UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Period Ended March 31, 2000
Commission File #0-11321
UNIVERSAL AMERICAN FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2580136
(State of Incorporation) (I.R.S. Employer I.E. No.)
Six International Drive, Suite 190, Rye Brook, NY 10573
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 934-5200
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
The number of shares outstanding of the Registrant's Common Stock as of
April 30, 2000 was 46,970,047.
<PAGE>
2
UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
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Page No.
PART I - FINANCIAL INFORMATION
Consolidated Balance Sheets at March 31, 2000 and December 31, 1999 3
Consolidated Statements of Operations for the three months ended March 31, 2000
and March 31, 1999 4
Consolidated Statements of Cash Flows for the three months ended March 31, 2000
and March 31, 1999 5
Notes to Consolidated Financial Statements 6-13
Management's Discussion and Analysis of Financial Condition and Results of Operations 14-25
PART II - OTHER INFORMATION 26
Signature 26
</TABLE>
<PAGE>
5
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
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ASSETS March 31, 2000 Dec. 31, 1999
------------------- -------------------
Investments: (unaudited)
Fixed maturities available for sale, at fair value
(amortized cost: 2000, $ 746,315; 1999, $734,466) $730,115 $ 717,560
Equity securities, at fair value (cost: 2000, $5,042; 1999, $5,120) 4,622 4,838
Policy loans 25,254 25,640
Other invested assets 2,827 2,763
Mortgage loans 2,638 2,743
------------------- -------------------
Total investments 765,456 753,544
Cash and cash equivalents 41,566 58,753
Accrued investment income 11,296 11,506
Deferred policy acquisition costs 37,968 34,943
Amounts due from reinsurers 203,084 196,960
Due and unpaid premiums 3,471 3,578
Deferred income tax asset 70,350 70,968
Goodwill 5,672 4,201
Present value of future profits 8,471 1,226
Other assets 19,243 17,742
------------------- -------------------
Total assets 1,166,577 1,153,421
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 234,968 238,665
Reserves for future policy benefits 564,792 560,777
Policy and contract claims - life 5,787 5,644
Policy and contract claims - health 74,821 72,261
Loan payable 70,000 70,000
Amounts due to reinsurers 814 85
Restructuring accrual 9,565 9,980
Negative goodwill 9,036 9,622
Other liabilities 52,797 52,422
------------------- -------------------
Total liabilities 1,022,580 1,019,456
------------------- -------------------
STOCKHOLDERS' EQUITY
Common stock (Authorized, 80,000, issued and outstanding: 2000, 46,732,
1999, 45,914) 467 459
Additional paid-in capital 126,968 122,924
Accumulated other comprehensive income (6,565) (6,887)
Retained earnings 23,127 17,469
------------------- -------------------
Total stockholders' equity 143,997 133,965
------------------- -------------------
Total liabilities and stockholders' equity $1,166,577 $ 1,153,421
=================== ===================
See notes to unaudited consolidated financial statements.
</TABLE>
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three Months Ended March 31,
2000 1999
---------------- --------------------
Revenues: (in thousands, per share amounts in dollars)
Gross premium and policyholder fees earned $ 109,341 $ 32,066
Reinsurance premiums assumed 1,017 250
Reinsurance premiums ceded (55,219) (21,891)
---------------- --------------------
Net premium and policyholder fees earned 55,139 10,425
Net investment income 14,151 2,799
Net realized gains on investments 40 47
Fee income 1,440 579
---------------- --------------------
Total revenues 70,770 13,850
---------------- --------------------
Benefits, claims and expenses:
Increase in future policy benefits 56 317
Claims and other benefits 37,104 6,937
Interest credited to policyholders 2,562 1,918
Increase in deferred acquisition costs (3,006) (856)
Amortization of present value of future profits 812 44
Amortization of goodwill/negative goodwill (169) 39
Commissions 19,974 6,253
Commission and expense allowances on reinsurance ceded (15,725) (7,414)
Interest expense 1,680 93
Other operating costs and expenses 18,668 5,452
---------------- --------------------
Total benefits, claims and other deductions 61,956 12,783
---------------- --------------------
Operating income before taxes 8,814 1,067
Federal income tax expense 3,156 356
---------------- --------------------
Net income 5,658 711
Redemption accrual on Series C and Series D Preferred Stock - 180
================ ====================
Net income applicable to common shareholders $ 5,658 $ 531
================ ====================
Earnings per common share:
Basic $ 0.12 $ 0.07
================ ====================
Diluted $ 0.12 $ 0.05
================ ====================
</TABLE>
See notes to unaudited consolidated financial statements
<PAGE>
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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Three Months Ended March 31,
2000 1999
--------------- -----------------
(In thousands)
Cash flows from operating activities:
Net income $ 5,658 $ 711
Adjustments to reconcile net income to net cash used by operating
activities:
Deferred income taxes (1,777) 356
Change in reserves for future policy benefits 4,015 (647)
Change in policy and contract claims 2,703 459
Change in deferred policy acquisition costs (3,006) (856)
Change in deferred revenue (8) (11)
Amortization of present value of future profits 812 44
Amortization of goodwill/negative goodwill (169) 39
Change in policy loans 386 (77)
Change in accrued investment income 210 (169)
Change in reinsurance balances (4,503) (4,306)
Change in due and unpaid premium 107 (198)
Realized gains on investments (40) (47)
Other, net (1,766) (1,321)
--------------- ----------------
Net cash provided by/(used in) operating activities 2,622 (6,023)
--------------- -----------------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for sale 13,022 1,548
Proceeds from redemption of fixed maturities available for sale 1,935 3,180
Cost of fixed maturities purchased available for sale (26,459) (9,218)
Change in amounts held in trust by reinsurer (475) (283)
Proceeds from sale of equity securities 98 206
Cost of equity securities purchased - (104)
Change in other invested assets 10 39
Purchase of business, net of cash held (3,852) -
--------------- -----------------
Net cash used in investing activities (15,721) (4,632)
--------------- -----------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 26 318
Net proceeds from issuance of Series D Preferred Stock - 1,813
Increase in policyholder account balances (3,697) 1,309
Change in reinsurance balances on policyholder account balances (417) (702)
Principal payment on notes payable - (250)
--------------- -----------------
Net cash (used in)/provided by financing activities (4,088) 2,488
--------------- -----------------
Net decrease in cash and cash equivalents (17,187) (8,167)
Cash and cash equivalents at beginning of period 58,753 17,093
--------------- -----------------
Cash and cash equivalents at end of period $ 41,566 $ 8,926
=============== =================
Supplemental cash flow information:
Cash paid during the period for interest $ 1,680 $ 93
=============== =================
Cash paid during the period for income taxes $ 124 $ 25
=============== =================
</TABLE>
See notes to unaudited consolidated financial statements
<PAGE>
26
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim financial information herein is unaudited, but in the
opinion of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results of operations for the three months
ended March 31, 2000 are not necessarily indicative of the results to be
expected for the full year. The consolidated financial statements should be read
in conjunction with the Form 10-K for the year ended December 31, 1999. Certain
reclassifications have been made to prior year's financial statements to conform
with current period classifications.
