock 93,209 421 274
Proceeds from the issuance of Series C Preferred Stock -- -- 4,838
Proceeds from the issuance of Series D Preferred Stock 1,750 2,250 --
Increase/(decrease) in policyholder account balances (974) 7,522 10,547
Change in short-term debt -- -- (800)
Increase in loan payable 70,000 1,850 3,500
Principle repayment on loan payable (4,750) (600) --
--------- --------- ---------
Net cash provided from financing activities 159,235 11,443 18,359
Net (decrease) increase in cash and cash equivalents 41,660 (7,921) 9,611
--------- --------- ---------
Cash and cash equivalent at beginning of year 17,093 25,014 15,403
--------- --------- ---------
Cash and cash equivalent at end of year $ 58,753 $ 17,093 $ 25,014
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 2,859 $ 307 $ 77
========= ========= =========
Income taxes $ 2,335 $ -- $ 62
========= ========= =========
</TABLE>
Non Cash items consist of preferred stock conversions ($13.1 million) and stock
compensation items ($1.5 million).
See notes to consolidated financial statements.
F-6
<PAGE> 53
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND COMPANY BACKGROUND:
Universal American Financial Corp. ("the Company" or "Universal") was
incorporated in the State of New York in 1981 as a life and accident & health
insurance holding company. Until July 30, 1999, the Company had three principal
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"), in
addition to 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 have operated through a general agency
system, marketing and underwriting products aimed at the senior market,
including Medicare supplement, long-term care, home health care, life insurance
and annuities. With the acquisition of Pennsylvania Life and PennCorp Canada,
the Company has expanded its issuance of fixed benefit accident and health
insurance products. The acquisition expanded the Company's general agency system
and provided 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 and are under
exclusive contract with Pennsylvania Life and PennCorp Canada.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. BASIS OF PRESENTATION: The significant accounting policies
followed by Universal American Financial Corp. and
subsidiaries that materially affect financial reporting are
summarized below. The accompanying consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP")
which, as to the insurance subsidiaries, differ from statutory
accounting practices prescribed or permitted by regulatory
authorities. The preparation of financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the
reported revenues and expenses during the reporting period.
Accounts that the Company deems to be sensitive to changes in
estimates include policy liabilities and accruals, deferred
policy acquisition costs, present value of future profits and
deferred taxes. As additional information becomes available or
actual amounts become determinable, the recorded estimates may
be revised and reflected in operating results. Actual results
could differ from those estimates.
b. PRINCIPLES OF CONSOLIDATION: The accompanying consolidated
financial statements include the accounts of Universal
American Financial Corp. and its wholly-owned subsidiaries,
including the operations of the companies acquired on July 30,
1999 since the date of their acquisition, and of American
Exchange since December 4, 1997, the date of its acquisition.
All material intercompany transactions and balances have been
eliminated.
F-7
<PAGE> 54
c. INVESTMENTS: Investments are shown on the following bases:
The Company follows Financial Accounting Standards Board
("FASB") Statement No. 115, "Accounting for Certain Debt and
Equity Securities" ("Statement No. 115"). Statement No. 115
requires that debt and equity securities be classified into
one of three categories and accounted for as follows: Debt
securities that the Company has the positive intent and the
ability to hold to maturity are classified as "held to
maturity" and reported at amortized cost. Debt and equity
securities that are held for current resale are classified as
"trading securities" and reported at fair value, with
unrealized gains and losses included in earnings. Debt and
equity securities not classified as held to maturity or as
trading securities are classified as "available for sale" and
reported at fair value. Unrealized gains and losses on
available for sale securities are excluded from earnings and
reported as accumulated other comprehensive income, net of tax
and deferred policy acquisition cost adjustments.
As of December 31, 1999 and 1998, all fixed maturity
securities were classified as available for sale and were
carried at fair value, with the unrealized gain or loss, net
of tax and other adjustments (deferred policy acquisition
costs), included in accumulated other comprehensive income.
Equity securities are carried at current fair value. Policy
loans and mortgage loans are stated at the unpaid principal
balance. Short-term investments are carried at cost, which
approximates fair value. Other invested assets include
property tax liens, real estate and collateral loans. The real
estate and collateral loans are carried at cost which is equal
to the fair value of their estimated future cash flows at the
date of acquisition. Investment income is recorded when
earned.
The Company regularly evaluates the carrying value of their
investments based on current economic conditions, past credit
loss experience and other circumstances. A decline in net
realizable value that is other than temporary is recognized as
a realized investment loss and a reduction in the cost basis
of the investment in the period when such determination is
made. The Company discounts expected cash flows in the
computation of net realizable value of its investments, other
than certain mortgage-backed securities. In those
circumstances where the expected cash flows of residual
interest and interest-only mortgage-backed securities,
discounted at a risk-free rate of return, result in an amount
less than the carrying value, a realized loss is reflected in
an amount sufficient to adjust the carrying value of a given
security to its fair value. Realized investment gains and
losses on the sale of securities are based on the specific
identification method.
d. DEFERRED POLICY ACQUISITION COSTS: The cost of acquiring new
business, principally commissions and certain expenses of the
agency, policy issuance and underwriting departments, all of
which vary with, and are primarily related to the production
of new and renewal business, have been deferred. These costs
are being amortized in relation to the present value of
expected gross profits on the policies arising principally
from investment, mortality and expense margins for FASB
Statement No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments",
("Statement No. 97") products and in proportion to premium
revenue using the same assumptions used in estimating the
liabilities for future policy benefits for FASB Statement No.
60, "Accounting and Reporting by Insurance Enterprises",
("Statement No. 60") products. Deferred policy acquisition
costs are written off to the extent that it is determined that
future policy premiums and investment income or gross profits
would not be adequate to cover related losses and expenses. No
deferred policy acquisition costs were written off for the
years ended December 31, 1999, 1998 and 1997.
F-8
<PAGE> 55
The Company has several reinsurance arrangements in place on
its life and accident & health insurance risks (see Note 11).
In the accompanying statement of operations, the Company
reports commissions incurred on direct premium written and
commission and expense allowances on reinsurance ceded on
separate lines to correspond to the presentation of the
premiums earned by the Company. In determining the amounts
capitalized for deferred acquisition costs, the Company
includes an amount for gross commissions and direct issue
expenses, net of the related allowances received from the
reinsurer on these costs.
Details with respect to deferred policy acquisition costs for
the three years ended December 31, 1999 are as follows:
(Amounts in thousands)
<TABLE>
<CAPTION>
<S> <C>
Balance at January 1, 1997 $19,092
Capitalized costs 6,712
Adjustment relating to unrealized gain/(loss) on fixed maturities (1,205)
Amortization (3,767)
-------
Balance at December 31, 1997 $20,832
Capitalized costs 8,792
Adjustment relating to unrealized gain/ (loss) on fixed (79)
maturities
Amortization (5,262)
-------
Balance at December 31, 1998 $24,283
Capitalized costs 11,441
Adjustment relating to unrealized gain/(loss) on fixed 4,509
maturities
Foreign Currency Adjustment 24
Amortization (5,314)
-------
Balance at December 31, 1999 $34,943
=======
</TABLE>
e. RECOGNITION OF REVENUES, CONTRACT BENEFITS AND EXPENSES FOR
INVESTMENT AND UNIVERSAL LIFE TYPE POLICIES: Revenues for
universal life-type policies and investment products consist
of mortality charges for the cost of insurance and surrender
charges assessed against policyholder account balances during
the period. Benefit claims incurred in excess of policyholder
account balances are expensed. The liability for policyholder
account balances for universal life-type policies and
investment products under Statement No. 97 are determined
following a "retrospective deposit" method. The retrospective
deposit method establishes a liability for policy benefits at
an amount determined by the account or contract balance that
accrues to the benefit of the policyholder, which consist
principally of policy account values before any applicable
surrender charges. Premium receipts are not reported as
revenues when the retrospective deposit method is used.
Credited interest rates for these products range from 3.00% to
7.00%.
f. RECOGNITION OF PREMIUM REVENUES AND POLICY BENEFITS FOR
ACCIDENT & HEALTH INSURANCE PRODUCTS: Premiums are recorded
when due and recognized as revenue over the period to which
the premiums relate. Benefits and expenses associated with
earned premiums are recognized as the related premiums are
earned so as to result in recognition of profits over the life
of the policies. This association is accomplished by recording
a provision for future policy benefits and amortizing deferred
policy acquisition costs. The liability for future policy
benefits for accident & health policies consists of active
life reserves and the estimated present value of the remaining
ultimate net cost of incurred claims. Active life reserves
include unearned premiums and additional reserves. The
additional reserves are computed on the net level premium
method using assumptions for future investment yield,
mortality and morbidity experience. The assumptions are based
on past experience. Claim reserves are established for future
payments not yet due on incurred claims, primarily relating to
individual disability insurance and group long-term disability
insurance products. These reserves are established based on
past experience and are continuously reviewed and updated with
F-9
<PAGE> 56
any related adjustments recorded to current operations. Claim
liabilities represent policy benefits due but unpaid at
year-end and primarily relates to individual health insurance
products.
