INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN MEDICAL SECURITY GROUP, INC.
Report of Independent Auditors........................................................ F-2
Consolidated Balance Sheets at December 31, 1995 and 1994 and June 30, 1996
(Unaudited).......................................................................... F-3
Consolidated Statements of Income for the years ended December 31, 1995, 1994, 1993
and the six months ended June 30, 1996 and 1995 (Unaudited).......................... F-5
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1995,
1994, 1993 and the six months ended June 30, 1996 (Unaudited)........................ F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994,
1993 and the six months ended June 30, 1996 and 1995 (Unaudited)..................... F-7
Notes to Consolidated Financial Statements............................................ F-8
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors
American Medical Security Group, Inc.
We have audited the accompanying consolidated balance sheets of American
Medical Security Group, Inc. (the Company) as of December 31, 1995, and 1994,
and the related consolidated statements of income, shareholders' equity, and
cash flows for each of the three years in the period ended December 31, 1995.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of American
Medical Security Group, Inc. at December 31, 1995 and 1994, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1995, in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company
made certain accounting changes in 1995 and 1994.
ERNST & YOUNG LLP
Milwaukee, Wisconsin
April 5, 1996
F-2
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
------------------------ JUNE 30
1995 1994 1996
----------- ----------- -----------
(UNAUDITED)
(IN THOUSANDS)
ASSETS
Investments:
Bonds available for sale, at fair value................................. $ 8,464 $ 4,086 $ 8,450
Bonds held to maturity, at amortized cost............................... 1,880 1,880 1,880
Other invested assets................................................... 5,433 3,940 6,404
Investments in unconsolidated affiliates................................ 3,706 1,792 2,498
----------- ----------- -----------
19,483 11,698 19,232
Cash and cash equivalents................................................. 18,929 28,262 16,839
Property and equipment:
Furniture and equipment................................................. 12,621 8,335 14,706
Computer equipment and software......................................... 32,576 21,822 36,030
Leasehold improvements.................................................. 1,836 1,547 1,876
Less allowance for depreciation......................................... (22,156) (12,447) (28,550 )
----------- ----------- -----------
24,877 19,257 24,062
Deferred income taxes..................................................... 1,892 4,514 5,296
Receivables and other assets:
Funds held by insurance companies....................................... 144,390 110,263 129,349
Advance to affiliates................................................... 12,000 12,000 --
Premiums................................................................ 4,353 1,700 3,468
Interest................................................................ 565 413 238
Related party receivables............................................... 6,035 5,293 9,290
Commission advances..................................................... 2,347 1,586 1,941
Income tax receivable................................................... 1,205 -- 2,768
Prepaid expenses and other.............................................. 6,902 805 8,002
----------- ----------- -----------
177,797 132,060 155,056
----------- ----------- -----------
Total assets........................................................ $ 242,978 $ 195,791 $ 220,485
----------- ----------- -----------
----------- ----------- -----------
See accompanying notes.
F-3
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
DECEMBER 31
------------------------ JUNE 30
1995 1994 1996
----------- ----------- -----------
(UNAUDITED)
(IN THOUSANDS)
LIABILITIES AND SHAREHOLDERS' EQUITY
Health insurance claim reserves........................................... $ 82,223 $ 53,292 $ 75,662
Life claim reserves....................................................... 2,615 1,467 3,156
Unearned premium reserves................................................. 11,106 9,670 12,122
Notes payable............................................................. 2,229 3,693 11,936
Other liabilities:
Premiums payable........................................................ 28,985 39,147 13,553
Self-funded deposits.................................................... 11,279 4,337 10,460
Accounts payable........................................................ 2,188 2,065 4,781
Commissions payable..................................................... 5,065 2,598 4,561
Deferred administrative fees............................................ 6,580 5,280 6,880
Employee compensation, payroll taxes and amounts withheld............... 6,695 4,920 7,090
Income taxes payable.................................................... -- 666 --
Other................................................................... 3,287 3,069 1,489
Minority interest in subsidiary......................................... 231 455 165
----------- ----------- -----------
Total liabilities..................................................... 162,483 130,659 151,855
Commitments and contingencies (Note 13)
Shareholders' equity:
Common stock, par value $1 per share:
Authorized shares -- 600,000
Issued and outstanding shares -- 174,584 in 1994 and 174,734 in 1995
and 1996 (unaudited)................................................. 175 175 175
Preferred stock, par value $1 per share and $1,000 stated value per
share:
Authorized shares -- 15,000
Issued and outstanding shares -- 15,000............................... 15,000 -- 15,000
Additional paid-in capital.............................................. 3,816 3,786 3,816
Retained earnings....................................................... 57,898 64,747 50,030
Unrealized gain (loss) on debt securities............................... 3,606 (3,576) (391 )
----------- ----------- -----------
Total shareholders' equity............................................ 80,495 65,132 68,630
----------- ----------- -----------
Total liabilities and shareholders' equity.......................... $ 242,978 $ 195,791 $ 220,485
----------- ----------- -----------
----------- ----------- -----------
See accompanying notes.