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP") and
consolidate the accounts of Universal American Financial Corp. ("Universal" or
the "Parent Company") and its subsidiaries (collectively the "Company"),
American Progressive Life & Health Insurance Company of New York ("American
Progressive"), American Pioneer Life Insurance Company ("American Pioneer"),
American Exchange Life Insurance Company ("American Exchange"), 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"). On January 6, 2000, Universal
acquired American Insurance Administration Group ("AIAG").
Universal is a life and accident and health insurance holding company
whose principal insurance subsidiaries noted above traditionally, through a
general agency system, marketed and underwrote products aimed at the senior
market, including Medicare supplement, long-term care, home health care, life
insurance and annuities. With the acquisition of the Penn Union Companies, the
Company has expanded its issuance of fixed benefit accident and health insurance
products. The acquisition expanded the Company's general agency system and
generated a new distribution system consisting of career agents. The career
agent distribution system operates through a network of regional managers that
operate branch offices throughout the United States and Canada. These career
agents focus only on sales for Pennsylvania Life and PennCorp Canada.
2. BUSINESS COMBINATION
Penn Union Acquisition
On July 30, 1999, Universal acquired all of the outstanding shares
of common stock of certain direct and indirect subsidiaries of PennCorp
Financial Group ("PFG"), including six insurance companies (the "Penn Union
Companies") and certain other assets as follows (the "Penn Union Transaction").
The Penn Union Companies are:
Name of Insurance Company State or Province of Domicile
Pennsylvania Life Insurance Company Pennsylvania
Peninsular Life Insurance Company North Carolina
Union Bankers Insurance Company Texas
Constitution Life Insurance Company Texas
Marquette National Life Insurance Company Texas
PennCorp Life Insurance Company Ontario, Canada
The purchase price of $130.5 million in cash was financed with $92.8
million of proceeds generated from the UA Purchase Agreement and from the term
loan portion of an $80 million credit facility entered into on July 30, 1999
consisting of a $70 million term loan and a $10 million revolving loan facility.
None of the revolving loan facility has been drawn to date. The proceeds of the
financing in excess of the $130.5 million purchase price were used to pay
transaction costs of the acquisition and the financing, to retire an existing
Universal bank loan, to contribute to the surplus of Pennsylvania Life and for
working capital.
The 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 $17.2 million including a restructuring accrual of $10.0 million and
$3.0 million in stock compensation expense related to shares purchased by agents
and certain members of management at 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 $10.1 million,
which will be amortized on a straight line basis over a ten year period.
The consolidated pro forma results of operations for the three months
ended March 31, 1999, as if the companies described above had been purchased on
January 1, 1999, are as follows:
Three Months Ended
March 31, 1999
------------------------
(In thousands)
Total revenue $ 70,906
Operating income before taxes $ 7,512
Net income $ 4,885
Earnings per common share:
Basic $ 0.12
Diluted $ 0.11
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. During the
three months ended March 31, 2000, the Company paid $0.4 million in
restructuring charges.
In accordance with EITF 95-3, the Company's Board of Directors has
approved the plan and the Company will finalize any changes to the restructuring
plans no later than one year from the date of the Penn Union Acquisition (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.
Acquisition of American Insurance Administration Group ("AIAG")
In January 2000, Universal acquired all of the outstanding shares
of AIAG, a privately held third party administrator located in Clearwater,
Florida, for $2.875 million in cash, 809,860 shares on Universal common stock
and certain contingent future cash payments. AIAG is the third party
administrator of approximately $123 million of senior supplemental health
insurance, approximately $97 million of which is administered for Union
Bankers. Total revenue for the three months ended March 31, 2000 totaled
$2.6 million of which $1.9 million related to Union Bankers and was eliminated
in the accompanying consolidated financial statements. Pro forma results of
operations assuming that the company was purchased on January 1, 1999 are not
material.
3. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the
three-month periods ended March 31, 2000 and 1999 are as follows:
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For the Three Months
Ended March 31,
--------------------------------------
2000 1999
---------------- ----------------
(In thousands)
Net income $ 5,658 $ 711
---------------- ----------------
Other comprehensive income:
Unrealized gain/(loss) on securities (83) (793)
Foreign currency translation adjustment 405 -
---------------- ----------------
Other comprehensive income/(loss) 322 (793)
---------------- ----------------
Comprehensive income/(loss) $ 5,980 $ (82)
================ ================
</TABLE>
4. EARNINGS PER SHARE
Per share amounts for net income from operations are shown in the
income statement using i) an earnings per common share basic calculation and ii)
an earnings per common share-assuming dilution calculation. A reconciliation of
the numerators and the denominators of the basic and diluted EPS for the three
months ended March 31, 2000 and 1999 is as follows:
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For the Three Months Ended March 31, 2000
-----------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ----------------- -------------
(In thousands, per share amounts in dollars)
Basic EPS
Net income applicable to common shareholders $ 5,658 46,705 $ 0.12
Effect of Dilutive Securities
Incentive stock options 962
Director stock options 124
Agents and others stock options 567
Treasury stock assumed from proceeds of
options and warrants (1,217)
--------------- -----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $ 5,658 47,141 $ 0.12
=============== ================= =============
</TABLE>
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For the Three Months Ended March 31, 1999
-----------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
--------------- ----------------- -------------
(In thousands, per share amounts in dollars)
Net income $ 711
Less: Redemption accrual on Series C Preferred
Stock (180)
---------------
Basic EPS
Net income applicable to common shareholders 531 7,706 $ 0.07
=============
Effect of Dilutive Securities
Series B Preferred Stock 1,778
Series C Preferred Stock 180 2,176
Series D Preferred Stock 1,123
Non-registered warrants 2,016
Registered warrants 657
Incentive stock options 374
Director stock options 23
Agents and others stock options 73
Treasury stock assumed from proceeds of
options and warrants (1,072)
--------------- -----------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $ 711 14,854 $ 0.05
=============== ================= =============
</TABLE>
5. INVESTMENTS
As of March 31, 2000 and December 31, 1999, fixed maturity securities
are classified as investments available for sale and are carried at fair value,
with the unrealized gain or loss, net of tax and other adjustments (deferred
policy acquisition costs), included in accumulated other comprehensive income.