Activity in the accident & health policy and contract claim liability
is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 24,332 $ 22,592 $ 24,628
Less reinsurance recoverables (19,076) (17,034) (15,269)
-------- -------- --------
Net balance at beginning of year 5,256 5,558 9,359
-------- -------- --------
Balance acquired with Penn Union 31,043 -- --
Balance acquired with American Exchange -- -- 551
Balance acquired with Dallas General -- 785 --
Incurred related to:
Current year 58,163 18,044 19,363
Prior years (395) (782) (2,424)
-------- -------- --------
Total incurred 57,768 17,262 16,939
-------- -------- --------
Paid related to:
Current year 28,782 13,673 14,405
Prior years 29,320 4,676 6,885
-------- -------- --------
Total paid 58,102 18,349 21,290
Foreign currency adjustment 65 -- --
-------- -------- --------
Net balance at end of year 36,030 5,256 5,559
Plus reinsurance recoverables 36,231 19,076 17,033
-------- -------- --------
Balance at end of year $ 72,261 $ 24,332 $ 22,592
======== ======== ========
</TABLE>
Losses incurred related to prior years developed favorably in
1999, 1998 and 1997 due primarily to the fact that healthcare
trends were lower than those anticipated when the reserves
were established.
g. RECOGNITION OF PREMIUM REVENUES AND POLICY BENEFITS FOR
TRADITIONAL LIFE AND ANNUITY PRODUCTS: Premiums from
traditional life and annuity policies with life contingencies
generally are recognized as income when due. Benefits and
expenses are matched with such income so as to result in the
recognition of profits over the life of the contracts. This
match is accomplished by means of the provision for liabilities
for future policy benefits and the deferral and subsequent
amortization of policy acquisition costs.
h. INCOME TAXES: The Company's method of accounting for income
taxes is the asset and liability method. Under the asset and
liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date of a change in
tax rates.
i. REINSURANCE ACCOUNTING: Recoverables under reinsurance
contracts are included in
F-10
<PAGE> 57
total assets as amounts due from reinsurers rather than net
against the related policy asset or liability. The cost of
reinsurance related to long-duration contracts is accounted
for over the life of the underlying reinsured policies using
assumptions consistent with those used to account for the
underlying policies.
j. FOREIGN CURRENCY TRANSLATION: The financial statement accounts
of the Company's Canadian operations, which are denominated in
Canadian dollars, are translated into U.S. dollars as follows:
(i) Canadian currency assets and liabilities are translated at
the rates of exchange as of the balance sheet dates and the
related unrealized translation adjustments are included as a
component of accumulated other comprehensive income, and (ii)
revenues, expenses and cash flows, expressed in Canadian
dollars, are translated using a weighted average of exchange
rates for each period presented.
k. EARNINGS PER COMMON SHARE: Basic EPS excludes dilution and is
computed by dividing income available to common shareholders,
(after deducting the redemption accrual on the Series C and
Series D Preferred Stock), by the weighted average number of
shares outstanding for the period. Diluted EPS gives the
dilutive effect of the stock options, warrants and Series B, C
and D Preferred Stock outstanding during the year. As of
December 31, 1999 there were 2,479,500 stock options not
included in the diluted EPS computation because they were
antidilutive. A reconciliation of the numerators and the
denominators of the basic and diluted EPS for the years ended
December 31, 1999, 1998 and 1997 as follows:
<TABLE>
<CAPTION>
For the Year Ended December 31, 1999
---------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Net income $9,813
Less: Redemption accrual on Series C preferred Stock (180)
------
Basic EPS
Net income applicable to common shareholders 9,633 23,212 $ 0.42
======
Effect of Dilutive Securities
Series B Preferred Stock 1,037
Series C Preferred Stock 180 544
Series D Preferred Stock 744
Non-registered warrants 1,993
Registered warrants 614
Incentive stock options 1,261
Director stock option 93
Treasury stock purchased from proceeds of
exercise of options and warrants (937)
------ ------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $9,813 28,561 $ 0.34
====== ====== ======
</TABLE>
F-11
<PAGE> 58
<TABLE>
<CAPTION>
For the Year Ended December 31, 1998
-----------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Net income $ 2,608
Less: Redemption accrual on Series C Preferred (434)
Stock -------
Basic EPS
Net income applicable to common shareholders 2,174 7,533 $0.29
Effect of Dilutive Securities
Series B Preferred Stock 1,778
Series C Preferred Stock 434 2,176
Series D Preferred Stock -
Non-registered warrants 2,016
Registered warrants 658
Incentive stock options 229
Director stock option 7
Treasury stock purchased from proceeds of
exercise of options and warrants (1,241)
------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 2,608 13,156 $0.20
======= ====== =====
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended December 31, 1997
-------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
---------- ------------- -------
(In thousands, per share amounts in dollars)
<S> <C> <C> <C>
Net income $2,119
Less: Redemption accrual on Series C Preferred (249)
Stock ------
Basic EPS
Net income applicable to common shareholders 1,870 7,242 $0.26
Effect of Dilutive Securities
Series B Preferred Stock 1,778
Series C Preferred Stock 249 1,356
Non-registered warrants 2,016
Registered warrants 668
Incentive stock options 296
Director stock option 16
Treasury stock purchased from proceeds of
exercise of options and warrants (1,331)
------
Diluted EPS
Net income applicable to common
Shareholders plus assumed conversions $ 2,119 12,041 $0.18
======= ====== =====
</TABLE>
l. COMPREHENSIVE INCOME: The components of comprehensive income, net
of related tax, for the year ended December 31, 1999, 1998 and
1997 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Net income $ 9,813 $ 2,608 $ 2,119
Net unrealized gain (loss) arising during
the year (net of deferred acquisition costs) (9,091) 116 2,796
Foreign currency translation adjustment 1,294 -- --
Reclassification adjustment for gains
(losses) included in net income 52 (100) (982)
------- ------- -------
Comprehensive income (loss) $ 2,068 $ 2,624 $ 3,933
======= ======= =======
</TABLE>
The related tax effects allocated to each component of other
comprehensive income were as follows:
F-12
<PAGE> 59
<TABLE>
<CAPTION>
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
------ --------- ------
(In thousands)
<S> <C> <C> <C>
Year ended December 31, 1999
Net unrealized gain (loss) arising during
the year (net of deferred acquisition costs) $(15,293) $(6,202) $(9,091)
Reclassification adjustment for gains
(losses) included in net income 87 35 52
-------- -------- -------
Net unrealized gains (15,206) (6,167) (9,039)
Foreign currency translation adjustment 2,177 883 1,294
-------- -------- -------
Comprehensive income (loss) $(13,029) $ (5,284) $(7,745)
======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
------ --------- ------
(In thousands)
<S> <C> <C> <C>
Year ended December 31, 1998
Net unrealized gain (loss) arising during
the year (net of deferred acquisition costs) $ 171 $ 55 $116
Reclassification adjustment for gains
(losses) included in net income (147) (47) (100)
----- ---- ----
Net unrealized gains 24 8 16
Foreign currency translation adjustment - - -
----- ---- ----
Comprehensive income (loss) $ 24 $ 8 $ 16
===== ==== =====
</TABLE>
<TABLE>
<CAPTION>
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
------ --------- ------
(In thousands)
<S> <C> <C> <C>
Year ended December 31, 1997
Net unrealized gain (loss) arising during
the year (net of deferred acquisition costs) $3,471 $675 $2,796
Reclassification adjustment for gains
(losses) included in net income (1,220) (238) (982)
------ ---- ------
Net unrealized gains 2,251 437 1,814
Foreign currency translation adjustment - - -
------ ---- ------
Comprehensive income (loss) $2,251 $437 $1,814
====== ==== ======
</TABLE>
m. CASH FLOW INFORMATION: Included in cash and cash equivalents
are cash on deposit, money market funds, and short term
investments which had an original maturity of three months or
less from the time of purchase.
n. FASB STATEMENT NO. 133: In June 1998, the FASB issued
Statement 133, Accounting for Derivative Instruments and
Hedging Activities, as amended by FASB Statement 137, which is
required to be adopted in years beginning after June 15, 2000.
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.
O. GOODWILL/NEGATIVE GOODWILL: Business combinations accounted
for as a purchase result in the allocation of the purchase
consideration to the fair values of the assets and liabilities
acquired, including the present value of future profits,
establishing such fair
F-13
<PAGE> 60
values as the new accounting bases. Purchase consideration in
excess of the fair value of net assets acquired, for a
specific acquisition, is allocated to goodwill. Should the
fair value of the net assets acquired exceed the purchase
consideration, such excess is utilized to reduce certain
intangible assets, primarily present value of future profits
related to the specific acquisition, and any remaining excess
is allocated to negative goodwill. Allocation of purchase
price is performed in the period in which the purchase is
consummated and may be preliminary. Adjustments resulting from
the completion of the purchase allocation process affect the
value of assets and liabilities acquired.
In connection with the acquisition of First National
in 1996, the Company recorded $3.5 million of goodwill which
is being amortized on a straight line basis over 30 years.
Accumulated amortization through December 31, 1999 totaled
$0.5 million. In connection with the acquisition of American
Exchange in 1997, the excess of cost over net assets acquired
of $1.3 million was recorded as goodwill and is also being
amortized on a straight line basis over 30 years. Accumulated
amortization through December 31, 1999 amounted to $84,000.
Total amortization charged to operating expenses was
approximately $154,000, $171,000 and $112,000 for the years
ended December 31, 1999, 1998 and 1997, respectively.
Negative Goodwill relates to the Penn Union Acquisition and is
being amortized over 10 years on a straight-line basis.
Accumulated amortization was $427,000 at December 31, 1999
(see Note 4).
p. RECLASSIFICATIONS: Certain reclassifications have been made to
prior years' financial statements to conform to current period
classifications.
3. EQUITY TRANSACTIONS
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 prior to the
Penn Union Transaction 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).