F-4
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31 SIX MONTHS ENDED JUNE 30
------------------------------------- ------------------------
1995 1994 1993 1996 1995
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
(IN THOUSANDS)
Revenue:
Life and health premiums...................... $ 496,989 $ 374,875 $ 242,896 $ 281,513 $ 232,486
Administrative fees and commissions........... 246,458 192,109 124,148 134,385 116,310
Investment income............................. 14,102 7,020 5,288 7,735 5,135
Loss from unconsolidated subsidiaries......... (2,170) (472) (300) (1,903) (655)
Other......................................... 7,958 4,663 4,381 6,848 4,613
----------- ----------- ----------- ----------- -----------
Total revenue............................... 763,337 578,195 376,413 428,578 357,889
Expenses:
Life and health benefits...................... 389,498 249,992 163,642 224,899 186,457
Expense allowance on reinsurance assumed...... 118,996 92,405 59,821 66,261 55,898
Commissions................................... 119,137 95,299 57,545 63,490 56,472
Administrative expenses....................... 145,748 102,452 68,329 84,071 69,022
----------- ----------- ----------- ----------- -----------
Total expenses.............................. 773,379 540,148 349,337 438,721 367,849
----------- ----------- ----------- ----------- -----------
Income (loss) before minority interest, income
taxes and cumulative effect of change in
accounting principle........................... (10,042) 38,047 27,076 (10,143) (9,960)
Minority interest in net loss of subsidiary..... 244 42 -- 88 119
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes and cumulative
effect of change in accounting principle....... (9,798) 38,089 27,076 (10,055) (9,841)
Income taxes (benefit).......................... (1,947) 14,250 9,991 (2,628) (2,482)
----------- ----------- ----------- ----------- -----------
Income (loss) before cumulative effect of change
in accounting principle........................ (7,851) 23,839 17,085 (7,427) (7,359)
Cumulative effect of change in accounting
principle, net of tax.......................... 1,236 -- -- -- 1,236
----------- ----------- ----------- ----------- -----------
Net income (loss)......................... $ (6,615) $ 23,839 $ 17,085 $ (7,427) $ (6,123)
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
See accompanying notes.
F-5
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
UNREALIZED
ADDITIONAL GAIN (LOSS) TOTAL
COMMON PREFERRED PAID-IN RETAINED ON DEBT SHAREHOLDERS'
STOCK STOCK CAPITAL EARNINGS SECURITIES EQUITY
----------- --------- ----------- --------- ----------- -------------
(IN THOUSANDS)
Balance at January 1, 1993......................... $ 170 $ -- $ 2,801 $ 23,823 $ -- $ 26,794
Net income....................................... -- -- -- 17,085 -- 17,085
Common stock issued.............................. 5 -- 985 -- -- 990
----- --------- ----------- --------- ----------- -------------
Balance at December 31, 1993....................... 175 -- 3,786 40,908 -- 44,869
Net income....................................... -- -- -- 23,839 -- 23,839
Adjustment for change in accounting method, net
of deferred taxes............................... -- -- -- -- 1,305 1,305
Unrealized depreciation on available-for-sale
securities, net of deferred taxes............... -- -- -- -- (4,881) (4,881)
----- --------- ----------- --------- ----------- -------------
Balance at December 31, 1994....................... 175 -- 3,786 64,747 (3,576) 65,132
Preferred stock issued........................... -- 15,000 -- -- -- 15,000
Exercised stock options.......................... -- -- 30 -- -- 30
Dividends paid on preferred stock................ (234) (234)
Net loss......................................... -- -- -- (6,615) -- (6,615)
Unrealized appreciation on available-for-sale
securities, net of deferred taxes............... -- -- -- -- 7,182 7,182
----- --------- ----------- --------- ----------- -------------
Balance at December 31, 1995....................... 175 15,000 3,816 57,898 3,606 80,495
(UNAUDITED)
Dividends paid on preferred stock................ -- -- -- (441) -- (441)
Net loss......................................... -- -- -- (7,427) -- (7,427)
Unrealized depreciation on available-for-sale
securities, net of deferred taxes............... -- -- -- -- (3,997) (3,997)
----- --------- ----------- --------- ----------- -------------
Balance at June 30, 1996........................... $ 175 $ 15,000 $ 3,816 $ 50,030 $ (391) $ 68,630
----- --------- ----------- --------- ----------- -------------
----- --------- ----------- --------- ----------- -------------
See accompanying notes.