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March 31, 2000
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------- ---------------------- --------------------- ------------------ ------------------
(In thousands)
US Treasury securities
and obligations of
US government $ 34,651 $ 20 $ (406) $ 34,265
Foreign government debt
securities 131,536 300 (2,012) 129,824
Corporate debt securities 318,701 748 (8,535) 310,914
Mortgage-backed securities 261,427 126 (6,441) 255,112
---------------------- --------------------- ------------------ ------------------
$ 746,315 $ 1,194 $ (17,394) $ 730,115
====================== ===================== ================== ==================
</TABLE>
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December 31, 1999
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------- ---------------------- --------------------- ------------------ -----------------
(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>
The amortized cost and fair value of fixed maturities at March 31, 2000
by contractual maturity are shown below. Expected maturities may differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
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Amortized Fair
Cost Value
------------------ ------------------
(In thousands)
Due in 1 year or less $ 25,953 $ 25,821
Due after 1 year through 5 years 173,467 170,335
Due after 5 years through 10 years 225,826 220,598
Due after 10 years 56,312 55,025
Mortgage-backed securities 264,757 258,336
------------------ ------------------
$746,315 $730,115
================== ==================
</TABLE>
6. STOCKHOLDERS' EQUITY
Common Stock
The par value of common stock is $.01 per share with 80,000,000 shares
authorized for issuance. The shares issued and outstanding at March 31, 2000 and
December 31, 1999 were 46,732,297 and 45,914,327, respectively.
Changes in the number of shares of common stock outstanding were as follows:
Balance at December 31, 1999 45,914,327
Stock issued for purchase of AIAG 809,860
Stock options exercised 5,000
Stock purchases pursuant to Agents' Stock Purchase Plan 2,650
Stock issued under employee benefit plans 460
==========
Balance at March 31, 2000 46,732,297
==========
7. IMPACT OF THE YEAR 2000
The Year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information in years subsequent to 1999. Prior to 2000,
the Company underwent a corporate-wide program to address the Year 2000 issue,
as it relates to its own computer systems, as well as to instances in which
computer systems of third parties may have a significant impact on the Company's
operations, such as suppliers, business partners, customers, facilities and
telecommunications. In addressing the Year 2000 issue, the Company did not incur
any significant expenses other than the allocation of internal resources to test
and monitor this issue. The Company has not experienced any significant
disruptions of business operations related to the Year 2000 issue to date and
believes that the risk of such disruption in the future is low, although no
assurance can be given in this regard. It is possible that Year 2000 problems
that are not currently apparent may arise in the future. Accordingly, the
Company will continue to monitor its systems for the Year 2000 issue.
8. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS
American Progressive, American Pioneer, American Exchange, Constitution
Life, Marquette, Peninsular Life, PennCorp Canada, Pennsylvania Life and Union
Bankers (collectively, the "Insurance Subsidiaries") are required to maintain
minimum amounts of capital and surplus as determined by statutory accounting.
Each of the Insurance Subsidiaries' statutory capital and surplus exceeds its
respective minimum requirement. However, substantially more than such minimum
amounts are needed to meet statutory and administrative requirements of adequate
capital and surplus to support the current level of the Insurance Subsidiaries'
operations. At March 31, 2000 and December 31, 1999 the statutory capital and
surplus, including asset valuation reserve, of the U.S. insurance subsidiaries
totaled $89.3 and $89.2 million, respectively.
Beginning in 1993, the National Association of Insurance Commissioners
("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life
insurance enterprises. At December 31, 1999 all of the Insurance Subsidiaries
maintained ratios of total adjusted capital to RBC in excess of the Authorized
Control Level.
PennCorp Canada and Pennsylvania Life's Canadian branch reports to
Canadian regulatory authorities based upon Canadian statutory accounting
principles that vary in some respects from U.S. statutory accounting principles.
Canadian net assets based upon Canadian statutory accounting principles were
$64.5 and $63.9 million as of March 31, 2000 and December 31, 1999,
respectively. PennCorp Canada maintained a Minimum Continuing Capital and
Surplus Requirement Ratio ("MCCSR") in excess of the minimum requirement and
Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in
Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at March
31, 2000 and December 31, 1999.
9. BUSINESS SEGMENT INFORMATION
During the third quarter of 1999 and with the acquisition of the Penn
Union companies, Universal changed its segment structure. Under the new
structure, the insurance businesses are reviewed by management of the Company
along distribution lines, and decisions regarding the operation of the Company
are made accordingly. In addition, due to the vast difference in the nature of
the operations from the insurance businesses, management reviews and evaluates
the results of the Insurance Services and Corporate Segment separately.
Under the new segment structure, the Company considers itself to have
four distinct business segments: Career Agents, Senior Market Brokerage,
Special Markets and Insurance Services and Corporate Segment. Products
distributed through the Career Agents segment are sold through a network of
regional managers who operate branch offices throughout the U.S. and Canada.
The career agents focus only on sales for Pennsylvania Life and PennCorp
Canada and sell primarily fixed benefit accident and health insurance. Total
revenue and operating income before taxes generated by Canadian operations
through PennCorp Canada and Pennsylvania Life's Canadian branch totaled $14.4
million and $2.6 million, respectively, for the three month period ended
March 31, 2000. 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 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. The Insurance Services and Corporate Segment consists mainly
of the Parent Company, WorldNet and AIAG operations. Prior year segment
information has been restated to conform with the current segment structure.