As contemplated by the UA Purchase Agreement, certain members of management and
agents of Universal and of the companies acquired on July 30, 1999 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 Company
provided loans to certain members of management to purchase the shares of common
stock. The total amount of the loans of $967,000 was accounted for as a
reduction in paid in capital in the financial statements. 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 a
transaction fee and expense reimbursement of $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). In addition, the Company recorded an
expense of $1.7 million to record the difference between the purchase price of
the stock purchased by employees and agents of the Company and the fair value of
the stock on the closing date.
Shareholders' Agreement
F-14
<PAGE> 61
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 provides
for 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.
4. 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:
<TABLE>
<CAPTION>
Name of Insurance Company State or Province of Domicile
------------------------- -----------------------------
<S> <C>
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
</TABLE>
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 12). 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. In addition to the purchase price, the Company incurred costs
totaling $17.5 million including a restructuring accrual of $10.0 million and
$1.7 million in stock compensation
F-15
<PAGE> 62
expense related to shares purchased by agents and certain members of management
at discounted prices 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 $10.0 million, which will be amortized on a straight
line basis over a ten year period (see Note 2o).
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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 30,
------------------------
1999 1998 (a)
--------- ---------
(In thousands)
<S> <C> <C>
Total revenue $ 274,805 $ 300,812
Operating income/(loss) before taxes $ 32,279 $ (473)
Net income/(loss) $ 18,763 $ (1,097)
Earnings/(loss) per common share:
Basic $ 0.44 $ (0.03)
Diluted $ 0.41 $ (0.03)
</TABLE>
(a) The results of the Penn Union Companies for the twelve months ended
December 31, 1998 included reserve strengthenings which resulted in a
reduction in net income after tax of $20.5 million, or $0.51 per basic
share and $0.47 per diluted share.
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired in the Penn Union Transaction 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.
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 (July
31, 2000). 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.
F-16
<PAGE> 63
5. INVESTMENTS:
As of December 31, 1999 and 1998, investments consisted of the
following:
<TABLE>
<CAPTION>
December 31,1999
----------------------------------------------------------------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- -------------- ----- ---- ----- -----
<S> <C> <C> <C> <C>
(In thousands)
US Treasury bonds and notes $31,170 $ 31,776 $ 31,549 $ 31,549
Corporate bonds 791,087 702,690 686,011 686,011
Equity Securities 5,120 4,838 4,838
-------- -------- --------
Sub-total 739,586 $722,398 $722,398
========
Policy loans 25,640 25,640
Mortgage loans 2,743 2,743
Other invested assets 2,763 2,763
-------- --------
Total investments $770,732 $753,544
======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,1998
----------------------------------------------------------------------
Face Amortized Fair Carrying
Classification Value Cost Value Value
- -------------- ----- ---- ----- -----
<S> <C> <C> <C> <C>
(In thousands)
US Treasury bonds and notes $3,800 $3,848 $3,948 $3,948
Corporate bonds 129,150 128,379 130,850 130,850
Equity Securities 1,063 1,020 1,020
--------- -------- --------
Sub-total 133,290 $135,818 $135,818
========
Policy loans 7,276 7,276
Mortgage loans 4,457 4,457
Other invested assets 30 30
--------- --------
Total investments $ 145,053 $147,581
========= ========
</TABLE>
The amortized cost and fair value of fixed maturities as of December
31, 1999 and 1998 are as
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- -------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
(In thousands)
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>
F-17
<PAGE> 64
<TABLE>
<CAPTION>
December 31, 1998
-----------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- -------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
(In thousands)
US Treasury securities
and obligations of
US government $6,444 $ 182 $ (28) $6,598
Corporate debt securities 63,503 1,680 (472) 64,711
Mortgage-backed securities 62,280 1,821 (612) 63,489
-------- ------ -------- --------
$132,227 $3,683 $ (1,112) $134,798
======== ====== ======== ========
</TABLE>
The amortized cost and fair value of fixed maturities at December 31,
1999 by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
---- -----
(In thousands)
<S> <C> <C>
Due in 1 year or less $ 23,289 $ 23,648
Due after 1 year through 5 years 157,339 153,986
Due after 5 years through 10 years 228,964 224,548
Due after 10 years 70,262 67,146
Mortgage-backed securities 254,612 248,232
-------- ---------
$734,466 $ 717,560
======== =========
</TABLE>
Included in fixed maturities at December 31, 1999 and 1998 were
securities with carrying values of $32.5 million and $7.7 million, respectively,
held by various states as security for the policyholders of the Company within
such states.
Gross unrealized gains and gross unrealized losses of equity securities
as of December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Gross unrealized gains $ 83 $ 44
Gross unrealized losses (365) (88)
------- -------
Net unrealized losses $ (282) $ (44)
======= =======
</TABLE>
The components of the change in unrealized gains and losses included in
the consolidated statements of stockholders' equity for the three years ended
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Change in net unrealized gains (losses):
Fixed maturities $ (19,476) $ 104 $ 3,485
Equity securities (239) (1) (29)
Foreign currency 2,177 - -
Adjustment relating to
Deferred policy acquisition costs 4,509 (79) (1,205)
--------- ------ --------
Change in net unrealized gains
(losses) before income tax (13,029) 24 2,251
Income tax (expense)/benefit 5,284 (8) (437)
--------- ------ --------
Change in net unrealized gains (losses) $ 7,745 $ 16 $ 1,814
========= ====== ========
</TABLE>
The details of net investment income for the three years ended December
31, 1999 are as
F-18
<PAGE> 65
follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Investment Income:
Fixed maturities $ 25,950 $ 9,198 $ 8,961
Cash and cash equivalents 2,454 920 802
Equity securities 157 59 29
Property tax liens 52 5 23
Policy loans 1,004 612 496
Mortgage loans 485 363 103
------- --------- ---------
Gross investment income 30,102 11,157 10,414
Investment expenses 789 436 391
------- --------- ---------
Net investment income $29,313 $ 10,721 $ 10,023
======= ========= =========
</TABLE>
Gross realized gains and gross realized losses included in the
consolidated statements of operations for the three years ended December 31,
1999 are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Realized gains:
Fixed maturities $ 534 $ 1,250 $ 760
Equity securities 2,661 26 630
-------- ------- ---------
Total realized gains 3,195 1,276 1,390
-------- ------- ---------
Realized losses:
Fixed maturities (819) (991) (258)
Equity securities (2,617) (29) --
-------- ------- ---------
Total realized losses (3,436) (1,020) (258)
-------- ------- ---------
Net realized gains/(losses) $ (241) $ 256 $ 1,132
======== ======= =========
</TABLE>
During the year ended December 31, 1999 and 1998, the Company wrote
down the value of certain fixed maturity securities by $0.6 million and $0.6
million, respectively, which represents management's estimate of other than
temporary declines in value and was included in net realized gains (losses) on
investments. In 1997, the Company realized a gain of $0.6 million on the sale of
AmeriFirst Insurance Company, a non-operating subsidiary.
6. INCOME TAXES:
The Company files a consolidated return for federal income tax
purposes, in which American Exchange and its subsidiaries and PennCorp Canada
are not currently permitted to be included. American Exchange and its
subsidiaries file a separate consolidated federal income tax return.
The Company's federal income tax expense consisted of:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Current - US $ 127 $ - $ -
Current - Canadian 1,394 - -
Deferred - US 4,078 1,324 1,092
Deferred - Canadian 644 - -
------ ------ ------
Total tax expense $6,243 $1,324 $1,092
====== ====== ======
</TABLE>
A reconciliation of the "expected" tax expense at 35% (34% in 1997 and
1998) with the Company's actual tax expense applicable to operating income
before taxes reported in the Consolidated
F-19
<PAGE> 66
Statements of Operations is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Expected tax expense $ 5,619 $ 1,337 $ 1,092
Canadian taxes 365
Other 259 (13) --
------- ------- -------
Actual tax expense $ 6,243 $ 1,324 $ 1,092
======= ======= =======
</TABLE>
In addition to Federal income tax, the Company is subject to state
premium and income taxes, which taxes are included in other operating costs and
expenses in the accompanying statement of operations. Income taxes receivable
for the years ended December 31, 1999 and 1998 totaled $0.7 million and $3.7
million, respectively.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying value of assets and liabilities for financial
reporting purposes and the amount used for income tax purposes. The tax effects
of temporary differences that give rise to significant portions of the deferred
tax assets and deferred tax liabilities at December 31, 1999 and 1998 are as
follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
(In thousands)
<S> <C> <C>
Deferred tax assets:
Reserves for future policy benefits $ 30,637 $ 3,310
Deferred policy acquisition costs 24,582 -
Net operating loss carryforwards 19,899 5,219
Unrealized losses on investments 3,873 -
Investment valuation differences 7,176 189
Deferred revenues - 68
AMT credit carryforward 262 107
Other - 24
-------- --------
Total gross deferred tax assets 86,429 8,917
Less valuation allowance (11,343) (1,343)
-------- --------
Net deferred tax assets 75,086 7,574
-------- --------
Deferred revenues (1,190) -
Present value of future profits (488) (534)
Deferred policy acquisition costs - (6,756)
Unrealized gains on investments - (444)
Other (2,440) (1,059)
-------- --------
Total gross deferred tax liabilities (4,118) (8,793)
-------- --------
Net deferred tax asset (liability) $ 70,968 $ (1,219)
======== ========
</TABLE>
In 1999, a deferred tax asset relating to the purchase of the Penn
Union companies was established in the amount of $69.9 million (relating
primarily to acquired net operating loss carryforwards).