F-6
AMERICAN MEDICAL SECURITY GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31 JUNE 30
------------------------------- --------------------
1995 1994 1993 1996 1995
--------- --------- --------- --------- ---------
(UNAUDITED)
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income (loss)........................................... $ (6,615) $ 23,839 $ 17,085 $ (7,427) $ (6,123)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Provision for depreciation and amortization............. 10,450 7,369 3,660 6,588 4,524
Gain on sale of property and equipment.................. (8) (234) 228 -- (13)
Equity in loss of unconsolidated affiliates............. 2,170 472 300 1,903 813
Deferred income taxes (benefit)......................... (1,245) 675 (933) (1,254) (303)
Contribution of common stock to profit sharing plan..... -- -- 990 -- --
Changes in operating accounts:
Receivables and other assets.......................... (34,882) (37,915) (55,334) 18,696 (6,425)
Unearned premium reserves............................. 1,436 2,699 4,548 2,386 (374)
Insurance claim reserves.............................. 30,079 15,851 23,535 (4,995) 8,017
Other liabilities..................................... 1,313 20,746 11,134 (17,199) (16,054)
--------- --------- --------- --------- ---------
Net cash provided by (used in) operating activities......... 2,698 33,502 5,213 (1,302) (15,938)
INVESTING ACTIVITIES
Purchase of other invested assets........................... (1,493) (465) (2,250) (12) (422)
Purchase of investment securities........................... (5,025) (1,706) (3,481) (196) (3,418)
Maturity of investment securities........................... 950 100 551 43 375
Investments in subsidiaries................................. (4,084) (3,514) -- (4,307) (2,467)
Proceeds from sale of property and equipment................ 770 1,900 238 12 778
Purchase of property and equipment.......................... (16,480) (10,945) (11,559) (5,594) (9,835)
--------- --------- --------- --------- ---------
Net cash used in investing activities....................... (25,362) (14,630) (16,501) (10,054) (14,989)
FINANCING ACTIVITIES
Payments on notes payable................................... (16,465) (1,220) (556) (2,229) (1,443)
Proceeds from issuance of notes payable..................... 15,000 -- 3,500 11,936 10,484
Exercised stock options..................................... 30 -- -- -- 30
Issuance of preferred stock................................. 15,000 -- -- -- --
Dividends paid on preferred stock........................... (234) -- -- (441) (158)
Principal payments on capital lease obligations............. -- -- (22) -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing activities......... 13,331 (1,220) 2,922 9,266 8,913
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents........ (9,333) 17,652 (8,366) (2,090) (22,014)
Cash and cash equivalents at beginning of year.............. 28,262 10,610 18,976 18,929 28,262
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of year.................... $ 18,929 $ 28,262 $ 10,610 $ 16,839 $ 6,248
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
See accompanying notes.
F-7
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. ACCOUNTING POLICIES
ORGANIZATION
American Medical Security Group, Inc. (AMSG) is a holding company for
various subsidiaries involved primarily in the health insurance industry. Third
party administrator (TPA) operations market and administer primarily group life
and health insurance in 32 states and the District of Columbia. Insurance
operations consist of insurance business primarily assumed from a group of
affiliated insurance companies. These insurance risks are administered by AMSG's
TPA subsidiaries. Other consolidated and unconsolidated subsidiaries are
involved in managed care activities, such as health maintenance organizations
and preferred provider organizations.
The consolidated financial statements include the accounts of AMSG and its
subsidiaries:
- American Medical Security, Inc. (AMS), a third-party administrator
- American Medical Security Insurance Company (AMSIC), a life insurance
company
- American Medical Security Insurance Company of Ohio (AMSICO), a subsidiary
of AMSIC
- American Medical Security Insurance Company of Georgia (AMSICGA), a
subsidiary of AMSIC
- Accountable Health Plans of Texas, Inc. (AHP), a preferred provider
organization
- American Medical Security Provider Partnerships, Inc. (PPI), a preferred
provider
organization development company, formed January 1, 1995
- Continental Plan Services, Inc. (CPSI), a third party administrator
- Unity HMO of Illinois, Inc. (Unity), a 90% owned health maintenance
organization
Effective January 1, 1995, American Medical Security, Inc. changed its name
to AMSG Inc. and contributed all assets, except for its investments in
subsidiaries to American Medical Security, Inc., a newly formed subsidiary of
AMSG.
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP). Significant
intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INVESTMENTS
Debt securities (bonds) that AMSG has both the positive intent and ability
to hold to maturity are classified as held to maturity and stated at amortized
cost. Debt securities not classified as held to maturity are classified as
available for sale and stated at fair value. Unrealized holding gains and losses
on securities classified as available for sale are stated as a separate
component of shareholders' equity, net of applicable deferred taxes.