Financial data by segment as of and for the three months ended March
31, 2000 and 1999 is as follows:
<TABLE>
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March 31, 2000
---------------------------------------------------------------------------------
(In thousands)
Insurance
Career Senior Market Special Services and
Agents Brokerage Markets Corporate Total
-------------- -------------- ---------------- ---------------- ---------------
Net premiums and policyholder fees $ 33,314 $ 9,868 $ 11,957 $ - $ 55,139
earned
Net investment income 7,860 313 5,988 (10) 14,151
Realized gains 1 1 38 - 40
Fee and other income 166 - 127 1,147 1,440
-------------- -------------- ---------------- ---------------- ---------------
41,341 10,182 18,110 1,137 70,770
Policyholder benefits 20,771 7,682 11,269 - 39,722
Increase in deferred acquisition costs (2,303) (747) 44 - (3,006)
Commissions and general expenses 15,364 2,288 5,346 2,242 25,240
-------------- -------------- ---------------- ---------------- ---------------
Total benefits, claims and other 33,832 9,223 16,659 2,242 61,956
deductions
Operating income before taxes $ 7,509 $ 959 $ 1,451 $ (1,105) $ 8,814
============== ============== ================ ================= ===============
ASSETS
Cash and investments $451,086 $ 14,373 $ 341,157 $ 406 $ 807,022
Deferred policy acquisition costs 5,246 11,879 20,843 - 37,968
Accrued investment income 6,166 81 5,049 - 11,296
Goodwill - 3,635 527 1,510 5,672
Present value of future profits - 790 354 7,327 8,471
Due and unpaid premiums 2,238 338 895 - 3,471
Reinsurance recoverable 6,639 40,948 155,497 - 203,084
Deferred income tax asset - - - 70,350 70,350
Other assets 4,569 - 1,746 12,928 19,243
============== ============== ================ ================ ===============
Total assets $ 475,944 $ 72,044 $526,068 $92,521 $1,166,577
============== ============== ================ ================ ===============
</TABLE>
<TABLE>
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March 31, 1999
---------------------------------------------------------------------------------
Insurance
Career Senior Market Special Services and
Agents Brokerage Markets Corporate Total
-------------- -------------- ---------------- ---------------- ---------------
Net premiums and policyholder fees $ - $ 6,339 $ 4,086 $ - $ 10,425
earned
Net investment income - 258 2,512 29 2,799
Realized gains - 4 43 - 47
Fee and other income - - 11 568 579
-------------- -------------- ---------------- ---------------- ---------------
- 6,601 6,652 597 13,850
Policyholder benefits - 5,065 4,107 - 9,172
Increase in deferred acquisition costs - (939) 83 - (856)
Commissions and general expenses - 2,094 2,121 252 4,467
-------------- -------------- ---------------- ---------------- ---------------
Total benefits, claims and other - 6,220 6,311 252 12,783
deductions
Operating income before taxes $ - $ 381 $ 341 $ 345 $ 1,067
============== ============== ================ ================= ===============
ASSETS
Cash and investments $ - $ 14,425 $ 140,620 $ 3,337 $158,382
Deferred policy acquisition costs - 8,154 18,215 - 26,369
Accrued investment income - 341 3,328 38 3,707
Goodwill - 3,710 606 - 4,316
Present value of future profits - 965 561 - 1,526
Due and unpaid premiums - 354 370 - 724
Reinsurance recoverable - 37,117 44,434 - 81,551
Other assets - - - 7,640 7,640
============== ============== ================ ================ ===============
Total assets $ - $ 65,066 $208,134 $11,015 $284,215
============== ============== ================ ================ ===============
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company cautions readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this report
and in any other oral or written statements, either made by, or on behalf of the
Company, whether or not in future filings with the Securities and Exchange
Commission ("SEC"). Forward-looking statements are statements not based on
historical information. They relate to future operations, strategies, financial
results or other developments. In particular, statements using verbs such as
"expect," "anticipate," "believe" or similar words generally involve
forward-looking statements. Forward-looking statements include statements that
represent the Company's products, investment spreads or yields, or the earnings
or profitability of the Company's activities.
Forward-looking statements are based upon estimates and assumptions
that are subject to significant business, economic and competitive
uncertainties, many of which are beyond the Company's control and are subject to
change. These uncertainties can affect actual results and could cause actual
results to differ materially from those expressed in any forward-looking
statements made by, or on behalf of the Company. Whether or not actual results
differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable events or developments, some of which may be
national in scope, such as general economic conditions and interest rates. Some
of these events may be related to the insurance industry generally, such as
pricing competition, regulatory developments and industry consolidation. Others
may relate to Universal specifically, such as credit, volatility and other risks
associated with the Company's investment portfolio, and other factors. Universal
disclaims any obligation to update forward-looking information.
The following analysis of the consolidated results of operations and
financial condition of the Company should be read in conjunction with the
Consolidated Financial Statements and related consolidated footnotes included
elsewhere.
The Company owns nine insurance companies (collectively, the "Insurance
Subsidiaries"): American Progressive Life & Health Insurance Company of New York
("American Progressive"), American Pioneer Life Insurance Company ("American
Pioneer"), American Exchange Life Insurance Company ("American Exchange"),
Constitution Life Insurance Company ("Constitution Life"), Marquette National
Life Insurance Company ("Marquette"), Peninsular Life Insurance Company
("Peninsular Life"), Pennsylvania Life Insurance Company ("Pennsylvania Life"),
PennCorp Life Insurance Company ("PennCorp Canada") and Union Bankers Insurance
Company ("Union Bankers"). In addition to the Insurance Subsidiaries, Universal
owns two third party administrators: American Insurance Administration Group,
Inc. ("AIAG"), which was purchased January 6, 2000 and WorldNet Services Corp.
("WorldNet") that process the Company's brokerage senior market policies, as
well as business for unaffiliated insurance companies.
On July 30, 1999, Universal acquired all of the outstanding shares of
common stock of certain direct and indirect subsidiaries of PennCorp Financial
Group, Inc. ("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).
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. During the
three months ended March 31, 2000, the Company paid $0.4 million in
restructuring charges.
Subsequent to the acquisition of the Penn Union Companies, the Company
redefined its operating segments with primary emphasis on its distribution
channels. Currently, the Company manages its business through four operating
segments, Senior Market Brokerage, Career Agency, Special Markets and Insurance
Services and Corporate.
Senior Market Brokerage - This distribution channel consists of a general agency
system and insurance brokerage system that focus on the sale of products in the
senior market segment, including Medicare Supplement, Medicare Select and
Long-term Care.
Career Agency System - The Career Agency segment is comprised of a career agency
field force, which distributes fixed benefit accident and sickness, life
insurance and supplemental senior health insurance in the United States and
Canada. The Career Agents are under exclusive contract with Pennsylvania Life
and PennCorp Canada.
Special Markets - Through its own operating history and through prior
acquisitions, Universal has accumulated various lines of business that it
manages in its Special Markets segments. These products include annuities,
interest-sensitive and group life insurance, individual medical and other
accident and health insurance.
Insurance Services and Corporate - This segment is primarily made up of the
insurance administrative service companies that process certain business for the
Insurance Subsidiaries, as well as unaffiliated insurers. It also includes the
corporate operations of the holding company, including interest on debt.