At December 31, 1999, the Company (exclusive of American Exchange and
its subsidiaries and PennCorp Canada) had net operating tax loss carryforwards
of approximately $9.7 million that expire in the years 2001 to 2019. At December
31, 1999, the Company also had an Alternative Minimum Tax (AMT) credit
carryforward for Federal income tax purposes of approximately $0.3 million that
can be carried forward indefinitely. At December 31, 1999, American Exchange and
its subsidiaries had net operating tax loss carryforwards, most of which were
incurred prior to their acquisition by the Company, of approximately $47.1
million that expire in the years 2007 to 2013. As a result of changes in
ownership of
F-20
<PAGE> 67
the Company in July 1999, the use of most of the loss carryforwards of the
Company are subject to annual limitations.
At December 31, 1999 and 1998, the Company has established valuation
allowances of $11.3 million and $1.3 million, respectively, with respect to its
deferred tax assets. The Company establishes a valuation allowance based upon an
analysis of projected taxable income and its ability to implement prudent and
feasible tax planning strategies. Management believes it is more likely than not
that the Company will realize the recorded net deferred tax assets.
Two of the life insurance companies owned by the Company, Peninsular
and American Pioneer, have Policyholder Surplus Accounts (Phase III) that, if
required to be recognized as taxable income, would generate $2.9 million and
$0.4 million in Federal income tax, respectively. The Company does not expect to
recognize any Phase III tax; consequently, no deferred tax liability has been
established.
7. 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 conditions
were 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 cumulative 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. On July
30, 1999, 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.
8. STOCKHOLDERS' EQUITY
Preferred Stock
The Company had 2,000,000 authorized shares of preferred stock to be
issued in series with 74,580 shares issued and outstanding at December 31, 1998.
During 1999 all of the outstanding preferred stock was converted into common
stock (see Note 7 for a discussion of the conversion of previously outstanding
Series B, C, D and D-1 Preferred Stock).
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 December 31, 1999
and 1998 were 45,914,327 and 7,638,057, respectively. During the years ended
December 31, 1999, 1998 and 1997, the Company issued 38,276,270; 312,197; and
176,639 shares, respectively, of its common stock.
Common Stock Warrants
At December 31, 1998, the Company had 658,231 common stock warrants
issued and outstanding which were registered under the Securities Act of 1933
and 2,015,760 warrants outstanding which were not registered under the
Securities Act of 1933. The warrants had an exercise price to purchase common
stock on a one to one basis at $1.00 and expired on December 31, 1999. During
the year ended December 31, 1999, 650,410 of the registered common stock
warrants and all of the
F-21
<PAGE> 68
unregistered common stock warrants were exercised for $2,666,170 resulting in
the issuance of 2,666,170 shares of the Company's common stock. 7,821 of the
registered common stock warrants expired unexercised.
9. STOCK OPTION AND EQUITY PLANS
Option Plans
1998 ICP
On May 28, 1998, the Company's shareholders approved the 1998 Incentive
Compensation Plan (the "1998 ICP"). The 1998 ICP superceded the Company's
Incentive Stock Option Plan. Options previously granted under the Company's
Incentive Stock Option Plan will remain outstanding in accordance with their
terms and the terms of the respective plans.
The 1998 ICP provides for grants of stock options, stock appreciation
rights ("SARs"), restricted stock, deferred stock, other stock-related awards,
and performance or annual incentive awards that may be settled in cash, stock,
or other property ("Awards"). For the year ended December 31, 1999, the Company
recorded compensation expense for stock bonuses granted of $0.4 million.
The total number of shares of the Company's Common Stock reserved and
available for delivery to participants in connection with Awards under the 1998
ICP is (i) 1.5 million, plus (ii) the number of shares of Common Stock subject
to awards under Preexisting Plans that become available (generally due to
cancellation or forfeiture) after the effective date of the 1998 ICP, plus (iii)
13% of the number of shares of Common Stock issued or delivered by the
Corporation during the term of the 1998 ICP (excluding any issuance or delivery
in connection with Awards, or any other compensation or benefit plan of the
Corporation), provided, however, that the total number of shares of Common Stock
with respect to which incentive stock options ("ISOs") may be granted shall not
exceed 1.5 million. As of December 31, 1999, 6.5 million shares were reserved
for outstanding Awards under the 1998 ICP and 1.6 million shares were reserved
for issuance under future Awards.
The 1998 ICP imposes individual limitations on the amount of certain
Awards in order to comply with Section 162(m) of the Internal Revenue Code (the
"Code"). Under these limitations, during any fiscal year the number of options,
SARs, shares of restricted stock, shares of deferred stock, shares of Common
Stock issued as a bonus or in lieu of other obligations, and other stock-based
Awards granted to any one participant shall not exceed one million shares for
each type of such Award, subject to adjustment in certain circumstances, the
maximum cash amount that may be earned as a final annual incentive award or
other annual cash Award in respect of any fiscal year by any one participant is
$5 million, and the maximum cash amount that may be earned as a final
performance award or other cash Award in respect of a performance period other
than an annual period by any one participant on an annualized basis is $5
million.
Executive officers, directors, and other officers and employees of the
Corporation or any subsidiary, as well as other persons who provide services to
the Corporation or any subsidiary, are eligible to be granted Awards under the
1998 ICP, which is administered by the Board or a Committee established pursuant
to the Plan.
The Committee, may, in its discretion, accelerate the exercisability,
the lapsing of restrictions, or the expiration of deferral or vesting periods of
any Award, and such accelerated exercisability, lapse, expiration and vesting
shall occur automatically in the case of a "change in control" of the
Corporation, except to the extent otherwise determined by the Committee at the
date of grant or thereafter.
F-22
<PAGE> 69
Options Granted to Employees
In 1983, the Company had adopted an Incentive Stock Option Plan for
Employees. As of December 31, 1999, 434,000 of options to employees are
outstanding under this plan. Options under this plan expire ten years after the
date granted or following the earlier termination of employment. Options vest
50% in the first year after grant and 50% in the second year after grant.
In 1998 employees became eligible for options under the 1998 ICP.
During 1999, 2,349,000 options were granted to employees under the 1998 ICP. In
connection with the acquisition of the Penn Union companies, the Company issued
stock options to certain employees and members of management on August 1, 1999.
These options, which totaled 1,637,500, have an exercise price of $3.15 and vest
20% each year with an initial 20% vesting on the grant date. In addition, the
Company issued 622,500 options to members of management which have an exercise
price of $3.15 and vest in seven years unless Capital Z receives a predetermined
rate of return on their investment in the Company in which case the options will
cliff vest after five years. In accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25"), the
Company recorded an expense for the difference between the exercise price and
the value of the stock on the grant date in the amount of $921,373. Options
expire ten years after the date granted or following earlier termination of
employment. Additional information with respect to options issued to employees
is as follows:
<TABLE>
<CAPTION>
Shares Under
Options Exercise
Outstanding Price
----------------------------- --------------------
<S> <C> <C>
Balance, January 1, 1997 570,000
Granted 166,500 $2.00 - $3.03
Exercised (95,000) $1.25 - $1.44
Terminated (21,000) $1.25 - $3.33
-----------------------------
Balance, December 31, 1997 620,500
Granted 520,500 $2.25 - $2.62
Exercised (165,000) $1.25 - $1.63
Terminated (13,000) $0.80 - $2.00
-----------------------------
Balance, December 31, 1998 963,000
Granted 2,349,000 $3.15 - $4.25
Exercised (12,500) $2.00
Terminated (13,000) $2.00 - $2.25
-----------------------------
Balance, December 31, 1999 3,286,500
=============================
</TABLE>
At December 31, 1999, options granted to employees which are
exercisable amount to 1,192,750.
Stock Options Issued to Directors
At the 1992 Annual Shareholders' Meeting, the Universal American
Financial Corp. non-employee Directors Plan ("Stock Option Plan for Directors")
was approved. As of December 31, 1999, 19,000 options remain outstanding under
this plan. These options expire ten years after the date of grant or following
earlier termination of service as a director.
In 1998, directors of the Company became eligible for options under the
1998 ICP. The 1998 ICP provides that unless otherwise determined by the Board,
each non-employee director would be granted an option to purchase 4,500 shares
of Common Stock upon approval of the 1998 ICP by shareholders or, as to
directors thereafter elected, his or her initial election to the Board, and at
each annual meeting of shareholders starting in 1999 at which he or she
qualifies as a non-employee director. Unless otherwise determined by the Board,
such options will have an exercise price equal to 100% of the fair market value
F-23
<PAGE> 70
per share on the date of grant and will become exercisable in three equal
installments after each of the first, second and third anniversaries of the date
of grant based on continued service as a director. Options outstanding under
this plan totaled 109,500. Options outstanding for directors at December 31,
1999 which are exercisable totaled 76,500. Additional information with respect
to the Company's stock options issued to directors is as follows:
<TABLE>
<CAPTION>
Options Exercise
Outstanding Price
---------------------------- ------------
<S> <C> <C>
Balance, January 1, 1997 28,000
Granted 8,000 $1.88
----------------------------
Balance, December 31, 1997 36,000
Granted 85,500 $2.25 - $2.62
Exercised (8,700) $0.56 - $1.63
Terminated (4,300) $1.88 - $3.50
----------------------------
Balance, December 31, 1998 108,500
Granted 36,000 $4.00
Exercised (16,000) $1.88 - $3.50
----------------------------
Balance, December 31, 1999 128,500
============================
</TABLE>
Stock Option Plan for Agents and Others
On December 15, 1995, the Board of Directors approved a plan under
which up to 200,000 options could be granted to agents of the Company's
subsidiaries (subject to insurance law restrictions) and to other persons as to
whom the board of directors believes the grant of such options will serve the
best interests of the Corporation, provided that no options may be granted under
this plan to officers, directors or employees of the Company or of any
subsidiary, while they are serving as such. Such options expire ten years from
the date of the grant. Options outstanding under this plan total 102,786, all of
which are exercisable. In 1998, agents and other persons became eligible for
options under the 1998 ICP. 152,000 options were issued in 1999 to agents and
others. In accordance with FASB Statement No. 123, "Accounting for Stock Based
Compensation," ("FASB 123"), the fair value of these options totaling $0.2
million was expensed These options vest in equal installments over a three year
period and expire ten years from the date of grant.