Amortization and accretion on bonds are calculated using an effective
interest method. Realized gains and losses on disposals of investments are
determined by specific identification of investments sold. Other invested assets
represent an investment in a real estate partnership (see Note 9), which is
valued at AMSG's share of net equity in the partnership.
Investment in unconsolidated subsidiaries are carried under the equity
method at AMSG's proportionate share of ownership in the subsidiary.
F-8
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and depreciated over the
estimated useful lives of the assets using the straight-line method for
financial reporting purposes and accelerated methods for income tax purposes.
FUNDS HELD BY INSURANCE COMPANIES
Funds held by insurance companies represent amounts on deposit with insurers
related to reinsurance agreements. See Note 6 for further discussion.
INSURANCE CLAIM RESERVES
Insurance claim reserves represent the liabilities arising from life and
health benefits provided under the respective policies. These reserves include
claims in process of adjudication and unreported claims. This liability
represents management's best estimate of the ultimate net cost of all reported
and unreported claims which are not paid at year end. The estimates are
continually reviewed and, as adjustments to these reserves become necessary,
such adjustments are reflected in current operations.
PREMIUMS, ADMINISTRATIVE FEES AND COMMISSIONS
Life and health premiums are recognized as revenue over the periods for
which insurance protection is provided. Administrative fees are recognized as
income as administrative services are provided. Commissions revenue and
commissions expense are recognized on the effective dates of the related
policies.
INCOME TAXES
Deferred income taxes are provided for temporary differences between the
carrying value of assets and liabilities for financial statement purposes and
the amounts used for income tax purposes. The differences relate primarily to
unrealized gains and losses on available for sale investments, tax basis
discounting of loss reserves, capitalization of deferred acquisition costs for
tax purposes and the deferral of certain administration fees for financial
statement purposes.
CASH AND CASH EQUIVALENTS
The Company considers short-term investments with remaining maturities of
three months or less at the date of acquisition to be cash equivalents.
RECLASSIFICATIONS
Certain 1994 and 1993 financial statement amounts have been reclassified to
conform with the 1995 presentation.
2. CHANGE IN ACCOUNTING METHOD
During 1995, AMSG changed the method of accounting for printed and
promotional materials by recording such materials as inventory and expensing the
materials as they are used in order to better match the expenses to the periods
benefited. Prior to January 1, 1995, all purchases of such materials were
immediately expensed. The effect of the change in accounting was an increase to
1995 net income of $1,236,000, net of taxes of $665,000.
Effective January 1, 1994, AMSG adopted Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." Debt securities (bonds) that AMSG has both the positive intent and
ability to hold to maturity are stated at amortized cost. Debt securities that
AMSG does not have the positive intent and ability to hold to maturity and all
marketable equity securities are classified as available for sale and stated at
market value. Unrealized holding gains and losses on securities classified as
available for sale are stated as a separate component of shareholders' equity.
Prior to January 1, 1994, investments in bonds were stated at amortized
F-9
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. CHANGE IN ACCOUNTING METHOD (CONTINUED)
cost. The effect of adopting SFAS No. 115 on January 1, 1994, was to increase
shareholders' equity by $1,305,000, resulting from unrealized gains on bonds
available for sale and funds held by insurance companies of $2,007,000, net of
deferred taxes of $702,000. See Note 6 for discussion of funds held balances.
3. INVESTMENTS
The amortized cost and fair values of bonds are summarized as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ----------- ----------- ---------
(IN THOUSANDS)
At December 31, 1995:
Available for sale --
U.S. Treasury securities $ 8,318 $ 152 $ 6 $ 8,464
----------- ----- ----- ---------
----------- ----- ----- ---------
Held to maturity --
U.S. Treasury securities $ 1,880 $ 18 $ -- $ 1,898
----------- ----- ----- ---------
----------- ----- ----- ---------
At December 31, 1994:
Available for sale --
U.S. Treasury securities $ 4,260 $ -- $ 174 $ 4,086
----------- ----- ----- ---------
----------- ----- ----- ---------
Held to maturity --
U.S. Treasury securities $ 1,880 $ -- $ 33 $ 1,847
----------- ----- ----- ---------
----------- ----- ----- ---------
The amortized cost and estimated fair values of bonds at December 31, 1995,
by contractual maturity are shown below:
AMORTIZED FAIR
COST VALUE
----------- ---------
(IN THOUSANDS)
Bonds available for sale:
Due in one year or less............................................... $ 1,223 $ 1,234
Due after one through five years...................................... 6,251 6,370
Due after five through ten years...................................... 844 860
----------- ---------
$ 8,318 $ 8,464
----------- ---------
----------- ---------
Bonds held to maturity:
Due in one year or less............................................... $ 600 $ 605
Due in one through five years......................................... 1,280 1,293
----------- ---------
$ 1,880 $ 1,898
----------- ---------
----------- ---------
No bond sales occurred during 1995 or 1994. Proceeds from sales of bonds
during 1993 were $77,000. Gross losses of $45 were realized on these bond sales.
