SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1998, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File No.0-13591
PROVIDENT AMERICAN CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2214195
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2500 DeKalb Pike, Norristown, Pennsylvania 19404
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 279-2500
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 Par Value
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, based upon the closing sale price of the Common Stock on
March 25, 1999 as reported on the NASDAQ National Market System, was
approximately $77,764,815. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of March 25, 1999, Registrant had 11,624,780 shares of Common Stock
outstanding.
The Exhibit Index is located on Page 78
PROVIDENT AMERICAN CORPORATION
Table of Contents
Page
I. Part I. ----
Item 1. Business 2-43
Item 2. Properties 44
Item 3. Legal Proceedings 44
Item 4. Submission of Matters to a Vote of Security Holders 44
II. Part II.
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters 45-49
Item 6. Selected Financial Data 50
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 51-59
Item 8. Financial Statements and Supplementary Data 60
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 61
III. Part III.
Item 10. Directors and Executive Officers of the Registrant 62-64
Item 11. Executive Compensation 65-71
Item 12. Security Ownership of Certain Beneficial
Owners and Management 72-74
Item 13. Certain Relationships and Related Transactions 74-75
IV. Part IV.
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K 76-77
Exhibit Index 79-89
PART I
Item 1. Business
Provident American Corporation ("PAMCO") is a Pennsylvania corporation
organized in 1982 and regulated as an insurance holding company by the states in
which its wholly owned insurance subsidiaries are licensed. The operations of
PAMCO and its subsidiaries (the "Company") are principally those of its majority
owned subsidiary HealthAxis.com, Inc. ("HealthAxis") and PAMCO's insurance
operations. PAMCO's insurance operations are currently conducted through its
wholly owned subsidiary, Provident Indemnity Life Insurance Company ("PILIC")
and PILIC's subsidiaries which, during 1996 through 1998, were Provident
American Life and Health Insurance Company ("PALHIC"), Montgomery Management
Corporation ("MMC") and NIA Corporation ("NIA"). Hereinafter, PAMCO and all of
its subsidiaries are collectively referred to as the Company and PILIC and all
of its subsidiaries are referred to as the Company's Insurance Operations.
During 1998, the Company sold 80% of MMC's outstanding common stock and on
December 31, 1998 sold 100% of the outstanding common stock of PALHIC and NIA.
Revised Strategy and Recent Developments
The Company markets and underwrites medical insurance and life
insurance and derived a majority of its revenue from group association major
medical products sold to individuals. A smaller proportion of revenue is derived
from traditional life (whole life and limited pay) products. During 1998 the
Company revised its business strategy to focus predominately on HealthAxis, the
Company's E-Commerce Insurance Marketing subsidiary along with a more focused
strategy for PILIC. The following are the financial highlights for the Company:
(Dollars in thousands)
1998 1997 1996
---- ---- ----
Gross premiums $ 119,533 $ 97,267 $ 68,503
Total revenue $ 77,499 $ 62,030 $ 74,147
Net income (loss) $ (12,156) $ (18,425) $ 16,120
Total assets $ 116,689 $ 98,365 $ 93,054
2
Total revenue for each year was net of premium ceded to reinsurers.
Gross premium growth was the result of sales of the Company's primary managed
care products, The Provident Solution and HealthQuest. The net loss in 1998 and
1997 was attributable primarily to higher group medical policy benefits. The net
loss in 1998 was also impacted by $4.9 million of expenses related to HealthAxis
while 1997's net loss was also impacted by the write off of certain deferred
acquisition costs related principally to its group health business, impairment
of certain assets, principally goodwill, and transition costs associated with
the transfer of insurance servicing operations to Health Plan Services ("HPS").
Total revenues and net income in 1996 included a litigation settlement of $22.4
million.
In early 1998 the Company determined that the Internet provided the
opportunity to sell medical insurance directly to the consumer thereby reaching
individuals under-served by insurance agents at a cost potentially lower than
the Company's current traditional agency marketing channel. During 1998, the
Company entered into various agreements in order to sell and service insurance
business via the Internet. Accordingly a new subsidiary, HealthAxis.com, Inc.
was formed in March 1998 to conduct this new venture. HealthAxis is not licensed
as an insurance company but rather an Internet-based distributor of health
insurance products. As of February 1, 1998 (as amended November 13, 1998) the
Company entered into an Amended and Restated Interactive Marketing Agreement
(the "AOL Agreement") with America Online, Inc. ("AOL"). HealthAxis became AOL's
exclusive third-party direct marketer for specified insurance products along
with vision, dental, prescription, critical care insurance and long-term care
insurance coverage for individuals and groups of less than fifty individuals in
the United States. HealthAxis is advertising these products to AOL subscribers
on AOL's online network under the HealthAxis.com brand name. HealthAxis markets
medical insurance products underwritten by PALHIC and plans to market medical
and related insurance products underwritten by other companies.
Additionally, in June 1998, HealthAxis entered into promotional
agreements with CNet, Inc. ("CNet") and Lycos, Inc. ("Lycos") whereby CNet and
Lycos will exclusively promote HealthAxis health insurance and other related
products on CNet's and Lycos' web sites. During the first quarter of 1999,
advertising began on a limited basis on the Lycos network of web sites.
In light of the continued losses experienced in the Company's group
medical products and the need to devote capital and focus to HealthAxis, the
Company entered into various agreements to sell a portion or all of PILIC's
subsidiaries MMC, PALHIC and NIA and additionally ceded 100% of its group
medical and life business during 1998.
3
In February 1998, the Company sold for $4 million, 49% of Montgomery
Management Corporation ("MMC") Common Stock along with a warrant to purchase an
additional 31% of MMC's Common Stock for a nominal amount, which warrant was
exercised in the fourth quarter of 1998. The Company recognized a pre-tax gain
of approximately $4 million on the sale and, accordingly, accounts for its
remaining 20% interest in MMC on the equity basis. PILIC, continues to assume
via reinsurance approximately 30% of the premiums, benefits and expenses of the
stop-loss business administered by MMC and receives 20% of MMC's net income in
the form of dividends.
On December 31, 1998 the Company executed a series of transactions
whereby PALHIC reinsured 100% of its insurance inforce to PILIC, which, in turn,
reinsured, all of the Company's group medical and group life business to the
Reassurance Company of Hannover ("RCH") via a 100% co-insuance agreement,. In
addition, PILIC sold PALHIC and NIA to CRLC for $5.6 million which approximates
PALHIC's capital and surplus. The Company also transferred all rights and
control regarding the Company's agents and entered into non-compete and
non-solicitation agreements regarding the Company's agents with respect to the
future sale of health insurance products by agents for a 3-year period ending
December 31, 2001. The Company received regulatory approval for all of these
transactions for statutory reporting purposes. The Company's expectation is that
these transactions should provide PILIC the necessary statutory basis capital to
pursue its more focused strategy, see "Revised Strategy for Insurance
Operations".
4
The $10 million ceding commission paid by CRLC to PILIC consisted of a
$5 million non-refundable payment plus a $5 million contingent payment, whereby
PAMCO guaranteed that CRLC will earn at least $10 million in future profits from
the purchased inforce business, plus 12% interest on $10 million and other
amounts due (the "guaranteed amount"). If at the end of 5 years CRLC fails to
earn the guaranteed amount, PAMCO must repay CRLC the lesser of the guaranteed
amount less CRLC's actual profits on the inforce business, or $5 million plus
12% interest on $5 million and other amounts due. As security for PAMCO's
guarantee, PAMCO executed a Guarantee Agreement and Stock Pledge Agreement in
favor of RCH and CRLC which allows CRLC and RCH to take ownership of PILIC if
PAMCO defaults on its guarantee to CRLC. The Guarantee Agreement and Stock
Pledge Agreement prevent PAMCO from selling or otherwise disposing of PILIC's
stock. Furthermore these agreements prevent PAMCO from paying dividends,
incurring debt, making loans and from selling substantially all of PILIC's
assets without CRLC and RCH's approval. These agreements do not directly involve
HealthAxis. If CRLC's future profits exceed the guaranteed amount PILIC would be
entitled to receive additional payments from CRLC equal to the lesser of CRLC's
future profits less the guaranteed amount, or 2/3 of the policy fees collected
during 1999 and 1/3 of the policy fees collected during 2000. The $10 million
ceding commission has been recognized as ceding commission revenue by PILIC, and
PAMCO has recognized $5 million ceding commission liability.
5
Special Considerations and Risk Factors
All statements and information herein, other than statements of
historical fact, are forward looking statements that are based upon a number of
assumptions concerning future conditions that may ultimately prove to be
inaccurate. Many phases of the Company's operations are subject to influences
outside its control. Any one, or any combination of factors could have a
material adverse effect on the Company's results of operations. These factors
include: changes in governmental regulation, claims experience and reserve
adequacy, rating changes, competitive pressures, economic conditions, changes in
consumer spending, interest rate fluctuations, and other conditions affecting
capital markets. The following factors should be carefully considered, in
addition to other information contained in this document. This document contains
certain forward-looking statements within the meaning of section 27A of the
Securities Act of 1933 as amended ("Act") and section 21E of the Securities
Exchange Act of 1934, as amended. The Statements include among other things,
statements regarding trends, strategies, plans, beliefs, intentions,
expectations, goals and opportunities. Also they include uncertainty of future
operating results, new business challenges, risks associated with brand
development, competition, funding; need for additional capital, management of
potential growth; new management team, dependence on key personnel, dependence
on the Internet, dependence on strategic alliances with Internet partners,
liability for information transmitted through the Internet, uncertain acceptance
of the Internet as a medium for health insurance sales and risk capacity
constrains; reliance on internally developed systems; system development and
other risks, dependence on third party technology, rapid technological change,
risk of system failure; A.M. Best's insurance ratings, dependence on key
suppliers of insurance products, dependence upon third party claims
administration services, changes in the insurance industry, insurance industry
factors, health care reform legislation, government regulation and legal
uncertainties, potential conflicts of interest, intercompany agreements not
subject to arm's length negotiations, risk associated with the Year 2000,
absence of dividends, statements regarding change in strategic focus, greater
control of costs, conversion and expansion of administrative infrastructure and
varying significance of particular states within which the Company can write
insurance; beliefs regarding attractiveness of products; enhancements to claims
system; increased processing capacity; investments in computer hardware and
funding of capital expenditures; sufficient liquidity to fund growth fulfill
statutory requirements and meet all cash requirements, funding surrenders,
benefit payments and loan payments. Actual events, developments and results
could differ materially from those anticipated or projected in the forward
looking statements as a result of uncertainties set forth below and elsewhere in
this document. Any investment in the Company's securities involves a high degree
of risk.
The following factors, in addition to the other information contained
in this report, should be considered carefully in evaluating an investment in
the Company.
6
Historical and Anticipated Losses; Uncertainty of Future Results: The
Company has incurred losses in its Insurance Operations related primarily to its
group medical products and in HealthAxis to develop and enhance its technology,
to create, introduce and enhance its web site, to establish marketing, insurance
carrier and claims administration relationships. As a result, the Company has
incurred significant losses and expects to continue to incur losses on a
quarterly and annual basis at least through fiscal 2000. The Company currently
intends to increase substantially HealthAxis operating expenses as a result of
strategic alliances, to fund increased sales and marketing, to enhance its
existing web site and to fund increased salaries and other costs. To the extent
that such expenses precede or are not subsequently followed by increased
revenues, the Company's business, results of operations and financial condition
will be materially adversely affected. There can be no assurance that the
Company will be able to generate sufficient revenues from the sale of insurance
products over the Internet to achieve or maintain profitability on a quarterly
or annual basis in the future. The Company expects negative cash flow from
operations to continue for the foreseeable future as it continues to develop and
market its Internet-based health insurance business.
Control of the Company: Alvin H. Clemens, Chairman and Chief Executive
Officer of the Company ("Mr. Clemens"), acquired control of the Company in
October 1989. Mr. Clemens is the largest shareholder of the Company. As of March
16, 1999, Mr. Clemens owned, either directly or beneficially, 2,006,068 shares,
or 19.8% of the Company's Common Stock, and 1,100,000 shares, or 99.4%, of the
Company's Preferred Stock which includes the right to acquire 364,176 shares of
common and 550,000 preferred pursuant to the exercise of stock options. As of
March 16, 1999, Mr. Clemens controlled 30.5% of the Company's outstanding voting
rights and, if he were to exercise all of his outstanding options, he would
control 40.0% of the Company's voting rights. In addition, pursuant to terms of
an agreement to grant options dated March 10, 1997, Mr. Clemens has the right to
be granted an option to acquire 55% of the common stock of the Company, subject
to the conditions set forth therein. Accordingly, Mr. Clemens could greatly
influence the outcome of any matter requiring shareholder approval, even if such
matters were deemed by the shareholders, other than Mr. Clemens, to be in their
best interests.
7
New Business Challenges: As a result of the various insurance related
transactions described in the preceding sections, HealthAxis, the Company's
Internet-based distributor of health insurance products, has become a major
operating unit of the Company which began selling a limited line of health
insurance products over the Internet in December 1998. Accordingly, the Company
has a very limited operating history in the Internet health insurance sales
business upon which an evaluation of HealthAxis and its prospects can be based.
The Company's prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in new, unproven and rapidly
evolving markets. To address these risks, the Company must, among other things,
develop and expand its customer base, respond to competitive developments,
continue to attract, retain and motivate qualified employees, maintain its
current relationships with Internet service providers, continue to upgrade its
technologies and, finally, attract significant sources of capital to fund its
start-up activities. There can be no assurance that the Company will be
successful in addressing such risks. If the Company is not successful in
developing and expanding its Internet-based health insurance sales business, the
Company's ability to achieve profitability will be materially adversely
affected.
Risks Associated with Brand Development: The Company believes that
HealthAxis' ability to create and continue to strengthen its brand identity is
critical to achieving widespread acceptance of HealthAxis, particularly in light
of the competitive nature of the Company's business. Promoting and positioning
its brand identity will depend largely on the success of the Company's marketing
efforts and the ability of the Company to provide high quality insurance
products and services. In order to promote its brand identity, the Company will
need to increase its marketing efforts and budget and otherwise increase its
financial commitment to creating and maintaining brand loyalty among Internet
users. There can be no assurance that brand promotion activities will yield
increased revenues or that any such revenues would offset the expenses incurred
by the Company in building its brand identity. Further, there can be no
assurance that any new Internet users attracted to HealthAxis will conduct
transactions with HealthAxis on an ongoing basis. If the Company fails to
promote and maintain its brand identity or incurs substantial expenses in an
attempt to promote and maintain its brand identity or if the Company's existing
or future strategic relationships fail to promote the Company's brand identity
and increase brand awareness, the Company's financial position and projected
results of operations would be materially adversely affected.
8
Competition: Since the Internet's commercialization in the early
1990's, the number of web sites on the Internet competing for consumers'
attention and spending has proliferated. Although the Company believes that it
is the first transaction-enabled, Internet-based direct distributor of health
insurance , there are limited barriers to entry and the Company expects that
various others may attempt to establish similar web sites. In addition, in the
area of health insurance sales, the Company will compete with large insurance
and financial service companies with established insurance agent networks as
well as the independent insurance agents and brokers. Substantially all of the
HealthAxis' potential competitors have longer operating histories, significantly
greater financial, marketing and other resources, greater name recognition and
significantly larger existing customer bases than the Company. These competitors
may be able to respond more quickly to changes in customer preferences and to
devote greater resources to the development, promotion and sale of their
products or claims processing services than the Company. There can be no
assurance that the Company will be able to compete successfully with these
competitors. The Company's success will depend heavily upon its ability to
provide health insurance products at prices below those currently being provided
by traditional sources, along with expedited claims processing and access to
claims information via the Internet. Other factors that will affect the
Company's success include the Company's continued ability to attract experienced
technical, marketing, sales and management talent. The Company believes that the
principal competitive factors in the online health insurance market will be
price, name recognition, product selection, Internet access to claims
information, ease of use, site content, quality of claims processing services
and technical experience. HealthAxis' failure to compete successfully in the
health insurance business would have a material adverse effect on the Company's
business, results of operations and financial condition.
Funding; Need for Additional Capital: The Company's funding needs for
fiscal 1999 are estimated to be approximately $15.0 million for HealthAxis. In
fiscal 1999, HealthAxis' obligations to AOL, Lycos and CNet approximate $3.8
million. In order to implement its business plan in 1999, in addition to
payments to AOL, Lycos and CNet, HealthAxis anticipates incurring expenses of
approximately $4.0 million to advertise HealthAxis' offline, $1.0 million for
upgrades of its web site and $4.6 million for salary and other operating
expenses.
The Company's capital needs for HealthAxis during fiscal 1998 were
funded through the sale of a $5.0 million convertible note to HPS, $750,000
received from HPS in payment for the exclusive rights to administer the
insurance claims process for PALHIC products sold through HealthAxis, $3.0
million from the sale of additional shares of HealthAxis Common Stock to PAMCO,
the sale of $2.4 million of Series A Preferred Stock to PILIC and $2.75 million
from the sale of shares of Series B Preferred Stock to AOL.
9
HealthAxis expects to use a portion of the net proceeds of any private
or public offering to make payments to AOL, Lycos and CNet. HealthAxis expects
to utilize the remaining proceeds for working capital and other general
corporate purposes, including marketing expenses, web site enhancements and
salary and other operating expenses. Such net proceeds, together with cash
generated by operations, which are expected to be minimal, are unlikely to be
sufficient to fund future operating losses and the Company expects that it will
be required to raise additional funds to sustain and expand its sales, marketing
and development activities, particularly if a well-financed competitor emerges
or if technological enhancements are necessary in order for HealthAxis to remain
competitive. Future funding commitments beyond 1999 will be approximately $48.9.
(The renewal terms are optional for AOL and CNet. The Lycos renewal term is
based upon policies sold). Although, the Company believes that the $14.0 million
net proceeds will be sufficient to fund HealthAxis' operations through December
31, 1999, no assurances can be given that such funding will be sufficient. As a
result of these funding needs, the Company will need to seek additional debt
and/or equity financing. Adequate funds for these and other purposes on terms
acceptable to the Company, whether through additional equity financing, debt
financing or other sources, may not be available when needed or may result in
significant dilution to existing HealthAxis shareholders, including PAMCO. The
inability to obtain sufficient funds from operations and external sources would
have a material adverse effect on the Company.
10
Management of Potential Growth; New Management Team: HealthAxis
believes that it may experience a period of expansion and anticipates that
future expansion will be required to address potential growth in its customer
base and market opportunities. To the extent HealthAxis experiences a period of
rapid and significant growth, including a substantial increase in the number of
applications received, such growth may place significant demands on HealthAxis'
management, operations, systems and financial resources. To the extent that
HealthAxis grows rapidly, the Company will be faced with risks, including risks
associated with the assimilation of new personnel and products, and increasing
the capacity of its web site. From inception to December 1998, HealthAxis
expanded from one to 26 full time employees. HealthAxis expects to add
additional key personnel in the future. To manage the expected growth of its
operations and personnel, HealthAxis will be required to improve existing and
implement new transaction processing, operational and financial systems,
procedures and controls, and to expand, train and manage its growing employee
base. HealthAxis also will be required to expand its finance, administrative and
operations staff. Further, HealthAxis may be required to enter into
relationships with various strategic partners, web sites and other online
service providers and other third-parties necessary to support HealthAxis'
business. There can be no assurance that HealthAxis' current and planned
personnel, systems, procedures and controls will be adequate to support
HealthAxis' future operations, that management will be able to hire, train,
retain, motivate and manage required personnel or that HealthAxis' management
will be able to identify, manage and exploit existing and potential strategic
relationships and market opportunities. HealthAxis' ability to compete
effectively will depend, in part, upon its ability to overcome these growth
related risks and to revise, improve and effectively use its operational,
management, marketing and technical systems. Furthermore, there can be no
assurance that HealthAxis will be able to effectively manage such growth. Any
failure of HealthAxis to effectively manage its growth and to respond to changes
in its business would have a material adverse effect on HealthAxis' and the
Company's business, results of operations and financial condition.
11
Dependence on Key Personnel: HealthAxis' performance will be
substantially dependent on the continued services and on the performance of its
senior management and other key personnel, all of whom are employed on an
at-will basis. HealthAxis is negotiating employment agreements for several key
senior management personnel. HealthAxis' performance also will depend on
HealthAxis' ability to retain and motivate its other officers and key employees.
The loss of the services of any of its executive officers or other key employees
could have a material adverse effect on HealthAxis. As of December 31, 1998,
HealthAxis did not have employment agreements with any of its key personnel and
maintains no "key person" life insurance policies on such individuals.
HealthAxis' future success also will depend on its ability to identify, attract,
hire, train, retain and motivate other highly skilled technical, managerial,
financial, marketing and customer service personnel. Competition for such
personnel is intense, and there can be no assurance that HealthAxis will be able
to successfully attract, integrate or retain sufficiently qualified personnel,
including software developers and other technical experts. The failure to
attract and retain the necessary personnel could have a material adverse effect
on HealthAxis and the Company.
Dependence on Strategic Alliances with Internet Partners: HealthAxis
relies on its strategic alliances with AOL, Lycos and CNet to attract customers
to its web site and to promote sales of insurance products over the Internet.
HealthAxis' ability to generate sufficient revenues from insurance sales over
the Internet to fund its operations generally depends on increased traffic and
purchases that HealthAxis expects to generate partially through these strategic
alliances with Internet content and service providers. Pursuant to its agreement
with AOL, HealthAxis has the exclusive rights, subject to certain exceptions, to
offer certain health insurance products to AOL subscribers. In November 1998,
HealthAxis renegotiated its agreements with AOL, CNet and Lycos in order to
obtain additional time needed to develop and test its web site and to secure
additional funds necessary to enable HealthAxis to make payments that were
coming due and/or past due under these agreements. AOL, CNet and Lycos each
agreed to extend the launch date for HealthAxis' web site and the due dates for
HealthAxis' payment of fees. The inability of HealthAxis to enter into new, and
to maintain any one or more of its existing, strategic alliances with AOL and
others could have a material adverse effect on HealthAxis' and the Company's
business, results of operations and financial condition.
12
Liability for Information Transmitted through the Internet: A
significant barrier to online insurance sales and communications is the secure
transmission of confidential information over public networks. Computer viruses,
break-ins or other security breaches could lead to misappropriation of personal
or proprietary information and interruptions, delays or cessation in service to
HealthAxis' customers. Although HealthAxis relies on encryption and
authentication technology licensed from third parties to provide the security
and authentication necessary to effect secure transmission of confidential
information, such as customer credit card numbers and claims information, there
can be no assurance that advances in computer capabilities, new discoveries in
the field of cryptography, or other events or developments will not result in a
compromise or breach of the algorithms used by HealthAxis to protect application
information and policyholder claims data. If any such compromise of HealthAxis'
security were to occur, it could have a material adverse effect on HealthAxis. A
party who is able to circumvent HealthAxis' security measures could
misappropriate proprietary information or cause interruptions in HealthAxis'
operations or cessation of service to HealthAxis' policyholders and applicants.
In addition, such a party could also cause HealthAxis to download to third
parties personal medical information, viruses or other objectionable materials.
HealthAxis may be required to expend significant capital and other resources to
protect against such security breaches or to alleviate problems caused by such
breaches or viruses. Consumer concerns over the security of transactions
conducted on the Internet and other online services and the privacy of users may
also inhibit the growth of the Internet and other online services generally, and
the Web in particular, especially as a means of conducting commercial
transactions such as health insurance sales and claims processing, where
consumers are required to send credit card and highly personal health
information over the Internet. To the extent that activities of HealthAxis and
HPS involve the storage and transmission of proprietary information, such as
medical and claims information, security breaches could damage HealthAxis'
reputation and expose HealthAxis to a risk of loss or litigation and possible
liability. There can be no assurance that HealthAxis' security measures will
prevent security breaches or that failure to prevent such security breaches will
not have a material adverse effect on HealthAxis. Although HealthAxis carries
general liability insurance, HealthAxis' insurance may not cover potential
claims of this type or may not be adequate to cover all costs incurred in
defense of potential claims or to indemnify HealthAxis for all liability that
may be imposed. HealthAxis does not intend to secure errors and omissions
insurance to enhance its existing coverage. Any costs or imposition of liability
that is not covered by insurance or in excess of insurance coverage could have a
material adverse effect on HealthAxis' and the Company's business, results of
operations and financial condition.
13
Uncertain Acceptance of the Internet as a Medium for Health Insurance
Sales: HealthAxis initiated a "soft launch" of the fully functional version of
its web site in December 1998 which included a limited number of impressions
from AOL. HealthAxis expects to increase marketing efforts and drive higher
volumes of transactions through its web site during the second quarter of 1999.
As a result, HealthAxis has limited experience in the on-line insurance sales
business. Use of the Internet by consumers to purchase health insurance products
is a relatively new development, and market acceptance of the Internet as a
medium for insurance sales is subject to a high level of uncertainty.
HealthAxis' future success will depend on its ability to significantly increase
revenues, which will require the development and widespread acceptance of the
Internet as a medium for insurance sales. There can be no assurance that
consumers who are willing to purchase relatively simple, low cost and low risk
items such as compact discs, flowers, books and groceries over the Internet will
be willing to purchase complicated and higher cost items such as health and
related insurance policies in such manner or may prefer to discuss insurance
decisions with an insurance agent as opposed to Internet purchases with no agent
involvement. Finally, consumers may be unwilling to divulge highly personal
medical information through the Internet. There can be no assurance that
HealthAxis' products, application process, pricing and Internet-based claims
processing will be attractive to a sufficient number of users to generate
significant revenues. There can also be no assurance that HealthAxis will be
able to anticipate, monitor and successfully respond to rapidly changing
technology and consumer preferences so as to continually attract and retain a
sufficient number of customers. If HealthAxis is unable to develop and implement
competitively priced products that allow it to attract, retain and expand its
customer base, it and the Company could be materially adversely affected.
In addition, HealthAxis will be primarily reliant upon the Internet as
a means of marketing and selling its insurance policies. The Internet in general
as well as online services could lose their viability due to delays in the
development or adoption of new standards and protocols required to handle
increased levels of Internet or other online service activity, or due to
increased governmental regulation. Changes in or insufficient availability of
telecommunications services to support the Internet or other online services
also could result in slower response times and adversely affect usage of the
Internet and other online services generally and the HealthAxis services in
particular. Accordingly, any adverse change or a failure in the character of the
Internet will have a corresponding adverse effect on HealthAxis' sales and the
Company's financial condition.
14
Risk of Capacity Constraints; Reliance on Internally Developed Systems;
System Development and Other Risks: A key element of HealthAxis' strategy is to
generate a high volume of traffic on, and use of, its web site to generate
insurance sales. Accordingly, the satisfactory performance, reliability and
availability of HealthAxis' web site, transaction processing systems and network
infrastructure is critical to HealthAxis' reputation and its ability to attract
and retain customers and maintain adequate policyholder service levels.
HealthAxis' revenues depend on the number of customers who purchase insurance
products from its web site and the volume of renewals received. In addition,
from time to time, HealthAxis and its key suppliers may experience capacity
constraints and failures of their information systems which could result in
decreased levels of service delivery or interruptions in service. While
HealthAxis continually will review and seek to upgrade its technical
infrastructure and provide for certain system redundancies and backup power to
limit the likelihood of systems overload or failure, any damage, failure or
delay that causes interruptions in HealthAxis' operations could have a material
adverse effect on HealthAxis. Any system interruptions that result in the
unavailability of HealthAxis' web site, reduced applications processing or the
unavailability of claims information would reduce the volume of policies sold or
claims processed and the attractiveness of HealthAxis' insurance products.