Prior to the Penn Union Transaction, the Company reported its results
through four segments, with primary emphasis on major product lines. These
segments were Senior Market Accident and Health Insurance, Other Accident and
Health Insurance, Life Insurance and Non-insurance Business.
The new Senior Market Brokerage Segment includes substantially all of
the Senior Market Accident and Health Insurance business.
The Career Agency segment includes only business which is new to the
Company as a result of the acquisition of Pennsylvania Life and PennCorp Canada.
The Special Markets segment includes a combination of existing
Universal business from the Other Accident and Health and Life Insurance
segments, as well as new business resulting from the acquisition of the
Peninsular, Marquette, Union Bankers and Constitution.
The Insurance Services and Corporate Segment includes all businesses
previously included in the Non-insurance Business Segment. Results of operations
for the three months ended March 31, 2000 include the results of AIAG.
Results of Operations
Three Months Ended March 31, 2000 and 1999
Consolidated net income after Federal income taxes increased by $5.0
million to $5.7 million ($0.12 per diluted share) in 2000, compared to $0.7
million ($0.05) in 1999. Operating income before income tax increased by $7.7
million to $8.8 million in 2000 compared to $1.1 million in 1999.
The Senior Market Brokerage segment more than doubled its operating
results, increasing by $0.6 million in addition to the $7.5 million added by the
acquisition of the Career Agency segment. The Special Markets segment improved
its results by $1.1 million primarily as a result of the business acquired in
the Penn Union Acquisition. These increases are offset by a reduction of $1.5
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 three months ended March 31, 2000 and 1999 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 $3.6 million to approximately $10.2 million for the
three months ended March 31, 2000, compared to total revenues of approximately
$6.6 million in the prior year. This increase results from the increase in
internally generated production and not from the acquisition of the Penn Union
Companies.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended March 31, 2000, the Senior Market Brokerage
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $57.6 million, a $35.2 million increase over the $22.4
million amount in 1999. The gross earned premiums on the Company's senior market
products increased as follows:
<TABLE>
<S> <C> <C>
Premium Increase 2000 Total
Description (Decrease) Premium Earned
-------------------------------------------- ----------------------- ----------------------
(in millions) (in millions)
Medicare Supplement/Select $ 11.16 $ 18.64
Freedom Care 0.78 1.89
Hospital Indemnity, Home Health Care and
Nursing Home 0.24 1.15
First National business acquired 1.09 11.66
Union Bankers Medicare Supplement 17.53 17.53
Constitution Medicare Supplement 4.69 4.69
Other (0.31) 2.05
----------------------- ----------------------
Totals $ 35.18 $ 57.61
======================= ======================
</TABLE>
The Medicare Supplement at Union Bankers and Constitution is 100%
reinsured with an unaffiliated reinsurer.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
March 31, 2000 for the Senior Market Brokerage Segment amounted to $47.7
million, a $31.6 million increase from the 1999 amount of $16.1 million. Details
of the changes in reinsurance premiums ceded are as follows:
<TABLE>
<S> <C> <C>
Ceded Premium 2000 Total
Description Increase (Decrease) Premium Ceded
-------------------------------------------- ----------------------- --------------------
(in millions) (in millions)
Business acquired:
First National $ 1.17 $ 9.29
Dallas General (0.38) 1.80
Medicare Supplement 8.2 13.15
Union Bankers Medicare Supplement 17.53 17.53
Constitution Medicare Supplement 4.69 4.69
Freedom Care 0.27 0.63
Hospital Indemnity, Home Health Care and
Nursing Home 0.15 0.52
Other lines 0.01 0.12
----------------------- --------------------
Totals $ 31.64 $ 47.73
======================= ====================
</TABLE>
Investment related revenue
Net investment income of the Senior Market Brokerage Segment increased
$55 thousand to $0.3 million for the three months ended March 31, 2000, compared
to 1999. Realized gains on investments decreased slightly from the prior year.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions in the Senior Market Brokerage Segment increased approximately $3.0
million to $9.2 million for the three months ended March 31, 2000, compared to
$6.2 million for the three months ended March 31, 1999.
Claims and other benefits increased $1.7 million to $6.2 million for
the three months ended March 31, 2000 compared to $4.4 million in the prior
year. The change in reserves for the three months ended March 31, 2000 amounted
to an increase of $1.5 million compared to an increase of $0.7 million in 1999
generating a variance of $0.8 million. These increases in claims and change in
reserves are the result of the $3.5 million increase in net premiums earned for
the three months ended March 31, 2000 discussed above.
The change in deferred acquisition costs decreased by $0.2 million for
the three months ended March 31, 2000 compared to 1999. The amount of
acquisition costs capitalized decreased $18 thousand from the prior year. The
amortization of deferred acquisition costs increased $0.2 million from $0.3
million for the three months ended March 31, 1999 to $0.5 million for the three
months ended March 31, 2000.
Commissions in the Senior Market Brokerage Segment increased $5.5
million in the three months ended March 31, 2000 to $9.3 million, compared to
$3.8 million in 1999. This increase is the direct result of the $35.2 million
increase in gross premium discussed above. Commissions and expense allowances on
reinsurance ceded increased $8.3 million in the three months ended March 31,
2000 to $13.3 million, compared to $5.0 million in 1999. This increase is the
direct result of the $31.6 million increase in reinsurance premium ceded
discussed above.
Other operating costs and expenses increased $3.1 million in the three
months ended March 31, 2000 to $6.3 million, compared to $3.2 million in 1999
due in part to the increase in expenses incurred in generating new business
as well as the increase in premium taxes associated with the growth in new
business in this segment.
Career Agents Segment
The Career Agent Segment was acquired in the Penn Union Acquisition and
comprises the operations of Pennsylvania Life Insurance Company ("Pennsylvania
Life") and PennCorp Life Insurance Company of Canada ("PennCorp Canada"). The
Career Agents market life and health insurance products focusing primarily on
fixed benefit accident and sickness products. Penn Corp Canada operates
exclusively in Canada, while Pennsylvania Life operates in both the U.S.
("Pennsylvania Life U.S.") and Canada.