Fair values represent quoted market prices for securities traded in the
public marketplace. The fair values of AMSG's other financial instruments
approximates their carrying value.
At December 31, 1994, AMSG's funds held balance was decreased by $5,328,000
and shareholders' equity decreased by $3,463,000, net of deferred taxes of
$1,865,000 related to AMSG's share of net unrealized losses on
available-for-sale investments backing the funds held balance. At December 31,
F-10
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
1995, AMSG's funds held balance was increased by $5,401,000 and shareholders'
equity increased by $3,511,000, net of deferred taxes of $1,890,000 related to
AMSG's share of net unrealized gains on available-for-sale investments backing
the funds held balance.
Net investment income is comprised of the following:
1995 1994 1993
--------- --------- ---------
(IN THOUSANDS)
Bonds........................................................ $ 422 $ 166 $ 125
Cash equivalents............................................. 880 532 290
Funds held................................................... 12,436 6,123 4,728
Other investments............................................ 297 193 164
Notes receivable............................................. 422 263 103
--------- --------- ---------
14,457 7,277 5,410
Investment expenses.......................................... (355) (257) (122)
--------- --------- ---------
Investment income............................................ $ 14,102 $ 7,020 $ 5,288
--------- --------- ---------
--------- --------- ---------
Unrealized gains (losses) is comprised of the following at December 31:
1995 1994 1993
--------- --------- ---------
(IN THOUSANDS)
Bonds available for sale:
Gross unrealized gains..................................... $ 152 $ -- $ --
Gross unrealized losses.................................... (6) (174) --
Funds held................................................... 5,401 (5,328) --
Deferred income taxes........................................ (1,941) 1,926 --
--------- --------- ---------
Net unrealized gains (losses)................................ $ 3,606 $ (3,576) $ --
--------- --------- ---------
--------- --------- ---------
4. SHAREHOLDERS' EQUITY
On September 29, 1995, AMSG issued preferred stock to United Wisconsin Life
Insurance Company (UWLIC). Holders of the preferred stock have preferential
rights in regard to dividends and payment upon liquidation. There are no voting
rights associated with the stock, with the exception of the occurrence of
certain events, as outlined in the stock agreement. The stock is redeemable at
the discretion of AMSG, or at the occurrence of certain events as defined by the
stock agreement.
Preferred stock dividends are cumulative and paid on a quarterly basis.
During the first five years the stock is outstanding, the dividend rate will be
adjusted quarterly equal to 2.5% below Bank One Milwaukee's reference rate on
the last day of the previous quarter. After five years, the dividend rate will
be adjusted to 125% of the applicable treasury rate.
At December 31, 1995, consolidated retained earnings included $2,942,000 of
undistributed losses of AMSG's 50% or less owned investees accounted for using
the equity method.
F-11
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INSURANCE CLAIM RESERVES
Activity in the liability for health insurance claim reserves is summarized
below:
1995 1994 1993
----------- ----------- -----------
(IN THOUSANDS)
Balance at January 1................................... $ 53,292 $ 37,757 $ 15,179
Plus --
Incurred related to:
Current year....................................... 376,337 250,691 162,801
Prior year......................................... 5,395 (5,478) (2,743)
----------- ----------- -----------
Total incurred................................... 381,732 245,213 160,058
Less --
Paid related to:
Current year....................................... 294,441 197,399 125,044
Prior year......................................... 58,687 32,279 12,436
----------- ----------- -----------
Total paid....................................... 353,128 229,678 137,480
----------- ----------- -----------
Balance at December 31................................. $ 81,896 $ 53,292 $ 37,757
----------- ----------- -----------
----------- ----------- -----------
Liabilities for health insurance claim reserves are based upon actuarial
projections applied to historical claim data. As a result of significant growth
in AMSG's health insurance business, AMSG has experienced variability in the
ultimate settlement of health insurance claim reserves. Actuarial projections of
health insurance claim reserves are continually reviewed and adjusted as
necessary as experience develops and new information becomes available.
6. REINSURANCE
AMSG administers a block of group life and health insurance business for
UWLIC and United Wisconsin Insurance Company (UWIC) through an administrative
services agreement. The agreement includes maintaining membership records, claim
processing and payment, coordination of benefits and billing/cash collection
processing, underwriting and marketing. In 1995, 1994 and 1993, AMSG earned
administrative fees and commissions of $216,946,000, $170,287,000 and
$109,311,000, respectively under the agreement. UWIC and UWLIC ceded 50% of
their respective life and health insurance risk to AMSIC, a subsidiary of AMSG,
through reinsurance agreements.