In addition, in connection with the acquisition of the Penn Union
companies, the Company adopted additional stock option plans for agents and
regional managers of the Penn Union companies. Agents are to be issued stock and
stock options based on new premium production at predetermined exercise prices.
The plan ends at the earlier of December 31, 2001 or when the aggregate number
of options have been issued. Total options granted may not exceed $1.0 million
of proceeds to be received upon exercise to a maximum of 175,778 options.
Options issued under this plan cliff vest 24 months after the end of the year of
option grant and expire at the earliest of the termination date as an agent or
30 days after the option becomes exercisable. During 1999, a total of 84,254
options were issued to agents of the Penn Union companies related to 1999 sales
performance at an exercise price of $3.62. In accordance with FASB 123, the fair
value of these options was expensed which totaled $0.2 million. These agents
were also eligible for stock grants based on new premium production. Total stock
grants in 1999 totaled 84,254 shares for which the Company recorded an expense
of $0.4 million.
Regional managers will receive options based on growth of new premium
earned. The plan ends at the earlier of December 31, 2001, or when aggregate
numbers of options are issued. Total options to be granted cannot exceed $5.0
million of proceeds to be received upon exercise of such options to a maximum of
1,178,986 options. Options cliff vest on the January 1st following the second
calendar year after the year of option grant. Options issued to regional
managers expire at the earliest of termination as an agent for cause, 30 days
after termination not for cause, or 5 years after the grant date. Total options
issued in 1999 for 1998 performance were 183,055 with an exercise price of
$3.15. Options issued
F-24
<PAGE> 71
related to 1999 performance totaled 66,299 with an exercise price of $3.62. In
accordance with FASB 123, a total of $0.7 million was expensed representing the
fair value of the options issued.
Additional information with respect to stock options issued to agents
and others is as follows:
<TABLE>
<CAPTION>
Options Exercise
Outstanding Price
---------------------------- --------------------
Balance, January 1, 1997 86,393
<S> <C> <C>
Granted 16,393 $2.50 - $2.97
----------------------------
Balance, December 31, 1997 102,786
Granted 134,500 $2.62- $3.25
----------------------------
Balance, December 31, 1998 237,286
Granted 485,608 $3.09 - $5.31
----------------------------
Balance, December 31, 1999 722,894
============================
</TABLE>
Accounting for Stock-Based Compensation
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB 123 requires use of
option valuation models that were not developed for use in valuing employee
stock options.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1999, 1998 and 1997, respectively: risk-free interest rates of
6.51%-6.68%, 5.63% - 6.63%; and 6.13% - 6.63% and dividend yields of 0%, 0% and
0%; volatility factors of the expected market price of the Company's common
stock of 43.63% - 48.64%, 43.74% - 46.08%, and 49.97% - 53.48%, and a
weighted-average expected life of the option of 4.5 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------ ----------------- ------------
(In thousands)
<S> <C> <C> <C>
Net Income $ 9,813 $ 2,608 $ 2,119
Less: Pro forma estimated fair value
Options vested 1,979 526 234
------------ ----------------- ------------
Pro forma net income (loss) $ 7,834 $ 2,082 $ 1,885
============ ================= ============
Pro forma diluted earnings per share $0.27 $0.16 $0.16
============ ================= ============
</TABLE>
A summary of the status of the Company's three stock option plans as of
December 31, 1999
F-25
<PAGE> 72
and 1998, and changes during the years ending on those dates is presented below:
<TABLE>
<CAPTION>
1999 1998
------------------------------------------------------------ -------------------------------
Weighted-Average Weighted-Average Weighted-Average
Exercise Price Fair Exercise
Fixed Options Options Value Options Price (1)
- ----------------------------- ------------------ ------------------- ----------------- ------------ ----------------
(In thousands) (In thousands)
<S> <C> <C> <C> <C> <C>
Outstanding-beginning of year 1,309 $2.57 $2.57 759 $2.22
Granted 2,870 3.32 4.84 741 2.61
Exercised (28) (2.33) (2.33) (174) 1.49
Terminated (13) (2.18) (2.18) (17) 1.83
------------------ ----------
Outstanding-end of year 4,138 $3.09 $4.15 1,309 $2.57
================== ===========
Options exercisable at end
of year 1,732 485
Weighted average fair value of
options granted during the year
$3.32 $1.12
</TABLE>
(1) In 1998, all stock options were issued with the exercise price equal to
the fair value price at the date of grant.
The following table summarizes information about stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
Number Weighted-Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
- --------------- -------------- ---------------- -------------- --------------- --------------
(In thousands) (In thousands)
<S> <C> <C> <C> <C> <C>
$ 1.88 6 7.5 years $1.88 6 $1.88
2.00 to 2.97 1,045 8.0 years 2.45 858 2.46
3.03 to 3.62 2,832 9.4 years 3.18 451 3.15
4.00 to 4.25 116 9.9 years 4.17 - -
5.31 139 9.9 years 5.31 - -
------------- -----
$ 1.88 to 5.31 4,138 9.1 years 3.09 1,315 2.69
============= =====
</TABLE>
10. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS:
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
December 31, 1999 and 1998 the statutory capital and surplus, including asset
valuation reserve, of the U.S. insurance subsidiaries totaled $89.2 million and
$21.1 million, respectively. Total statutory net income for the three years
ended December 31, 1999, 1998 and 1997 was $24.2 million ($25.4 million of which
related to the Penn Union companies), $0.6 million and $0.7 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
F-26
<PAGE> 73
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
$63.9 million as of December 31, 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 December 31, 1999.
Dividend payments from American Progressive to the Company would
require regulatory approval, which, in all likelihood, would not be obtained
until American Progressive generated enough statutory profits to offset its
entire negative unassigned surplus, which was approximately $8.6 million at
December 31, 1999. American Progressive made no dividends or distributions
during the three years ended 1999.
American Pioneer may pay a dividend or make a distribution without the
prior written approval of the Florida Insurance Department when (a) the dividend
is equal to or less than the greater of (1) 10% of the insurer's surplus as to
policyholders derived from net operating profits on its business and net
realized capital gains ("policyholder surplus from operations"); or (2) the
insurer's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year but not more than its
policyholder surplus from operations; (b) the insurer will have surplus as to
policyholders equal to or exceeding 115% of the minimum required statutory
surplus as to policyholders after the dividend or distribution is made; and (c)
the insurer has filed notice with the department at least 10 business days prior
to the dividend payment or distribution. American Pioneer paid dividends in 1997
totaling $610,000. American Pioneer did not pay any dividends in 1998 and 1999.
Under current North Carolina, Pennsylvania and Texas insurance law, a
life insurer may pay dividends or make distributions out of unassigned surplus
without the prior approval of the Insurance Department as long as the dividend
distributions do not exceed the greater of (i) 10% of the insurer's surplus as
to policyholders as of the preceding December 31st; or (ii) the insurer's net
gain from operations for the immediately preceding calendar year. American
Exchange made no dividends or distributions during the three years ended 1999.
Since their acquisition on July 30, 1999, the Penn Union Companies have made no
dividends or distributions.
Under current Canadian law, a life insurer may pay a dividend after
such dividend declaration has been approved by its board of directors and upon
at least 10 days prior notification to the Superintendent of Financial
Institutions. In considering approval of a dividend, the board of directors must
consider whether the payment of such dividend would be in contravention of the
Insurance Companies Act of Canada.
The Insurance Subsidiaries' statutory basis financial statements are
prepared in accordance with accounting practices prescribed or permitted by
their respective domiciliary states. "Prescribed" statutory accounting practices
include state laws, regulations and general administrative rules, as well as
publications of the NAIC. "Permitted" statutory accounting practices encompass
all accounting practices that are not prescribed but are authorized by the
relevant insurance departments; such practices may differ from state to state,
may differ from company to company within a state and may change in the future.
In 1998, the NAIC approved a codification of statutory accounting
principles, effective January 1, 2001, which will serve as a comprehensive and
standardized guide to statutory accounting principles. The adoption of the
codification will change, to some extent, the accounting practices that the
Company's Insurance Subsidiaries use to prepare their statutory financial
statements. Although the Company has not completed its assessment of the effect
of codification, it does not believe that such changes will have a material
adverse impact on the reported statutory financial condition of any such
subsidiaries.