HealthAxis believes that as part of doing business on the Internet, it
will, from time to time, experience periodic system interruptions. Any
unexpectedly high volume of traffic on the HealthAxis site or in the number of
applications placed by customers may require HealthAxis to expand and upgrade
further its technology, transaction processing systems and network
infrastructure. There can be no assurance that HealthAxis will be able to
accurately project the rate or timing of increases, if any, in the use of its
web site. Further, there can be no assurance that HealthAxis will be able to
expand and upgrade its systems and infrastructure to accommodate such increases
in a timely manner. Moreover, HealthAxis is entirely dependent upon the ability
of third parties to increase the capacity of its back end systems and a failure
by such third parties would have a material adverse impact upon HealthAxis'
operations.
The source code and design of HealthAxis' software will be protected by
HealthAxis through applicable trade secret law and, it is intended, through the
use of confidentiality agreements with its employees. Policing the unauthorized
use of HealthAxis' software and other proprietary materials is difficult and
HealthAxis believes that the unregulated open access provided to third parties
via the Internet creates a substantial risk that HealthAxis' technology may be
duplicated.
15
Dependence on Third Party Technology: The Company relies upon a variety
of technology that it licenses from third parties, including its data base and
Internet server software, which is used in the HealthAxis' web site to perform
key functions. There can be no assurance that these third party technology
licenses will continue to be available to HealthAxis on commercially reasonable
terms. The loss of or inability of HealthAxis to maintain or obtain upgrades to
any of these technology licenses could result in delays in completing its
proprietary software enhancements and new development until equivalent
technology could be identified, licensed or developed, and integrated. Any such
delays would materially affect HealthAxis and the Company. In this regard it is
noted that certain disputes have arisen between the Company, HealthAxis and HPS.
See "Back End Processing Technology" and "Insurance Operations - Claims."
Rapid Technological Change; Risk of System Failure: The Internet is
characterized by rapid technological change, changes in user and customer
requirements and preferences, frequent new product and service introductions
embodying new technologies and the emergence of new industry standards and
practices that could render the HealthAxis' existing web site, technology and
systems obsolete. To remain competitive as other providers enter the Internet
insurance market, HealthAxis must continue to enhance and improve the
responsiveness, functionality and features of the HealthAxis web site.
HealthAxis' success will depend, in part, on its ability to add and delete
additional carriers or products, enhance its existing services, develop new
services and technology that address the increasingly sophisticated and varied
needs of its prospective customers, and respond to technological advances and
emerging industry standards and practices on a cost-effective and timely basis.
There can be no assurance that HealthAxis will successfully use new technologies
effectively or adapt HealthAxis' web site, technology and systems to customer
requirements or emerging industry standards. If HealthAxis is unable, for
technical, legal, financial or other reasons, to adapt in a timely manner in
response to changing market conditions or customer requirements it would be
materially adversely affected.
In addition, HealthAxis' operations are dependent on its ability and
the ability of its key business partners to maintain their computer and
telecommunications equipment in effective working order and to protect their
systems against damage from fire, natural disaster, power loss,
telecommunications failure or similar events. In addition, the growth of
HealthAxis' customer base may strain or exceed the capacity of its or its key
business partners' computer and telecommunications systems and lead to
degradations in performance or systems failure. In addition, critical elements
of HealthAxis' computer and telecommunications operations, (and those of its key
business partners) including their processing operations, is located at single
site facilities. In the event of a catastrophic loss at any of single site
facilities of HealthAxis or its key business partners' sites, resulting in the
destruction of HealthAxis' (or its key business partners') computer and
telecommunications operations, HealthAxis would experience a significant
interruption of its business until such time as a second site backup is
established. Although HealthAxis maintains insurance and is in the process of
developing a second backup site, such insurance may not be adequate to
compensate HealthAxis for all property damage and business interruption losses
that may occur.
16
Dependence on Key Suppliers of Insurance Products: Although HealthAxis
has entered into agreements with additional insurance companies to offer their
products in the future, HealthAxis is currently dependent upon maintaining its
existing relationship with PALHIC, which currently is HealthAxis' sole provider
of insurance products. Concurrently, HealthAxis is continuing to attempt to
establish new relationships with additional insurance providers in order to
diminish its reliance upon any one carrier's products and to expand its product
offerings. There can be no assurance that HealthAxis will be successful in
establishing relationships with additional insurance providers on terms
satisfactory to HealthAxis. PALHIC's inability to underwrite a sufficient number
of policies, absent the development of relationships with additional insurance
providers, could materially adversely affect HealthAxis. In addition, to the
extent that PALHIC or the HealthAxis' other Carrier Partners, hereinafter
defined are unable to underwrite an increasing number of policies for
HealthAxis, such capacity constraint would have a material adverse effect on
HealthAxis' and the Company's business, results of operations and financial
condition.
Dependence Upon Third Party Claims Administration Services: The Company
does not have the ability to service claims for group medical and group life
policies and, accordingly, will be dependent upon maintaining its existing
relationship with HPS, a provider of health claims administration services, or
establishing a new claims administration relationship with a comparable claims
services company. There can be no assurance that the Company will maintain its
relationship with HPS (the current term of which expires in October 1999 for
HealthAxis and for the Company's Insurance Operations on December 31, 2002). The
termination of such relationship would, absent establishing a substitute
relationship with another claims servicer, or HPS' inability to timely and
efficiently process an increasing number of claims will have a material adverse
effect on the Company. In addition, the failure of HPS or another third party
claims administration company to adequately, efficiently and timely service
claims related to policies sold by HealthAxis or the Company's Insurance
Operations could have an adverse effect on HealthAxis' future sales and renewals
and PILIC's profitability.
Changes in the Insurance Industry: The Company's success will depend in
part upon HealthAxis ability to develop and provide new products that meet
customers' changing health insurance needs and changes in government
requirements. During recent years, the health insurance industry has experienced
substantial changes, primarily caused by healthcare legislation, originally at
the state level, and more recently at the federal level and the introduction of
managed care organizations. Additionally, over the past several years the rapid
growth of Health Maintenance Organizations ("HMOs") and Preferred Provider
Organizations ("PPOs") as well as the organization of healthcare providers in
new ways such as Physician Hospital Organizations ("PHOs") has dramatically
changed the sales of health insurance products. The Company's future success
will depend, in part, on its ability to effectively enhance its current products
and claims processing capabilities and to develop new products in the changing
health care environment on a timely and cost-effective basis.
17
Health Care Reform Legislation: In the past, there have been, and
currently there are, a number of proposals introduced in the United States
Congress and currently there are proposals pending in state legislatures to
reform the current health care system. Many states have already enacted
comprehensive health care reform legislation and a number of legislative and
regulatory proposals are currently being considered at the state and federal
level. Legislative proposals have included requirements with respect to mandated
universal health insurance coverage, restrictions on preexisting condition
limitations, community rating standards, guaranteed issue and renewal
requirements and restrictions on premium increases. Several states have passed
and many other states are considering legislation that includes voluntary health
care purchasing alliances, differential limitations in rates for new and renewal
business or for demographic groups, and underwriting practice restrictions.
These reforms generally include the formation of voluntary purchasing alliances
for small employers (typically with less than 50-100 employees) and require
insurers to accept all qualified small employer groups as a condition of
providing small group insurance, prohibit the imposition of preexisting
condition limitations or medical condition terminations, and phase out
experience-rating for small employer groups. Certain jurisdictions also have
enacted so-called "any willing provider" laws which may decrease the demand for
managed care plans. While the Company cannot predict whether any of the
proposals currently being considered will be enacted or whether any new federal
or state proposals will be considered, and thus cannot predict what specific
effects health care reform may have on the Company's business, the Company may
be adversely affected by changes to the health care system.
Government Regulation and Legal Uncertainties: The insurance industry
is one of the most highly regulated fields. As a result, the Company is subject,
both directly and indirectly, to various laws and governmental regulations
relating to its business. Currently state laws regulate product marketing and
advertising on the Internet. Although the Company believes it is in compliance
with such laws, no assurance can be given that compliance with future rules and
regulations will not have a materially adverse effect on the Company. The
insurance products offered by the HealthAxis must be approved by HealthAxis'
Carrier Partners in the various states in which such products are offered. The
Carrier Partners are also subject to extensive supervision and regulation at the
state level. The Company could be adversely affected if HealthAxis' Carrier
Partners are unable to obtain approval for the products which HealthAxis plans
to offer on its web site or are otherwise adversely affected by actions taken by
state regulatory authorities against any Carrier Partner.
18
A. M. Best's Insurance Ratings: The ratings assigned by A.M. Best
Company Inc. ("Best") are an important factor influencing the competitive
position of insurance companies. Best's ratings are based on an analysis of the
financial condition and operating performance of the companies rated. Best's
classifications are A++/A+ (superior), A/A- (excellent), B++/B+ (very good),
B/B- (adequate), C++/C+ (fair), C/C- (marginal), D (below minimum standards) and
E (under state supervision). Best's ratings are based upon factors of concern to
policyholders and insurance agents, and are not necessarily directed toward the
interests of investors in the rated insurance company and/or its parent and
therefore should not be relied upon as a basis for investment decisions. There
can be no assurance that Best will reaffirm PILIC's ratings in the future.
In 1997, PILIC and PALHIC Best's ratings were upgraded from a B- to a
"B" (adequate) rating, reflecting the Company's improved capital and surplus
position as a result of a litigation settlement resulting in a net gain of $19.0
million. This "B" (adequate) rating was reaffirmed in February, 1998. In 1999
the Company was notified by Best that PILIC's Best rating will be downgraded to
a B- due to PILIC's reduced capital and surplus position as a result of
operating losses on group medical products. The Company's goal is to strengthen
the financial position of PILIC, including the reinsurance of its group medical
business with RCH, which the Company believes will result in an improved rating
over time; although there can be no assurance that PILIC will be successful in
improving or maintaining its current rating.
Dividends: Dividends paid by the Company over and above the financial
assets of PAMCO are dependent on the ability of HealthAxis and PILIC to pay
dividends to PAMCO. The terms of HealthAxis' Certificate of Designation for
Series C Cumulative Convertible Preferred Stock restrict HealthAxis' ability to
pay dividends to shareholders including PAMCO. PAMCO's Guarantee Agreement with
RCH restricts PAMCO's ability to enter into new agreements and the payment of
dividends. Under Pennsylvania law, PILIC is currently unable to pay dividends
without the prior approval of the Pennsylvania Insurance Commissioner as a
result of PILIC's statutory unassigned deficit of $20.1 million, which excludes
common stock and additional paid-in capital amounts. The Company has not paid a
cash dividend on its common stock since its inception in 1982 and intends on
using capital and surplus to fund its growth and liquidity needs.
Possible Adverse Impact of Inadequate Loss Reserves or Deferred
Acquisition Costs: Policy claims and the related policy benefit expenses are
based upon a variety of estimation methods which are continually revised,
incorporating the Company's benefit experience. The Company's Insurance
Operations has, in the past, underestimated its loss reserves with regard to
these products The need for increased reserves could have a materially adverse
affect on the Company's results of operations.
19
The Company's Insurance Operations deferred policy acquisition costs as
of December 31, 1998 and 1997 related to the Company's individual life business
and were based on management's estimation that these costs will be recoverable
against future profits on these products. Increased lapsation over current
levels or unprofitability in these products could result in an increase in the
amortization rate of deferred acquisition costs which could have a material
adverse impact on the Company's financial condition.
Reinsurance: The Company's Insurance Operations ceded approximately
47.5% of group medical benefits incurred during 1996 through 1998 via quota
share agreements. The Company's medical quota share and excess reinsurance
agreements with Swiss Re were terminated effective December 31, 1997. Swiss Re's
obligation to assume its proportionate share of medical paid losses incurred
prior to January 1, 1998 remains in effect. The Company is currently in
negotiation with a group of reinsurers and has placement slips regarding a
replacement Quota Share Agreement and Excess of Loss Agreement effective January
1, 1998 through December 31, 1998. The Company is negotiating specific terms
regarding the risk attaching provisions for those policies inforce as of
December 31, 1997 until such time that those policies were rate increased during
1998. While the Company believes that the Company will execute a final
reinsurance agreement with its reinsurers there can be no assurance that the
terms will not be unfavorable to the Company which would have a material adverse
effect on the Company's results of operations and financial condition.
Effective December 31, 1998 PILIC entered into a reinsurance agreement
with the RCH whereby the Company guaranteed that RCH will earn at least $10
million in future profits from the ceded inforce business, plus 12% interest
(the "Guaranteed Amount"). If RCH fails to earn the Guaranteed Amount within
five years of the date of the closing of the CRLC transaction, PAMCO must repay
RCH the lesser of the Guaranteed Amount less RCH's actual profits on the inforce
business, or $5 million, plus 12% interest on $5 million. As of December 31,
1998 the Company has recorded a $5 million ceding commission liability related
to PAMCO's guarantee and is accruing interest at the guaranteed rate over the
five year term.
As security for PAMCO's guarantee, PAMCO executed a security agreement
in favor of RCH secured by a pledge of the stock of PILIC. This agreement
provides that RCH may foreclose on the stock of PILIC if PAMCO defaults on its
guarantee to RCH. PAMCO provides various affirmative covenants regarding
corporate existence; compliance with laws; furnishing various notices to RCH;
inspection and audit rights and insurance coverage. Additionally, PAMCO provides
certain negative covenants with regard to selling, assigning, leasing or
otherwise disposing of PAMCO or PILIC assets; entering into agreements
materially and adversely effecting PAMCO's or PILIC's ability to carry on
business; entering into an agreement materially and adversely effecting PAMCO or
PILIC ability to perform obligations under the agreements with RCH and CRLC.
There also exist various provisions regarding PAMCO or PILIC incurring or
creating indebtedness or declaring dividends. There can be no assurance that RCH
will earn future profits from the ceded inforce business or that the PAMCO will
have sufficient funds in the future to satisfy PAMCO's guarantee to RCH.
20
Year 2000 compliance: Year 2000 issues are the result of computer
programs being written using two digits rather than four to define the
applicable year. In other words, date-sensitive software may recognize a date
using "00" as the year 1900 rather than the Year 2000. This could result in
system failures or miscalculations causing disruptions in operations, including,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
The Company utilizes various computer software programs, operating
systems and vendors whose software programs and communication links ("Computer
Systems") are used in the Company's insurance and HealthAxis e-commerce
businesses. For the Company's insurance business these Computer Systems include
health insurance administration provided by HPS, life insurance administration,
health claims discount repricing provided by First Health Group Corporation of
Downers Grove, Illinois ("FHG") along with financial accounting and actuarial
systems. For HealthAxis, these Computer Systems include the www.healthaxis.com
web site, links to AOL along with the AOL online network, HPS, FHG, along with
HealthAxis' data warehouse. In 1999, the Company expects to have links to CNET,
Lycos, and Snap.com, as well as various insurance companies who will offer their
products through the HealthAxis web site ("Carrier Partners"). To the extent
that the Company's Computer Systems contain source codes that are unable to
appropriately interpret the Year 2000 then some level of modification, or even
replacement of such applications may be necessary. The result of these Year 2000
issues may, if not resolved, have a significant negative impact on Company's
business.
The Company has begun an assessment of the Company's Year 2000
readiness and has identified applications owned by the Company, which are not
Year 2000 compliant. Furthermore, the Company believes that the Computer Systems
of many of its vendors or Carrier Partners that provide critical services to the
Company are not currently Year 2000 compliant.
To date, the Company has experienced very few Year 2000 problems, with
those problems centering on life administration processing. The cost of
programming changes as of December 31, 1998 has been less than $20,000. The
Company is in the process of evaluating alternatives to its life administration
Year 2000 issues including the modification of the life administration system at
a cost yet to be estimated or the effective replacement of the system via
outsourcing of the life system at an estimated incremental annual cost of
approximately $300,000 per year and a one time conversion cost of approximately
$300,000. The Company anticipates selecting a Year 2000 plan to address its life
administration Year 2000 issues by the end of the second quarter of 1999. To
date, the Company has replaced its general ledger and accounts payable
accounting systems, which were not Year 2000 compliant, in January 1998 at a
cost of approximately $180,000, which has been capitalized.
21
The Company intends to conduct an analysis to determine whether its
vendors, Carrier Partners and other business partners (in so far as they are
material to the Company's business) have any Year 2000 issues. As part of this
process, the Company intends to request its vendors provide the Company with
information regarding their progress in identifying and addressing their Year
2000 problems. Based on information reported in quarterly SEC filings, AOL and
HPS anticipate being Year 2000 compliant no later than December 31, 1999 and
June 30, 1999, respectively.
To date the Company has eliminated its health administration system via
the Company's outsourcing of its health administration and claims processing to
HPS effective February 1998 and assigned responsibility of the oversight of
HPS's health administration and claims processing along with the Company's
former health agent and underwriting Computer Systems to CRLC effective December
31, 1998.
In the event that the Computer Systems of the Company or any of the
Company's vendors Carrier Partners or other business partners fail or exhibit
significant problems as a result of Year 2000 processing the Company's service
to its customers could be disrupted for a significant amount of time and result
in significant lost income to and possible liability for damages by the Company.
There are risks associated with the Company's Year 2000 exposure
relating to some external vendors with whom the Company depends on material
sales and service processing. Because the Company does not control these vendors
or their resources, the Company can provide no assurance that such vendors will
complete their respective Year 2000 solutions in time for the Company to fully
test system interfaces with them. Although the Company is coordinating its
efforts with vendors to minimize this impact of Year 2000 issues, the Company is
currently unable to predict the extent to which Year 2000 issues will affect its
operations, or the extent to which it would be vulnerable to the failure of its
vendors, Carrier Partners or other business partners to remediate any Year 2000
issues on a timely basis.
The Company has begun the process of developing a contingency plan to
address possible Year 2000 risks to its Computer Systems. There is no assurance
that the Company will successfully implement its contingency plan or make all of
its systems Year 2000 compliant. The Company does not currently have a
contingency plan in place in the event any third party in which it engages in
business is not Year 2000 compliant.
The Company has not yet fully developed a comprehensive contingency
plan addressing situations that may result if the Company is unable to achieve
Year 2000 readiness of its critical operations. Contingency plan development is
in process and the Company expects to finalize its plan during the remainder of
1999. There can be no assurance that the Company will be able to develop a
contingency plan that will adequately address issues that may arise in the year
2000.
Description of the Business and Recent Significant Developments
PAMCO is a Pennsylvania corporation organized in 1982 and regulated as
an insurance holding company by the states in which its wholly owned insurance
subsidiaries are licensed. The operations of PAMCO and its subsidiaries are
principally those of its majority owned subsidiary HealthAxis.com, Inc. and its
insurance operations. PAMCO's insurance operations are currently conducted
through its wholly owned subsidiary, Provident Indemnity Life Insurance Company
and PILIC's subsidiaries which, during 1996 through 1998, were Provident
American Life and Health Insurance Company , Montgomery Management Corporation
and NIA Corporation . During 1998, the Company sold 80% of MMC's outstanding
common stock and on December 31, 1998 sold 100% of the outstanding common stock
of PALHIC and NIA.
22
Revised Strategy and Recent Developments
The Company markets and underwrites medical insurance and life
insurance and derived a majority of its revenue from group association major
medical products sold to individuals. A smaller proportion of revenue is derived
from traditional life (whole life and limited pay) products. During 1998 the
Company revised its business strategy to focus predominately on HealthAxis, the
Company's E-Commerce subsidiary along with more focused strategy for PILIC. The
following are financial highlights for the Company:
(Dollars in thousands)
1998 1997 1996
---- ---- ----
Gross premiums $ 119,533 $ 97,267 $ 68,503
Total revenue $ 77,499 $ 62,030 $ 74,147
Net income (loss) $ (12,156) $ (18,425) $ 16,120
Total assets $ 116,689 $ 98,365 $ 93,054
Total revenue for each year was net of premium ceded to reinsurers.
Gross premium growth was the result of sales from The Provident Solution and
HealthQuest managed care products. The net loss in 1998 and 1997 was
attributable primarily to higher group medical policy benefits. The net loss in
1998 was also impacted by $4.9 million of expenses related to HealthAxis while
1997's net loss was also impacted by the write off of deferred acquisition
costs, impairment of certain assets, and transition costs associated with HPS.
Total revenues and net income in 1996 included a litigation settlement of $22.4
million.
In early 1998 the Company determined that the Internet provided the
opportunity to sell medical insurance direct to the consumer thereby reaching
individuals under-served by insurance agents at a cost potentially lower than
the Company's current traditional agency marketing channel. During 1998 the
Company entered into various agreements in order to sell and service insurance
business via the Internet. During 1998 the Company formed a new subsidiary,
HealthAxis.com, Inc. to conduct this new venture. HealthAxis is not licensed as
an insurance company but rather an Internet-based distributor of health
insurance products. As of February 1, 1998 (as amended November 18, 1998) the
Company entered into an Amended and Restated Interactive Marketing Agreement
with AOL. HealthAxis is AOL's exclusive third-party direct marketer for health
insurance products along with vision, dental, prescription, critical care
insurance and long-term care insurance coverage for individuals and groups of
less than fifty individuals in the United States. HealthAxis is advertising
these products to AOL subscribers on AOL's online network under the
HealthAxis.com brand name. HealthAxis markets medical insurance products
underwritten by PALHIC and plans to market medical and related insurance
products underwritten by other companies. In June 1998 HealthAxis entered into
promotional agreements with CNet, Inc. and Lycos, Inc. whereby CNet and Lycos
will exclusively promote HealthAxis' health insurance and other related products
on CNet's and Lycos' web sites. HealthAxis' strategy is discussed later in
greater detail. Advertising has begun in a limited fashion on the Lycos network
of web sites.
23
In light of the continued losses experienced in the Company's group
medical products and the need to devote capital and focus to HealthAxis, the
Company entered into various agreements to sell PILIC's subsidiaries MMC, PALHIC
and NIA and cede 100% of the group medical and group life business during 1998.
In February 1998 the Company sold for $4 million, 49% of Montgomery
Management Corporation Common Stock along with a warrant to purchase an
additional 31% of MMC's Common Stock for one dollar. During the fourth quarter
of 1998 the buyer exercised the warrant to purchase the additional 31% of MMC's
Common Stock for $8,000. The Company recognized an approximate $4 million
pre-tax gain on the sale of MMC and no longer includes MMC in the Company's
consolidated financial statements. PILIC continues to assume via reinsurance
approximately 30% of the premiums, benefits and expenses of the stop-loss
business administered by MMC and receives 20% of MMC's net income in the form of
dividends.
On December 31, 1998 PILIC reinsured 100% of its group medical and
group life inforce business and sold the Company's group medical marketing,
sales distribution rights and PALHIC to CRLC. The Company's expectation is that
these transactions should provide PILIC the necessary statutory basis capital to
pursue its more focused strategy discussed later in greater detail. See "Revised
Strategy for Insurance Operations".
On December 31, 1998 the Company executed a series of transactions
whereby PALHIC reinsured 100% of its business to PILIC, which in turn reinsured
via a 100% quota share reinsurance agreement all of the Company's group medical
and group life business to RCH. In addition PILIC sold PALHIC and NIA to CRLC
for $5.6 million which approximates PALHIC's capital and surplus. The Company
also transferred all rights and control regarding the Company's agents and
entered into non-compete and non-solicitation agreements regarding the Company's
agents with respect to the future sale of health insurance products by agents
for a 3-year period ending December 31, 2001. The Company received regulatory
approval for these transactions for statutory purposes.
24
The $10 million ceding commission paid from CRLC to PILIC consisted of
a $5 million non-refundable payment plus a $5 million contingent payment,
whereby PAMCO guarantees that CRLC will earn at least $10 million in future
profits from the purchased inforce business, plus 12% interest on $10 million
and other amounts due. If at the end of 5 years CRLC fails to earn the
guaranteed amount, PAMCO must repay CRLC the lesser of the guaranteed amount
less CRLC's actual profits on the inforce business, or $5 million plus 12%
interest on $5 million and other amounts due. As security for PAMCO's guarantee,
PAMCO executed a Guarantee Agreement and Stock Pledge Agreement in favor of RCH
and CRLC which allows CRLC and RCH to take ownership of PILIC if PAMCO defaults
on its guarantee to CRLC. The Guarantee Agreement and Stock Pledge Agreement
prevent PAMCO from selling PILIC or entering into agreements that may cause it
to sell PILIC in the future. Furthermore these agreements prevent PAMCO from
paying dividends, incurring debt, making loans and from selling substantially
all of PILIC's assets without CRLC and RCH's approval. The terms and
restrictions contained in the agreements do not involve HealthAxis. If CRLC's
future profits exceed the guaranteed amount PILIC would be entitled to receive
an additional payment from CRLC equal to the lesser of CRLC's future profits
less the guaranteed amount, or 2/3 of the policy fees collected during 1999 and
1/3 of the policy fees collected during 2000.
HealthAxis Strategy, Description of Business and Operations
HealthAxis is in the electronic health insurance distribution business
serving the health insurance needs of the individual and small group markets.
HealthAxis also seeks to utilize its exclusive distribution agreements with AOL,
Lycos and CNet, to create a distinct branded identity for its online health
insurance "store." HealthAxis provides around-the-clock, online access to health
insurance products. By selling directly to consumers via the Internet,
HealthAxis is attempting to reduce the cost of product distribution by
circumventing the traditional sales agent. The Company augments its online
presence with telephone-based customer support from a toll-free service center
("Customer Call Center") where seven (7) days a week customer service
representatives are available to answer questions pertaining to the product and
provide technical assistance in navigating the web site and operating a web
browser. After the sale, the HealthAxis Web site functions as the primary point
of interaction between the policyholders and their policy information. Thus,
customers purchasing insurance products through the HealthAxis web site are able
to purchase directly from the distributor, share in substantial savings and have
access to a variety of policyholder policy information. The Company believes
that the services provided by HealthAxis represent a complete end-to-end
personalized solution to an individual's health insurance needs.
The Company believes that the health insurance industry is uniquely
suited for online retailing. HealthAxis had no financial activity prior to 1998.
HealthAxis' financial impact on the Company in 1998 was a net loss of $4,790,
from inception (March 26, 1998) to December 31, 1998, and total assets of
$14,969 as of December 31, 1998.
25
The traditional insurance distribution system involves multiple tiers
of sales agents, each adding incremental cost to the product, with the ultimate
result being a health insurance product heavily burdened by significant
distribution related costs. The Company believes the insurance agents' total
cost typically represents approximately 20% of the premiums over the life of a
health insurance product, the second largest component of the insurance
carrier's cost structure. The Company believes this cost burden offers
HealthAxis a substantial disintermediation opportunity, especially in the market
place for individual and small group insurance. The Company estimates this
market represents over $74 billion in aggregate annual premiums. HealthAxis
expects to earn additional revenues through sales of ancillary products such as
prescription, vision, dental, critical care, long-term care, long term
disability and life insurance policies.
The Company believes that a large portion of the uninsured population
has elected to forego or remain unisured with health insurance coverage due to
the cost of the product. The ability of the Company to reduce health insurance
costs through re-structuring of the distribution process is expected to expand
the marketplace for the Company's insurance products to include these presently
uninsured individuals.