Revenues. Total net revenues for the Career Agent segment amounted to
$41.3 million of which $26.9 million was generated by Pennsylvania Life U.S. and
$14.4 million was generated by the Canadian operations. Gross premium totaled
$34.1 million, $21.9 million derived from Pennsylvania Life U.S. and $12.2
million derived from the Canadian operations. The Company reinsures a portion of
these premiums to outside parties. Total ceded premiums for the three months
ended March 31, 2000 were $0.2 million at the Canadian operations and $0.6
million at Pennsylvania Life U.S. Investment income of $7.9 million consists
mostly of interest on bonds held by the company.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions in the Career Agent Segment totaled $33.8 million for the three
months ended March 31, 2000.
Claims and other benefits amounted to $18.7 million for the three
months ended March 31, 2000. Of this amount, $14.5 million related to claims
incurred at Pennsylvania Life U.S. and $4.2 million related to the Canadian
operations. The change in reserves for the three months ended March 31, 2000
amounted to $2.1 million.
Deferred acquisition costs increased $2.3 million for the three months
ended March 31, 2000. Acquisition costs capitalized at Pennsylvania Life U.S.
totaled $1.3 million net of amortization. Canadian costs capitalized, net of
amortization amounted to $1.0 million.
Commissions in the Career Agent Segment for the three months ended
March 31, 2000 amounted to $8.1 million, of which $5.5 million related to
Pennsylvania Life U.S. Commissions and expense allowances on reinsurance ceded
totaled $0.2 million in the three months ended March 31, 2000. Other operating
costs and expenses totaled $7.5 million for the three months ended March 31,
2000
Special Markets Segment
The Special Markets Segment consists of blocks of business that were
acquired through the acquisitions of various companies or are not currently
produced through the career or brokerage agency distribution systems as well as
some specialty life and accidental insurance products. The results of operations
for the three months ended March 31, 2000 and 1999 include the results of the
sales of such products.
Revenues. Total revenues for the Special Markets Segment increased
approximately $11.4 million to approximately $18.1 million for the three months
ended March 31, 2000, compared to total revenues of approximately $6.7 million
in the prior year. $10.6 million of this increase is attributable to the Penn
Union Transaction.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended March 31, 2000, the Special Markets Segment
gross premium and policyholder fees earned (including reinsurance assumed)
amounted to $18.6 million, a $8.7 million increase over the $9.9 million amount
in 1999. The gross earned premiums on the Company's special market products
increased as follows:
<TABLE>
<S> <C> <C>
2000 Total
Description Premium Increase Premium Earned
-------------------------------------------- ----------------------- ----------------------
Acquired Businesses: (in millions) (in millions)
Constitution Life Insurance $ 0.61 $ 0.61
Union Bankers 6.86 6.86
Peninsular 0.73 0.73
International Medical - 1.13
Major Medical 0.01 3.25
Life and annuity products 0.23 3.90
Other Health Products 0.28 2.13
======================= ======================
Totals $ 8.72 $ 18.61
======================= ======================
</TABLE>
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
March 31, 2000 for the Special Markets Segment amounted to $6.7 million, a $0.9
million increase from the 1999 amount of $5.8 million. Details of the changes in
reinsurance premiums ceded is as follows:
<TABLE>
<S> <C> <C>
Ceded Premium 2000 Total
Description Increase (Decrease) Premium Ceded
-------------------------------------------- ----------------------- --------------------
(in millions) (in millions)
Business acquired
Constitution $ 0.57 $ 0.57
Union Bankers 0.09 0.09
Peninsular 0.20 0.20
Life and annuity products (0.27) 1.71
Major Medical 0.09 2.06
International Medical 0.10 1.09
Other lines 0.06 0.93
----------------------- --------------------
Totals $ 0.84 $ 6.65
======================= ====================
</TABLE>
Investment related revenue
Net investment income of the Special Markets Segment increased $3.5
million to $6.0 million for the three months ended March 31, 2000, compared to
$2.5 million in 1999. This increase is attributable to the increase in invested
assets outstanding in this segment during 2000 compared to 1999 as a result of
the Penn Union Transaction.
Benefits, Claims and Other Deductions. Total benefits, claims and other
deductions in the Special Markets Segment increased approximately $10.4 million
to $16.7 million for the three months ended March 31, 2000, compared to $6.3
million for the three months ended March 31, 1999.
Claims and other benefits increased $9.7 million to $12.3 million for
the three months ended March 31, 2000 compared to $2.6 million in 1999. $9.0
million of this increase is attributable to the Penn Union Transaction. The
change in reserves for the three months ended March 31, 2000 amounted to a
decrease of $3.6 million compared to a decrease of $0.4 million in 1999
generating a variance of $3.2 million. The change in reserves for Penn Union
Companies for the three months ended March 31, 2000 amounted to a decrease of
$3.4 million. Interest credited to policyholders increased $0.7 million from
$1.9 million in 1999 to $2.6 million in 2000. Approximately $0.4 million of the
increase relates to the acquired companies.
The change in deferred acquisition costs decreased by $36 thousand for
the three months ended March 31, 2000 compared to the same period in 1999. The
amount of acquisition costs capitalized decreased $39 thousand from $0.6 million
for the three months ended March 31, 1999 to $0.6 million for the three months
ended March 31, 2000. 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 $78 thousand
from $0.7 million for the three months ended March 31, 1999 to $0.6 million for
the three months ended March 31, 2000. This decrease is the result of the
decrease in the asset balance.
Commissions in the Special Markets Segment increased $0.2 million in
the three months ended March 31, 2000 to $2.6 million, compared to $2.4 million
in 1999. This increase is due largely to the acquisition of the Penn Union
Companies which increase of $0.4 million was offset by a decrease of $0.2
million in some of the life products no longer marketed. Premiums on products in
this segment are generally renewal premiums as little new business is being
written. Commissions on renewal business are at lower rates than new business.
Commissions and expense allowances on reinsurance ceded decreased $0.3 million
in the three months ended March 31, 2000 to $2.2 million, compared to $2.5
million in 1999. This increase is largely due to runoff of the life business.
Other operating costs and expenses increased $2.7 million in the three
months ended March 31, 2000 to $4.9 million, compared to $2.2 million in 1999.
This increase is due mainly to expenses related to the newly acquired Penn Union
lines of business. This increase is offset by a decrease in the cost of
generating new business as some of the lines of business in this segment run
off.
Insurance Services and Corporate
The Non Insurance Businesses Segment consists of WorldNet, Quincy, PFI,
Inc ("PFI")(an internal servicing company acquired in July, 1999), a minority
interest in Security Health and the Parent Company as well as AIAG which was
acquired in January, 2000.