F-27
<PAGE> 74
11. REINSURANCE:
In the normal course of business, the Company reinsures portions of
certain policies that they underwrite to limit disproportionate risks. The
Company is party to several reinsurance agreements on its life and accident &
health insurance risks. The Company's senior market accident & health insurance
products are reinsured under coinsurance treaties with unaffiliated insurers,
while the life insurance risks are reinsured under either coinsurance or
yearly-renewable term treaties with unaffiliated insurers. Under coinsurance
treaties, the reinsurer receives an agreed upon percentage of all premiums and
reimburses the Company that same percentage of any losses. In addition, the
Company receives certain allowances from the reinsurers to cover commissions,
expenses and premium taxes. Under yearly-renewable term treaties, the reinsuring
company receives premiums at an agreed upon rate and holds the required reserves
for its share of the risk on a yearly-renewable term basis. The Company is also
party to certain reinsurance agreements whereby the Company limits its loss in
excess of certain thresholds. The Company evaluates the financial condition of
its reinsurers and monitors concentrations of credit risk to minimize its
exposure to significant losses from reinsurer insolvencies. A contingent
liability exists with respect to reinsurance that may become a liability of the
Company in the event that the reinsurers should be unable to meet the
obligations that they assumed.
The Company has several quota share reinsurance agreements in place
with Reassurance Company of Hanover ("RCH"), Cologne Life Reinsurance Company
("CLR") and Transamerica Occidental Life ("TA"), (collectively, the
"Reinsurers"), which Reinsurers are rated A or better by A.M. Best. These
agreements cover various accident & health insurance products written or
acquired by the Company and contain ceding percentages ranging between 50% and
100%. The Reinsurers receive their pro-rata premium and pay their pro-rated
benefits. In addition, the Company receives allowances from the Reinsurers to
reimburse the commission, administration and premium tax expenses associated
with the business reinsured. At December 31, 1999 and 1998 amounts due from
these Reinsurers were as follows:
<TABLE>
<CAPTION>
1999 1998
------------------- ------------------
Reinsurer (In thousands)
<S> <C> <C>
CLR $95,390 $3,686
RCH 46,877 29,177
TA 16,898 21,761
------------------- ------------------
Total $159,165 $54,624
=================== ==================
</TABLE>
In conjunction with the Penn Union acquisition, Peninsular entered into
a coinsurance agreement with Occidental Life Insurance Company of North Carolina
("Occidental"), a former affiliate, to cede 100% of its direct business
(primarily life and annuity business). Currently, Occidental is rated B+ by A.M.
Best. It is the intent of the parties to this agreement to replace the
coinsurance agreement with a full assumption agreement and effectively transfer
the business to Occidental. At December 31, 1999, the reinsurance recoverable
from Occidental totaled $19.2 million.
F-28
<PAGE> 75
A summary of reinsurance activity for the three years ended December
31, 1999 is presented below:
<TABLE>
<CAPTION>
As of December 31,
----------------------------------------------------------------------
1999 1998 1997
---------------- ------------------------- ----------------------
(In thousands)
<S> <C> <C> <C>
Life insurance in force
Gross amount $4,445,889 $ 2,038,438 $ 2,118,492
Ceded to other companies (1,855,019) (735,791) (842,624)
Assumed from other companies 50,699 47,084 42,237
---------------- ------------------------- ----------------------
Net Amount $ 2,641,569 $ 1,349,731 $ 1,318,105
================ ========================= ======================
Percentage of assumed to net 2% 4% 3%
================ ========================= ======================
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------
Premiums 1999 1998 1997
-------------------- ----------------------- ------------------
(In thousands)
<S> <C> <C> <C>
Life insurance $ 25,704 $ 15,242 $ 12,660
Accident & health 226,849 115,802 86,177
-------------------- ---------------------- ------------------
Total gross premiums 252,553 131,044 98,837
-------------------- ----------------------- ------------------
Ceded to other companies
Life insurance (9,290) (7,238) (5,585)
Accident & health (129,537) (82,308) (57,038)
-------------------- ----------------------- -------------------
Total ceded premiums (138,827) (89,546) (62,623)
-------------------- ----------------------- -------------------
Assumed from other companies
Life insurance 1,177 998 998
Accident & health 574 - -
-------------------- ----------------------- -------------------
Total assumed premium 1,751 998 998
-------------------- ----------------------- -------------------
Net amount
Life insurance 17,591 9,002 8,073
Accident & health 97,886 33,494 29,139
-------------------- ----------------------- -------------------
Total net premium $ 115,477 $ 42,496 $37,212
==================== ======================= ===================
Percentage of assumed to net
Life insurance 7% 11% 12%
===================== ======================== ====================
Accident & health 1% 0% 0%
===================== ======================== ====================
Total assumed to total net 2% 2% 3%
====================== ========================= ====================
</TABLE>
Total claims recovered for 1999 totaled $104.9 million.
12. LOAN AGREEMENTS:
As of December 31, 1998 the Company had a loan outstanding of $4.8
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
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
F-29
<PAGE> 76
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
five months ended December 31, 1999, the Company paid $2.65 million in interest
on the term loan. In addition, the Company incurred loan origination fees of
$3.5 million which were capitalized and will be amortized on a straight line
basis over the life of the loan.
The following table sets forth certain summary information
with respect to total borrowings of the Company for the three years ended
December 31, 1999:
<TABLE>
<CAPTION>
As of December 31, Year Ended December 31,
------------------------------------ ------------------------------------------------------------
Weighted
Maximum Average(a) Average
Amount Interest Amount Amount Interest
Outstanding Rate Outstanding Outstanding Rate (b)
----------------- -------------- ------------------ ----------------- ----------------
(In thousands) (In thousands) (In thousands)
<S> <C> <C> <C> <C> <C>
1999 $70,000 9.01% $70,000 $31,833 8.98%
================= ============== ================== ================= ================
1998 $4,750 7.97% $5,000 $3,743 8.19%
================= ============== ================== ================= ================
1997 $3,500 8.19% $3,500 $ 952 9.76%
================= ============== ================== ================= ================
</TABLE>
(a) The average amounts of borrowings outstanding were computed by
determining the arithmetic average of the months' average outstanding
in borrowings.
(b) The weighted-average interest rates were determined by dividing
interest expense related to total borrowings by the average amounts
outstanding of such borrowings.
The following table shows the schedule of principal payments on the
Company's outstanding loan. Principal repayments begin in July, 2000, with the
final payment in July, 2006:
<TABLE>
<CAPTION>
Principal
Repayment
---------------------------
(In thousands)
<S> <C>
2000 $ 3,350
2001 8,175
2002 10,700
2003 11,525
2004 12,400
2005 13,275
2006 10,575
===============
Total $ 70,000
===============
</TABLE>
13. COMMITMENTS:
The Company is obligated under certain lease arrangements for its
executive and administrative offices in New York, Florida, Texas, North
Carolina, Alabama and Ontario, Canada. Rent expense for the three years ended
December 31, 1999, 1998 and 1997 was $1.5 million, $0.7 million and $0.8
million, respectively. The minimum rental commitments, subject to escalation
clauses, at December 31, 1999 under non-cancelable operating leases are as
follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
2000 $ 1,848
2001 1,819
2002 1,664
2003 927
2004 and thereafter 177
---------------
Totals $ 6,435
===============
</TABLE>
F-30
<PAGE> 77
14. UNIVERSAL AMERICAN FINANCIAL CORP. 401(K) SAVINGS PLAN:
Effective April 1, 1992, the Company adopted the Universal American
Financial Corp. 401(k) Savings Plan ("Savings Plan"). The Savings Plan is a
voluntary contributory plan under which employees may elect to defer
compensation for federal income tax purposes under Section 401(k) of the
Internal Revenue Code of 1986. The employee is entitled to participate in the
Savings Plan by contributing through payroll deductions up to 20% of the
employee's compensation. In the two year period ended December 31, 1997, the
Company matched the employee's contribution up to 1% of the employee's
compensation. Beginning in 1998, the Company matched the employee's contribution
up to 2% of the employee's compensation. The Company's matching contributions
are made with Company common stock. As of December 31, 1999, 375,000 shares of
the Company's common stock were held by the Savings Plan.
The participating employee is not taxed on these contributions until
they are distributed. Moreover, the employer's contributions vest at the rate of
25% per plan year. Amounts credited to employee's accounts under the Savings
Plan are invested by the employer-appointed investment committee. Generally, a
participating employee is entitled to distributions from the Savings Plan upon
termination of employment, retirement, death or disability. Savings Plan
participants who qualify for distributions may receive a single lump sum, have
the assets transferred to another qualified plan or individual retirement
account, or receive a series of specified installment payments. Total matching
contributions by the Company under the Savings Plan were $172,000, $92,000 and
$41,000 in 1999, 1998 and 1997, respectively.
15. OTHER POST-RETIREMENT BENEFIT PLANS
The Company does not offer post-retirement health, medical or life
benefits to its active employees. Obligations of approximately $4.3 million
relate to post-retirement benefit plans made available to former employees of
the Penn Union Companies, their predecessors or affiliates, who retired prior to
the Company's acquisition of the Penn Union Companies, which obligations are
included in other liabilities in the accompanying balance sheet. The Company is
currently reviewing the extent of its and PFG's obligations, and the scope of
benefits and coverage, under these plans. Any changes in the benefits provided
will result in an adjustment to this accrual.
16. FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK:
For the years ended December 31, 1999 and 1998, the Company held
unrated or less-than-investment grade corporate debt securities with carrying
and estimated fair values as follows:
<TABLE>
<CAPTION>
1999 1998
-------------------- --------------
(In thousands)
<S> <C> <C>
Carrying value $ 8,040 $3,357
==================== ==============
Estimated fair value $ 8,040 $3,357
==================== ==============
Percentage of total assets 0.7% 1.2%
==================== ==============
</TABLE>
The holdings of less-than-investment grade securities are widely
diversified and the investment in any one such security is currently less than
$2,000,000, which is approximately 0.1% of total assets.
17. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
a. Fixed maturities available for sale: For those securities available for
sale, fair value equals quoted market price, if available. If a quoted
market price is not available, fair value is
F-31
<PAGE> 78
estimated using quoted market prices for similar securities.
b. Equity securities: For equity securities carried at fair value, fair
value equals quoted market price.
c. Cash and cash equivalents: For cash and cash equivalents, the carrying
amount is a reasonable estimate of fair value.
d. Investment contract liabilities: For annuity and universal life type
contracts, the carrying amount is the policyholder account value (see
Note 2e); estimated fair value equals the policyholder account value
less surrender charges.
e. Short term debt and loan payable: For short-term borrowings and loan
payable, the carrying value is a reasonable estimate of fair value due
to their short-term nature.
f. Accounts receivable and uncollected premiums: Accounts receivable and
uncollected premiums are primarily insurance contract related
receivables, which are determined based upon the underlying insurance
liabilities and added reinsurance amounts.
The estimated fair values of the Company's financial instruments as of
December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999
-------------------------------------------------------------------------
Carrying
Amount Fair Value
------------------------------ --------------------------------------
(In thousands)
<S> <C> <C>
Financial assets:
Fixed maturities available for sale $717,560 $717,560
Equity securities 4,838 4,838
Policy loans (a) 25,640
Other invested assets (b) 2,763
Mortgage loans (b) 2,743
Cash and cash equivalents 58,753 58,753
Financial liabilities:
Investment contract liabilities 238,665 215,867
Loan payable 70,000 70,000
</TABLE>
<TABLE>
<CAPTION>
1998
--------------------------------------
Carrying
Amount Fair Value
--------------------------------------
(In thousands)
<S> <C> <C>
Financial assets:
Fixed maturities available for sale $134,798 $134,798
Equity securities 1,020 1,020
Policy loans (a) 7,276
Other invested assets (b) 31
Mortgage loans (b) 4,457
Cash and cash equivalents 17,093 17,093
Financial liabilities:
Investment contract liabilities 159,883 147,911
</TABLE>
F-32
<PAGE> 79
<TABLE>
<S> <C> <C>
Loan payable 4,750 4,750
</TABLE>
(a) It is not practicable to estimate the fair value of policy
loans, as they have no stated maturity and their rates are set
at a fixed spread to related policy liability rates. Policy
loans are carried at the aggregate unpaid principal balances
in the consolidated balance sheets, and earn interest at rates
between 6% to 8%. Individual policy liabilities, in all cases,
equal or exceed outstanding policy loan balances.
(b) Mortgage loans are carried at the aggregate unpaid balances
and the fair market value was not determined as the amount
involved was considered to be immaterial. Other invested
assets consists mainly of collateralized loans which are
carried at cost. The determination of fair value for these
invested assets is not practical because there is no active
trading market for such invested assets.
18. IMPACT OF THE YEAR 2000 (UNAUDITED):
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.
19. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The quarterly results of operations for the three years ended December
31, 1999 are presented below . 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 twelve months ended December 31, 1999 (as disclosed in Note 2k).
<TABLE>
<CAPTION>
1999 Three Months Ended
- ---------------------------------------------- -------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
------------- ---------- ------------- ---------------
(In thousands)
<S> <C> <C> <C> <C>
Total revenue $13,850 $14,713 $50,188 $69,385
Total benefits, claims & other expenses 12,783 13,640 45,002 60,655
------------ --------- --------- ------------
Operating income (loss) before income taxes 1,067 1,073 5,186 8,730
Federal income tax expense 356 371 1,953 3,563
------------ --------- --------- ------------
Net Income 711 702 3,233 5,167
Redemption accrual on Series C
Preferred Stock 180 - - -
Net income applicable to common
Shareholders $ 531 $ 702 $ 3,233 $ 5,167
============ ========= ========= ============
Basic earnings per share $ 0.07 $ 0.07 $ 0.10 $ 0.12
============ ========= ========= ============
Diluted earnings per share $ 0.05 $ 0.05 $ 0.09 $ 0.11
============ ========= ========= ============
</TABLE>
<TABLE>
<CAPTION>
1998 Three Months Ended
- ---------------------------------------------- -------------------------------------------------------------------
March 31, June 30, September 30, December 31,
----------- -------------- -------------- ----------------
(In thousands)
<S> <C> <C> <C> <C>
Total revenue $ 13,815 $ 14,331 $ 14,068 $ 13,875
Total benefits, claims & other expenses 13,040 13,071 13,050 12,996
----------- -------------- -------------- ----------------
</TABLE>
F-33
<PAGE> 80
<TABLE>
<S> <C> <C> <C> <C>
Operating income (loss) before income taxes 775 1,260 1,018 879
Federal income tax expense 242 450 346 286
----------- -------------- -------------- ----------------
Net Income 533 810 672 593
Redemption accrual on Series C
Preferred Stock 108 109 108 109
----------- -------------- -------------- ----------------
Net income applicable to common
Shareholders $ 425 $ 701 $ 564 $ 484
=========== ============== ============== ================
Basic earnings per share $ 0.06 $ 0.09 $ 0.07 $ 0.07
=========== ============== ============== ================
Diluted earnings per share $ 0.04 $ 0.06 $ 0.05 $ 0.05
=========== ============== ============== ================
</TABLE>
F-34
<PAGE> 81
<TABLE>
<CAPTION>
1997 Three Months Ended
- ---------------------------------------------- ------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
------------------------------------- --------------- ------------
(In thousands)
<S> <C> <C> <C> <C>
Total revenue $ 12,885 $ 13,274 $ 14,030 $ 11,141
Total benefits, claims & other expenses 12,325 12,565 12,792 10,437
--------------------- ------------ --------------- ------------
Operating income (loss) before income taxes 560 709 1,238 704
Federal income tax expense 190 241 421 240
--------------------- ------------ --------------- ------------
Net Income 370 468 817 464
Redemption accrual on Series C
Preferred Stock - 55 91 103
Net income applicable to common
Shareholders $ 370 $ 413 $ 726 $ 361
===================== ============ =============== ============
Basic earnings per share $ 0.05 $ 0.06 $ 0.10 $ 0.05
===================== ============ =============== ============
Diluted earnings per share $ 0.03 $ 0.04 $ 0.07 $ 0.04
===================== ============ =============== ============
</TABLE>
20. SUBSEQUENT EVENT
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 and
received administrative fees of $11.3 million in 1999. This acquisition is
expected to generate cost savings and strengthen the Company's administrative
capabilities while it expands its presence in the senior market and initiates
cross selling opportunities between the Company's Brokerage and Career Sales
Divisions.
21. 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, management reviews and evaluates the results of the Insurance
Services and Corporate Segment.
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 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. Total revenue and operating income
before taxes generated by Canadian operations through PennCorp Canada and
Pennsylvania Life's Canadian branch totaled $23.8 million and $3.8 million,
respectively in 1999. The career agents will begin 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
F-35
<PAGE> 82
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 Markets Segment. Prior year segment information
has been restated to conform with the current segment structure. The Insurance
Services and Corporate Segment consists mainly of the Parent Company and
WorldNet operations.