HealthAxis utilizes a direct selling model to complete sales and
process transactions electronically via the Internet.
HealthAxis is not an insurance quoting service; rather HealthAxis
enables the customer to complete the entire insurance purchase transaction in an
online environment. The prospective purchaser is able to research products,
receive price quotations, complete applications, request customer service and
purchase a policy online.
Since its inception, HealthAxis has incurred significant costs to
develop and enhance its technology, to create its web site and to establish
Internet marketing, insurance carrier, and claims administration relationships.
HealthAxis began delivering preliminary online services in December 1998 when it
initiated a "soft launch" of its web site. As part of the "soft launch",
individual health insurance products of PALHIC, formerly a subsidiary of the
Company, were offered for sale on the web site in 19 states.
During 1998, HealthAxis entered into various strategic alliances with
Internet companies such as AOL, Lycos and CNet, in order to establish channels
for its sale of insurance policies via the Internet. HealthAxis also seeks to
form and has formed alliances with insurance carriers committed to utilizing the
Internet as a distribution channel for the sale of their insurance products. To
date, HealthAxis has entered into distribution relationships with several
insurance carriers, including CRLC, Fortis Insurance Company ("Fortis"),
Security Life Insurance Company of America ("SLICOA"), Ameritas Life Insurance
Corporation ("ALIC") and United Insurance Companies, Inc. ("UICI"). HealthAxis
seeks to continue to expand its product portfolio in geographic scope and
product offerings.
26
HealthAxis will also manage the entire process of bringing Carrier
Partners online. Through HealthAxis' strategic partner, HPS, HealthAxis will
have the ability to offer new Carrier Partners claims processing services. In
many cases, Carrier Partners may prefer to handle their own claims
administration. In this event, the HealthAxis technology team will assist the
Carrier Partner in writing the appropriate system interfaces. In either case,
HealthAxis will provide a totally automated back-end solution for Internet-based
insurance products. Accordingly, the Carrier Partner can focus primarily on
underwriting the risk while HealthAxis will manage and assist in the resolution
of many other technological issues. Namely, HealthAxis will assist in the
process of writing proprietary software to interface between the Carrier
Partner's legacy systems, and the HealthAxis web environment. It is intended
that this software will provide a seamless connection whereby pertinent
information downloaded and uploaded from each of the Carrier Partners will be
accessible through the HealthAxis web site.
Competition
Overview: HealthAxis competes with other insurance online providers and
traditional, agent-based insurance distribution system participants. The online
commerce market is new, rapidly evolving and intensely competitive. It is
anticipated that online commerce competition will continue to intensify in the
future. Barriers to entry are limited, and current and new competitors can
launch web sites at a relatively low cost. Although HealthAxis believes it is
the first direct transaction-enabled distributor of health insurance via the
Internet capable of accepting online applications and online claims processing
and information, it expects that others may attempt to provide similar services
in the future, many of whom may have greater resources than HealthAxis.
Online Insurance Competition: HealthAxis' principal online competitors
provide information on various types of insurance providers, an agent referral
and offer rates or price quotes via the Internet. These multi-category insurance
providers do not presently focus on the health category and have business
models, which are agent-referral driven. By contrast, HealthAxis provides a
transaction-based model that intentionally avoids agent referrals in order to
deliver its products to consumers at reduced costs.
Traditional Competitors: HealthAxis competes with some of the largest
financial services companies in the world as well as independent insurance
agents and brokers. Most of HealthAxis' potential competitors, both online and
traditional insurance companies selling insurance products over the Internet,
have longer operating histories, significantly greater financial, marketing and
other resources, greater name recognition and significantly larger customer
bases than the Company. These competitors may be able to respond more quickly to
changes in customer preferences and devote greater resources to the development,
promotion and sales of their products and claims processing services than the
Company. Most health insurance carriers of significance maintain their own web
site; however, these sites exist chiefly to focus business to the traditional,
agent-based system.
27
The Company believes that the principal competitive factors in the
online insurance market will be price and convenience as well as name
recognition and reputation, product selection, Internet access to claims
information, ease of use, site content, quality of claims processing services
and technical experience. The Company also believes that it possesses a
competitive advantage in the distribution and pricing areas of health insurance
sales. Since large traditional insurance providers rely heavily on revenues
generated from policy sales derived from their agent distribution network, the
Company believes such insurers may be reluctant to sell their products directly
to the consumer and risk disenfranchising their lucrative agent distribution
systems. As a result, the Company believes that the large carriers are unlikely
to enter the market as direct competitors in the online distribution of
insurance products. An intermediary, like HealthAxis, represents a less
controversial online distribution vehicle than does direct self-distribution by
the large carriers, who also lack the selection planned by HealthAxis. See "Risk
Factors - Competition."
Regulation
Internet Related: Although there are currently few laws and regulations
directly applicable to the Internet, it is likely that new laws and regulations
will be adopted in the United States and elsewhere covering issues such as
copyrights, privacy, pricing, sales taxes and characteristics and quality of
Internet services. The adoption of restrictive laws or regulations could slow
Internet growth or expose the Company to significant liabilities associated with
content available on its web sites. The application of existing laws and
regulations governing Internet issues such as property ownership, libel and
personal privacy is also subject to substantial uncertainty at this time. There
can be no assurance that current or new government laws and regulations, or the
application of existing laws and regulations (including laws and regulations
governing issues such as property ownership, content, taxation, defamation and
personal injury), will not expose the Company to significant liabilities,
significantly slow Internet growth or otherwise cause a material adverse effect
on the Company.
Insurance Related: As a result of the business activities presently
being conducted by the Company, the Company has organized HealthAxis Insurance
Services, Inc., a Pennsylvania corporation, which has also organized subsidiary
companies in four states (the "HealthAxis Agency"), the purpose of which is to
cause the HealthAxis Agency to become licensed with state insurance departments
to sell insurance and receive commissions from the sale of insurance. HealthAxis
Agency has filed or is in the process of filing for licenses in all 50 states.
As a licensed agency, HealthAxis Agency will be subject to the supervision
regulation and examination by the insurance departments or commissions in the
states in which HealthAxis Agency is licensed. The Company, either directly, or
through wholly-owned subsidiaries doing business in certain states, is subject
to the laws and regulations of such insurance departments or commissions which
laws and regulations are primarily intended to benefit purchasers of insurance
and generally grant supervisory agencies broad administrative powers, including
the power to restrict the carrying on of business for failure to comply with
such laws and regulations. In such event, the possible sanctions which may be
imposed include the suspension of licenses to sell insurance, limitations on
engaging in business for specific periods, censures and fines. Advertisements in
connection with insurance products sold through HealthAxis' web site are
pre-approved by the state insurance departments and commissions by the
applicable insurer sponsoring the particular product. See "Risk Factors -
Insurance Industry Factors" and "Government Regulation and Legal Uncertainty."
28
HealthAxis Web Site and Operations
General: The HealthAxis web site provides a fully transactional
platform for the sale of health insurance over the Internet. The HealthAxis web
site guides a consumer through every step in the health insurance purchase
process from education and price quotation through enrollment and post sale
service. The Company believes that no other insurance web site currently has the
breadth of functionality - covering all pre- and post-sale activities.
Quoting Process: The HealthAxis' price quotation service is offered
through a user friendly quoting tool called "ClickQuoteTM". With the entry of
minimal information, the customer is able to obtain an accurate price quote in
as little as thirty seconds, depending on connection speeds. The quote is
customizable by the change of the claims deductible, which the consumer can
adjust using a single mouse click. If so inclined, the consumer can proceed
directly from the ClickQuoteTM to an application to purchase the desired policy.
Upon the addition of multiple carriers to the HealthAxis web site, customers
will be prompted to select from among competing brands and/or plan types. Users
can also use the ClickQuoteTM as a launch point from which to discover more
information about the products available on HealthAxis.
Enrollment Process: HealthAxis believes that it can significantly
enhance the ease of enrollment, traditionally the most onerous task in the
insurance purchasing process. HealthAxis believes it has created several
features that will make the application process as simple to use as possible.
First, HealthAxis' enrollment forms come with extensive, context-sensitive
"help" modules to assist consumers in understanding the application questions.
HealthAxis also provides a progress bar which allows consumers to monitor their
progress through the application. HealthAxis believes this kind of tool helps
manage expectations and reduces the application abandonment rate. Also,
HealthAxis' unique `save application' feature allows consumers to "save" their
work without losing the information already provided. Saved applications reside
in a password protected personal space which only the specific user can access.
Users are able to return to their saved applications at any time to finish their
work and subsequently submit their enrollment information. Upon completion of
the enrollment forms, a consumer simply clicks the "send" button to submit the
application to HealthAxis. Certain Carrier Partners, at their own discretion,
may charge application fees which will be assessed by way of electronic funds
transfer, credit card or check.
29
Customer Call Center: HealthAxis provides a toll free telephone
Customer Call Center to aid customers in the purchase of health insurance via
the HealthAxis web site. HealthAxis' Customer Service Representatives are
on-site, seven days a week, at the Customer Call Center located at the Company's
Norristown headquarters. Many of the Customer Service Representatives are
licensed insurance agents and all are versed in the products sold on the web
site. Customer Service Representatives answer questions pertaining to product
information, corporate information, as well as technical assistance regarding
the web site and operating a web browser. HealthAxis currently employs 16
Customer Service Representatives and intends to increase the number of Customer
Service Representatives as web site traffic requires increases. The Customer
Call Center will also have product specialists who will handle more detailed
questions regarding the products offered. These product specialists will be
expensed to the Carrier Partner whose product they represent.
Underwriting Process: Applications submitted are electronically
transmitted to HPS, the third party administrator currently used by HealthAxis
for all PALHIC products, or to another third party processor designated by the
Carrier Partner. Professional underwriters review submitted applications to
determine if additional information is required. In the event additional
information is required, an underwriter will contact the applicant and request
further information. If medical records are required, the applicant can download
an authorization form from the web site, sign it, and send it in to HPS or
another administrator designated by the Carrier Partner. If the application is
complete, the underwriting determination shall be made by HPS using the
pre-established criteria agreed upon by HPS and the Carrier Partner. Carrier
Partners will have the option of using their existing underwriting and
processing operations or appointing HPS or another third-party administrator to
handle the transaction. Management believes that HealthAxis' ability to sell and
service policies is not impaired by a Carrier Partner's selection of an
underwriter/administrator. Each Carrier Partner will be able to adhere to its
own underwriting procedures and standards.
Policy Issuance Process: Once a policy is underwritten, the new
HealthAxis policyholder is mailed a plastic identification card with an
accompanying welcome letter. The letter directs the policyholder to his or her
HealthAxis personal space where HealthAxis has deposited an electronic copy of
the policy certificate.
Customer Inquiry Process: HealthAxis provides its customers with a
robust, online customer service facility. Customers have access to their policy
information, billing data, claims history and claims status reports. These
records are viewable on www.healthaxis.com via the customer's personal space.
All records are kept in a fully secure, online environment.
HealthAxis believes that empowering customers with the ability to
self-service administrative issues provides a cost savings to the delivery of
the post-sale insurance services and improves customers' access to their own
personal data. Under the traditional agent-based system, the customer would be
required to call either the agent who sold the product or the underwriter's
customer service center. HealthAxis' 24 hour a day, seven-day a week online
access provides convenient and immediate access for HealthAxis customers
relative to the availability of either underwriter call centers or insurance
agents. Further, a customer can review his or her policy information in a
private environment, without having to engage in conversation with either an
underwriter's customer service representative or the local insurance agent.
30
Policy Maintenance Process: HealthAxis provides customers with the
ability to modify personal data such as address, phone numbers, billing
preferences and other information. This tool further empowers the customer with
the ability to manage his or her insurance relationship. Policy maintenance is
another example of HealthAxis' ability to utilize the functionality of the
Internet to lower the cost of selling and servicing health insurance.
Billing Process: Customers can select from multiple payment methods
including credit card or an automatic debit from their checking account. The
traditional "direct bill" (personal check every month) will be available in the
future. The web site is fully enabled to process both credit card and monthly
debit transactions.
Sales and Marketing
Insurance Product Offerings: HealthAxis' mission is to offer consumers
a select list of affordable insurance products from trusted, reputable vendors
which meet HealthAxis' value criteria. These specific product offerings will
vary by state based on the availability of product supply, which is generally
dictated by the state regulatory environment. The HealthAxis web site utilizes
customer zip code information to determine which set of products to offer to a
given customer. HealthAxis intends to offer a selection of products supplied by
leading insurance carriers. HealthAxis currently offers products of PALHIC and
has entered into Carrier Partners agreements with CRLC, Fortis, SLICOA, ALIC and
UICI to offer their insurance products online in the future. HealthAxis is
committed to offering its customers a choice of products in order to position
HealthAxis as a "trusted advisor" rather than a salesperson for a particular
product.
Product Portfolio: Currently HealthAxis offers the individual health
insurance underwritten by PALHIC through its web site. Following the addition of
additional carrier partner products, HealthAxis' insurance product portfolio
expects to include the following:
Individual Health Critical Care College Student Health
Small Group Health Long Term Disability Senior Health
Prescription Long Term Care Senior Life
Vision Life
Dental Short Term Health
As HealthAxis increases its product mix, HealthAxis will seek to take
advantage of cross-selling opportunities for companion products. Although, these
policies are relatively inexpensive, they are important additions to general
health coverage. HealthAxis also intends to utilize its data warehouse to
identify these customer cross-sale opportunities.
31
General Marketing Strategy: HealthAxis' marketing strategy is designed
to promote awareness of the HealthAxis name, increase customer traffic to the
web site, encourage purchases of HealthAxis' insurance products over the
Internet, build customer loyalty through efficient claims processing and the
availability of access to claims related and other information over the
Internet, and maximize annual renewals. Commencing in the second quarter of
1999, HealthAxis intends to employ a combination of online and off-line
advertising and promotion campaigns to stimulate web site traffic and increase
its brand name recognition. The marketing efforts will also educate consumers as
to the opportunity offered by online insurance purchasing, promote HealthAxis'
brand name, and reduce its reliance on any one source of consumer traffic.
Web Site Promotion and Strategic Alliances: HealthAxis' core
promotional strategy involves the development of exclusive distribution
relationships with major Internet gateways. HealthAxis' principal Distribution
Partners are AOL, CNet, and Lycos. The Company expects these strategic
relationships to raise brand awareness and to provide access to millions of
online users. Based upon International Data Corp's ("IDC") estimate of 65
million U.S. Internet users, HealthAxis' relationship with AOL, alone, provides
the Company with access to over 13.5 million members, representing approximately
20% of all U.S. Internet users.
Use of Related Online Channels: HealthAxis Distribution Partners are
expected to add value to HealthAxis not just by the placement of banners and
buttons, but by building information-rich environments attractive to HealthAxis'
potential customer base. As these online services increasingly enhance their
"insurance centers" and related product offerings, the Company believes overall
customer traffic to HealthAxis should increase. The Company intends to
prominently place itself not just in "insurance centers," but across multiple
Internet channels to enhance the likelihood of attracting potential customer
interest. Examples of such non-insurance channels may include, but are not
limited to, health, money and business and shopping.
Online and Offline Marketing: HealthAxis marketing efforts will extend
beyond the confines of its marketing arrangements with its Distribution
Partners. HealthAxis intends to execute a variety of incremental media purchases
both on the web and in traditional advertising mediums such as direct mail,
radio, print and billboards. On the World Wide Web, HealthAxis plans to drive
traffic to its site by buying spot media space both on additional portals and
web sites that target the Company's core audience. The combination of exclusive
distribution relationships and spot media purchases across multiple advertising
mediums is intended to stimulate HealthAxis traffic and enhance the brand
awareness among the target customer market.
32
Online Demographics: The demographics of the Company's potential
customers are closely aligned with those of the online community. Generally,
Internet subscribers are (i) predominately younger than the average for the
general population; (ii) have higher household incomes than the national
average; (iii) obtain higher educational levels than the national average; and
(iv) include a high proportion of self-employed, small office and home office
individuals. Based upon statistical information provided by AOL, the average AOL
subscriber is 37 years old, has a household income of $60,000 or greater, has a
college education and is self-employed.
Target Marketing Strategy: The primary target markets are the small
group and the individual market. Within the individual market, the targeted
customers are individuals who are not covered by a corporate sponsored health
plan. Potential individual customers include (but are not limited to) people who
are self-employed, part-time employees or full-time independent contractors or
other individuals who are not covered by a corporate sponsored health plan.
Initially within the small group market, the Company intends to focus its
marketing efforts on groups of four or less, including small office and home
office-based individuals. The Company believes its combination of cost advantage
and customer-centric shopping environment will prove a compelling proposition
for its targeted customer segments.
The small office/home office community is a highly attractive market to
HealthAxis. HealthAxis expects to exploit this market with both its individual
and small group products. The cost savings resulting from buying direct can be
substantial when experienced by multiple employees, even for very small groups.
HealthAxis expects the average size of a group sale to increase over time.
Product Pricing: HealthAxis believes that pricing will represent its
single most important competitive advantage relative to the competing health
insurance distribution channels. Offering product to consumers via the Internet
will allow the Company to re-engineer a multi-layered distribution system that
has historically added significant cost to the typical health insurance product.
Depending on the policy, consumers may enjoy savings of up to 15% as compared to
product offered through the traditional insurance distribution system. The
Company plans to continually monitor its price competitiveness across the
country. HealthAxis evaluates pricing environments on a zip code by zip code
basis, to ensure the competitiveness of its products. HealthAxis plans to strive
to be a cost leader at any given level of plan benefits in the markets in which
it participates.
Life Cycle Marketing: The Company's market research indicates that the
purchase of health insurance is generally associated with a variety of
identifiable life events. These events represent situations in which a potential
customer may recognize a heightened need for insurance and include, among other
things, loss of job, new job, graduation from college, marriage, birth of a
child, divorce, relocation, starting a new business and discontinuing operations
of an existing business. These life events generally result in the destruction
of existing health care relationships and require the establishment of new ones.
Identifying these events and targeting individuals experiencing such events are
important elements of the Company's marketing strategy.
Direct Marketing: HealthAxis plans to use direct marketing techniques
to target new and existing customers with promotions. HealthAxis plans to send
e-mail letters to potential customers highlighting HealthAxis products and the
advantages of Internet based insurance product purchases. The Company's
agreement with AOL gives HealthAxis the right to send a mailing to AOL's
customer base. The Internet allows rapid and effective experimentation and
analysis, instant user feedback and efficient personalization of insurance
products for each customer, all of which the Company seeks to incorporate in its
marketing activities. Direct e-mail to HealthAxis customers also will be an
important driver of the Company's cross-selling efforts. HealthAxis' customer
relationship will allow the Company to target existing customers with offers for
related, ancillary health care insurance products. For example, following the
customer's initial purchase of an individual health insurance policy, the
Company might send that Customer an e-mail introducing a long-term disability
product.
33
Intellectual Property and Technology
Patent, Trademark and Copyright Protection: The Company's ability to
compete is dependent to a significant degree upon its proprietary systems,
technology, and intellectual property. The Company relies upon a combination of
trademark, copyright, confidentiality agreements and trade secret laws as well
as other measures to protect its proprietary rights. The Company does not have
any patents or patent applications and currently does not plan to file any
patent applications. The Company has registered the names "HealthAxis.com" with
Internic, a private corporation organized by U.S. government which administers
Internet domain names. The Company has applied for registration of the
trademarks "HealthAxis.com" and "ClickQuote" with the United States Patent and
Trademark Office. The Company has determined not to file registrations for these
marks in foreign countries at this time. The Company's sales materials, content
and software is protected by copyright. The Company intends to take the
additional step of registering these copyrights with the United States Copyright
Office.
Third Party Technology, Web Site Ownership And Maintenance: The Company
also relies on a variety of technology that it licenses from third parties,
including its database and Internet server software, which is used in
HealthAxis' web site to perform key functions. The Company's technology is
centered around its interactive web site "www.healthaxis.com" which was
constructed by Vivid Studios, a division of Platinum Technology, Inc. of San
Francisco, CA. The Company considers all of the content contained in its web
site and much of the software contained in the web site to be proprietary and
has negotiated confidentiality and non-compete provisions with Vivid Studios.
Vivid Studios granted the Company sole ownership of all content developed by
Vivid Studios that is contained in its web site. The Company intends to continue
to use Vivid Studios to provide maintenance to its web site, but in the event
the Company opts to perform such services itself or through another contractor,
the Company has obtained a perpetual license to all source code and other
proprietary materials required for it to maintain and enhance its web site. The
Company anticipates updating its web site on an ongoing basis. See "Risk Factors
- - - Dependence on Third Party Technology."
34
Web Site Technology. The technology supporting the web site itself
consists of a scalable client/server architecture in a fully load balanced
environment using redundant Sun Enterprises servers. The Company's applications
are specifically designed for the web site and are written in the programming
language Java under a Sun Enterprises implementation of the Unix operating
system. The Company uses RAID technology to provide a greater degree of
reliability for data contained in its Oracle 8 based database. The host for the
web site is Best Communications, located in San Francisco, California. The
infrastructure, web applications software and the web servers are owned by the
Company. The Company continually monitors web site statistics, network
performance and service levels using CA unicenters from Computer Associates.
Back End Processing Technology: Underwriting, policy administration and
claims systems will be neither processed by the Company nor its web site, but
instead by HPS at a site in Tampa, Florida or at sites maintained by Carrier
Partners. HPS` Tampa site consists of large IBM mainframe systems running CICS.
For PALHIC product currently on the web site, the provider network information
is operated by another third party, FHG. Both HPS and FHG own the strategic
software applications which they operate on their own systems in secure,
environmentally controlled rooms twenty-four hours per day. Additionally, the
Company has created an executive information system operating in an Oracle 8
environment under an HP 9000 computer running Unix. The Company's systems have
back up and disaster recovery programs in place. The Company uses multiple web
servers within a single site but plans to distribute its servers to multiple
sites for greater redundancy.
On May 29, 1998, HealthAxis, PAMCO, and Provident Health Services, inc.
("PHS"), a subsidiary of Provident, entered into an Internet claims
administration agreement with HPS (the "E-Commerce Agreement"). The E-Commerce
Agreement provides HPS with the right to be the exclusive administrator of all
insurance business sold over HealthAxis' web site and any other form of
electronic commerce ("e-commerce") used by HealthAxis to sell insurance which is
underwritten by PILIC and PALHIC during the term of the E-Commerce Agreement.
HealthAxis also agreed to use its best efforts to provide HPS with the right of
first refusal to provide claims administration services for insurance business
sold by HealthAxis but not underwritten by PILIC and PALHIC that may require the
services of a third party administrator.
HPS has advised HealthAxis and the Company that certain actions taken
by HealthAxis are inconsistent with HealthAxis' obligations under certain
agreements between the parties. HealthAxis and the Company disagree with the
position adopted by HPS.
Communications: All of the above installations are interconnected using
high-speed private telecommunications links. All transmissions between the
consumer, web site, and HPS are secured using "Secured Socket Layer" (SSL
version 3). Domestic encryption is used where applicable (i.e., 128 bit)
including all server to server communications. A minimum export encryption is
also used (i.e., 40 bit).
35
Revised Strategy for Insurance Operations
The Company's Insurance Operations market and underwrite medical
insurance and life insurance and derived a majority of its revenue from group
association major medical products sold to individuals. Recent significant
developments for the Company's Insurance Operations were:
o The sale of an 80% interest in MMC at a gain of $4 million. See Revised
Strategy and Business Components for the net profit and loss impact table.
o The Company sold its group medical products through its agency marketing
channel effective January 1, 1999. The Company transferred all rights and
control regarding the Company's agents and entered into non-compete and
non-solicitation agreements regarding the Company's agents with respect to
the future sale of health insurance products by agents for a 3-year
period.
o The cession via a 100% co-insurance reinsurance agreement of all of the
Company's group medical and group life business to RCH for a $10 million
ceding commission. See Revised Strategy and Business Components for the
net profit and loss impact table.
o The sale of PALHIC and NIA to CRLC for PALHIC's statutory basis capital
and surplus. See Revised Strategy and Business Components for the net
profit and loss impact table.
As a result, the Company is focusing on its military life business and
its Internet distribution of insurance products.
Highly Competitive Nature of the Insurance Industry
The Company operates in a competitive industry with regard to products,
prices and services. Many competitors have considerably greater financial
resources than the Company. In the United States more than 2,200 life insurance
companies compete for life and health insurance business, and no one company
dominates the marketplace. Most of the Company's direct competitors are small to
medium sized life insurance companies and regional Blue Cross/Blue Shield
organizations. Additionally, competition in the insurance industry may affect
the Company's ability to achieve greater critical mass in its chosen product
lines, while remaining competitive in compensation and product pricing.
36
Product Profile
The following table sets forth the Company's gross earned premium by
product during each of the three years ended December 31:
(Dollars in thousands) 1998 1997 1996
-------- -------- --------
Managed Care:
The Provident Solution $ 37,534 $ 44,204 $ 22,634
HealthQuest 40,019 23,062 6,136
-------- -------- --------
77,553 67,266 28,770
-------- -------- --------
Non-Managed Care:
Small Group 2,795 4,784 7,258
Individual 25,099 12,414 18,463
-------- -------- --------
27,894 17,198 25,721
-------- -------- --------
Group Life 1,772 2,655 2,406
-------- -------- --------
Subtotal (Ceded to RCH) 107,219 87,119 56,897
Excess Loss Insurance 5,279 3,248 2,704
-------- -------- --------
Total Health Products 112,498 90,367 59,601
-------- -------- --------
Individual Life 7,035 6,900 8,902
-------- -------- --------
Gross Premium $119,533 $ 97,267 $ 68,503
======== ======== ========
Health Products: The Company ceded all of its managed care and non
managed care medical insurance business to RCH on December 31, 1998 via a 100%
quota share reinsurance agreement. Effective January 1, 1999 PILIC no longer
sells or directly underwrites group medical products sold either through the
Company's former agency sales force or through HealthAxis. Premium earned
through the excess loss or stop loss business is not affected by the
transactions with CRLC and RCH.
PILIC's managed care comprehensive major medical product designs
incorporate both freedom of choice and financial incentives to utilize network
health care providers. PILIC has a long-term agreement with FHG, the largest
independent PPO in the country. Other regional networks are used if and when the
primary network is not a practicable option. FHG also provides utilization and
cost management services such as pre-certification of hospital admissions and
large case management which, when taken together with the discounts PILIC enjoys
through all of its PPO arrangements, are intended to allow for better control of
claim costs and, ultimately, competitively priced products.
37
The administrative support for all of the Company's medical products,
including billing and collection of premium, claim adjudication, and on-going
policy services are provided by HPS pursuant to the HPS Outsourcing Agreement.
See Insurance Operations - Claims for additional information regarding HPS.
In 1996, PILIC entered into a marketing agreement with the country's
largest third party administrator, HPS. In October 1997, the Company announced
an outsourcing arrangement with HPS, whereby HPS provides administrative support
for all of PILIC's medical products, including billing and collection of
premium, claims adjudication and ongoing policyholder services (the "HPS
Outsourcing Agreement"). The HPS Outsourcing Agreement, which commenced February
1, 1998, is for a five-year term. PILIC has agreed to pay a base monthly fee and
a sliding scale percentage of premiums, which will decrease as the volume of
business increases. The Company transitioned all functions covered by the
outsourcing agreement to HPS effective February 1998. Agreements between the
Company and CRLC call for CRLC to assume responsibility for the HPS Outsourcing
Agreement with the exclusion of the base service fee, loss ratio management fee
and claims changes for claims incurred prior to February, 1998, effective
January 1, 1998. HPS will continue to process the Company's claims incurred on
or before December 31, 1998.