Fees and other income increased $0.5 million due to revenue generated
at AIAG of $0.7 million. General expenses increased $1.9 million from $0.3
million in 1999 to $2.2 million in 1999. This increase is due to an increase in
interest expense of $1.7 million related to a loan with Chase Manhattan to
finance the purchase of the Penn Union Companies. In addition, the Parent
Company incurred compensation expenses of approximately $0.2 million related to
the issue of stock options and bonuses to employees and members of management
related to the acquisition of the Penn Union Companies.
Liquidity and Capital Resources
The Company's need for capital is primarily to maintain or increase the
surplus of its Insurance Subsidiaries and to support the Company as an insurance
holding company, including the maintenance of its status as a public company. In
addition, the Company requires capital to fund its anticipated growth through
acquisitions of other companies and blocks of insurance business.
The Company
The Company requires cash to pay the operating expenses necessary to
function as an insurance holding company (which under applicable Insurance
Department regulations must bear its own expenses), and to meet the cost
involved in being a publicly owned company. In addition, it requires cash to
meet Universal's obligations under the loan agreement discussed below, the
debentures outstanding with American Progressive and to fund the planned
reorganization of the Company being performed in connection with the acquisition
of the Penn Union Companies.
Loan Agreements
As of March 31, 2000 and December 31, 1999, the Company had outstanding
an $80 million credit facility consisting of a $70 million term loan and a $10
million revolving loan facility. The term loan calls for interest at the London
Interbank Offering Rate ("LIBOR") plus 350 basis points (currently 9.8%) with
principal repayment over a seven-year period and a final maturity date of July
31, 2006. The Company has not drawn down any of the revolving loan facility and
pays a commitment fee of 50 basis points on the unutilized facility. For the
three months ended March 31, 2000, the Company paid $1.7 million in interest.
The Company is due to repay $3.4 million in principal during 2000.
In connection with an agreement entered into 1996 whereby American
Pioneer became a direct subsidiary of Universal, rather than an indirect
subsidiary owned through American Progressive, Universal has $7.9 million in
debentures outstanding to its subsidiary, American Progressive. The debentures
pay interest quarterly at 8.50% and are due between September 2002 and May 2003.
During the three months ended March 31, 2000 the Company paid $0.2 million in
interest on these debentures to American Progressive, which was eliminated in
consolidation.
Acquisition of American Insurance Administration Group ("AIAG")
In January 2000, Universal acquired all of the outstanding shares
of AIAG, a privately held third party administrator located in Clearwater,
Florida, for $2.875 million in cash, 809,860 shares on Universal common stock
and certain contingent future cash payments. AIAG is the third party
administrator of approximately $123 million of senior supplemental health
insurance, approximately $97 million of which is administered for Union Bankers.
For the three months ended March 31, 2000, AIAG, Inc. received administrative
fees of $2.6 million of which $1.9 million related to Union Bankers and was
eliminated in the consolidated financial statements of the Company.
Management believes that the current cash position, the availability of
the revolving loan facility, the expected cash flows of the non-insurance
companies (including AIAG), the surplus note interest payments from American
Exchange and the availability of dividends from its Insurance Subsidiaries can
support the obligations of Universal noted above for the foreseeable future.
However, there can be no assurance as to the expected future cash flows or to
the availability of dividends from the Insurance Subsidiaries.
Insurance Subsidiaries
The Insurance Subsidiaries are required to maintain minimum amounts of
capital and surplus as determined by statutory accounting. Each of the Insurance
Subsidiaries' statutory capital and surplus exceeds its respective minimum
requirement. At March 31, 2000 and December 31, 1999 the statutory capital and
surplus, including asset valuation reserves, of the U.S. Insurance Subsidiaries
totaled $89.3 million and $89.2 million, respectively.
Beginning in 1993, the National Association of Insurance Commissioners
("NAIC") imposed regulatory risk-based capital ("RBC") requirements on life
insurance enterprises. At March 31, 2000 all of the Insurance Subsidiaries
maintained ratios of total adjusted capital to RBC in excess of the Authorized
Control Level.
PennCorp Canada and Pennsylvania Life's Canadian branch report to
Canadian regulatory authorities based upon Canadian statutory accounting
principles that vary in some respects from U.S. statutory accounting principles.
Canadian net assets based upon Canadian statutory accounting principles were
$64.5 million and $63.9 million as of March 31, 2000 and December 31, 1999,
respectively. PennCorp Canada maintained a Minimum Continuing Capital and
Surplus Requirement Ratio ("MCCSR") in excess of the minimum requirement and
Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in
Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at March
31, 2000.
Cash generated by the Insurance Subsidiaries will be made available to
Universal, the ultimate parent, principally through periodic payments of
principal and interest on surplus debentures. Currently, the surplus notes
between Universal and American Exchange total $70 million and it is anticipated
that it will be primarily serviced by dividends from Pennsylvania Life, a wholly
owned subsidiary of American Exchange, and by tax-sharing payments among the
insurance companies which are wholly owned by American Exchange and file a
consolidated Federal income tax return. During 2000, $4.3 million of taxes have
been paid to American Exchange pursuant to the tax-sharing agreement.
Dividend payments by insurance companies are limited by, or subject to
the approval of the insurance regulatory authorities of each insurance company's
state of domicile. Such dividend requirements and approval processes vary
significantly from state to state. The maximum amount of dividends which can be
paid to American Exchange from Pennsylvania Life without the prior approval of
the Pennsylvania Department of Insurance is restricted to the greater of 10% of
Pennsylvania Life's surplus as regards to policyholders as of the preceding
December 31 or the net gain from operations during the preceding year, but such
dividends can be paid only out of unassigned surplus. As part of its approval of
the Penn Union Acquisition, the Pennsylvania Insurance Department approved a
quasi reorganization of Pennsylvania Life's surplus in which its previously
negative unassigned surplus was reset to zero. Thus, future earnings of the
company would be available for dividends without prior approval, subject to the
restrictions noted above. As of March 31, 2000, $5.0 million of dividends can be
paid by the insurance subsidiaries of American Exchange.