Financial data by segment for the three years ended December 31, 1999
is as follows:
<TABLE>
<CAPTION>
December 31, 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 $ 55,563 $ 29,589 $ 30,325 $ - $ 115,477
Net investment income 12,131 900 16,178 104 29,313
Realized gains 80 (17) (304) - (241)
Fee and other income 228 - 350 3,009 3,587
-------------- ----------------- ------------ --------------- ------------
Total revenues 68,002 30,472 46,549 3,113 148,136
Policyholder benefits 30,398 22,204 29,321 - 81,923
Increase in deferred acquisition costs (2,919) (3,925) 615 - (6,229)
Commissions and general expenses 28,933 9,078 12,264 6,111 56,386
-------------- ----------------- ------------ --------------- ------------
Total benefits, claims
and other deductions 56,412 27,357 42,200 6,111 132,080
-------------- ----------------- ------------ --------------- ------------
Operating income before taxes $11,590 $3,115 $4,349 $(2,998) $16,056
============== ================= ============ =============== ============
ASSETS
Cash and investments $445,205 $ 18,961 $340,850 $ 7,281 $ 812,297
Deferred policy acquisition costs 2,944 11,251 20,748 - 34,943
Accrued investment income 6,225 133 5,148 - 11,506
Goodwill - 3,669 532 - 4,201
Present value of future profits - 841 385 - 1,226
Due and unpaid premiums 2,114 310 1,154 - 3,578
Reinsurance recoverable 4,953 38,355 153,652 - 196,960
Other assets 4,452 - 4,143 80,115 88,710
-------------- ----------------- ------------ --------------- ------------
Total assets $465,893 $ 73,520 $526,612 $ 87,396 $1,153,421
============== ================= ============ =============== ============
</TABLE>
F-36
<PAGE> 83
<TABLE>
<CAPTION>
December 31, 1998 (restated)
(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 $ - 23,857 $18,639 $ - $42,496
Net investment income - 683 10,015 23 10,721
Realized gains - 16 240 - 256
Fee and other income - - 365 2,251 2,616
------------ --------------- ---------------------- ---------------- -------------
Total revenues - 24,556 29,259 2,274 56,089
Policyholder benefits - 18,456 19,779 - 38,235
Increase in deferred
acquisition costs - (2,885) (645) - (3,530)
Commissions and general expenses - 7,409 8,773 1,270 17,452
------------ --------------- ---------------------- ---------------- -------------
Total benefits, claims
and other deductions - 22,980 27,907 1,270 52,157
------------ --------------- ---------------------- ---------------- -------------
Operating income before taxes $ - $1,576 $1,352 $ 1,004 $ 3,932
============ =============== ====================== ================ =============
ASSETS
Cash investments $ - $10,677 $151,014 $ 2,983 $164,674
Deferred policy acquisition costs - 7,139 17,144 - 24,283
Accrued investment income - 225 3,306 8 3,539
Goodwill - 3,743 611 - 4,354
Present value of future profits - 993 576 - 1,569
Due and unpaid premiums - 200 326 - 526
Reinsurance recoverable - 33,166 44,228 - 77,394
Other assets - - - 6,963 6,963
------------ --------------- ---------------------- ---------------- -------------
Total assets $ - $56,143 $217,205 $ 9,954 $ 283,302
============ =============== ====================== ================ =============
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 (restated)
(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 $ - $ 15,973 $ 21,741 $ - $ 37,714
Net investment income - 611 9,348 64 10,023
Realized gains - 35 529 569 1,133
Fee and other income - - 366 2,094 2,460
------------- ------------- -------------- -------------- -----------
Total revenues 16,619 31,984 2,727 51,330
Policyholder benefits - 11,219 19,587 - 30,806
Increase in deferred acquisition costs - (1,703) (1,243) - (2,946)
Commissions and general expenses - 6,605 12,132 1,522 20,259
------------- ------------- -------------- -------------- -----------
Total benefits, claims
and other deductions - 16,121 30,476 1,522 48,119
------------- ------------- -------------- -------------- -----------
-
Operating income before taxes $ - $498 $1,508 $ 1,205 $3,211
============= ============= ============== ============== ===========
ASSETS
Cash and investments $ - $13,910 $142,916 $ 2,603 $159,429
Deferred policy acquisition costs - 4,377 16,455 - 20,832
Accrued investment income - 205 3,132 21 3,358
Goodwill - 3,876 633 - 4,509
Present value of future profits - 641 641 - 1,282
Due and unpaid premiums - 256 292 - 548
Reinsurance recoverable - 27,852 48,725 - 76,577
Other assets - - - 6,040 6,040
------------- ------------- -------------- -------------- -----------
Total assets $ - $51,117 $212,794 $ 8,664 $272,575
============= ============= =============== ============== ==========
</TABLE>
F-37
<PAGE> 84
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
--------------- ------------
ASSETS (In thousands)
<S> <C> <C>
Cash and cash equivalents $ 6,413 $ 1,794
Investments in subsidiaries at equity 142,877 47,825
Note receivable from affiliate 70,000 1,000
Interest on surplus note 2,721
Due from subsidiary 422 368
Loan origination 3,516
Deferred tax asset 58 1,328
Other assets 1,467 798
--------------- -------------
Total assets $227,474 $ 53,113
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Loan Payable 70,000 4,750
Note Payable to American Progressive 7,900 7,900
Due to subsidiary 4,185 3,863
Amounts payable and other liabilities 11,424 180
--------------- -------------
Total liabilities 93,509 16,693
--------------- -------------
Series C Preferred Stock - 5,168
--------------- -------------
--------------- -------------
Redemption accrual on Series C Preferred Stock - 684
--------------- -------------
Series D Preferred Stock - 2,250
--------------- -------------
Total stockholders' equity 133,965 28,318
--------------- -------------
Total liabilities and stockholders' equity $227,474 $ 53,113
=============== =============
</TABLE>
See notes to consolidated financial statements.
F-38
<PAGE> 85
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
1999 1998 1997
------------------- -------------- ---------------
(In thousands)
REVENUES:
<S> <C> <C> <C>
Net investment income $ 2,762 $ 98 $ 73
Other income 10 38 -
Dividends received from American Pioneer - - 425
------------------- ------------- ---------------
Total revenues 2,772 136 498
------------------- ------------- ---------------
EXPENSES:
Selling, general and administrative expenses 6,479 1,662 502
------------------- ------------- ---------------
Total expenses 6,479 1,662 502
------------------- ------------- ---------------
Operating loss before provision for federal
Income taxes and equity income (3,707) (1,526) (4)
Federal income taxes (benefit) 1,250 (345) (119)
------------------- ------------- ---------------
Net income (loss) before equity income of subsidiaries (4,957) (1,181) 115
Equity in undistributed income 14,770 3,789 2,004
------------------- ------------- ---------------
Net income 9,813 2,608 2,119
Redemption accrual on Series C Preferred Stock 180 434 249
------------------- ------------- ---------------
Net income applicable to common shareholders $9,633 $2,174 $1,870
=================== ============== ===============
</TABLE>
See notes to consolidated financial statements.
F-39
<PAGE> 86
Schedule II - continued
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
1999 1998 1997
----------- ------------ ------------
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 9,813 $ 2,608 $ 2,119
Adjustments to reconcile net income to
net cash used by operating activities:
Increase in investment in subsidiaries (91,818) (5,805) (1,730)
Change in surplus note interest receivable (2,721) - -
Change in amounts due to/from subsidiaries 268 2,914 186
Change in loan origination fees (3,515) - -
Change in deferred income taxes 1,269 - -
Change in other assets and liabilities 1,113 (838) (205)
-------------- ---------------- ---------------
Net cash (used by) provided from operating activities (85,591) (1,121) 370
-------------- ---------------- ---------------
Cash flows from investing activities:
Issuance of surplus note receivable to American Exchange (70,000) - (1,000)
Redemption of surplus note due from American Pioneer 1,000 - -
Capital contribution to American Pioneer (1,000) - -
Purchase of business - (3,950) (11,850)
-------------- ---------------- ---------------
Net cash used by investing activities (70,000) (3,950) (12,850)
-------------- ---------------- ---------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 93,209 421 274
Proceeds from the issuance of Series C Preferred Stock - - 4,838
Proceeds from the issuance of Series D Preferred Stock 1,750 2,250 -
Increase in note payable to American Progressive - 1,975 5,561
Increase in loan payable 70,000 1,250 3,500
Principle repayment on debt (4,750) - (800)
-------------- ---------------- ---------------
Net cash provided from financing activities 160,209 5,896 13,373
-------------- ---------------- ---------------
Net increase in cash and cash equivalents 4,618 825 893
Cash and cash equivalents:
At beginning of year 1,795 970 77
-------------- ---------------- ---------------
At end of year $ 6,413 $ 1,795 $ 970
============== ================ ===============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 2,859 $ 307 $ 77
============== ================ ==============
Income taxes $ 18 $ - $ -
============== ================ ==============
</TABLE>
See notes to consolidated financial statements
F-40
<PAGE> 87
Schedule III - Supplementary Insurance Information
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -------------
(In thousands)
<S> <C> <C> <C>
Deferred policy acquisition costs $34,943 $ 24,283 $ 20,832
=========== =========== ===============
Policyholder account balances $238,665 $154,886 $ 145,086
=========== =========== ===============
Policy and contract claims $77,905 $26,630 $ 23,760
=========== =========== ===============
Premiums and policyholders fees earned $115,477 $42,496 $ 37,714
=========== =========== ===============
Net investment income $29,313 $10,721 $ 10,023
=========== =========== ===============
Interest credited to policyholders $ 8,668 $ 7,240 $ 6,646
=========== =========== ===============
Claims and other benefits and
Change in future policy benefits $73,255 $30,994 $ 24,160
=========== =========== ===============
Increase in deferred acquisition costs $ 6,229 $ 3,530 $ 2,946
=========== =========== ===============
Commissions and other operating costs and expenses $56,316 $17,452 $ 20,147
=========== =========== ===============
</TABLE>
F-41
<PAGE> 1
Exhibit 23(a)
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 11-258016) pertaining to the Universal American Financial Corp.
401(k) Plan and in the Registration Statement (Form S-2 No. 333-3641)
pertaining to the Universal American Financial Corp. Incentive Stock Option
Plan, Agents Stock Purchase Plan, Deferred Compensation Plan for Agents, Stock
Option Plan for Directors, and Non-qualified Stock Option Plans for Agents and
Others, of our report dated March 6, 2000, with respect to the consolidated
financial statements and financial statement schedules of Universal American
Financial Corp. and subsidiaries included in the Annual Report (Form 10-K) for
the year ended December 31, 1999.
/s/ Ernst & Young LLP
--------------------------
ERNST & YOUNG LLP
New York, New York
March 29, 2000
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 717560
<DEBT-MARKET-VALUE> 717560
<EQUITIES> 4838
<MORTGAGE> 2743
<REAL-ESTATE> 0
<TOTAL-INVEST> 753544
<CASH> 58753
<RECOVER-REINSURE> 196960
<DEFERRED-ACQUISITION> 34943
<TOTAL-ASSETS> 1153421
<POLICY-LOSSES> 560777
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 238665
<POLICY-HOLDER-FUNDS> 77905
<NOTES-PAYABLE> 70000
0
0
<COMMON> 459
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 1153421
115477
<INVESTMENT-INCOME> 29313
<INVESTMENT-GAINS> (241)
<OTHER-INCOME> 3587
<BENEFITS> 72898
<UNDERWRITING-AMORTIZATION> (6229)
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 16056
<INCOME-TAX> 6243
<INCOME-CONTINUING> 9813
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9633
<EPS-BASIC> 0.42
<EPS-DILUTED> 0.34
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