Also see Claims discussed later in Insurance Operations.
PILIC's principal managed care products were "The Provident Solution"
and "HealthQuest" which together offer a variety of deductibles, coinsurance
amounts and managed care options. Minimum amounts of group term life are
required with many of the medical products. "The Provident Solution" relies on
FHG for access to network providers and advantageous fee schedules, while
"HealthQuest" relies on regional PPOs. At December 31, 1998 PILIC had a total of
45,000 in-force group medical certificates compared to 50,000 at December 31,
1997. PILIC has systematically withdrawn from the small group indemnity markets
as healthcare reform at the state level has rendered those products obsolete.
The book of small group indemnity business has been in a runoff mode since 1992
and the Company's individual indemnity products have only generated modest sales
since 1994, when "The Provident Solution" was developed. The following table
illustrates the composition of annualized premium in-force for the last three
years:
(Dollars in thousands) 1998 1997 1996
-------- -------- --------
Managed Care:
The Provident Solution $ 41,867 $ 43,244 $ 33,169
HealthQuest 47,034 34,913 12,718
Non-Managed Care:
Small group 2,188 5,681 7,009
Individual 11,633 12,983 17,797
-------- -------- --------
$102,722 $ 96,821 $ 70,693
======== ======== ========
38
The states which generated the largest share of health premiums during
each of the last three years were as follows:
1998 1997 1996
------ ------ ------
Georgia 28.0 28.7 24.4
Florida 17.6 20.5 21.8
Texas 9.8 6.7 7.5
South Carolina 7.7 4.4 2.6
Louisiana 6.6 8.1 7.3
Colorado 4.5 2.6 .4
Pennsylvania 3.0 6.9 13.2
Ohio 2.7 2.3 2.3
Virginia 2.1 2.1 2.3
West Virginia 1.9 2.2 3.5
All other 16.1 15.5 14.7
------ ------ ------
100.0% 100.0% 100.0%
====== ====== ======
The acquisition of PALHIC in 1996 significantly increased the number of
states within which the Company wrote its insurance business through 1999. As
part of the terms of PILIC's sale of PALHIC to CRLC, PILIC can continue to write
military life business in PALHIC through 1999. Thereafter the Company must
negotiate a new agreement with CRLC or another insurance company to underwrite
military life business in states that PILIC is not licensed. PILIC is licensed
to underwrite life, annuity and health business in the 25 states, the District
of Columbia and the U.S. Virgin Islands.
As part of its health product portfolio, the Company's Insurance
Operations derived premiums (and prior to 1998 both premiums and fees) through
the sale and underwriting of high-deductible medical excess loss insurance
(a.k.a. "stop loss") for self-insured employers. MMC sells and services these
insurance products which are issued by unrelated insurance companies. PILIC
assumes a portion of the insurance risk and earns premiums and prior to 1998
earned profit sharing fees. During the first quarter of 1998 the Company sold
80% of MMC to HPS. The sale resulted in a realized gain of $4 million in the
first quarter of 1998. The Company continues to assume the premium administered
by MMC.
Life Products: PILIC's pre-need insurance products, single premium and
limited payment life insurance, provide funding in conjunction with pre-arranged
funerals. The policies sold average $2,830 of face amount and the buyer's
average age is 72. The Company's "Senior Estate Plan" is a whole life insurance
policy designed for senior citizens who have not yet pre-arranged their
funerals, but wish to plan for death-related expenses. The average policy size
is $5,000 and the buyer's average age is 65.
39
During 1998, PILIC issued 1,013 pre-need and final expense policies
representing approximately $7.9 million of face value, as compared with 1,1347
pre-need and final expense policies representing approximately $8.5 million of
face value during 1997. Combined gross premium income for these two products
approximated $5.2 million in 1998 and $5.8 million in 1997. At December 31,
1998, the Company had 16,328 pre-need and final expense policies in-force with a
face value approximating $94.0 million.
During 1997, the Company expanded its life distribution to include a
newly designed product for the military marketplace.
The Company issued 536 and 2,573 Career Benefits Maximizer ("CBM")
polices in 1997 and 1998, respectively. Premium income from this product
amounted to approximately $55,000 and approximately $559,000 for the years ended
December 31, 1997 and 1998, respectively. At December 31, 1998, there were 1,138
CBM policies inforce representing about $45.1 million of face value.
Insurance Operations
The Company's Insurance Operations are organized and managed along
functional lines which include marketing, underwriting, claims, administration,
investments and finance.
Marketing: The marketing area manages agent recruiting, training and
agent compensation plan design, and provides agents and consumers with a Company
advocate regarding product development and customer service. Effective January
1, 1999 CRLC assumed responsibility and control of the marketing of group
medical business. Sales of the CBM are accomplished through eight (8) regional
vice presidents (RVP) who are responsible for recruiting, training and managing
agents in assigned states throughout the United States. These RVPs utilize their
considerable experience in this market together with the endorsement of the USBA
to reach the target customer.
Underwriting: All policies are fully underwritten. In some cases, PILIC
may require attending physicians' statements with respect to conditions
disclosed on applications. A physician provides consulting services to the
underwriting department with respect to the evaluation of the insurability of
certain applicants and the general health prognosis for such applicants. In
connection with the HPS outsourcing agreement, the underwriting associated with
the HealthQuest products is done by HPS in accordance with pre-set standards and
all other products are underwritten by PILIC's underwriting group. Prior to
1999, essentially all policies were underwritten by PILIC's underwriting group.
Effective January 1, 1999 CRLC assumed responsibility and control of the
underwriting of group medical business. PILIC continues to underwrite Military
life business and under the terms of the agreements with CRLC continues to have
the right to issue business on PALHIC through 1999.
40
Claims: In connection with the HPS outsourcing agreement, claims
adjudication associated with PILIC's health products is provided by HPS. Prior
to 1998 PILIC had augmented its core internal claims processing with the use of
selected third party claims administrators who review and pay claims in
accordance with guidelines and procedures approved and monitored by PILIC. PILIC
anticipates that HPS will continue to process claims on policies directly
underwritten by PILIC. Effective January 1, 1999 CRLC assumed responsibility for
claims incurred after December 31, 1998 and overall responsibility for claims
processing of all of PILIC's claims. PILIC continues to process claims for its
individual life and annuity business.
In 1996, PILIC entered into a marketing agreement with the country's
largest third party administrator, HealthPlan Services, Inc. ("HPS"). In October
1997, the Company announced an outsourcing arrangement with HPS, whereby HPS
provides administrative support for all of PILIC's medical products, including
billing and collection of premium, claims adjudication and ongoing policyholder
services. The HPS Outsourcing Agreement, which commenced February 1, 1998, has
for a five-year term. PILIC has agreed to pay a base monthly fee and a sliding
scale percentage of premiums, which will decrease as the volume of business
increases. The Company transitioned all functions covered by the outsourcing
agreement to HPS effective February 1998. Agreements between the Company and
CRLC call for CRLC to assume responsibility for the HPS Outsourcing Agreement
with the exclusion of the base service fee, loss ratio management fee and claims
changes for claims incurred prior to February, 1998, effective January 1, 1999.
HPS will continue to process the Company's claims incurred on or before December
31, 1998. See "Insurance Operations - Claims" herein for a discussion of certain
disputes between HPS and the Company.
Since the Fall of 1998, a number of disputes have arisen between the
Company and HPS relative to the quality of services provided by HPS pursuant to
the HPS Outsourcing Agreement. The Company has made a claim for indemnification
under the HPS Outsourcing Agreement for losses, costs, claims and damages
incurred which related primarily to the payment of claims by HPS. HPS has
disagreed that it has engaged in any wrongdoing with regard to the performance
of its services and has indicated that it would assert various claims against
the Company. The Company is presently reviewing the matter.
Administration: This area includes customer service, premium and
commission processing and computer systems for life and group medical business
which was acquired in mid 1996. In connection with the HPS outsourcing
agreement, customer service, premium and commission processing associated with
PILIC and PALHIC's health products is provided by HPS. PILIC continues to
administer its individual life and annuity business.
41
Investments and Finance: The majority of PILIC's investments consist of
securities of the U. S. government (or its agencies) and fixed income
securities, principally issued by public utilities and corporations. At December
31, 1998, 100% of the Company's bond portfolio was of investment grade quality;
43% of the Company's bonds will mature within a five-year period and 73% of the
Company's bonds will mature within a ten-year period. The following table shows
the Company's market value of its total investments as of December 31, the
investment income net of expenses which excludes realized gains and losses and
the weighted average annualized yield.
(Dollars in thousands) 1998 1997 1996
---- ---- ----
Total investments, valued at market $ 32,969 $ 47,101 $ 61,942
Net investment income (excludes realized gains) $ 3,764 $ 3,487 $ 3,280
Annualized yield on the market value of investments 6.28% 6.8% 6.5%
The Company utilizes both in-house actuaries and consulting actuaries
for product development, pricing and valuation. Effective January 1, 1999 CRLC
assumed responsibility and control for pricing and development of group medical
and group life business.
Insurance Regulation: The Company's business is subject to a changing
legislative and regulatory environment. Some of the proposed changes include
initiatives to restrict insurance pricing and the application underwriting
standards, reform health care and restrict investment practices. Proposals
relating to national health care reform have been under consideration, and could
significantly change the way health care is financed and provided. The effect on
the Company of comprehensive health care reforms, if enacted, could have a
material adverse impact upon the ability of the Company to achieve profitability
and engage in the writing of health insurance.
All of the states in which PILIC and PALHIC are licensed to do business
have life and health guaranty fund laws under which insurers doing business in
such states can be assessed in order to fund policyholder liabilities of
insurance companies that may become insolvent. Under these laws, an insurer is
subject to assessment, depending upon its market share of a given line of
business, to assist in the payment of policyholder claims against insolvent
insurers. Although recent assessments have not been material, no assurances can
be given that such will be the case in the future.
Insurance companies are subject to supervision and regulation in the
states and jurisdictions in which they transact business, and such supervision
and regulation usually includes (1) regulating premium rates, policy forms
(coverages and terms), (2) setting minimum capital and surplus requirements, (3)
imposing guaranty fund assessments which fund insolvencies of other insurers (4)
licensing insurance companies and agents, (5) approving accounting methods and
methods of setting loss and loss-adjusted expense ("LAE") liabilities, (6)
setting requirements and limiting investments, establishing requirements for
filing of annual statements and other financial reports, (7) approving changes
in control, (8) limiting dividend payments that may be made without regulatory
approval, (9) regulating transactions with affiliated parties and (10)
regulating trade practices and market conduct. Compliance creates additional
expense and penalties may be imposed for non-compliance, which could have a
material adverse effect on the Company's business financial position and results
of operations.
42
PILIC is domiciled in Pennsylvania and is regulated by the Insurance
Department of Pennsylvania which recognizes as net income and surplus those
amounts determined in conformity with statutory accounting practices prescribed
or permitted by the Department which may differ in certain respects from
generally accepted accounting principles. The amounts of statutory net income
for the year ended and surplus as of December 31 were as follows:
1998 1997 1996
---- ---- ----
Unaudited (3)
PILIC (1)
Net income (loss) (5,671) $(10,385) $ 9,668
Total capital and surplus 4,807 11,408 13,971
Adjusted capital and surplus 5,281 11,968 14,838
Company action level Risk Based Capital 6,938 9,303 6,569
PALHIC (2)
Net income (loss) $ (1,097) $ (862) $ 1,631
Total capital and surplus N/A 4,283 5,351
Adjusted capital and surplus N/A 4,302 5,367
Company action level Risk Based Capital N/A 1,730 19
(1) PILIC's total capital and surplus, adjusted capital and surplus and company
action level Risk Based Capital include amounts for its subsidiaries
including PALHIC. PALHIC is not included in 1998.
(2) PALHIC includes amounts prior to its acquisition by the Company.
(3) The amounts reflect amounts reported to the State Insurance Departments and
have not yet been audited by Certified Public Accountants. Such amounts may
be adjusted and such amounts may be material.
43
At December 31, 1998, PILIC calculated its "Risk Based Capital" (RBC)
utilizing a formula required by the National Association of Insurance
Commissioners. The results of this computation shown in the above table indicate
that PILIC's adjusted capital of $5.3 million exceeded Regulatory Action Level
but was below Company Action Level. PILIC's year end 1998 RBC calculation
included approximately $4.8 million of RBC related to PILIC's one life group
health and group life business 100% ceded to RCH effective after December 31,
1998. The RBC formula estimates RBC based on a variety of historical data
including 1998 net earned premium. The effects of the reinsurance agreement
between PILIC and RCH on PILIC's RBC calculation will not be realized until
1999. Since PILIC failed to meet its RBC requirement as of December 31, 1998 it
may be subject to regulatory action. Insurers failing to meet their RBC
requirement may be subject to scrutiny by its domiciled insurance department and
other insurance departments, which the insurer does business in, and,
ultimately, rehabilitation or liquidation.
Number of Employees
The Company, including its subsidiaries, currently employs
approximately 124 people of which 27 are employed by HealthAxis and 97 are
employed by PILIC. As a result of the transactions with CRLC, PILIC leases 62 of
the 97 people to CRLC. The leased employees continue to support the group
medical business and are facilitating the transition of this business to CRLC.
PILIC's employee leasing will terminate no later than July 1, 1999 at which time
all leased employees will cease to be employed by PILIC. None of the employees
is represented by a collective bargaining representative. The Company believes
that its employee relations are good.
Item 2. Properties.
The Company's principal office, located at 2500 DeKalb Pike,
Norristown, Pennsylvania, is owned by PILIC. This property is comprised of
approximately 6.5 acres of land and buildings containing approximately 44,000
square feet of space. The Company believes its existing facilities are suitable
to conduct its present business.
Item 3. Legal Proceedings.
The Company is involved in normal litigation in the settlement of
insurance claims and other matters, including disputes with HPS. Management is
of the opinion that neither the litigation nor these claims will have a material
adverse effect on the results of operations or financial position of the
Company.
Item 4. Submission of Matters to a Vote of Security Holders.
Registrant held an annual meeting of shareholders on December 17, 1998,
at which time the shareholders voted to elect nine (9) directors to serve until
the next Annual Meeting of Shareholders and until their successors are duly
elected, and approved the appointment of BDO Seidman, LLP as the independent
auditors of Registrant for the fiscal year 1998.
44
PART II
Item 5. Market For Registrant's Common Equity and Related Shareholder Matters.
Price Range of Common Stock
The following table shows the range of quarterly high and low sale
prices for the Company's common stock. The Company's common stock was listed on
the NASDAQ National Market with the exception of the period June 12, 1998
through November 6, 1998. During this time period the Company's stock was
delisted due to the delayed filing of the Company's December 31,1997 Annual
Report on Form 10-K and the March 31, 1998 Quarterly Report on Form 10-Q. During
this period, the Company's common stock traded on OTC Bulletin Board . Trading
on NASDAQ National Market has been reinstated as a result of filing of the
Company's December 31, 1997 Annual Report on Form 10-K and the timely filing of
all 1998 Quarterly Form 10-Q reports.
1998 1997 1996
--------------------- ------------------ ------------------
High Low High Low High Low
---- --- ---- --- ---- ---
First Quarter 6-15/16 2-1/4 14-3/8 8-5/8 9-3/8 5-3/4
Second Quarter 6-15/16 3-5/16 10-1/2 3-3/4 10-5/8 5-1/8
Third Quarter 8-1/4 3 5-1/8 3 15-7/8 8-1/2
Fourth Quarter 14-1/8 2-3/4 3-7/8 2-1/8 14-1/2 10-5/8
On March 25, 1999, the closing price of the Company's common stock was
$10.69. On that same date, there were approximately 2,200 shareholders.
Dividends
The Company has not paid a cash dividend on its Common Stock since its
inception in 1982. The Company currently intends to retain all earnings to
finance the expansion of its business and does not anticipate paying cash
dividends in the foreseeable future.
Dividends paid by the Company over and above the financial assets of
PAMCO are dependent upon the ability of PILIC and HealthAxis to pay dividends to
PAMCO. PAMCO and PILIC are restricted from declaring and paying dividends by
provisions of a guarantee agreement between PAMCO and RCH which PAMCO entered
into in connection with a reinsurance agreement between PILIC and RCH.
Dividend payments by PILIC are dependent upon a number of factors,
including earnings and financial condition, business needs and capital and
surplus requirements, as well as applicable regulatory restrictions. Under
Pennsylvania law, PILIC is currently unable to pay dividends without the prior
approval of the Pennsylvania Insurance Commissioner as a result of PILIC's
statutory unassigned deficit of $20,139,000 which excludes common stock and
additional paid-in capital amounts.
45
Dividend payments by HealthAxis are subject to restrictions set for in
the Certificate of Designation related to the Series A and Series B Convertible
Preferred Stock and subject to restrictions set for in the Certificate of
Designation related to the Series C Convertible Preferred Stock once issued.
HealthAxis does not anticipate paying cash dividends for the foreseeable future.
The Company paid cash dividends on the Series A and Series B Preferred
Stock at the rate of $0.0636363 and $0.109090, respectively, per quarter from
1993 to the present. All Series B Preferred Stock was converted into common
stock in 1996.
Recent Sales of Unregistered Securities
During 1998, the Company issued 961,543 shares of Common Stock, in
private offerings which were not registered with the Securities and Exchange
Commission. The following provides information regarding such transactions which
were engaged in by the Company as part of its capital raising efforts, in
connection with the conversion of its preferred stock, for compensatory reasons
and for payments to consultants.
The following Company Common Stock transactions were engaged in with
the individuals identified below as part of compensatory arrangements with
employees, payment for consulting services and in connection with the conversion
of preferred stock:
Aggregate
Name of Person Number Purchase Nature of
Date of Transaction Purchasing Securities Of Shares Price Transaction
------------------- --------------------- --------- ----- -----------
April 3, 1998 Paul Klimczak 75,000 N/A Stock issued pursuant to
consulting arrangement
July 27, 1998 Edward Bolton 25,000 N/A Stock issued pursuant to
employment agreement
October 28, 1998 Butera, Beausang, Cohen 4,400 N/A Conversion of Preferred Shares
& Brennan Pension Plan into Common Stock
46
The remaining 857,143 shares of Provident Common Stock were issued as a
sale of stock on November 13, 1998 to the following individuals in a private
offering:
Name of Person Aggregate
Purchasing Securities Number of Shares Purchase Price
--------------------- ---------------- --------------
Lynx Private Equity Partners I, LLC (1) 250,000 $ 875,000
James Burke 207,143 $ 725,000
Craig Gitlitz (2) 42,857 $ 150,000
Interhotel Company, Ltd. 357,143 $ 1,250,000
- - ---------------------------------
(1) Lynx Private Equity Partners I, LLC ("LPEP") is a limited liability
corporation of which Lynx Capital Group, LLC ("LCG") is the investment
advisor and general partner. Michael Ashker, a director of the Company and
President and Chief Executive Officer of HealthAxis, is the sole manager
of LCG and an investor in LPEP.
(2) Mr. Gitlitz is an employee of HealthAxis.
The proceeds of the private offering were used to fund the Company's
purchase of HealthAxis Common Stock.
On March 23, 1998, the Company issued currently exercisable warrants to
purchase 300,000 shares of the Company's Common Stock to AOL at an exercise
price of $4.48 per share. Such warrants had an exercise period of five years
from the date of issue. Such warrant agreement was subsequently amended on
November 13, 1998 in connection with the amendment of the AOL Agreement to,
among other things, extend the exercise period from five to seven years from
November 13, 1998. On November 13, 1998, the Company also issued to AOL a
warrant to purchase 300,000 shares of the Company's Common Stock at an exercise
price of $3.38 per share and HealthAxis issued AOL a warrant to purchase 300,000
shares of HealthAxis Common Stock at an exercise price of $1.77 per share. Both
warrants are immediately exercisable, fully vested and unless sooner exercised,
expire nine years from the date of issuance. Pursuant to the terms of such
warrants, AOL may only exercise such warrants for a total of 300,000 shares of
either HealthAxis Common Stock or the Company's Common Stock or a combination of
both.
Also on November 13, 1998, the Company issued AOL a Stock Subscription
Renewal Performance Warrant for an aggregate of 300,000 shares at an exercise
price of $5.15; the warrants become exercisable upon the completion of certain
performance criteria, and expire seven years from the date of issuance.
47
The issuances of securities described above were made pursuant to
exemptions from registration pursuant to Section 4(2) of the Securities Act of
1933, as amended, in reliance upon the fact that such sales did not involve a
public offering. As a result, such securities are subject to restrictions on
transfer. No commissions were paid in connection with the above transactions.
Effective September 15, 1998, HealthAxis issued 405,886 share of its
Series A Preferred Stock to PILIC, a subsidiary of PAMCO, for aggregate
consideration of $2.4 million, or $5.91 per share. Effective November 16, 1998,
HealthAxis issued an additional 140,030 shares of its Series A Preferred Stock
to PILIC pursuant to the price adjustment provisions of the stock purchase
agreement between HealthAxis and PILIC. The Series A Preferred Stock is
convertible into HealthAxis Common Stock on a one for one basis, subject to
adjustment. Each share of Series A Preferred Stock has the same voting rights as
a share of HealthAxis Common Stock into which it is convertible and has certain
preferences with respect to the payment of dividends and upon liquidation over
HealthAxis Common Stock.
On September 30, 1998, Health Plan Services, Inc. ("HPS"), the holder
of HealthAxis' $5.0 million convertible note (the "Convertible Note"), exercised
an option to convert the Convertible Note into 2,316,177 shares of HealthAxis
Common Stock, representing approximately 15% of outstanding HealthAxis Common
Stock. In addition, HealthAxis issued 49,188 shares of HealthAxis Common Stock
to HPS in consideration for approximately $106,000 of outstanding accrued but
unpaid interest on the Convertible Note. The conversion agreement with HPS
includes an anti-dilution provision which requires HealthAxis to issue
additional shares of HealthAxis Common Stock to such holder in certain
circumstances. Under such agreement, if HealthAxis issues additional shares of
Common Stock (or any stock convertible into HealthAxis Common Stock) for
consideration less than $2.16 per share prior to having a registration statement
declared effective by the SEC, HealthAxis would be required to issue additional
shares to HPS. In connection with the conversion of the Convertible Note, the
number of shares issuable upon the conversion of the Convertible Note was
increased from 12.5% to 15% of the outstanding shares of HealthAxis, resulting
in a conversion premium approximating $953,000 which was charged to operations
and credited to additional paid-in-capital.
On November 13, 1998, HealthAxis issued 625,529 shares of Series B
Cumulative Convertible Preferred Stock ("Series B Preferred Stock") to AOL at a
price of approximately $4.40 per share for an aggregate purchase price of $2.75
million, of which a portion was used to pay amounts due to AOL under the IM
Agreement. The Series B Preferred Stock is convertible into a number of shares
of HealthAxis Common Stock on a one for one basis, subject to adjustment, as
described in the Certificate of Designation related to the Series B Preferred
Stock of HealthAxis. The outstanding shares of Series B Preferred Stock shall
automatically convert into shares of HealthAxis Common Stock based upon a
conversion ratio set forth in the Certificate of Designation of HealthAxis upon
the consummation of the first public offering of HealthAxis Common Stock at a
pre-offering market capitalization of not less than $200.0 million and aggregate
proceeds of the offering are not less than $25.0 million. Holders of 51% of the
outstanding shares of Series B Preferred Stock have the right to require
HealthAxis to redeem any or all of the outstanding Series B Preferred Stock
within six months of the occurrence of certain triggering events described in
the Certificate of Designation.
48
Each share of Series B Preferred Stock has the same voting rights as a
share of HealthAxis Common Stock into which it is convertible and has certain
preferences with respect to the payment of dividends and upon liquidation over
the Series A Preferred Stock and the HealthAxis Common Stock. Reference is made
to the Certificate of Designation attached hereto as Exhibit 10.7 for additional
information on the Series B Convertible Preferred Stock of HealthAxis.
The issuances of securities described above were made pursuant to
exemptions from registration pursuant to Section 4(2) of the Securities Act of
1933, as amended, in reliance upon the fact that such sales did not involve a
public offering. As a result, such securities are subject to restrictions on
transfer. No commissions were paid in connection with the above transactions.
49
Item 6. Selected Financial Data.
The following selected consolidated financial information has been
derived from the consolidated financial statements of the Company and should be
read in conjunction with the Consolidated Financial Statements and notes thereto
included elsewhere in this report which have been audited by BDO Seidman, LLP
for 1998 and 1997, and by PricewaterhouseCoopers, LLP for all prior years.
Years Ended December 31,
Statement of Operations Data: 1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(In thousands, except per share data)
Premiums earned excluding HealthQuest $ 45,482 $ 43,083 $ 41,656 $ 32,709 $ 36,395
Premiums earned - HealthQuest 24,135 11,170 3,050
Net investment and other income 4,610 7,027 4,941 4,127 3,736
Realized gains (losses) on investments 270 750 2,100 211 (89)
Realized gain on the sale of subsidiaries 3,002
Litigation settlement, net 22,400
--------- --------- --------- --------- ---------
Total revenues 77,499 62,030 74,147 37,047 40,042
Benefits and expenses 91,401 85,044 51,630 40,728 41,026
--------- --------- --------- --------- ---------
Income (loss) before income taxes and
minority interest (13,902) (23,014) 22,517 (3,681) (984)
Income taxes (benefit) (1,030) (4,589) 6,397 20 13
--------- --------- --------- --------- ---------
Net income (loss) before minority interest (12,872) (18,425) 16,120 (3,701) (997)
Minority interest in affiliate 716
--------- --------- --------- --------- ---------
Net income (loss) (12,156) (18,425) 16,120 (3,701) (997)
Dividends on preferred stock 254 148 194 334 334
--------- --------- --------- --------- ---------
Net income (loss) applicable to common stock $ (12,410) $ (18,573) $ 15,926 $ (4,035) $ (1,331)
========= ========= ========= ========= =========
Per share data, Basic $ (1.20) $ (1.84) $ 1.66 $ (0.44) $ (0.16)
Per share data, Diluted $ (1.20) $ (1.84) $ 1.36 $ (0.44) $ (0.16)
Per share dividends paid on common stock, basic $ 0.00 $ 0.00 $ 0.00 $ 0.02 $ 0.00
Per share dividends paid on common stock, diluted $ 0.00 $ 0.00 $ 0.00 $ 0.02 $ 0.00
Shares outstanding, basic 10,331 10,090 9,610 9,100 8,421
Shares outstanding, diluted 10,331 10,090 11,674 9,100 8,421
Balance Sheet Data:
Investments $ 32,969 $ 47,101 $ 61,942 $ 46,890 $ 39,467
Total assets 116,689 98,365 93,054 67,151 60,586
Loans payable 3,865 5,077 298 830 1,166
Stockholders' equity 5,495 4,009 22,053 3,424 4,530
Stockholders' equity
per common share (1) $ 0.48 $ 0.38 $ 2.08 $ 0.34 $ 0.48
(1) Assumes conversion of Series A and Series B Preferred stock into common
stock of the Company on a share-for-share basis in years 1995 and 1994 and
conversion of Series A Preferred stock in 1998, 1997 and 1996 on a
share-for-share basis.