During 1992 UWIC ceded 30 percent of its insurance risk to AMSIC. The
reinsurance agreement contained a profit-sharing provision which required the
underwriting gains or losses on the underlying business to be allocated 50
percent to AMSIC. A contingent commission of $1,760,000 was recorded in 1993 in
conjunction with this reinsurance agreement. UWIC and UWLIC generally hold funds
on behalf of AMSIC equivalent to the claim reserves, the accumulated net
underwriting profits and accumulated investment earnings. UWIC and UWLIC pay
interest to AMSIC on the funds held balance at their average portfolio yields.
F-12
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. REINSURANCE (CONTINUED)
A summary of financial balances which represent amounts assumed by AMSIC as
a result of the reinsurance agreements with UWIC and UWLIC is as follows:
DECEMBER 31
------------------------
1995 1994
----------- -----------
(IN THOUSANDS)
Funds held by insurance companies...................... $ 142,328 $ 110,263
Unearned premium reserves.............................. 9,736 9,670
Health insurance claim reserves........................ 80,636 53,292
Life claim reserves.................................... 2,229 1,467
YEARS ENDED DECEMBER 31
-------------------------------------
1995 1994 1993
----------- ----------- -----------
(IN THOUSANDS)
Life and health premiums............................... $ 494,107 $ 374,875 $ 242,896
Investment income...................................... 12,436 6,123 4,728
Life and health benefits............................... 386,900 250,034 163,642
Expense allowance on reinsurance assumed:
Commissions.......................................... $ 61,485 $ 49,481 $ 30,369
Administrative fees.................................. 46,987 35,663 24,287
Premium taxes........................................ 8,671 6,632 4,431
Miscellaneous fees................................... 1,139 629 734
----------- ----------- -----------
Total expense allowance on reinsurance assumed..... $ 118,282 $ 92,405 $ 59,821
----------- ----------- -----------
----------- ----------- -----------
7. STATUTORY REPORTING
AMSG's life insurance subsidiaries and Unity report to their respective
state departments of insurance in conformity with statutory reporting practices.
The recorded and minimum surplus of these subsidiaries, in accordance with
statutory reporting practices, were as follows at December 31, 1995:
MINIMUM
STATUTORY STATUTORY
SURPLUS SURPLUS
--------- -----------
(IN THOUSANDS)
Statutory surplus at December 31:
AMSIC.................................................... $ 61,332 $ 500
AMSICO................................................... 3,489 2,500
AMSICGA.................................................. 4,230 3,000
Unity.................................................... 1,716 1,500
Net income (loss) for these subsidiaries, in accordance with statutory
reporting practices, was as follows:
1995 1994 1993
--------- --------- ---------
(IN THOUSANDS)
AMSIC...................................................... $ 247 $ 24,171 $ 15,443
AMSICO..................................................... 123 126 159
AMSICGA.................................................... 194 (39) (74)
Unity...................................................... (1,512) (215) --
F-13
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. STATUTORY REPORTING (CONTINUED)
The payment of dividends by AMSG's life insurance subsidiaries and Unity is
limited and generally cannot be made except from earned profits and, in certain
circumstances, without the prior approval of the respective state departments of
insurance.
8. INCOME TAXES
AMSG and its eligible non-life insurance subsidiaries file a consolidated
federal income tax return. Under a written tax sharing agreement, AMSG collects
from or refunds to the subsidiaries the amount of taxes or benefits determined
as if AMSG and subsidiaries filed separate returns.