Liquidity for the life Insurance Subsidiaries is measured by their
ability to pay scheduled contractual benefits, pay operating expenses, and fund
investment commitments. Sources of liquidity include scheduled and unscheduled
principal and interest payments on investments, premium payments and deposits
and the sale of liquid investments. These sources of liquidity for the Insurance
Subsidiaries significantly exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including
death benefits, benefits under accident & health policies and interest-sensitive
policy surrenders and withdrawals. The amount of surrenders and withdrawals is
affected by a variety of factors such as credited interest rates for similar
products, general economic conditions and events in the industry that affect
policyholders' confidence. Although the contractual terms of substantially all
of the Company's in force life insurance policies and annuities give the holders
the right to surrender the policies and annuities, the Company imposes penalties
for early surrenders. At March 31, 2000 the Company held reserves that exceeded
the underlying cash surrender values of its in force life insurance and
annuities by more than $26.9 million. The insurance companies, in management's
view, have not experienced any material changes in surrender and withdrawal
activity in recent years.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity, unanticipated
surrenders and withdrawals in a changed interest rate environment could
adversely affect earnings if the Company were required to sell investments at
reduced values in order to meet liquidity demands. The Company manages the asset
and liability portfolios in order to minimize the adverse earnings impact of
changing market rates. The Company seeks to invest in assets that have duration
and interest rate characteristics similar to the liabilities that they support.
At March 31, 2000, the Insurance Subsidiaries held cash and cash
equivalents totaling $35.5 million, as well as fixed maturity and equity
securities that could readily be converted to cash with carrying values (and
fair values) of $734.7 million. The fair values of these liquid holdings totaled
more than $770.2 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 1.4% and 1.1% of total fixed maturities
as of March 31, 2000 and December 31, 1999, respectively). As of March 31, 2000
all of the Company's securities were current in the payment of principal and
interest.
Federal Income Taxation of the Company
The provision for federal income taxes was $3.2 million during the
first quarter of 2000 compared to $0.4 million for the same period in 1999.
These provisions resulted in effective tax rates of 35.8% and 33.4%,
respectively. The increase in the effective tax rate relates primarily to the
acquisition of the Penn Union companies in 1999 since certain business of the
Penn Union companies is subject to income tax in Canada at a corporate tax rate
of approximately 42%.
At March 31, 2000 and December 31, 1999, the Company has established
valuation allowances of $11.3 million and $11.3 million, respectively, with
respect to net operating loss carryforwards (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. Management believes
it is more likely than not that the Company will realize the recorded net
deferred tax assets.
Impact of Year 2000
The Year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information in years subsequent to 1999. Prior to 2000,
the Company underwent a corporate-wide program to address the Year 2000 issue,
as it relates to its own computer systems, as well as to instances in which
computer systems of third parties may have a significant impact on the Company's
operations, such as suppliers, business partners, customers, facilities and
telecommunications. In addressing the Year 2000 issue, the Company did not incur
any significant expenses other than the allocation of internal resources to test
and monitor this issue. The Company has not experienced any significant
disruptions of business operations related to the Year 2000 issue to date and
believes that the risk of such disruption in the future is low, although no
assurance can be given in this regard. It is possible that Year 2000 problems
that are not currently apparent may arise in the future. Accordingly, the
Company will continue to monitor its systems for the Year 2000 issue.
Effects of Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 2000. Management does not anticipate that the
adoption of the new statement will have a significant impact on earnings or the
financial position of the Company.
Quantitative and Qualitative Disclosures about Market Risk
Market risk relates, broadly, to changes in the value of financial
instruments that arise from adverse movements in interest rates, equity prices
and foreign exchange rates. The Company is exposed principally to changes in
interest rates that affect the market prices of its fixed income securities.
Interest Rate Risk
The Company could experience economic losses if it was required to
liquidate fixed income securities during periods of rising and/or volatile
interest rates. However, the Company attempts to mitigate its exposure to
adverse interest rate movements through a combination of active portfolio
management and by staggering the maturities of its fixed income investments to
assure sufficient liquidity to meet its obligations and to address reinvestment
risk considerations. The Company's insurance liabilities are generally long
tailed in nature, which generally permits ample time to prepare for their
settlement. To date, the Company has not utilized various financial risk
management tools on its investment securities, such as interest rate swaps,
forwards, futures and options to modify its exposure to changes in interest
rates. However, the Company may consider them in the future.
The Company is aware that certain classes of mortgage backed securities
are subject to significant prepayment risk due to the fact that in periods of
declining interest rates, individuals may refinance higher rate mortgages to
take advantage of the lower rates then available. The Company monitors
investment portfolio mix to mitigate this risk.
Sensitivity Analysis
The Company regularly conducts various analyses to gauge the financial
impact of changes in interest rates on it financial condition. The ranges
selected in these analyses reflect management's assessment as being reasonably
possible over the succeeding twelve-month period. The magnitude of changes
modeled in the accompanying analyses should, in no manner, be construed as a
prediction of future economic events, but rather, be treated as a simple
illustration of the potential impact of such events on the Company's financial
results.
The sensitivity analysis of interest rate risk assumes an instantaneous
shift in a parallel fashion across the yield curve, with scenarios of interest
rates increasing and decreasing 100 and 200 basis points from their levels at
March 31, 2000, and with all other variables held constant. A 100 and 200 basis
point increase in market interest rates would result in a pre-tax decrease in
the market value of the Company's fixed income investments of $39.9 million and
$72.2 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 $32.6 million and $67.1 million,
respectively.
Foreign Currency Sensitivity
Portions of Universal's operations are transacted utilizing the
Canadian dollar as the functional currency. Approximately 14.1%, 20.4% and 29.6%
of Universal's assets, revenues and operating income before taxes, as of and for
the three months ended March 31, 2000 respectively, are derived from the
Canadian operations. Accordingly, Universal's earnings and business equity are
affected by fluctuations in the value of the U.S. dollar as compared to the
Canadian dollar. Although this risk is somewhat mitigated by the fact that both
the assets and liabilities for Universal's foreign operations are denominated in
Canadian dollars, Universal is still subject to translation losses.
Universal periodically conducts various analyses to gauge the financial
impact of changes in the foreign currency exchange rate on their financial
condition. The ranges selected in these analyses reflect management's assessment
as being reasonably possible over the succeeding twelve-month period. The
magnitude of changes modeled in the following analysis should, in no manner, be
construed as a prediction of future economic events, but rather as a simple
illustration of the potential impact of such events on Universal's financial
results.
At March 31, 2000, a 10% strengthening of the U.S. dollar relative to
the Canadian dollar would result in a decrease to the operating income before
taxes of approximately $237 thousand and a decrease in equity of $5.4 million.
Universal's sensitivity analysis of the effects of changes in foreign currency
exchange rates does not factor in any potential change in sales levels or local
prices.
<PAGE>
PART II - OTHER INFORMATION
NONE
- --------------------------------------------------------------------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /S/ Robert A. Waegelein
Robert A. Waegelein
Senior Vice President
Chief Financial Officer
Date: May 15, 2000
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