50
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Results of Operations
1998 Results compared to 1997 Results
Net loss applicable to common stock was $12.4 million or ($1.20) per
basic and diluted share for 1998 compared to net loss of $18.6 million or $1.84
per basic and diluted share for 1997. The Company's 1998 results continue to be
unfavorably impacted by high health policy benefits, along with other operating
expenses of $4.9 million, related to the start-up operations of HealthAxis. The
1998 results were favorably impacted by a net $3.0 million gain on the sale of
subsidiaries and a $0.8 million ceding commission relating to the 100% ceding of
the managed care business as described in the Financial Statements' Notes C and
D, respectively, and later in this discussion of results of operations.
During 1998 the Company revised its strategy to focus predominately on
HealthAxis, the Company's E-Commerce insurance marketing subsidiary along with
more focused strategy for PILIC. In early 1998 the Company determined that the
Internet provided the opportunity to sell health insurance direct to the
consumer thereby reaching individuals under-served by insurance agents at a cost
potentially lower than the Company's current traditional agency marketing
channel. In light of the losses experienced in the Company's small group and
managed care products and the need to devote capital and focus to HealthAxis,
the Company entered into various agreements to sell PILIC's subsidiaries MMC,
PALHIC and NIA and cede 100% of the group medical and group life business during
1998.
On November 12, 1998 PILIC signed an agreement to reinsure 100% of its
group medical and group life inforce business and sell the Company's group
medical marketing, sales distribution rights and PALHIC to CRLC. On December 31,
1998 the Company executed a series of transactions whereby PALHIC reinsured 100%
of its business to PILIC, which in turn reinsured via a 100% co-insurance
reinsurance agreement all of the Company's group medical and group life business
to the RCH. In addition PILIC sold PALHIC and NIA to CRLC, transferred all
rights and control regarding the Company's agents and entered into non-compete
and non-solicitation agreements regarding the Company's agents with respect to
the future sale of health insurance products by agents for a 3-year period.
Accident and health gross premium was $110.7 million for 1998 compared
to $87.7 million for 1997. Accident and health ceded premium was $49.7 million
for 1998 compared to $39.5 for 1997. These increases were the result of
increased new business relating to the Company's managed care health insurance
products. As a result of the transactions with CRLC and RCH, the Company
anticipates a substantial decline in premium in future years. The Company will
cede 100% of the Company's small group and managed care business to RCH. The
Company's small group and managed care business comprised $104 million and $49.2
million of accident and health gross and ceded premiums, respectively. The
Company's future gross, ceded and net health premium will be derived from the
assumption of stop loss business administered by MMC and business assumed from
CRLC.
51
At December 31, 1998 and 1997, gross annualized accident and health
premium inforce on small group and managed care business amounted to $102.7
million and $96.8 million, respectively, consisting of approximately 45,000 and
50,000 certificate holders, respectively. All of the small group and managed
care business is 100% ceded to RCH effective January 1, 1999.
Life and annuity premium, gross of $8.8 million for 1998 declined from
$9.6 million for 1997 due to reduced pre-need premium. As a result of the
transactions with CRLC and RCH, the Company anticipates a substantial decline in
life premium. Included in 1998's gross premium was $2.0 million of group life
premium which is 100% ceded to RCH effective January 1, 1999. Individual life
insurance lapse ratios for 1998 and 1997 were 8% and 11%, respectively. Life and
annuity reinsurance ceded was $0.2 million for 1998 compared to $0.5 million
recaptured for 1997, which correlates to the decline in gross premium.
Net investment income of $3.8 million for 1998 increased modestly
compared to $3.5 million for 1997, primarily due to an increase in bond
investments. Net realized gains on investments of $0.3 million for 1998 relates
to the Company's sale of an investment in real estate while 1997's realized gain
of $0.8 million relates to the Company's sale of Loewen common stock acquired as
a result of a lawsuit.
Realized gain on the sale of subsidiaries of $3.0 million consists of a
realized gain of $4.0 million on the sale of MMC to HPS net of a $1.3 million
loss on the sale of PALHIC and a $0.3 million gain on the sale of NIA. PALHIC
and NIA were both sold as a result of the transactions with CRLC.
Ceding allowance net of policy acquisition costs of $0.8 million
represents $10.0 million ceding commission received from RCH net of $5.0 million
conditional payment, $3.8 million of unamortized deferred acquisition cost and
$0.4 million of transaction costs. The $5.0 million contingent payment received
from RCH has been accounted for as a ceding commission liability.
Accident and health policy benefits ratio net of reinsurance decreased
to 79.3% for 1998 compared to 86.3% for 1997 as a result of premium increases
and improved claim experience on the Company's managed care products. The
Company's small group and managed care business will be 100% ceded to RCH in the
future. The Company's small group and managed care business loss ratio was 77%
in 1998. Although the Company believes policy claim liabilities are adequate,
experience with these newer managed care products is limited and continues to
evolve. A greater then anticipated claim experience could have a materially
adverse impact on the financial position and results of operations.
Commissions, net of ceding allowance and deferred acquisition costs of
$7.1 million for 1998 increased from $6.8 million for 1997 due to increased
premium volume. Commissions, net of ceding allowance and deferred acquisition
costs for group health and group life business which is 100% ceded to RCH
effective January 1, 1999 was approximately $6.3 million.
52
Other operating expenses, net of ceding allowance and deferred
acquisition costs of $25.8 million for 1998 increased from $15.3 million in
1997, primarily due to $4.9 million of expenses associated with HealthAxis and
higher costs associated with the Company's small group and managed care
business.
Amortization of deferred policy acquisition costs of $2.0 million for
1998 decreased from $10.9 million for 1997 primarily resulting from accelerated
amortization in 1997 attributable to higher than expected lapses and worse than
expected loss ratios. As a result of the reinsurance agreement with RCH, the
Company's managed care business is ceded 100%, effective January 1, 1999 and,
accordingly, deferred policy acquisition costs were written off against the
ceding allowance received from RCH. Future amortization is limited to the life
business, which in 1998 was $0.6 million.
1997 Results compared to 1996 Results
Net loss applicable to common stock was $18.6 million or $1.84 per
basic and diluted share for 1997 compared to net income of $15.9 million or
$1.46 per basic and diluted share for 1996. The 1997 results were unfavorably
impacted by higher health policy benefits, write-off of deferred acquisition
costs, and transition costs associated with the HPS outsourcing. The 1996
results were primarily the result of a gain on litigation settlement of $14.6.
Policy claims are based on a variety of estimation methods, which are
continually revised incorporating the Company's most recent benefit experience.
As a result of higher than expected out-of-network claim utilization and greater
than expected claim frequency, the Company increased its loss ratio assumptions
during the year, which, in turn, resulted in an underwriting loss for 1997. In
reaction to these items, the Company began a series of corrective actions,
including premium rate increases, more stringent underwriting and revised policy
designs providing for more severe penalties for those policyholders who elect to
receive medical treatment outside of the authorized PPO networks.
Accident and health gross premium was $87.7 million for 1997 compared
to $57.2 million for 1996. Accident and health ceded premium was $39.5 million
for 1997 compared to $25.7 for 1996. These increases were the result of
increased new business relating to the Company's managed care health insurance
products.
At December 31, 1997 and 1996, gross annualized accident and health
premium inforce on small group and managed care business amounted to $96.8
million and $70.7 million, respectively, consisting of approximately 50,000 and
36,000 certificate holders, respectively. The $26.1 million net increase in
annualized premium resulted from new business of $68.1 million issued in 1997,
plus premium rate increases of approximately $10.0 million less lapses amounting
to approximately $49.5 million. Managed care products accounted for 82% and 65%
of the inforce premium at year-end 1997 and 1996, respectively, of the group
accident and health business.
53
The lapse ratio on small group and managed care accident and health
insurance business based on annualized premium was 45% for 1997 compared to 38%
for 1996. The lapse ratios reflect the results of premium rate increases as well
as the Company's continued shift toward managed care plans and away from
traditional healthcare insurance. The Company's traditional healthcare insurance
plans have higher premiums and higher policy benefits than its managed care
plans. The accident and health lapse ratios include small group medical plans,
which by their nature have high lapsation.
Life and annuity premium of $9.6 million for 1997 declined from $11.3
million for 1996 due to reduced pre-need premium. Individual life insurance
lapse ratios for 1997 and 1996 were 11% and 10%, respectively. Life and annuity
reinsurance ceded was $0.5 million for 1997 compared to $1.9 million recaptured
for 1996, due to the Company's 1996 recapture of reinsurance originally ceded in
1995 on certain multi-pay pre-need life insurance policies.
Net investment income of $3.5 million for 1997 increased modestly
compared to $3.3 million for 1996, primarily due to an increase in bond
investments. Net realized gains on investments of $0.8 million for 1997
decreased from $2.1 million for 1996, and reflect the sale of the Company's
remaining holdings of Loewen stock.
Accident and health policy benefits ratio net of reinsurance increased
to 86.3% for 1997 compared to 60% for 1996 as a result of higher than expected
claim experience on the Company's managed care products.
Commissions, net of ceding allowance and deferred acquisition costs of
$6.8 million for 1997 decreased from $7.9 million from 1996 due to the increased
deferral of acquisition costs related to the Company's one-life managed-care
products in 1997. These costs were written-off in 1997 as amortization of
deferred policy acquisition costs.
Other operating expenses of $15.3 million for 1997 increased from $11.7
million for 1996, due to increased policy administration expenses caused by
increased sales volume and transition expenses associated with the HPS
outsourcing.
Amortization of deferred policy acquisition costs of $10.9 million for
1997 increased from $0.6 million for 1996 primarily due to accelerated
amortization in 1997 due to higher than expected lapses and worse than expected
loss ratios. Increased lapsation over current levels or future unprofitability
in certain life products could result in an increase in the amortization rate of
unamortized deferred policy acquisition costs, which would adversely impact
future earnings.
Liquidity and Capital Resources
A major objective of the Company is to maintain sufficient liquidity to
fund growth, fulfill statutory requirements and meet all cash requirements with
cash and short term equivalents plus funds generated from operating cash flow.
54
The primary sources of cash for insurance operations are premiums,
investment income and investment sales and maturities. The primary uses of cash
for insurance operations are benefit payments to insureds, operating costs
including policy acquisition costs and investment purchases.
During 1998, the Company's liquidity requirements were primarily
created and met by PILIC and PALHIC, along with the sale proceeds of MMC,
PALHIC, and NIA. The primary sources of cash for HealthAxis were the issuance of
debt and equity securities to outside parties and to PILIC. The primary uses of
cash for HealthAxis were operating costs and payments to AOL, Lycos and CNet.
During 1999, the Company's liquidity requirements will be primarily
created and met by HealthAxis through the issuance of debt and equity securities
by the Company to outside parties. PILIC's contribution will be limited to
individual life premiums and administrative fees. The primary uses of cash for
HealthAxis will continue to be operating costs and payments to AOL, Lycos and
CNet, while PILIC's primary uses will be claim payments and associated general
expenses related to the 1998 claim run-off, which have been established as claim
reserves.
Cash and investments carried at market value at December 31, 1998
amounted to $59.2 million. This included $31.9 million of bonds issued by the
U.S. Government, government agencies, public utilities and other corporations,
$1.1 million invested in policy loans and other invested assets and $26.2
million in cash and cash equivalents. Bonds are investment grade securities with
fixed incomes ranging in maturity from one to 30 years. The gross average yield
on fixed income bonds as of December 31, 1998, 1997 and 1996 was 6.3%, 6.8%, and
6.5%, respectively. The Company's investment policy is to buy medium term U.S.
government direct and agency bonds. All bonds are considered to be "available
for sale". The Company and its subsidiaries do not invest in high-yield debt
instruments, defined as securities below investment grade with interest rates or
yields significantly above market rates nor does the Company invest in
derivatives or hedging in financial instruments.
The Company entered into a line of credit with a bank during 1997 in
the amount of $1.0 million with interest at 1% above the prime rate. The
outstanding borrowing at December 31, 1997 amounted to $1.0 million. The Company
repaid this amount during 1998.
Net cash used in operating activities of $18.2 million in 1998 reflects
negative cash flow from the Company's group medical business, the impact of the
transition of business to HPS, and the impact of HealthAxis' AOL, CNet and Lycos
payments of $9.3 million.
In connection with the Company's outsourcing to HPS the Company
received premiums, net of commissions, HPS fees and certain out of pocket
expenses monthly on or before the 15th of following month. The $6.8 million
change in amounts due from third party administrator represented December 1998's
net cash settlement collected from HPS in January 1999.
Change in other assets, current and deferred income taxes and other
liabilities of $2.0 million related primarily to HealthAxis' payments to AOL and
Lycos, net of funds received from HPS.
55
Change in future policy benefits and claims of $4.3 million in the
current year in comparison to the prior year reflects higher paid claim volume
on the Company's group medical business and is partially offset by the change in
amounts due from reinsurers.
The Company sold an 80% interest in MMC for $4.0 million realizing a
gain for the same amount during the first quarter of 1998. The Company also sold
PALHIC and NIA for $5.6 million, resulting in a $1.0 million loss.
The Company anticipates that it will fund surrenders and benefit
payments along with other operating expenses by a significantly reduced level of
premiums together with scheduled investment maturities and the liquidation of
short and intermediate-term investments.
The statutory capital and surplus of PILIC, was $4.8 million at
December 31, 1998. At December 31, 1998, PILIC calculated its "Risk Based
Capital" utilizing a formula required by the National Association of Insurance
Commissioners. The results of this computation indicate that PILIC's adjusted
capital of $5.3 million exceeded Regulatory Action Level but was below Company
Action Level. PILIC's year end 1998 RBC calculation included approximately $4.8
million of RBC related to PILIC's one life group health and group life business
100% ceded to RCH effective January 1, 1999. The RBC formula estimates RBC based
on a variety of historical data including 1998 net earned premium. The effects
of the reinsurance agreement between PILIC and RCH on PILIC's RBC calculation
will not be realized until 1999. In concept, Risk Based Capital standards are
designed to measure the acceptable amounts of capital an insurer should have
based on inherent and specific risks of the insurers business. This formula is a
primary measurement as to the adequacy of total capital and surplus of life
insurance companies. Since PILIC failed to meet its RBC requirement as of
December 31, 1998 it may be subject to regulatory action. Insurers failing to
meet their RBC requirement may be subject to scrutiny by its domiciled insurance
department and other insurance departments, which the insurer does business in,
and, ultimately, rehabilitation or liquidation.
Administrative rules and legal restrictions of state insurance
departments presently prevent payment of dividends by PILIC to PAMCO without
regulatory approval. Payment of dividends paid by HealthAxis to PAMCO is subject
to restrictions set for in the Certificate of Designation related to HealthAxis
Series A and Series B Convertible Preferred Stock and subject to restrictions
set for in the Certificate of Designation related to the Series C Convertible
Preferred Stock once issued. HealthAxis has not nor does it anticipate paying a
cash dividend in the foreseeable future.
Impact of Inflation
Inflation increases the need for insurance. Many policyholders who once
had adequate insurance programs increase their life insurance coverage to
provide the same relative financial benefits and protection. The effect of
inflation on medical costs leads to accident and health policies with higher
benefits. Thus, inflation has generally increased the need for life and accident
and health products.
The higher interest rates, which have traditionally accompanied
inflation, also affect the Company's investment operation. The market value of
the Company's fixed rate long-term investments decreases as interest rates
increase.
56
The Company's pre-need products include periodic adjustments to the
face amount of the policy for increases in the consumer price index.
HealthAxis Expenditures and Commitments
During 1998 HealthAxis entered into an Interactive Marketing Agreement
with AOL and promotional agreements with CNet and Lycos. In connection with
these agreements the Company has paid $12.24 million in cash and warrants as of
December 31, 1998 and is required to pay additional amounts as described in
Notes F, G and H to the Company's Consolidated Financial Statements.
Additionally, the Company expects to incur significant HealthAxis costs that
will require additional funding.
In 1998, HealthAxis obtained $13.9 million in funding consisting of (i)
a $750,000 fee paid by HPS in March 1998 in consideration of HPS being granted
the right to administer certain of the health insurance business written by
PILIC and PALHIC; (ii) a $5.0 million loan together with accrued interest from
HPS to HealthAxis in May 1998, which was converted in September 1998 into
2,365,365 shares of HealthAxis common stock; (iii) the purchase by PILIC of $2.4
million of Series A Preferred Stock of HealthAxis in September 1998; (iv) the
purchase by PAMCO of 682,395 shares of common stock of HealthAxis in November
1998 for $3.0 million; and (v) the purchase by AOL of $2.75 million of Series B
Preferred Stock of HealthAxis in November, 1998.
In November HealthAxis renegotiated the AOL, CNet and Lycos Agreements
in order to obtain additional time needed to test its web site and secure funds.
AOL, CNet and Lycos agreed to extend HealthAxis' launch date and payment of
fees. In consideration for the extension HealthAxis agreed to pay AOL an
additional $2 million during the initial term, $1 million during the renewal
term, revise the terms of the warrants to purchase the Company's common stock
from five to seven years and issue warrants to purchase the Company's and/or
HealthAxis' common stock as described in Note F. Lycos agreed to reduce the fees
payable by HealthAxis by $4.57 million during the first term of the Lycos
Agreement and HealthAxis agreed to an approximately 30% reduction in guaranteed
impressions during the first term of the Lycos Agreement.
As of December 31, 1998 HealthAxis does not have sufficient funds to
satisfy HealthAxis cash needs for 1999. HealthAxis is seeking $15 million
through issuance of 2,599,653 shares of Series C Preferred Stock in order to
fund payments to its marketing partners and operating expenses. No assurances
can be given with regard to the success or timing of the Company's efforts in
obtaining such funding. In the event that HealthAxis is unable to obtain funding
or launch its web site in accordance with the AOL, CNet and Lycos agreements,
HealthAxis will be in breach of one or more of those agreements. HealthAxis
would forfeit all amounts paid to AOL, CNet or Lycos if it is in breach of any
of the aforementioned agreements.
57
Year 2000 compliance
Year 2000 issues are the result of computer programs being written
using two digits rather than four to define the applicable year. In other words,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the Year 2000. This could result in system failures or miscalculations
causing disruptions in operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities.
The Company utilizes various computer software programs, operating
systems and vendors whose software programs and communication links ("Computer
Systems") are used in the Company's insurance and HealthAxis e-commerce
businesses. For the Company's insurance business these Computer Systems include
health insurance administration provided by HPS, life insurance administration,
health claims discount repricing provided by First Health Group along with
financial accounting and actuarial systems. For HealthAxis, these Computer
Systems include the www.healthaxis.com web site, links to AOL along with the AOL
online network, HPS, First Health Group, along with HealthAxis' data warehouse.
In 1999, the Company expects to have links to CNet, Lycos, Snap.com as well as
Carrier Partners who will offer their products through the HealthAxis web
site. To the extent that the Company's Computer Systems contain source codes
that are unable to appropriately interpret the Year 2000 then some level of
modification, or even replacement of such applications may be necessary. The
result of these Year 2000 issues may, if not corrected, have a significant
negative impact on Company's business.
The Company has begun an assessment of the Company's Year 2000
readiness and has identified applications owned by the Company, which are not
Year 2000 compliant. Furthermore, the Company believes that the Computer Systems
of many of its vendors or Carrier Partners that provide critical services to the
Company are not currently Year 2000 compliant.
To date, the Company has experienced very few Year 2000 problems with
those problems centering on life administration processing. The cost of
programming changes as of December 31, 1998 was less than $20,000. The Company
is in the process of evaluating alternatives to its life administration Year
2000 issues including the modification of the life administration system at a
cost yet to be estimated or the effective replacement of the system via
outsourcing of the life system at an estimated incremental annual cost of
approximately $300,000 per year and a one time conversion cost of approximately
$300,000. The Company anticipates selecting a Year 2000 plan to address its life
administration Year 2000 issues by the end of the second quarter of 1999. To
date, the Company has replaced its general ledger and accounts payable
accounting systems, which were not Year 2000 compliant, in January 1998 at a
cost of approximately $180,000.
The Company intends to conduct an analysis to determine whether its
vendors, Carrier Partners, Distribution Partners, and other business partners
(in so far as they are material to the Company's business) have any Year 2000
issues. As part of this process, the Company intends to request its vendors
provide them with information regarding their progress in identifying and
addressing their Year 2000 problems. Based on information reported in quarterly
SEC filings, AOL and HPS anticipate being Year 2000 compliant no later than
December 31, 1999 and June 30, 1999, respectively.
58
To date the Company has eliminated its health administration system by
outsourcing of the health administration and claims processing to HPS effective
February 1998 and assigned responsibility of the oversight of HPS' health
administration and claims processing along with the Company's former health
agent and underwriting Computer Systems to CRLC effective December 31, 1998.
In the event that the Computer Systems of the Company or any of the
Company's vendors Carrier Partners or other business partners fail or exhibit
significant problems as a result of Year 2000 processing the Company's service
to its customers could be disrupted for a significant amount of time and result
in significant lost income to the Company.
There are risks associated with the Company's Year 2000 exposure
relating to some external vendors with whom the Company depends on material
sales and service processing. Because the Company does not control these vendors
or their resources, the Company can provide no assurance that such vendors will
complete their respective Year 2000 solutions in time for the Company to fully
test system interfaces with them. Although the Company is coordinating its
efforts with vendors to minimize this impact of Year 2000 issues, the Company is
currently unable to predict the extent to which Year 2000 issues will affect its
operations, or the extent to which it would be vulnerable to the failure of its
vendors, Carrier Partners or other business partners to remediate any Year 2000
issues on a timely basis.
The Company has begun the process of developing a contingency plan to
address possible Year 2000 risks to its Computer Systems. There is no assurance
that the Company will successfully implement its contingency plan or make all of
its systems Year 2000 compliant. The Company does not currently have a
contingency plan in place in the event any third party in which it engages in
business is not Year 2000 compliant.
59
Item 8. Financial Statements and Supplementary Data.
Report of Current Independent Accountants F-1
Report of Previous Independent Accountants F-2
Consolidated Balance Sheets - December 31, 1998 and 1997 F-3
Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7 to F-41
60
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
Provident American Corporation
Norristown, Pennsylvania
We have audited the accompanying consolidated balance sheets of Provident
American Corporation and Subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the two years in the period ended December 31, 1998. Our
audits also included the financial statement schedules listed in the index at
Item 14(a) of the Form 10-K. These financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedules 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 Provident American
Corporation and Subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of two years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedules
referred to above, when considered in relation to the basic financial statements
taken as a whole, present fairly, in all material respects, the information
required to be included therein.
BDO Seidman LLP
1700 Market Street
Philadelphia, Pennsylvania
March 30, 1999
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
Provident American Corporation
Norristown, Pennsylvania
We have audited the consolidated financial statements and the financial
statement schedules of Provident American Corporation and Subsidiaries listed in
Item 14(a) of this Form 10-K. These financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedules 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 Provident American
Corporation and Subsidiaries as of December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the three years ended
December 31, 1996 in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedules referred to
above, when considered in relation to the basic financial statements taken as a
whole, present fairly, in all material respects, the information required to be
included therein.
As discussed in Note B to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
during 1995.
Coopers & Lybrand, LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 11, 1997
F-2
Provident American Corporation and Subsidiaries
Consolidated Balance Sheets
December 31, December 31,
(Dollars in thousands except preferred and common stock data) 1998 1997
----------- -----------
Assets
Investments:
Securities available for sale $ 31,880 $ 45,134
Real estate less accumulated depreciation of $182 in 1997 0 918
Policy loans 560 498
Other invested assets 529 551
--------- ----------
Total Investments 32,969 47,101
Cash and cash equivalents 26,185 16,767
Amount due from third party administrator 6,849 0
Premiums due and uncollected 1,167 2,106
Amounts due from reinsurers 22,222 16,092
Loans receivable from officer, director and stockholder 1,328 1,243
Accrued investment income 420 610
Federal income taxes receivable 0 3,325
Prepaid interactive marketing expense 11,655 0
Property and equipment, less accumulated depreciation of $3,099 and $2,751 7,950 6,804
Unamortized deferred policy acquisition costs 2,106 1,499
Goodwill, less accumulated amortization of $150 and $1,973 0 1,193
Other assets 3,838 1,625
--------- ----------
Total assets $116,689 $ 98,365
========= ==========
Liabilities and Stockholders' Equity
Liabilities:
Future policy benefits:
Life $ 42,546 $ 40,665
Annuity and other 4,871 5,428
Policy claims 42,481 31,109
Premiums received in advance and unearned 335 2,677
Amounts due to reinsurers 501 37
Accounts payable 2,107 1,151
Accrued commissions and expenses 2,384 5,451
Loans payable 3,865 5,077
Federal income taxes 1,222 100
Ceding commission liability 5,000 0
Other liabilities 1,945 2,661
--------- ----------
Total liabilities 107,257 94,356
Commitments and Contingencies:
Minority interest in HealthAxis.com, Inc.:
Minority interest in HealthAxis.com, Inc. common stock 1,132 0
HealthAxis.com, Inc. preferred stock-Cumulative preferred stock, par value $1:
authorized 5,000,000, issued 625,529 2,805 0
Stockholders' Equity:
Preferred stock, par value $1: authorized 20,000,000 shares:
Series A Cumulative Convertible, issued 556,600 and 580,250 557 580
Series B Cumulative Convertible, none issued 0 0
Common stock, par value $.10: authorized 50,000,000, issued 11,488,911 and 10,209,160 1,149 1,021
Common stock, Class A, par value $.10: authorized 20,000,000, none issued 0 0
Additional paid-in capital 27,002 13,767
Accumulated other comprehensive income 666 185
Retained earnings (23,879) (11,468)
--------- ----------
5,495 4,085
Less common stock held in treasury, at cost, 36,300 shares in 1997 0 (76)
--------- ----------
Total stockholders' equity 5,495 4,009
--------- ----------
Total liabilities and stockholders' equity $116,689 $ 98,365
========= ==========
See notes to condensed consolidated financial statements.
F-3
Provident American Corporation and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31,
(Dollars in thousands, except per share data) 1998 1997 1996
--------- --------- ---------
Revenue:
Premium:
Accident and health, gross $ 110,726 $ 87,712 $ 57,195
Life and annuity, gross 8,807 9,555 11,308
--------- --------- ---------
Total gross premium 119,533 97,267 68,503
--------- --------- ---------
Accident and health reinsurance ceded 49,667 39,548 25,670
Life and annuity reinsurance ceded 249 473 (1,873)
--------- --------- ---------
Total reinsurance ceded 49,916 40,021 23,797
--------- --------- ---------
Net premium 69,617 57,246 44,706
Net investment income 3,764 3,487 3,280
Realized gains on investments 270 750 2,100
Realized gain on the sale of subsidiaries, net 3,002 0 0
Ceding allowance net of policy acquisition costs 799 0 0
Other revenue 47 547 1,661
Litigation settlement, net of expenses 0 0 22,400
--------- --------- ---------
Total revenue 77,499 62,030 74,147
--------- --------- ---------
Benefits and expenses:
Death and other policy benefits:
Life 5,707 6,112 4,396
Accident and health, net of reinsurance 47,509 38,981 18,963
Annuity contracts and other considerations 353 737 1,137
Increase in liability for future policy benefits 1,811 1,896 6,474
Commissions, net of ceding allowance and
deferred acquisition costs 7,139 6,813 7,855
Other operating expenses, net of ceding allowance
and deferred acquisition costs 25,823 15,301 11,716
Amortization of deferred policy acquisition costs 2,049 10,943 584
Depreciation and amortization of goodwill 1,010 4,261 505
--------- --------- ---------
Total benefits and expenses 91,401 85,044 51,630
--------- --------- ---------
(Loss) income before income taxes and minority interest (13,902) (23,014) 22,517
Provision (benefit) for income taxes:
Current (1,030) (5,205) 6,816
Deferred 0 616 (419)
--------- --------- ---------
Total income taxes (1,030) (4,589) 6,397
--------- --------- ---------
Net (loss) income before minority interest (12,872) (18,425) 16,120
Minority interest net loss of subsidiary 716
--------- --------- ---------
Net (loss) income (12,156) (18,425) 16,120
Dividends on preferred stock 254 148 194
--------- --------- ---------
Net (loss) income applicable to common stock $ (12,410) $ (18,573) $ 15,926
========= ========= =========
(Loss) income per share of common stock
Basic $ (1.20) $ (1.84) $ 1.66
========= ========= =========
Diluted $ (1.20) $ (1.84) $ 1.36
========= ========= =========
Common shares and equivalents used in computing (loss) income per
share
Basic 10,331 10,090 9,610
Diluted 10,331 10,090 11,674
See notes to consolidated financialstatements.