AMSG's recorded income taxes before cumulative effect of change in
accounting principle varies from income taxes computed at the federal statutory
rate as follows:
1995 1994 1993
--------- --------- ---------
(IN THOUSANDS)
Tax (benefit) at federal statutory rate................................ $ (3,429) $ 13,331 $ 9,477
Nondeductible expenses................................................. 1,014 884 137
State income and franchise taxes, net of federal benefit............... 90 195 136
Goodwill amortization.................................................. 6 -- --
Unconsolidated life insurance company income........................... 95 -- --
Small life company deduction........................................... (48) -- --
Other.................................................................. 325 (160) 241
--------- --------- ---------
Income taxes (benefit) before cumulative effect of change in accounting
principle............................................................. $ (1,947) $ 14,250 $ 9,991
--------- --------- ---------
--------- --------- ---------
Components of the provision for income taxes are as follows:
1995 1994 1993
--------- --------- ---------
(IN THOUSANDS)
Current:
Federal............................................................ $ (174) $ 14,630 $ 10,714
State.............................................................. 138 300 210
--------- --------- ---------
(36) 14,930 10,924
Deferred (benefit)................................................... (1,246) (680) (933)
--------- --------- ---------
$ (1,282) $ 14,250 $ 9,991
--------- --------- ---------
--------- --------- ---------
F-14
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Significant components of the deferred tax liabilities and assets as of
December 31 are as follows:
1995 1994
--------- ---------
(IN THOUSANDS)
Deferred tax assets:
Deferred administrative fees..................................................... $ 2,303 $ 1,848
Tax-basis reserve adjustment..................................................... 944 730
Tax-basis unearned premium reserve adjustment.................................... 566 352
Tax-basis deferred acquisition costs............................................. 318 184
Accrued compensation............................................................. 503 233
Losses from unconsolidated subsidiaries.......................................... 907 270
Unrealized investment losses..................................................... -- 1,926
Start-up and organization costs.................................................. 319 --
Other -- net..................................................................... 715 76
--------- ---------
Deferred tax assets............................................................ 6,575 5,619
Valuation allowance................................................................ (907) (270)
--------- ---------
Deferred tax assets, net of valuation allowance.................................... 5,668 5,349
Deferred tax liabilities:
Unrealized investment gains...................................................... 1,941 --
Capitalized supply inventory..................................................... 668 --
Tax over book depreciation....................................................... 372 728
Other -- net..................................................................... 795 107
--------- ---------
Deferred tax liabilities....................................................... 3,776 835
--------- ---------
Net deferred tax assets............................................................ $ 1,892 $ 4,514
--------- ---------
--------- ---------
The nature of AMSG's deferred tax assets and liabilities are such that the
reversal pattern for those temporary differences should generally result in
realization of the deferred assets. AMSG establishes a valuation allowance for
any portion of the deferred tax asset that management believes may not be
realized. AMSG established a valuation allowance in 1995 and 1994 relating to
undistributed losses from investments in unconsolidated affiliates.
AMSG paid federal income taxes of $1,766,000, $14,768,000 and $10,198,000 in
1995, 1994 and 1993, respectively.
9. LEASES
AMSG leases office space and certain equipment under operating leases.
Future minimum lease payments by year and in aggregate under noncancelable
operating leases consisted of the following at December 31, 1995 (in thousands):
1996.............................................. $ 5,234
1997.............................................. 5,110
1998.............................................. 5,019
1999.............................................. 4,938
2000.............................................. 4,734
Thereafter........................................ 19,717
---------
Total minimum lease payments...................... $ 44,752
---------
---------
F-15
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LEASES (CONTINUED)
Operating lease rent totaled $3,867,000, $2,997,000 and $2,287,000 during
1995, 1994 and 1993, respectively.
AMSG leases office space from U&C Real Estate Partnership (U&C) under an
agreement which expires September 30, 2005. U&C is jointly owned by AMSIC and
UWIC. Under this agreement, monthly lease payments for 1995 were $159,000 per
month from January to July and $344,000 per month from August to December. Under
the terms of the agreement, AMSG paid $2,833,000, $1,908,000 and $517,000 during
1995, 1994 and 1993, respectively.
AMSG leases office space under an agreement with certain officers and
shareholders which expires September 30, 2000, with an option to renew the lease
for an additional five years. This agreement requires annual lease payments of
$768,000. Additionally, all sublease rental revenue, property taxes and
operating expenses are the responsibility of AMSG. AMSG received sublease
revenue of $406,000, $422,000 and $426,000 in 1995, 1994 and 1993, respectively.
Under the terms of this lease, AMSG must pay a penalty of $1,800,000 to the bank
if the lease is not renewed in 2000. Future minimum rental income on
noncancelable subleases, by year and in aggregate, consists of the following at
December 31, 1995 (in thousands):
1996................................................. $ 374
1997................................................. 191
1998................................................. 198
1999................................................. 204
---------
Total minimum rental income.......................... $ 967
---------
---------
10. NOTES PAYABLE
Notes payable consist of the following:
1995 1994
--------- ---------
(IN THOUSANDS)
Note payable, Bank One -- Green Bay, 0.5% in excess of prime, adjusted monthly,
payable in monthly installments of $53,735, including principal and interest, with
final payment made in October 1995................................................ $ -- $ 528
Note payable, Bank One -- Green Bay, prime, adjusted monthly, payable in monthly
installments of $71,995, including principal and interest, with final payment due
February 1996..................................................................... 2,229 2,865
Other notes payable................................................................ -- 300
--------- ---------
$ 2,229 $ 3,693
--------- ---------
--------- ---------
Interest paid on debt and lease obligations during 1995, 1994 and 1993 was
$247,000, $293,000 and $91,000 respectively.
The notes payable are secured by AMSG's assets and personal guarantees of
certain officers and shareholders.
AMSG has a line of credit from a bank of $750,000 available at December 31,
1995 and 1994. The unused portion was $15,000 and $350,000 at December 31, 1995
and 1994, respectively.