F-4
Provident American Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Preferred Stock Common Stock Additional
------------------ ------------------ Paid-In
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
(Dollars in thousands)
BALANCE, DECEMBER 31, 1995 1,006 $ 1,006 9,260 $ 926 $ 10,166
Comprehensive income:
Net income (loss) 1996
Other comprehensive income (loss)
Comprehensive income
Conversion of Series B Cumulative
Preferred stock (426) (426) 426 43 383
Retirement of treasury stock (100) (10) (234)
Stock options and warrants exercised 204 20 625
Compensation expense on stock issuance 15 2 153
and stock option grants
Issuance of common stock in connection 274 27 1,852
with acquisition of business
Cash dividends declared on preferred
stock
--- ------- ------ ------- -------
BALANCE, DECEMBER 31, 1996 580 580 10,079 1,008 12,945
Comprehensive income:
Net income (loss) 1997
Other comprehensive income (loss)
Comprehensive income
Stock options and warrants exercised 30 2 96
Compensation expense on stock issuance 100 11 478
Compensation expense on stock option 248
grants
Cash dividends declared on preferred
stock
--- ------- ------ ------- -------
BALANCE, DECEMBER 31, 1997 580 580 10,209 1,021 13,767
Comprehensive income:
Net income (loss) 1998
Other comprehensive income (loss)
Comprehensive income
Issuance of common stock 410
Stock options and warrants exercised 882 89 2,991
Increase in net assets in 4,210
HealthAxs.com, Inc.
Warrants issued 4,469
Conversion of Preferred Stock (23) (23) 24 2 21
Conversion of Treasury Stock (36) (4) (73)
Cash dividends declared on preferred
stock
--- ------- ------ ------- -------
BALANCE, DECEMBER 31, 1998 557 $ 557 11,489 $ 1,149 $26,309
=== ======= ====== ======= =======
Accumulated
Retained Other Treasury
Earnings Comprehensive Stock
(Deficit) Income (Loss) (at cost) Total
--------- -------------- --------- -----
(Dollars in thousands)
BALANCE, DECEMBER 31, 1995 $ (8,821) $ 467 $ (320) $ 3,424
Comprehensive income:
Net income (loss) 1996 16,120 16,120
Other comprehensive income (loss) 24 24
---------
Comprehensive income 16,144
---------
Conversion of Series B Cumulative
Preferred stock 0
Retirement of treasury stock 244 0
Stock options and warrants exercised 645
Compensation expense on stock issuance 155
and stock option grants
Issuance of common stock in connection 1,879
with acquisition of business
Cash dividends declared on preferred (194) (194)
stock
--------- ------- ----------- ---------
BALANCE, DECEMBER 31, 1996 7,105 491 (76) 22,053
Comprehensive income:
Net income (loss) 1997 (18,425) (18,425)
Other comprehensive income (loss) (306) (306)
---------
Comprehensive income (18,731)
---------
Stock options and warrants exercised 98
Compensation expense on stock issuance 489
Compensation expense on stock option 248
grants
Cash dividends declared on preferred (148) (148)
stock
--------- ------- ----------- ---------
BALANCE, DECEMBER 31, 1997 (11,468) 185 (76) 4,009
Comprehensive income:
Net income (loss) 1998 (12,156) (11,463)
Other comprehensive income (loss) 481 481
---------
Comprehensive income (10,982)
---------
Issuance of common stock 1,657
Stock options and warrants exercised 3,080
Increase in net assets in 4,210
HealthAxs.com, Inc.
Warrants issued 3,776
Conversion of Preferred Stock 0
Conversion of Treasury Stock 76 0
Sale of Subsidiaries 0
Cash dividends declared on preferred (255) (255)
stock
--------- ------- ----------- ---------
BALANCE, DECEMBER 31, 1998 $ (23,186) $ 666 $ 0 $ 5,495
========= ======= =========== =========
F-5
Provident American Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollars in thousands) Years Ended December 31,
Cash flows from operating activities 1998 1997 1996
-------- -------- --------
Net income (loss) $(12,156) $(18,425) $ 16,120
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Issuance of common stock 106 -- --
Depreciation and amortization 1,622 4,286 515
Equity securities received from litigation settlement (19,400)
Net realized (gain) on investments (270) (750) (2,100)
Net realized (gain) on sale of subsidiary (3,002)
Issuance of warrants 1,314
Write off goodwill 1,193
Net Loss Minority Loss (716)
Interest on Loan Conversion 953
Decrease (increase) in
Premium due and uncollected, unearned
premium and premium received in advance (1,403) 130 971
Prepaid interactive marketing expense (9,300)
Due to/from reinsurers (5,666) (7,520) (2,112)
Due from third party administrator (6,849)
Deferred policy acquisition costs, net (607) 1,641 (2,154)
Accrued investment income 190 226 (186)
Other assets, current and deferred income
taxes and other liabilities 2,474 (3,222) (969)
Accrued commissions and expenses (3,067) 1,272 1,906
Ceding commission liability 5,000
Future policy benefits and claims 12,696 16,951 8,528
-------- -------- --------
Net cash provided by (used) operating activities (17,488) (5,411) 1,119
-------- -------- --------
Cash flows from investing activities
Purchases of bonds (2,674) (25,128) (24,861)
Purchase of equity securities (99) (100) (1,194)
Sale of bonds 11,244 35,879 16,719
Sale of equity securities 24 4,420 18,504
Sale of subsidiaries 9,853
Sale of investment in real estate 1,162
Maturity of investments and loans 14 250 645
Loans to officer, director and shareholder (85) (1,032) (461)
Purchases of property and equipment (1,960) (3,206) (745)
Acquisition of businesses, net of cash
-------- -------- --------
Net cash from investing activities 17,479 11,083 4,862
-------- -------- --------
Cash flows from financing activities
Withdrawals from contractholder deposit funds (248) (589) (1,797)
Proceeds from note payable 0 5,039 78
Repayments of notes payable (1,212) (260) (745)
Issuance of common stock 1,657 835 733
Exercise of stock options 1,680 0 0
Issuance of HealthAxis.com, Inc. preferred stock 2,699 0 0
Issuance of HealthAxis.com, Inc. convertible note 5,000 0 0
Dividends paid on preferred and common stock (148) (148) (194)
-------- -------- --------
Net cash from financing activities 9,427 4,877 (1,925)
-------- -------- --------
Increase (decrease) in cash and cash equivalents 9,418 10,549 4,056
Cash and cash equivalents, beginning of period 16,767 6,218 2,162
-------- -------- --------
Cash and cash equivalents, end of period $ 26,185 $ 16,767 $ 6,218
-------- -------- --------
Supplemental disclosure of cash flow information:
Interest paid $ 416 $ 97 $ 56
Income taxes pad (refunded), net $ (5,218) $ (1,490) $ 6,330
Non-cash financing Activities:
Issuance of warrants $ 3,428
Exercise of options $ 1,400
Non cash investing activities:
In 1997, the Company incurred capital lease obligations
in connection with the acquisition of certain equipment
in 1996, the Company issued stock in connection with
certain business acquisitions described in Note C and
received stock in connection with a litigation settlement
described in notes
F-6
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1998
(Dollars in thousands, except per share amounts)
Note A - Nature of Operations
Provident American Corporation ("PAMCO") is a Pennsylvania corporation
organized in 1982 and regulated as an insurance holding company by the states in
which its wholly owned insurance subsidiary are licensed. The operations of
PAMCO and its subsidiaries (the "Company") are principally those of its
majority-owned subsidiary HealthAxis.com, Inc. ("HealthAxis") and its insurance
operations. PAMCO's insurance operations are conducted through its wholly owned
life insurance company Provident Indemnity Life Insurance Company ("PILIC") and
PILIC's subsidiaries which during 1996 through 1998 were Provident American Life
and Health Insurance Company ("PALHIC"), Montgomery Management Corporation
("MMC") and NIA Corporation ("NIA"). Hereinafter, PAMCO and all of its
subsidiaries are collectively referred to as the Company and PILIC and all of
its subsidiaries are referred to as the Company's Insurance Operations. During
1998, the Company sold 80% of MMC's outstanding common stock and on December 31,
1998 sold 100% of the outstanding common stock of PALHIC and NIA.
Note B - Significant Accounting Policies
Principles of consolidation: The consolidated financial statements of
PAMCO and subsidiaries have been prepared in accordance with generally accepted
accounting principles (GAAP) and include the accounts of PAMCO and its
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
Use of estimates: The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of revenues, expenses, assets, and liabilities and disclosure
of contingencies. Actual results could differ from those estimates.
Bonds and equity securities are classified as "available-for-sale",
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of stockholders' equity, net of applicable
deferred income taxes.
Real estate is stated at cost, less accumulated depreciation; policy
loans are stated at the aggregate unpaid principal balances.
Cash equivalents consist of highly liquid investments with maturities
of three months or less from date of purchase. The Company maintains its cash
accounts at several commercial and savings banks. Cash accounts at each bank are
insured by the Federal Deposit Insurance Corporation for up to $100,000. During
the year, uninsured balances at times exceed insured limits.
Credit risk: Insurance is written by the Company primarily throughout
the Commonwealth of Pennsylvania. The Company performs ongoing credit and risk
evaluations of its brokers, insureds and reinsurers.
F-7
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Realized gains and losses (including provisions for market declines
considered to be other than temporary) are included in the determination of net
income (loss) as revenues. The cost of investments sold is determined on a
specific identification basis.
Prepaid interactive marketing expense represents cash and other
consideration paid to AOL, Cnet and Lycos for exclusivity and advertising
impressions related to services to be provided to the Company under the terms of
the respective marketing agreements. Prepayments related to exclusivity are
amortized on a straight-line basis over the respective contract term.
Prepayments related to advertising impressions are expensed as impressions are
delivered under the respective agreements.
Deferred policy acquisition costs are costs, which vary with and in
direct proportion to new business volume and include excess first year
commissions, policy issue and underwriting expenses net of application fees and
reinsurance ceding allowances. Accordingly, policy acquisition costs are
deferred and amortized in order to match the costs of writing new business
against the expected future revenues. Amortization of deferred policy
acquisition costs relating to managed care business ("The Provident Solution"
and HealthQuest) are established when polices are issued. It is based on
projected premium over a four-year period incorporating current lapse experience
and for life insurance business based on the same projected premium assumptions
used in computing reserves for future policy benefits. Effective December 31,
1998, all unamortized policy acquisition costs for the Company's managed care
business was netted against the ceding commission received as described in Note
E - Reinsurance of Inforce Group Medical and Group Life Inforce. Unamortized
costs relate to the Company's individual life business and are compared to the
estimated future profitability for these products. If the unamortized costs
exceed the estimated future profitability for these products, the unamortized
cost will be written down to equal the estimated future profitability. The
Company's estimates of future profitability consider investment income.
Property and equipment (principally home office property) are recorded
at cost. Expenditures for improvements that increase the estimated useful life
of the asset are capitalized. Expenditures for repairs and maintenance are
charged to operations as incurred. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets. Upon sale or
retirement, the cost of the asset and the related accumulated depreciation are
removed from the accounts and the resulting gain or loss, if any, is included in
operations.
Start-Up Costs: In accordance with AICPA statement of position No. 98-5
"Reporting on the Costs of Start-Up Activities", Start-Up Cost have been
expensed as incurred.
Goodwill represents the excess of the Company's purchase price over the
fair value of the net assets acquired and is being amortized on a straight line
basis over 10-20 years. The Company continually monitors the net realizable
value of goodwill and recognizes a charge to expense when it is determined that
a permanent impairment exists. During 1997 the Company determined the goodwill
associated with the NIA and CSE acquisitions were impaired as a result of the
outsourcing agreement with HPS described in Note Z and was written off. On
December 31, 1998, the Company sold PALHIC and included the remaining goodwill
in the determination of the realized gain on the sale of subsidiaries as
described in Note C.
Income taxes: The Company files a consolidated federal income tax
return, which allocates income taxes based upon the taxable income of the
companies included in the return. Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes.
F-8
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Recognition of premium revenue: For accident and health policies,
premiums are recognized when earned. For life insurance policies, premiums are
recognized when due. Limited-payment contract premiums received in excess of net
premiums are deferred and recognized into income in a constant relationship with
insurance in-force. Considerations from annuity contracts are accounted for as
fund deposits with revenues reflecting administrative and other charges.
Future policy benefits: The liabilities for future life policy benefits
have been computed using a net level premium method including assumptions as to
investment yields ranging from 2 1/2% to 11 1/2%. Mortality, withdrawals and
other assumptions are based either on the Company's past experience or various
actuarial tables modified as necessary for possible unfavorable variations.
Future policy benefits for annuities represent the policyholders' accumulated
value that includes accrued interest at the credited rate and excludes any
provision for surrender charges.
Policy claims: The liability for life and health policy claims is based
upon the aggregate of claim estimates for reported and unreported losses based
upon the Company's experience. The methods for making such estimates and
establishing the resulting liabilities are continually revised and updated and
any changes resulting therefrom are immediately charged or credited to income
(loss) in the periods in which they are made. As a result of various reserving
factors, including higher lapse rates, policy changes, and claims processing
problems as described in Note T, the Company provided additional reserve
strengthening of approximating $6,000 during the fourth quarter by 1998.
Reinsurance: The Company uses reinsurance to limit the impact of large
losses by spreading the risk, and therefore limiting adverse claims experience.
A significant portion of the reinsurance is effected under co-insurance and/or
quota-share reinsurance contracts and, in some instances, by excess-of-loss
reinsurance contracts. The Company's consolidated statements of operations
present premium on a gross basis before reinsurance ceded together with the
ceded premiums while policy benefits are presented net of reinsurance and
commissions are presented net of reinsurance allowances.
Earnings (loss) per share of common stock: The Company presents basic
and diluted earnings per share. Equivalents including warrants, stock options,
and preferred stock were anti-dilutive in 1998 and 1997.
Reclassifications and restatement of prior year amounts: Certain prior
year amounts have been reclassified to conform to the current year's
presentation.
Impairment of Long-lived Assets: Long-lived assets and certain
identifiable intangibles including goodwill are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. At December 31,1998 no assets were deemed to have been
impaired. During 1997 the Company wrote off certain computer hardware,
equipment, software and goodwill as described in Note Z.
F-9
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In 1998, the Company adopted Statement of Financial Accounting Standard
No. 130, "Reporting Comprehensive Income". This statement establishes rules for
the reporting of comprehensive income and its components. Comprehensive income
consists of unrealized appreciation and deprecations on available for sale
securities, which prior to adoption were reported separately in shareholders
equity.
Recent accounting standards: In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments" ("SFAS 133"). SFAS 133 establishes
accounting and reporting standards for derivative instruments and for hedging
activities. SFAS 133 requires that an entity recognize all derivatives as either
assets or liabilities and measure those instruments at fair market value. Under
certain circumstances, a portion of the derivative's gain or loss is initially
reported as a component of other comprehensive income and subsequently
reclassified into income when the transaction affects earnings. For a derivative
not designated as a hedging instrument, the gain or loss is recognized in income
in the period of change. Presently, the Company does not use derivative
instruments either in hedging activities or as investments. Accordingly, the
Company believes that adoption of SFAS 133 will have no impact on it financial
position or results of operations.
The American Institute of Certified Public Accountants issued Statement
of Position No. 97-3 ("SOP 97-3"), "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments". SOP 97-3 provides guidance for
determining whether an entity should recognize a liability for guaranty-fund and
other assessments. In addition to the disclosure requirements, SOP 97-3 provides
guidance on how to measure the liability and criteria for when an asset may be
recognizd for a portion or all of the assessment liability or paid assessment
that can be recovered through premium tax offsets or policy surcharges. SOP 97-3
is effective for financial statements for fiscal years beginning after December
15, 1998. Management believes that this accounting pronouncement will not have a
material impact on the Company's financial statements.
Note C - Acquisitions of Subsidiaries and Business
Effective March 1, 1996, PILIC acquired all of the issued and
outstanding stock of Union Benefit Life Insurance Company, a Pennsylvania stock
life insurance company, ("UBLIC") for an amount equal to its adjusted capital
and surplus (approximately $3,750), $500 in cash, plus the issuance of 100,000
shares of PAMCO's common stock. The shares issued are registered securities but
have trading restrictions attached. The Company has changed UBLIC's name to
PALHIC. Concurrently, the Company, PALHIC and PILIC entered into an agreement
for the purchase and sale of the PALHIC business with Life and Health Insurance
Company of America, a Pennsylvania insurer ("LHI"), pursuant to which all of the
insurance business of PALHIC was purchased by LHI immediately prior to the
purchase of the PALHIC stock by PILIC. The purchase price payable by LHI to
PALHIC for the purchase of the PALHIC business was $1,800. PALHIC is licensed to
transact life, accident and health insurance in forty (40) states and the
District of Columbia. PALHIC began underwriting the Company's life, accident and
health insurance products in 1997. This transaction was accounted for as a
purchase . On December 31, 1998 the Company sold all of the outstanding shares
of PALHIC to Central Reserve Life Insurance Company ("CRLC") for $5,600 which
approximates PALHIC's capital and surplus. The Company recognized, loss of
approximately $1,300 on the sale of PALHIC.
Effective May 1, 1996, the Company acquired all of the issued and
outstanding stock of NIA Corporation ("NIA"), d/b/a National Insurance
Administrators, and its wholly owned subsidiary, American Brokerage Corporation
("ABC") from MidAmerica Mutual Life Insurance Company ("MAM") for $254 of cash
and 50,000 shares of PAMCO's common stock. NIA and ABC are Colorado
corporations. NIA, a third party administrator, and ABC, an insurance marketer,
collectively design, market and service private-label health insurance plans. As
a part of this transaction, PILIC assumed approximately 3,500 in-force
"HealthQuest" medical policies originally underwritten by MAM and its
subsidiaries. This transaction was accounted for as a purchase. On December 31,
1998 the Company sold all of the outstanding shares of NIA to CRLC. The Company
recognized a gain of approximately $300 on the sale of NIA.
F-10
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Effective January 1996, the Company acquired all of the stock of Richard
E. Field & Associates, Inc., d/b/a REF & Associates, Inc. ("REF"), for 610,000
shares of PAMCO's common stock. REF, a California corporation, is engaged in
marketing certain life and health insurance products of PILIC. This transaction
was accounted for as a pooling of interests. REF did not conduct any business in
1998.
On August 15, 1996, the Company acquired Coastal Services Eastern, Inc.
("CSE") for 123,937 shares of the Company's common stock. CSE's sole business
was providing the Company with policy and claims administration at the Company's
facility using CSE's administration system along with its employees. This
transaction was accounted for as a purchase.
CSE did not conduct any business in 1998.
In February 1998 the Company sold for $4,000, 49% of Montgomery
Management Corporation ("MMC") Common Stock along with a warrant to purchase an
additional 31% of MMC's Common Stock for one dollar. During the fourth quarter
of 1998 the buyer exercised the warrant to purchase the additional 31% of MMC's
Common Stock for $8. The Company recognized a $4,008 pre-tax gain on the sale of
MMC and now accounts for MMC on the equity basis of accounting. PILIC, continues
to assume via reinsurance approximately 30% of the premiums, benefits and
expenses of the stop-loss business administered by MMC.
Note D - Losses and Uncertainties
The Company has incurred costs to develop and enhance its technology,
to create and introduce its website, to establish marketing, insurance carrier
and claims administration relationships. As a result, the Company has incurred
significant losses and expects to continue to incur losses on a quarterly basis
at least through 2000. The Company currently intends to increase, substantially,
its operating expenses as a result of the Company's strategic alliances, to fund
increased sales and marketing, to enhance its existing web site and to fund
increased salaries and other costs. Consequently, the Company expects negative
cash flow from operations to continue for the foreseeable future as it continues
to develop and market its Internet-based health insurance business.
HealthAxis is offering approximately $15,000 of Series C Preferred
Stock solely to "accredited investors" (as defined in Rule 501 of Regulation D
under the Securities Act) of which $8.8 million was received on March 30, 1999.
The net proceeds from the sale of the Series C Preferred Stock are anticipated
to be $14,000 and will be used to fund amounts due under the Company's strategic
alliance agreements with AOL, Lycos and CNet through the end of fiscal 1999 and
the balance will be used for working capital and other general corporate
purposes. Although no assurance can be given that the Company will complete the
offering of Series C Preferred Stock for the maximum amount offered, the Company
believes that the $14,000 net proceeds together with its current cash and cash
equivalents will be sufficient to fund current operations and amounts due to
AOL, Cnet and Lycos in the near term. However, subsequent equity or debt
financings may be necessary after 1999 to enable the Company to continue to
implement its current business strategy. See Note BB.
Management believes the sale of PALHIC, MMC and the reinsurance of the
group medical business will enable the Company to more sharply focus its efforts
on its remaining insurance operations including military life, stop loss and
HealthAxis.
F-11
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note E - Investments and Financial Instruments
Available-for-sale securities consisted of the following:
December 31, 1998
---------------------------------------------------------------------------------------
Amortized Unrealized Reported
Type of Investment Cost Cost Gains Losses Fair Value
------------------ ---- ---- ----- ------ ----------
Fixed maturities:
United States Government
and Agencies $ 28,315 $ 28,331 $ 909 $ 16 $ 29,224
Public Utilities 292 293 12 0 305
Corporate 2,211 2,231 121 1 2,351
-------- -------- ------- ------ --------
Total fixed maturities $ 30,818 $ 30,855 $ 1,042 $ 17 $ 31,880
======== ======== ======= ====== ========
December 31, 1997
---------------------------------------------------------------------------------------
Amortized Unrealized Reported
Type of Investment Cost Cost Gains Losses Fair Value
------------------ ---- ---- ----- ------ ----------
Fixed maturities:
United States Government
and Agencies $ 42,114 $ 42,079 $ 428 $ 198 $ 42,309
Public Utilities 788 790 8 0 798
Corporate 1,960 1,976 52 0 2,027
-------- -------- ------- ------ --------
Total fixed maturities $ 44,862 $ 44,845 $ 488 $ 198 $ 45,134
======== ======== ======== ======= ========
F-12
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Summary of net changes in unrealized appreciation and depreciation of
investment securities was as follows:
Year ended
December 31, December 31,
1998 1997 1998 1997
------- ------- ------- -------
Net Unrealized Appreciation (Depreciation) on Bonds
Unrealized gains (losses), pre-tax
Gains $ 1,042 $ 487 $ 555 $ 99
Losses (17) (198) 181 463
------- ------- ------- -------
Net gains (losses) 1,025 289 736 562
Deferred federal income tax (provision) benefit (359) (101) (258) (197)
------- ------- ------- -------
Net unrealized appreciation (depreciation) of bonds $ 666 $ 188 $ 478 $ 365
======= ======= ======= =======
Net Unrealized Appreciation (Depreciation) on Stocks
Unrealized gains (losses), pre-tax
Gains $ 0 $ 0 $ 0 $(1,311)
Losses 0 (4) 4 278
------- ------- ------- -------
Net gains (losses) 0 (4) 4 (1,033)
Deferred federal income tax (provision) benefit 0 1 (1) 362
------- ------- ------- -------
Net unrealized appreciation (depreciation) of bonds $ 0 $ (3) $ 3 $ (671)
======= ======= ======= =======
Changes in fair value of bonds were generally attributable to changes
in interest rates. The Company's bond investments are comprised of high-quality
investment-grade securities.
Fair values of bond investments in good standing are principally a
function of current interest rates, which are not considered in computing
related future liabilities to contract holders. The presentation of estimated
values for assets based on current interest yields without a corresponding
revaluation of contract holder liabilities can be misinterpreted.
The Company has various financial assets and liabilities (including
cash and invested assets, future policy benefits and notes payable) outstanding
at December 31, 1998. Management believes that the book value of these financial
instruments approximates their fair values because such instruments carry
interest rates which approximate market or the amounts involved are not
material.
Bond investments on deposit as required by regulatory agencies were
valued at approximately $8,846 at December 31, 1998. In addition, approximately
$1,210 of bonds or other interest bearing deposits have been placed in escrow
with a bank in connection with certain reinsurance agreements (see note W).
F-13
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The amortized cost and recorded fair value of bonds at December 31,
1998, by contractual maturity, is shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations.
Amortized Recorded Fair
Contractual Maturity Cost Value
-------------------- --------- -------------
Within one year $ 241 $ 254
After one year but within five years 13,185 13,548
After five years but within ten years 8,787 9,335
Over ten years 5,126 5,168
-------- --------
27,339 28,305
Mortgage-backed securities 3,516 3,575
-------- --------
$ 30,855 $ 31,880
======== ========
Proceeds from sales of debt securities during 1998, 1997 and 1996 were
$11,245, $35,848 and $16,719, respectively. Gross gains of $0, $455 and $200 in
1998, 1997 and 1996, respectively, and gross losses of $0, $92 and $123 in 1998,
1997 and 1996, respectively, were realized on those sales.
Equity securities representing 100,000 shares of National Media Corp.
and 108,119 shares of Loewen common stock (acquired as a result of litigation)
were sold during 1997.
Net investment income consisted of the following:
1998 1997 1996
------- ------- -------
Bonds $ 2,636 $ 3,293 $ 3,072
Equity securities 293 14 39
Mortgage loans 21 27 28
Real estate 386 250 160
Policy loans 75 19 22
Cash and cash equivalents 482 329 244
Other 72 116 36
------- ------- -------
3,965 4,048 3,601
Investment expenses (201) (561) (321)
------- ------- -------
Net investment income $ 3,764 $ 3,487 $ 3,280
======= ======= =======
F-14
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note F - AOL Interactive Marketing Agreement
HealthAxis's Amended and Restated Interactive Marketing Agreement ("IM
Agreement") with AOL, dated November 13, 1998, provides that HealthAxis will be
the exclusive third-party direct marketer of managed-care and indemnity health
insurance policies, dental insurance, vision insurance, prescription coverage,
critical care insurance and long-term care insurance coverage and, subject to
certain restrictions, the non-exclusive third party marketer of life and
long-term disability (collectively, the "Products") for individuals and groups
of less than fifty individuals in the United States via AOL's online service.