F-16
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. EMPLOYEE BENEFIT PLANS
The employees of AMSG are included in a contributory defined contribution
profit sharing plan covering all eligible salaried and hourly employees who meet
minimum service requirements. Contributions are determined by AMSG's Board of
Directors and amounted to $1,675,000, $2,490,000 and $1,899,000 for 1995, 1994
and 1993, respectively.
AMSG has a Nonqualified Stock Option Plan covering certain key employees as
defined by the Board of Directors. The plan expires on December 1, 1996, except
as to options then outstanding. A maximum of 10,000 shares of common stock may
be issued under the plan.
Options to purchase 8,000 shares of common stock at an exercise price of
$198.00 per share were granted in 1993. The grantee's rights vest ratably over
four years and expire 10 years after the date of grant. Options for 150 shares
were exercised in 1995. During 1995, 650 outstanding options lapsed. No options
were exercised in 1994 or 1993.
12. RELATED PARTY TRANSACTIONS
United Wisconsin Services, Inc. (UWS), a subsidiary of Blue Cross & Blue
Shield United of Wisconsin (BCBSUW), owns 11.9% of the outstanding common stock
of AMSG. UWS is the parent company of UWLIC and UWIC.
AMSG has employment contracts with the two primary founders of AMSG. Under
the terms of the contracts, either party may terminate the contract upon three
years prior written notice. As of December 31, 1995, notice of termination of
the contract had not been given by either party.
AMSG has advanced UWIC $12,000,000 of accumulated premium deposits, in order
to take advantage of higher portfolio interest rates earned on the UWIC
investment portfolio. UWIC pays interest to AMSIC on the advance at its average
portfolio yield.
AMSG has interests in several unconsolidated health maintenance
organizations (HMO's). In addition to capital investments in these
organizations, AMSG recognized its share of the organizations' income (loss) for
the year and recorded receivables due from these organizations. In addition,
administrative fees paid to AMS, the TPA, were recognized as revenue.
During 1995, these related party transactions were, in aggregate: capital
investments of $4,084,000, AMSG's share of net losses of $2,170,000, receivables
due to AMSG of $1,204,000 as of December 31 and administrative fees to AMS of
$19,000. The majority of these receivables are long term, bear interest at the
prime rate plus one percent, and are secured by a general business security
agreement.
AMSG has advanced money to several sales managers and key home office
employees. Receivables amounted to $2,590,000 at December 31, 1995.
13. COMMITMENTS AND CONTINGENCIES
AMSG and its subsidiaries are involved in various legal actions occurring in
the normal course of business. In the opinion of management, adequate provisions
have been made for losses which may result from these actions and, accordingly,
the outcome of these proceedings is not expected to have a material adverse
effect on the consolidated financial statements.
During 1993, U&C entered into a mortgage on an office building located in
the Village of Howard, Wisconsin, which is occupied by AMSG under a lease with
an initial term of twelve years. Another mortgage was entered into during 1995
to finance additions made to the home office building. The partners have each
signed a guarantee for 50% of the principal of the phase 1 and phase 2
mortgages, with balances of $5,041,000 and $6,050,000, respectively at December
31, 1995. AMSG's investment in U&C is included in other invested assets on the
consolidated balance sheets.
F-17
AMERICAN MEDICAL SECURITY GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
AMSG and its two primary founders are parties to a joint venture agreement
with UWS, UWLIC and UWIC which continues until December 31, 1996, subject to
annual renewal for subsequent one year terms upon mutual agreement of the
parties. The joint venture may not be terminated by either party without cause.
UWS has the option, exercisable on December 31, 1996, to purchase all the
outstanding capital stock of AMSG at a price based on AMSG's premium revenue,
book value and after tax earnings.
AMSG guarantees a line of credit of $1,460,000 for an unrelated corporation
as of December 31, 1995. The amount drawn under the line of credit was
$1,365,000 at December 31, 1995.
14. SUBSEQUENT EVENTS
On January 2, 1996, AMSIC acquired a 20% ownership interest in Personal
Physicians Care, Inc. (PPC), a health maintenance organization, for $3,500,000.
The purchase agreement specifies that AMSIC agrees to purchase an additional 1%
of PPC's outstanding shares of stock in 1997. The purchase of the additional
shares is at the option of PPC and is determined by a formula defined in the
purchase agreement. As an alternative to the purchase, AMSIC may sell a portion
of its ownership interest back to PPC for a nominal amount.
On February 1, 1996, AMSG secured a loan for $10,000,000 through Bank One,
with an interest rate at prime, adjusted monthly. Payments are interest only the
first year. Subsequent to securing the loan, AMSG was not in compliance with
certain covenants relating to required levels of net income and net worth as
defined by the agreement.
F-18