Under the IM Agreement, AOL will advertise the Products to its subscribers on
AOL's online network and the Products will be sold online through HealthAxis's
web site. The amount of promotions that AOL will provide HealthAxis is
contingent upon HealthAxis's ability to offer policies in all of the fifty
states, the quality of the policies offered, the adherence of HealthAxis to
AOL's standards and other similar factors. The IM Agreement's initial term ends
January 31, 2000, and can be extended for a renewal term of two additional years
at HealthAxis's election. Upon expiration of both the initial and the renewal
terms, AOL may renew the IM Agreement for additional one-year terms. See Note AA
Under the terms of the IM Agreement, HealthAxis shall make payments to
AOL of $10,000 for the initial term (of which $8,500 has been paid and is
accounted for as prepaid interactive marketing expense and the remaining $1,500
is due during 1999) and $33,500 due in 2000 for the renewal term. HealthAxis
also has agreed to pay administrative fees to AOL if approved applications
exceed certain thresholds. See Note AA
Under the original IM Agreement, PAMCO issued to AOL warrants to
purchase 300,000 shares of PAMCO's common stock at an exercise price of $4.48
per share for a period of seven years. In addition, warrant agreements executed
in connection with the amendment of the IM Agreement provide that AOL shall
receive immediately exercisable warrants to purchase 300,000 shares of
HealthAxis's or PAMCO's common stock, or any combination thereof, for an
aggregate of 300,000 shares. The exercise price of the warrant to purchase
shares of PAMCO's common stock is $3.38 per share and is exercisable for a
period of nine years commencing November 13, 1998. The warrants to purchase
shares of HealthAxis's common stock has an exercise price of $1.77 per share and
are exercisable for a period of nine years commencing November 13, 1998. The
fair value of these warrants (approximately $2,651) was accounted for as a
capital contribution from PAMCO and a prepaid interactive marketing expense. If
HealthAxis renews the IM Agreement, then PAMCO will issue warrants to AOL for
the purchase of up to 300,000 additional shares of PAMCO's common stock at an
exercise price of $5.15. These warrants shall be exercisable for a period of
seven years commencing April 1, 2000, vesting quarterly. HealthAxis and PAMCO
also granted AOL (including any transferee or successor thereof) certain
registration rights with respect to shares of HealthAxis' and PAMCO's common
stock acquired upon the exercise of the warrants granted to AOL.
F-15
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note G - CNet Promotional Agreement:
HealthAxis's amended agreement with CNet provides that CNet will
promote HealthAxis as its exclusive provider of medical and PPO, dental, vision,
prescription, long term care, and long term disability insurance through the
Internet and television, for a total approximating $2,400 (of which $500 has
been accounted for as advertising and promotional expense). The balance of
$1,900 will be paid in two increments of $1,008 (in 1999) and $882 (in 2000) and
accounted for as prepaid interactive marketing expense and amortized over the
initial term of the agreement. HealthAxis may, at its option, extend the
agreement during a renewal term until March 31, 2001 by paying CNet an
additional $7,500 of which $1,875 and $5,625 would be due in 2000 and 2001,
respectively. In addition, HealthAxis shall pay to CNet certain fees based upon
the success of sales from the co-branded web site.
Since signing the original agreement CNet and Snap.Com have become
separate entities. Consequently, CNet and Snap.Com have extended an offer
whereby they are requesting HealthAxis to separate the CNet agreement into two
agreements with CNet and Snap.Com. If the agreement is split, the payments as
discussed above will remain substantially the same. HealthAxis is currently
negotiating with both companies and has a verbal agreement to suspend the
payments due in 1999 until such time as the new arrangement can be mutually
agreed upon.
F-16
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note H - Lycos Promotional Agreement
HealthAxis's amended agreement with Lycos provides that Lycos will make
HealthAxis the exclusive provider of medical, HMO, PPO, indemnity, dental,
vision, prescription, long term care, and long term disability insurance through
the Internet, for total payments approximating $9,060 (of which $800 has been
paid and accounted for as prepaid interactive marketing expense) during the term
of the agreement which shall extend for twenty-four months from the launch of
the co-branded version of HealthAxis's site expected to be on or about May 31,
1999. Of the remaining $8,260 payments to Lycos, $1,275, $5,345 and $1,640
are due in 1999, 2000 and 2001, respectively. In addition, HealthAxis shall pay
to Lycos certain fees based upon the success of sales from the co-branded web
site.
Note I - HPS E-Commerce Agreement
On May 29, 1998, HealthAxis, PAMCO, and Provident Health Services, Inc.
("PHS"), a wholly-owned subsidiary of PAMCO, entered into an Internet claims
administration agreement with HPS (the "E-Commerce Agreement") which provides
HPS with the right to be the exclusive administrator of all insurance business
sold over HealthAxis' web site and any other form of electronic commerce
("e-commerce") used by HealthAxis underwritten by PILIC and PALHIC during the
term of the E-Commerce Agreement. HealthAxis also agreed to use its best efforts
to provide HPS with the right of first refusal to provide claims administration
services for insurance business sold by HealthAxis but not underwritten by PILIC
and PALHIC that may require the services of a third party administrator.
Under the terms of the E-Commerce Agreement, HealthAxis is required to
pay HPS 4% of the transaction fee revenue (the "License Fees") generated from
insurance companies whose products are available for sale through HealthAxis
("Carrier Partners") for various services to be provided, including but not
limited to, a transaction fee on each item of e-commerce transacted through
HealthAxis web site, excluding docking, advertising, front holding fees and
other fees for the right to participate in the sale of insurance products over
the HealthAxis web site or any other form of e-commerce, during the term of the
E-Commerce Agreement.
In the event of a change in control or an initial public offering by
HealthAxis, the Company will have the right to terminate HPS' right to License
Fees by paying HPS the lower of: (i) eight times the HPS License Fees earned by
HPS in the two quarters prior to the change in control as defined in the
E-Commerce Agreement or initial public offering, or (ii) the projected License
Fees based on the pro forma projections used for purposes of an HealthAxis
public offering or spin-off from PAMCO.
F-17
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Under the E-Commerce Agreement, HealthAxis received from HPS $750 as an
off-set against the fees paid to AOL as provided in the IM Agreement which was
accounted for as a deferred credit and amortized as a reduction to advertising
and promotional expense over the term of the E-Commerce Agreement. In addition,
PAMCO issued to HPS warrants to purchase 100,000 shares of PAMCO's common stock
at an exercise price of $9.00 per share, for a period of two years. In the event
that PAMCO issues any warrants after the effective date of the E-Commerce
Agreement and before six months following the effective date of the E-Commerce
Agreement (excluding warrants or options issued to employees, consultants, or
other interactive marketing partners), having an exercise price lower than $9.00
per share, PAMCO agrees that the exercise price per share shall be reduced to
such lower exercise price. The E-Commerce agreement shall further provide that
PAMCO shall have the right, upon 30 days notice, to cancel any unexercised
warrants in the event that the average weekly last-sale price for shares of
PAMCO common stock over any consecutive eight week period exceeds $12.825. The
fair value of the warrants (approximately $160) was accounted for as a capital
contribution from PAMCO and a reduction of the deferred credit.
Note J - Prepaid Interactive Marketing Expense
As described in Notes F, G and H HealthAxis has made payments and
issued warrants aggregating $12,240 which have been charged to prepaid
interactive marketing expense. These payments and warrants issued under the
terms of the respective agreements with AOL, Cnet and Lycos represent
exclusivity and impression advertising costs of $3,527 and $8,713, respectively.
Included in advertising and promotional expense is amortization of prepaid
interactive marketing expense of $585 consisting of exclusivity expense and
impression advertising of $381 and $204, respectively.
Note K - Deferred Policy Acquisition Costs
Effective December 31, 1998, all remaining unamortized policy
acquisition costs for the Company's group medical products sold or reinsured
during 1998 was netted against the ceding commission received as described in
Note W. Accordingly, deferred policy acquisition costs as of December 31, 1998
and 1997 relate only to the Company's individual life business. Based on an
analysis by the Company's appointed actuary, management believes the estimated
future profitability of the individual life business exceeds the unamortized
deferred policy acquisition costs for life products.
Note L - Loans Receivable - Officer and Director and Shareholder
Loans receivable, of related parties interest at rates ranging from
5.33% to 9.5%, are generally due in April 2000 and collateralized primarily by
the Company's common stock.
F-18
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note M - Loans Payable and Capital Lease Obligations
The Company has a bank line of credit aggregating $1,000 and bearing
interest at 1% above the prime rate. Average borrowings approximated $83 and
$131 in 1998 and 1997, respectively, and the weighted average interest rate was
approximately 5.0% and 6.7% in 1998 and 1997, respectively. The maximum amount
borrowed was $1,000 in both years.
As described in Note Z, the Company received $5,000 from HPS, which has
been accounted for as a loan payable discounted at the Company's recent
historical borrowing rate of 9.25%. The net discounted loan of $3,865 is payable
in 60 monthly installments of $95 including principal and interest commencing in
March 1998.
During 1997, the Company entered into capital lease obligations with
Harleysville National Bank in the amount of $1,390 on data processing and other
equipment which are included in property and equipment. The obligation in 1998
and 1997 was $840 and $1,151, respectively, with $101 and $92, respectively of
interest being paid on these leases.
Note N - Income Taxes
Significant components of deferred taxes consisted of the following:
1998 1997
----- ----
Deferred tax assets:
Policy reserves $ 2,542 $ 2,589
Policy acquisition costs 0 51
Advance premiums 2 427
Post employment benefits 207 207
Net operating loss carryforwards 5,308 944
Accrued expense 49 366
Unearned ceding commission 1,750 --
Goodwill related to NIA 258
Other, net 555 432
-------- --------
10,413 5,274
Valuation allowance for deferred tax assets 9,098 3,923
-------- --------
1,315 1,351
-------- --------
Deferred tax liabilities:
Policy acquisition costs 187 --
Real estate 720 733
Unrealized appreciation of investments 359 100
Deferred and uncollected premiums, net 408 618
-------- --------
1,674 1,451
-------- --------
Net deferred tax asset (liability) $ (359) $ (100)
======== ========
F-19
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The Company and its subsidiaries have a net operating loss carryforward
("NOLs") approximating $18,400, of which is available to offset future taxable
income through 2013. Approximately $4,100 of the NOLs result from a 1989
acquisition and expire between 1999 and 2004 and are subject to annual
limitations approximating $100, thereby significantly reducing their ultimate
utilization. The NOLs included as deferred tax assets have been reduced to
exclude the estimated amount of carryforwards that are unavailable due to
certain limitations.
The Company has established a valuation allowance for deferred tax
assets reflecting uncertainty as to whether the deferred tax asset is fully
realizable. The change in valuation allowance in 1998 amounting to $5,175
results primarily from the increase in NOLs.
F-20
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The reconciliation of income tax expense (benefit) to the amount
computed by applying the appropriate statutory income tax rate (35%) to income
(loss) before income taxes is as follows:
Years Ended December 31,
1998 1997 1996
------ ------ ------
Amount computed at statutory rate $(4,623) $(7,740) $ 7,881
Change in valuation allowance 5,175 2,324 (1,534)
Permanent differences (167) 600 (2)
State income taxes, net of tax benefit 302
Reversal of prior year federal income taxes (1,031)
Other, net (385) 227 (250)
------- ------- -------
Total income tax expense (benefit) $(1,031) $(4,589) $ 6,397
======= ======= =======
In accordance with the Life Insurance Company Income Tax Act of 1959, a
portion of the Insurance Subsidiaries' statutory income was not subject to
current income taxation but was accumulated in an account designated
Policyholders' Surplus. Under the Tax Reform Act of 1984, no further additions
may be made to the Policyholders' Surplus Account for tax years ending after
December 31, 1983. The balance in the account of approximating $2,400 at
December 31, 1998 would result in a tax liability of $840 (at a 35% rate), only
if distributed to shareholders or if the account balance exceeded a prescribed
maximum. No income taxes have been provided on this account because, in
management's opinion, the likelihood that these conditions will be met is
remote. "Shareholders' Surplus" represents an accumulation of taxable income
(net of tax thereon) plus the dividends-received deduction, tax-exempt interest,
and certain other special deductions as provided by the Act. At December 31,
1998, the balance in the "Shareholders' Surplus" account amounted to
approximately $3,500. There is no present intention to make distributions in
excess of "Shareholders' Surplus".
Note O - Minority Interest in HealthAxis.com, Inc.
As of December 31, 1998, 16,172,760 shares of HealthAxis common stock
were issued and outstanding. Of this amount, 13,807,395 or approximately 85%
were held by PAMCO and 2,365,365 or approximately 15% were held by HPS. The
minority interest in HealthAxis represents HPS' approximate 15% of HealthAxis'
equity.
The Series B Cumulative Preferred Stock, par value $1.00 per share (the Series B
Preferred Stock), held by AOL as described in Note P is also treated as
minority interest.
F-21
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note P - HealthAxis.com, Inc. Series B Cumulative Convertible Preferred Stock
During 1998, HealthAxis issued 625,529 shares of Series B to AOL at
$4.40 per share for an aggregate purchase price of $2,750, less issuance costs
amounting to $51, of which a portion of such net proceeds was used to pay
amounts due to AOL under the IM Agreement.
Holders of the Series B Preferred Stock will be entitled to cumulative
dividends accruing from the date of issuance, as and if declared by the Board of
Directors at the annual rate of $.13 per share. If all accrued dividends on the
Series B Preferred Stock have not been paid or set apart for payment, no
dividends or other distributions may be declared and paid or set apart for
payment upon the Common Stock, Series A Preferred Stock or any other class of
securities of HealthAxis having a dividend or distribution preference junior to
the Series B Preferred Stock (the "Junior Stock"); and HealthAxis shall not
repurchase, redeem or otherwise acquire any shares of its Common Stock, Series A
Preferred Stock or any series of Junior Stock, other than the repurchase by
HealthAxis of Common Stock from any HealthAxis employee upon the cessation of
the employee's employment with HealthAxis. Holders of Series B Preferred Stock
are not entitled to participate in any other dividends or other distributions
(cash, stock or otherwise) declared or paid on or with respect to the Common
Stock or any other class of stock of HealthAxis.
Holders of the Series B Preferred Stock are entitled to vote on all
matters as to which holders of Common Stock are entitled to vote. The holders of
each share of Series B Preferred Stock entitles the holder to the number of
votes equal to the nearest whole number of shares of Common Stock into which the
holder's Series B Preferred Stock is convertible under the holder's optional
conversion rights. Generally, the holders of Series B Preferred Stock shall vote
together with the holders of Common Stock and the Series A Preferred Stock as
one class.
In the event of any dissolution, liquidation or winding up of the
affairs of HealthAxis, after payment or provision for payment of the debts and
other liabilities of HealthAxis, the holders of the Series B Preferred Stock
shall be entitled to receive, out of the assets of HealthAxis legally available
for distribution to its shareholders, the amount of approximately $4.40 in cash
for each share of Series B Preferred Stock, plus an amount equal to all
dividends accrued and unpaid on each such share up to the date fixed for
distribution, before any distribution may be made to the holders of HealthAxis's
Common Stock, Series A Preferred Stock or any series of Junior Stock.
Holders of the Series B Preferred Stock have the option within six
months after the later of the occurrence of a Trigger Event to redeem any or all
of the shares of Series B Preferred Stock at a redemption price per share equal
to the original issuance price plus an amount that would yield a total
annualized return of 10%. As of December 31, 1998, HealthAxis has recorded $36
as an accretion to the stated value of the Series B Preferred Stock with a
corresponding dividend charge to retained additional paid in capital.
F-22
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
A "Trigger Event" means: (i) January 31, 2002, if by that date,
HealthAxis has not consummated an underwritten public offering of newly issued
Common Stock pursuant to a registration statement filed under the Securities
Act, at a net offering price per share of Common Stock that represents a
pre-offering market capitalization of not less than $150,000 and with aggregate
proceeds of not less than $25,000, (ii) failure to renew by HealthAxis or a
material breach by any party other than AOL or termination of the IM Agreement
with AOL, (iii) the date of the occurrence of a liquidation of HealthAxis (as
defined above) or (iv) March 31, 1999, if by that date, HealthAxis has not
consummated an equity financing yielding aggregate gross proceeds to HealthAxis
of not less than $10,500 at a price per share of at least $3.74 (a "Qualified
Financing"). Item (iv) was amended as described in Note BB.
Shares of Series B Preferred Stock are convertible at any time, at the
option of the holder, into Common Stock at a price equal to the original
issuance price ($4.40 per share) divided by the Conversion Price which is
defined as the original issuance price adjusted for future issuances of common
stock as defined in the preferred stock agreement.
All of the outstanding shares of Series B Preferred Stock shall be
converted into a number of shares of Common Stock at the Conversion Price (as
defined above) upon the consummation of an underwritten public offering of the
Common Stock of HealthAxis at a net offering price per share that represents a
pre-offering market capitalization of not less than $200,000 and aggregate
proceeds (net of underwriting commissions and discounts) to HealthAxis of not
less than $25,000.
In connection with AOL's purchase of the Series B Preferred Stock,
HealthAxis and AOL entered into a Registration Rights Agreement ("Registration
Agreement") which sets forth the rights of AOL in connection with the public
offering of Common Stock acquired in connection with the conversion of Series B
Preferred Stock or other shares of Common Stock acquired through the exercise of
warrants granted to AOL.
The Series B Preferred Stock is not subject to any sinking fund or
other similar provisions. The holders of Series B Preferred Stock are not
entitled to any preemptive rights.
The Stock Purchase Agreement, dated November 13, 1998, related to AOL's
purchase of the Series B Preferred Stock (the "Stock Purchase Agreement")
provides that HealthAxis with certain exceptions as outlined in the agreement
may not issue, sell, exchange or reserve or set aside for issuance any Common
Stock, any other equity security of HealthAxis, or any convertible debt security
or debt security with equity features or any option, warrant or right to
subscribe for, or purchase any equity or debt security of HealthAxis unless
HealthAxis offers to sell AOL its proportionate interest (as defined in the
Stock Purchase Agreement) of such securities at a price and terms specified by
HealthAxis, which offer is required to remain open for 30 days. These
above-described rights granted to AOL do not apply to and terminate upon an
underwritten public offering with a pre-offering market capitalization of
$150,000 which results in aggregate net cash proceeds of not less than $25,000.
HealthAxis and PAMCO also agreed that, provided AOL owned or possessed
the right to acquire at least 1% of HealthAxis's outstanding Common Stock,
HealthAxis would be precluded from certain transactions without the prior
consent of AOL.
F-23
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In addition, the Stock Purchase Agreement provides that provided AOL
owns or has the right to acquire more than 1% of the outstanding Common Stock of
HealthAxis, neither HealthAxis or PAMCO, nor shall PAMCO permit HealthAxis or
any of its other subsidiaries, without the prior written consent of AOL, to take
any action or enter into any transaction which under the circumstances under
which it was entered into, could reasonably be foreseen to prejudice the
interest of HealthAxis in favor of PAMCO or any PAMCO subsidiary.
Notwithstanding the foregoing, the prior consent of AOL shall not be required to
engage in an equity offering generating proceeds of at least $10,500 at a price
per share of at least $3.74 (as adjusted for stock splits, dividends
recapitalizations and like occurrences) as described in the Certificate of
Designation related to the Series B Preferred Stock. Item (iv) was amended as
described in Note BB.
The Stockholders' Agreement dated, November 13, 1998 (the
"Stockholders' Agreement") between HealthAxis, AOL, HPS, PAMCO, PILIC and
Messrs. Ashker and Clemens provides that in the event a Selling Group
Stockholder, which includes all parties to the Stockholders' Agreement other
than AOL and HealthAxis, intends to sell or transfer any shares of capital stock
of HealthAxis, such Selling Group Stockholder shall give notice to AOL of the
name and terms offered by the proposed purchaser and provide AOL with the right
to purchase such shares at the same price offered by the proposed purchaser for
a period of 30 days. If AOL does not elect to purchase such shares within 30
days, the Selling Group Stockholder may sell such shares to the proposed
purchaser within 90 days on the same terms, including price, contained in the
notice to AOL. If the sale is not effective within 90 days, additional notice to
AOL is required. A purchaser of the shares held by any Selling Group Stockholder
must agree to be bound by the terms of the Stockholders' Agreement as a
condition to the transfer. If any Selling Group Stockholder receives any bona
fide offer from a third party to purchase any shares of stock covered by the
Stockholders' Agreement, such stockholder shall provide notice of such offer to
AOL and shall not sell any stock of HealthAxis unless the terms of the offer are
extended to AOL. See Note BB.
If PAMCO or any affiliate of PAMCO that holds shares of HealthAxis
("PAMCO Group Holder') intends to engage in a "Change of Control Transaction,"
as defined in the Stockholders' Agreement such entity must provide AOL with 30
days prior written notice of such transaction and may not consummate such
transaction unless the acquiror agrees to acquire all of the stock owned by AOL
under the terms and procedures set forth in the Stockholders' Agreement.
The Stockholders' Agreement terminates upon: (i) an underwritten public offering
by HealthAxis which generates net cash proceeds of $25,000 and has a
pre-offering market capitalization of not less than $150,000; or (ii) with
respect to a particular party to such agreement, upon the transfer of all of the
stock owned by such stockholder.
See Note BB, subsequent events, for additional information.
F-24
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note Q - Stockholders' Equity and Dividend Restrictions
Series A Cumulative Convertable Preferred stock, $1 par value, entitles
its holder to vote on an "as-converted" basis at a rate of four common votes per
one share of Preferred Stock, to receive an annual cash dividend of $.25 per
share, to convert after March 1995 into either common voting stock or Class A
Common Stock on a share-for-share basis (each Class A Common Share has four
votes) adjusted for future dilution and to receive $3.65 per share plus all
accrued and unpaid dividends in the event of voluntary or involuntary
liquidation and may be redeemed at the option of the Company on June 30, 1998,
at the greater of (a) the current market price of the Class A Common Stock or
the common stock or (b) $5.45 per share, plus in each case all accrued and
unpaid dividends. Redemption payments shall be payable in up to three annual
installments, with interest at the then-current prime rate. However, no
redemption shall be made unless, immediately thereafter, the Company and all of
its subsidiaries shall be in compliance with the applicable laws, rules and
regulations relating to insurance companies in the various states in which a
subsidiary of the Company may be licensed to do business. During the fourth
quarter of 1998, 23,650 shares of Series A Cumulative Convertible Preferred
stock were converted to common stock on a share-for-share basis.
Series B Preferred Stock, $1 par value, is identical to the Series A
Preferred stock except it has only one vote per share. During 1996 all of the
outstanding Series B Preferred stock was converted into common stock on a
share-for-share basis. See Note BB.
Dividend restrictions: Dividends paid by the Company over and above the
financial assets of PAMCO are dependent on the ability of PILIC and HealthAxis
to pay dividends to PAMCO. The payment of dividends by PILIC is dependent upon a
number of factors including earnings and financial condition, business needs and
capital and surplus requirements as well as applicable regulatory restrictions.
Under Pennsylvania law, PILIC is currently unable to pay dividends without the
prior approval of the Pennsylvania Insurance Commissioner as a result of PILIC's
statutory unassigned deficit of $20,139 which excludes common stock and
additional paid-in capital amounts. Dividends paid by HealthAxis to PAMCO and
HPS are subject to restrictions set forth in the Certificate of Designation
related to HealthAxis' Series A and Series B Preferred Stock and subject to
restrictions set for in HealthAxis' Certificate of Designation related to the
Series C Preferred Stock once issued (see note). PAMCO, PILIC and HealthAxis
individually neither has paid nor anticipates paying a cash dividend in the
foreseeable future.
F-25
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
At December 31, 1998, PILIC calculated its "Risk Based Capital" (RBC)
utilizing a formula required by the NAIC. The results of this computation shown
in the following table indicate that PILIC's adjusted capital of $5.3 million
exceeded Regulatory Action Level but was below Company Action Level. PILIC's
year end 1998 RBC calculation included approximately $4.8 million of RBC related
to PILIC's one life group health and group life business 100% ceded to RCH
effective January 1,1999. The RBC formula estimates RBC based on a variety of
historical data including 1998 net earned premium. The effects of the
reinsurance agreement between PILIC and RCH on PILIC's RBC calculation will not
be realized until 1999. In concept, Risk Based Capital standards are designed to
measure the acceptable amounts of capital an insurer should have based on
inherent and specific risks of the insurer's business. This formula is a primary
measurement as to the adequacy of total capital and surplus of life insurance
companies. Since PILIC failed to meet its RBC requirement as of December 31,
1998 it may be subject to regulatory action. Insurers failing to meet their RBC
requirement may be subject to scrutiny by its domiciled insurance department and
other insurance departments, which the insurer does business in, and,
ultimately, rehabilitation or liquidation. Management believes that PILIC's
surplus is adequate given its reduced level of business as measured by RBC once
the Reinsurance Agreement with RCH takes full effect.
The Pennsylvania Insurance Department, in which PILIC is domiciled,
recognizes as net income and capital surplus (Stockholders' Equity) those
amounts determined in conformity with statutory accounting principles. The
amounts of statutory net income for the year ended and surplus as of December 31
were as follows:
1998 1997 1996
---- ---- ----
PILIC (1)
Net income (loss) $ (5,671) $(10,385) $ 9,668
Total capital and surplus 4,807 11,408 13,971
Adjusted capital and surplus 5,281 11,968 14,838
Company action level Risk Based Capital 6,938 9,303 6,569
PALHIC
Net income (loss) $ (1,097) $ (862) $ 1,631
Total capital and surplus N/A 4,283 5,351
Adjusted capital and surplus N/A 4,302 5,367
Company action level Risk Based Capital N/A 1,730 19
(1) PILIC's total capital and surplus, adjusted capital and surplus and company
action level Risk Based Capital includes amounts for its subsidiaries
including PALHIC in 1997 and 1996.
(2) PALHIC was sold to CRLC on December 31, 1998.
F-26
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note R - Stock Options and Warrants
Options: The Company has stock option plans which provide for the
granting of options to directors and key employees of the Company and its
subsidiaries and certain field representatives and agents.
The Incentive Stock Option Plan for Employees authorized the granting
of options for up to 650,000 shares of the Company's common stock to key
managerial employees of the Company, which are exercisable for up to five years
at a price not less than the fair market value of the shares on the date of
grant. All options granted under the Incentive Stock Option Plan have been
granted at 100% of the fair market value of the shares on the date of grant. The
Incentive Stock Option Plan for Employees expired during 1996 and the Company
adopted the 1996 Employee Incentive Stock Option Plan ("1996 Employee Plan"),
which was amended in 1997 to increase the number of shares issuable thereunder
from 950,000 shares to 1,250,000 shares of the Company's common stock to key
employees of the Company and its subsidiaries and affiliates, exercisable for up
to five years from the effective date of the grant at a price not less than the
fair market value of the shares on the effective date of grant. All options
granted under the 1996 Employee Plan have been granted at 100% of the fair
market value of the shares on the effective date of the grant, with the
exception of an option granted Mr. Clemens, which was granted at 110% of the
fair market value.
The Non-Qualified Stock Option Plan for Directors ("Directors' Plan")
was amended in 1996 to increase the number of shares authorized for the issuance
thereunder from 585,000 shares to 1,010,000 shares and to incorporate prior
amendments. Options granted under the Directors' Plan are exercisable for up to
ten years from the date of grant at a price of not less than the fair market
value of the shares on the date of the grant. All options granted under the
Directors' Plan have been granted at 100% of the fair market value of the shares
on the date of grant. During 1997, pursuant to the Directors' Plan, the Company
granted to each Director, with the exception of Mr. Clemens, an option to
purchase 30,000 shares of the Company's common stock at an exercise price of
$2.75 per share.
Also during 1997, the Company approved the adoption of a Military Stock
Option Plan and a 1997 Insurance Agent Stock Option Plan ("Agents Plan"),
designed to replace and supercede all previous stock option plans for
non-employee agents. Each Plan is administered by the Option Administration
Committee. Options are granted at fair market value and subject to certain other
vesting or performance conditions, and the Company has reserved 750,000 shares
of the Company's common stock for issuance under each Plan. Options will be
issued under each Plan only to insurance agents who are licensed to sell
insurance by a life insurance subsidiary of the company, and are exercisable for
up to five years from the effective date of the grant.
F-27
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In June 1998, HealthAxis adopted the 1998 Stock Option Plan (the "1998
Stock Option Plan") which provides for the award of options and stock purchase
rights (collectively "Awards") to purchase HealthAxis common stock. Awards for
an aggregate of 2,900,000 shares under the 1998 Stock Option Plan of which
1,956,500 shares have been granted as of December 31, 1998. Of which options to
purchase 991,000, 309,000, 50,000 and 50,000 shares were granted to Mr. Ashker,
Mr. Clemens, Mr. Beausang, Mr.Gillin respectively, and are immediately
exercisable at a price of $1.77 per share having a term of 10 years. Options to
purchase 556,500 shares of HealthAxis common stock awarded at $1.77 per share
were awarded to officers and employees. These options have a term of five years
and vest at a rate of 25% of the initial award on the grant date, 25% of the
initial award on February 1, 1999 and the balance in quarterly installments
thereafter. Options to purchase an additional 96,500 shares of Common Stock were
granted to officers and employees at an exercise price of $4.00 per share. Such
options have a term of five years and vest at a rate of 25% of the initial award
on the grant date, 25% of the initial award on November 20, 1999 and the balance
in quarterly installments thereafter.
Stock Purchase Rights ("SPRs") may be granted either alone, in addition
to, or in tandem with other awards granted under the 1998 Stock Option Plan.
SPRs may not be granted at less than 85% the fair market value on the date of
grant (or 100% of the fair market per share for ten percent shareholders) unless
otherwise determined at the time of grant under the terms of the 1998 Stock
Option Plan, the SPRs shall include a stock repurchase option exercisable by the
Company if the employee is terminated, voluntarily or involuntarily, following
the receipt of the restricted stock.
F-28
The following table lists changes in outstanding stock options for all
of PAMCO Option Plans:
Range of
Number Exercise Weighted Average
of Shares Price Exercise Price
--------- -------- ----------------
Outstanding, January 1, 1996
Exercisable 150,520 1.59 - 4.83 $3.35
Not exercisable 15,250 2.00 - 3.88 2.64
Total outstanding 165,770 1.59 - 4.83 3.29
1996
Granted 1,138,350 3.52 - 12.25 9.18
Exercised 79,275 1.59 - 8.06 3.79
Canceled/expired 0 0.00 0.00
Outstanding, December 31, 1996
Exercisable 356,217 8.38 - 12.25 6.70
Not exercisable 868,617 2.00 - 12.25 9.35
Total outstanding 1,224,845 2.00 - 12.25 8.73
1997
Granted 1,197,000 2.47 - 5.00 4.03
Exercised 30,450 2.00 - 3.64 3.23
Canceled/expired 113,000 2.00 - 10.00 9.43
Outstanding, December 31, 1997
Exercisable 943,972 2.38 - 12.25 5.99
Not exercisable 1,334,423 2.47 - 12.25 6.51
Total outstanding 2,278,395 2.38 - 12.25 6.30
1998
Granted 167,500 4.44 - 6.00 4.97 Weighted Average
Exercised 410258 3.13 - 7.00 4.04 of Remaining
Canceled/expired 278,195 3.52 - 11.00 9.85 Contractual Life
Outstanding, December 31, 1998 ----------------
Exercisable 228,575 2.35 - 3.88 2.93 6.7
Exercisable 206,733 4.00 - 5.00 4.95 3.9
Exercisable 107,075 6.00 - 7.00 6.15 2.6
Exercisable 210,000 8.06 - 8.76 8.72 7.3
Exercisable 166,750 10.00 10.30 2.6
Exercisable 25,000 12.25 12.25 7.8
Not exercisable 160,000 2.35 - 3.88 2.67 6.7
Not exercisable 412,559 4.00 - 5.00 4.82 3.9
Not exercisable 66,500 6.00 - 7.00 6.38 2.6
Not exercisable 174,250 10.00 10.00 2.6
Total outstanding 1,757,442 2.38 - 12.25 6.14 4.6
F-29
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The following table lists options granted by HealthAxis under the 1998
Stock Plan:
Weighted
Average
Number Exercise Weighted Average
of Shares Price Fair Value
--------- -------- ----------------
Granted during 1998 1,956,500 $1.88 $0.38
Outstanding, December 31, 1998
Exercisable 1,515,000 $1.77 $0.36
Exercisable 24,125 $4.00 $0.80
Not exercisable 345,000 $1.77 $0.36
Not exercisable 72,375 $4.00 $0.80
Total outstanding 1,956,500 $1.88 $0.38
The remaining weighted average contractual life for all options granted
and outstanding is approximately 5 years.
In addition, Mr. Clemens directly owns options to purchase 253,376
shares of the Company's Common Stock at $ .9091 per share expiring from time to
time between November 1999 through December 2004. Mr. Clemens indirectly owns
options to purchase 82,080 shares of the Company's common stock at $.9091 per
share expiring from time to time between November 1999 and December 2004. Mr.
Clemens disclaims beneficial ownership of all other options of any partnership
in which Mr. Clemens directly or indirectly is a partner.
In addition, a partnership of which Mr. Clemens is a partner owns
options to purchase 1,000,000 shares of the Company's Common Stock at $ .9091
per share expiring from time to time between November 1999 through December
2004. Mr. Clemens also owns an option to purchase up to 550,000 shares of Series
A Cumulative Convertible Preferred Stock at $3.64 per share (fair market value
at date of grant) exercisable on or before March 31, 2003.
The Stock Option Plan for Executives ("Executive Plan") was amended in
1996 and authorizes the granting of options to purchase up to 3,850,000 shares
of the Company's Series A Cumulative Convertible Preferred Stock ("Series A
Preferred Stock"), which are exercisable for up to ten years from the effective
date of grant at a price not less than the fair market value of the shares on
the date of grant. Also in 1997, the Company granted Mr. Clemens an option to
purchase shares of the Company's Series A Preferred Stock successively upon each
exercise by Mr. Clemens of his existing option and each subsequently granted
option to purchase shares of Series A Preferred Stock from time-to-time, limited
in the aggregate to (i) that the number shares of Series A Preferred Stock
which, when exercised, shall permit Mr. Clemens to acquire the right to vote not
more than 55% of the shares of the Company's common stock owned, either
directly or beneficially, by Mr. Clemens at such time, (ii) the shares of Series
A Preferred Stock which are, as of the date of any such exercise, authorized and
unissued; and (iii) an option to purchase more than 550,000 shares of Series A
Preferred Stock in any six month period shall be prohibited except upon the
occurrence of a "change of control" (within the meaning of the Securities
Exchange Act of 1934, as amended).
F-30
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Warrants: On June 6, 1996, the Company issued 100,000 stock purchase
warrants to an unaffiliated party at $9.00 per share and are exercisable through
June 6, 2001. The Company issued a warrant to an exclusive consultant of the
Company to purchase 100,000 shares of the Company's Common Stock at the market
price per share as of each of January 1, 1996, January 1, 1997, and January 1,
1998, provided PILIC has realized new annualized premium sales production of at
least $35,000, $45,000, and $50,000, respectively, for each of these calendar
years. PILIC has realized the annualized premium threshold for the years ending
December 31, 1996 and 1997, and accordingly, the consultant is entitled to
exercise 100,000 warrants at $7.375 per share for 1996, 100,000 at $14.00 per
share for 1997 and 100,000 at $2.81 per share for 1998.
During 1997 the Company issued warrants to two exclusive insurance
agents, who are also directors of a subsidiary of PAMCO, for the purchase of
50,000 shares of the Company's common stock at $5.00 per share. These warrants
become exercisable throughout 2001. The Company also issued a warrant
exercisable at any time to an employee for the purchase of 25,000 shares of the
Company's common stock at $4.00 per share.
During 1998 the Company issued warrants to AOL and HPS as described in
Notes F and I, respectively and to Lynx to purchase 400,000 shares of PAMCO
common stock at an average price of $4.5160 for a three year period of time in
accordance with the terms of a consulting agreement with Lynx to provide
consulting services in regards to entering into online and internet commerce
agreements and the subsequent development of the Company's capabilities and
business. The warrants, valued at $663, have been accounted for as prepaid
interactive marketing expense of $290 and other operating expenses, net of
ceding allowance and deferred acquisition costs of $373.
Effective January 1, 1996, the Company adopted the disclosure-only
provisions of SFAS 123 "Accounting for Stock Based Compensation." Accordingly,
no compensation cost has been recognized for stock option and warrant grants, to
employees and employee directors. The Company continues to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board opinion No. 25, "Accounting for Stock Issued to
Employees'. Compensation cost for stock options, if any, is measured as the
excess of the quoted market price of the Company's stock at the date of grant
over the amount an employee must pay to acquire the stock. Compensation cost for
shares issued under performance share plan is recorded based upon the current
market value of the Company's stock at the end of each period. Had compensation
cost for the Company's stock option grants been determined based on the fair
value at the date of grants in accordance with the provisions of SFAS 123, the
Company would have amortized the cost over the vesting period of the option
which generally is five years for the 1996 Employee Plan and three years for the
Directors Plan and 1998 Employee Plan. The Company's net income (loss) and net
income (loss) per common share would have been reduced to the following pro
forma amounts:
F-31
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
1998 1997 1996
---- ---- ----
Net income (loss) applicable to common shares
as reported $(12,410) $ (18,573) $ 15,926
pro forma $(13,319) $ (20,505) $ 15,681
Net income (loss) applicable to common shares Basic & Diluted Basic & Diluted Basic Diluted
as reported $(1.20) $ (1.84) $ 1.66 $ 1.36
pro forma $(1.27) $ (2.03) $ 1.63 $ 1.34
The fair value of the options and warrants granted are estimated on the
date of grant using the Black-Scholes option-pricing model. The major
assumptions used and the estimated fair value include no dividends paid, assumed
forfeitures of 10% annually for non-vested options and warrants granted in 1996,
and the following:
Expected Expected Risk Free Weighted
Term Stock Interest Average
In Years Volatility Rate Fair Value
-------- ---------- --------- ----------
For options granted in 1996
1996 Employee Plan 1 - 5 73% 5.55% - 6.32% $3.92
Directors Plan 3 75% 6.32% $4.64
For options granted in 1997
1996 Employee Plan & Employee Warrant 5 63% 5.50% $1.42
Directors Plan 5 63% 5.50% $1.36
Military Market Plan & Warrants 5 63% 5.50% $1.13
For options granted in 1998
1996 Employee Plan & Warrants 1 - 5 57% - 98% 4.48% $3.74
HealthAxis.com, Inc. 1998 Stock Plan 5 100% 4.48% $0.38
Note S - Litigation Settlement, Net of Expenses
The Company received from the Loewen Group, Inc. and Loewen Group
International, Inc. (collectively "Loewen") on April 1, 1996, $3,000 in cash and
718,519 shares of the common stock of Loewen Group to compensate the Company for
damages sustained pursuant to a February 12, 1996 agreement between the Company
and Loewen to settle certain litigation filed by the Company against Loewen. The
settlement, net of legal expenses, was valued at $22,400. The impact on net
income was approximately $14,600, which is net of approximately $7,800 of income
taxes.
F-32
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The Company sold the Loewen stock in 1996 and 1997 realizing a gain of
$2,023 and $961, respectively.
Note T - Commitments and Contingencies
Commitments: The Company has various agreements with AOL, CNet and
Lycos containing future cash and other commitments described in notes F, G and
H.
The Company has an employment contract with Mr. Clemens for a five year
term with an annual base salary of approximately $400.
During 1998, the Company, through its subsidiary NIA, which was sold on
December 31, 1998, leased property under a non-cancable lease within annual
payments approximating $125.
Risks Associated with the Year 2000: The Year 2000 issue is the result
of computer programs being written using two digits rather than four to define
the applicable year. In other words, date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
system failures or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
The Company is conducting an assessment of its own systems to determine
whether its existing systems correctly define the Year 2000. The Company is
conducting an analysis to determine the extent to which the systems of its
suppliers, Distribution Partners, Carrier Partners and other business partners
(insofar as they are material to the Company's business) are subject to the Year
2000 issue. The Company is currently unable to predict the extent to which the
Year 2000 issue will affect its operations, or the extent to which it would be
vulnerable to the Internet partners or claims administrator's failure to
remediate any Year 2000 issues on a timely basis. The failure of an Internet
partner or claims administrator to convert systems on a timely basis in a manner
that is compatible with the Company's systems could have a material adverse
effect on the Company. The Company does not currently have a contingency plan in
place in the event that it or any third party in which it engages in business is
not Year 2000 compliant. In addition, policy purchases are made with credit
cards, and the Company's operations may be materially adversely affected to the
extent its customers are unable to use their credit cards due to the Year 2000
issues that are not rectified by their credit card vendors.
Litigation: The Company is involved in litigation in the customary
settlement of insurance claims. Management is of the opinion that neither the
litigation nor these claims will have a material adverse effect on the results
of operations or financial position of the Company.
F-33
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
In the course of the on going monitoring and evaluation of HPS'
performance under the HealthPlan Services agreement dated October 1997, the
Company has determined that the level of service by HPS is below the minimum
standard specified in the Agreement. Although the Company's claims management
has not completed a full analysis of the claims processing accuracy of HPS,
management believes that HPS has not met the minimum quality standards for
dollar accuracy, procedure accuracy and technical accuracy; however, the
Company's assessment of the potential transaction errors posted by HPS has not
been completed. The preliminary analysis indicates that a substanial amount of
over "payments", principally in the form of duplicate payments and payments
outside policy parameters (such as pre-existing conditions and policy waiting
periods) has occurred and that such overpayments are expected to exceed, perhaps
by material amounts, the existence of "underpayments", or more appropriately,
claims that have not yet been adjucated and/or paid. Although management
believes that claims expense as reported in the accompanying financial statement
accurately reflects all claims paid by HPS on behalf of the Company, the Company
nonetheless believes, based on its analysis , as well as that of a third party
claims adjudication, firm hired by the Company to investigate the matter, that
actual claims expense may be over stated to the extent, if any, of overpayments
of claims by HPS. As a result, the Company is currently in discussion with HPS
concerning the resolution of the matter. The ultimate resolution of this matter
may also have an impact on the amount of estimated reserves for future policy
claims and amounts due from reinsurers. The potential effects, if any, on the
financial statements cannot reasonably be determined.
Government Legislation and Regulation: Unfavorable economic conditions
have contributed to an increase in the number of insurance companies that are
under regulatory supervision. This is expected to result in an increase in
mandatory assessments by state guaranty funds of solvent insurance companies to
cover losses to policyholders of insolvent or rehabilitated companies. Mandatory
assessments, which are subject to statutory limits, can be partially recovered
through a reduction in future premium taxes in some states. Although the Company
is not able to reasonably estimate the potential effect on it of any such future
assessments, such amounts charged against operations for 1998, 1997 and 1996
have not been material.
The Company's business is subject to a changing legislative and
regulatory environment. Some of the proposed changes include initiatives to
restrict insurance pricing and the application of underwriting standards; reform
health care; and restrict investment practices. Proposals on national health
care reform have been under consideration that could significantly change the
way healthcare is financed and provided. The effects on the Company of
comprehensive healthcare reforms, which, if enacted, may have a material adverse
impact upon the ability of the Company to profitably engage in the writing of
accident and health insurance. Additionally, competition in the insurance
industry may effect the Company's ability to reach critical mass while remaining
competitive in agent compensation and product pricing. In response to these
developments the Company entered into an outsourcing agreement described in Note
Z and continually reviews agent compensation and product pricing.
F-34
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note U - Employee Benefit Plans
The Company sponsors a defined contribution retirement savings plan
under section 401(k) of the Internal Revenue Code covering substantially all
employees. Employees may contribute up to 15% of compensation, of which the
Company will match 50% of the first 5%. All contributions are subject to
limitations imposed by IRS regulations. Effective January 1, 1995, employees
were given the option to invest the "employer match" portion of their
contribution in common stock of the Company. At December 31, 1998 and 1997, the
plan held 5,736 and 1,379 shares, of the Company's common stock, respectively.
All employee contributions are immediately vested, and the Company
contribution becomes 20% vested after two years of service. Thereafter, an
additional 20% becomes vested for each year of service up to 6 years. Pension
expense under this plan amounted to $21, $78 and $57 for 1998, 1997 and 1996,
respectively.
Note V - Liability for Unpaid Claims and Claim Adjustment Expenses
Activity in the liability for unpaid claims and claim adjustment
expenses is summarized as follows.
1998 1997 1996
-------- -------- --------
Liability at January 1 .................... $ 31,109 $ 15,438 $ 10,105
Less reinsurance recoverables ........ 14,165 6,930 4,275
-------- -------- --------
Net Balance at January 1 .................. 16,944 8,508 5,830
Provision (benefit) for unpaid losses:
Current year ......................... 70,610 41,528 23,858
Prior years .......................... 897 3,272 (499)
-------- -------- --------
Total incurred ............................ 71,507 44,800 23,359
Payments made related to:
Current year ......................... 48,186 24,754 15,705
Prior years .......................... 16,021 11,610 4,976
-------- -------- --------
Total paid ................................ 64,207 36,364 20,681
Net Balance at December 31 ................ 24,244 16,944 8,508
Plus reinsurance recoverables ........ 18,237 14,165 6,930
-------- -------- --------
Liabilty at December 31 ................... $ 42,481 $ 31,109 $ 15,438
======== ======== ========
F-35
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
The 1998 and 1997 provision for prior year unpaid losses of $897 and
$3,272, respectively, reflect higher than expected claim costs on the Company's
managed care plans for business written during 1996 and 1997. The 1996 benefit
for prior year unpaid losses of $499 reflects better than expected claim costs
on the company's stop loss plans.
Note W- Reinsurance
Effective December 31, 1998, the Company and PILIC, a subsidiary of
PAMCO, signed an agreement to reinsure 100% of its group medical and group life
inforce business and sell the Company's group medical marketing, sales
distribution rights and all of the outstanding capital stock of PALHIC to CRLC
(the "CRLC Agreement").
Under the CRLC Agreement, PALHIC reinsured 100% of its business to
PILIC, which in turn reinsured through a 100% coinsurance agreement all of the
Company's group medical and group life business to Reassurance Company of
Hannover ("RCH"). In addition, PILIC sold all of the outstanding shares of
PALHIC and NIA to CRLC for an amount equal to PALHIC's capital and surplus. The
Company transferred all rights and control regarding the Company's licensed
insurance agents and entered into a non-compete and non-solicitation agreements
with CRLC regarding the Company's licensed insurance agents with respect to the
future sale of health insurance products for a three year period.
Effective December 31, 1998 PILIC entered into a coinsurance agreement
with the RCH whereby PILIC received a $10,000 ceding commission which consisted
of a $5,000 non-refundable payment and a $5,000 payment contingent upon RCH's
earning at least $10,000 in future profits from the ceded inforce business, plus
12% interest (the "guaranteed amount"). PILIC recognized the $10 million as
ceding commission revenue net of transaction costs or $417 and PAMCO recognized
a $5 million ceding commission liability because of the negative financial
history of the business. As a result of the transaction, PILIC wrote-off
unamortized deferred acquisition costs and restructuring costs aggregating $4.2
million.
If RCH fails to earn the guaranteed amount within five years of the
date of the closing of the CRLC transaction, PAMCO must repay RCH the lesser of
the guaranteed amount less RCH's actual profits on the inforce business, or
$5,000, plus 12% interest. In the unlikely event that future profits exceed the
guaranteed amount, then PILIC is entitled to receive an additional payment from
RCH equal to two-thirds of the policy fees collected during 1999 and one-third
of the policy fees collected during 2000.
As security for PAMCO's guarantee, PAMCO executed a security agreement
in favor of RCH secured by the stock of PILIC. This agreement provides that RCH
will take ownership of PILIC if the Company defaults on its guarantee to RCH.
PAMCO provides various affirmative covenants regarding corporate existence;
compliance with laws; furnishing various notices to RCH; inspection and audit
rights and insurance coverage. Additionally, PAMCO provides certain negative
covenants with regard to selling, assigning, leasing or otherwise disposing of
PAMCO or PILIC assets; entering into agreements materially and adversely
effecting PAMCO's or PILIC's ability to carry on business; entering into an
agreement materially and adversely effecting PAMCO or PILIC ability to perform
obligations under the Guaranty, the reinsurance agreement with RCH, the Stock
Purchase Agreement and other related agreements. There also exist various
provisions regarding PAMCO or PILIC incurring or creating indebtedness or
declaring dividends.
F-36
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Under the CRLC Agreement, PILIC has the right to assume new business
written by PILIC's agents for five years after the effective date of the CRLC
Agreement. PILIC may assume up to 20% of the new business written by PILIC's
agents during 1999 and up to 50% for the remaining four years via a new quota
share reinsurance agreement with PALHIC. For the purpose of computing profit and
loss of the reinsured business, CRLC, through PALHIC, will charge not more than
43% of first year premium and 28% of renewal premium, plus an administrative fee
of 3%, which will be reduced to 2% if total policies under administration exceed
$100 million of premium inforce. In its 1999 forecast, PILIC has not projected
any such reinsurance with PALHIC.
Pursuant to the terms of the CRLC Agreement, PILIC may also assume 50%
of the new business sold through HealthAxis and directly underwritten by PALHIC
commencing January 1, 1999 via a new quota share reinsurance agreement with
PALHIC for a period of 3 years. For the purpose of computing profit and loss of
the reinsured business, CRLC, through PALHIC, will charge not more than 28% of
first year premium and 21% of renewal premium, plus an administrative fee of 3%.
PALHIC will pay HealthAxis commissions of 15% of first year premium and 8% of
renewal premium, plus all administrative fees until HealthAxis has recovered all
payments made to initiate its Internet program. After such time, the fees will
be subject to the quota share agreement between PALHIC and PILIC. CRLC will work
to develop additional health insurance products for sale by HealthAxis and enter
into comparable reinsurance agreements with PILIC. Such transactions are subject
to regulatory approval. In its 1999 forecast, PILIC has not projected any such
reinsurance with PALHIC.
Reinsurance does not relieve the Company of its primary obligation to
its policyholders and varies according to the age of the insured, type of risk
and type of policy. Retention amounts for life insurance range up to $50 of
coverage per individual life and for health insurance up to $85 per individual.
During 1998, the Company had Quota Share Reinsurance and Excess of Loss
Reinsurance on its group medical insurance with a group of reinsurers which were
terminated by the Company effective December 31, 1998 in connection with the
Company entering into reinsurance and other agreements with RCH and CRLC.
F-37
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Under the terms of Quota Share Reinsurance Agreements, the Company
ceded 47.5% of the liability on its accident and health insurance business. The
Company received ceding commissions of: 45.5% on all first year business, and
25.5% or 30.5% on renewal business, depending on product, in 1998; 45.5% on all
first year business, and 25.5% to 30.5% on renewal business, depending on
product in 1997; 41.5% on all first year business, and 26.5% to 30.5% on renewal
business, depending on product, in 1996. The combined ceding commissions
amounted to approximately 36.9%, 37% and 38.9% of ceded earned premium for 1998,
1997, and 1996, respectively.
The Company's medical quota share and excess reinsurance agreements
with Swiss Re were terminated effective December 31, 1997. Swiss Re's obligation
to assume its proportionate share of medical paid losses incurred prior to
January 1, 1998 remains in effect. The amount of reinsurance recoverable from
Swiss Reis currently in dispute. Although the amount of loss, if any, cannot
be determined with any certainty at this time, the Company believes that such
amounts are due and collectible and has asserted its rights under the
Reinsurance Contract.
In addition, the Company generally assumes 30% (up to $150 per
individual) of the liability on its limited self-funded accident and health
business, which consists generally of policies issued to limit the claims
expenses of employers that self-insure group medical benefits with respect to
any individual employee and in the aggregate.
F-38
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
A summary of insurance in-force, premium income, benefits and
commission expense with respect to reinsurance operations is as follows:
Ceded to Assumed % of Amt.
Gross Other From Other Net Assumed
Amount Companies Companies Amount To Net
------ --------- --------- ------ ------
Year ended December 31, 1998:
Life insurance in force $ 318,000 $ 55,000 $ 427,000 $ 690,000 61.9%
--------- -------- --------- ---------
Premium:
Life insurance 7,896 225 833 8,504 9.8%
Annuity 78 24 - 54
Accident and health 105,447 49,667 5,279 61,059 8.6%
--------- -------- --------- ---------
Total $ 113,421 $ 49,916 $ 6,112 $ 69,617
--------- -------- --------- ---------
Benefits:
Life insurance 5,791 173 89 5,707
Annuity and other 353 - - 353
Accident and health 92,710 49,603 4,402 47,509
--------- -------- --------- ---------
Total $ 98,854 $ 49,776 $ 4,491 $ 53,569
--------- -------- --------- ---------
Commissions $ 14,385 $ 8,848 $ 1,771 $ 7,308
--------- -------- --------- ---------
Year ended December 31, 1997:
Life insurance in force $ 446,300 $ 56,000 $ 528,000 $ 918,300 47.2%
--------- -------- --------- ---------
Premium:
Life insurance 8,893 444 524 8,973 5.8%
Annuity 137 29 - 108
Accident and health 81,472 39,548 3,248 45,172 7.2%
--------- -------- --------- ---------
Total $ 90,502 $ 40,021 $ 3,772 $ 54,253
--------- -------- --------- ---------
Benefits:
Life insurance 6,065 584 631 6,112
Annuity and other 711 - 26 737
Accident and health 72,950 36,785 1,916 38,081
--------- -------- --------- ---------
Total $ 79,726 $ 37,369 $ 2,573 $ 44,930
--------- -------- --------- ---------
Commissions $ 18,029 $ 12,571 $ 1,077 $ 6,535
--------- -------- --------- ---------
Year ended December 31, 1996:
Life insurance in force $ 495,000 $ 60,000 $ 417,000 $ 852,000 48.9%
--------- -------- --------- ---------
Premium:
Life insurance 10,384 (1,888) 816 13,088 6.2%
Annuity 108 15 - 93
Accident and health 52,442 25,670 4,753 31,525 15.1%
--------- -------- --------- ---------
Total $ 62,934 $ 23,797 $ 5,569 $ 44,706
--------- -------- --------- ---------
Benefits:
Life insurance 4,244 424 576 4,396
Annuity and other 1,128 - 9 1,137
Accident and health 34,414 18,190 2,739 18,963
--------- -------- --------- ---------
Total $ 39,786 $ 18,614 $ 3,324 $ 24,496
--------- -------- --------- ---------
Commissions $ 13,365 $ 8,241 $ 1,503 $ 6,627
--------- -------- --------- ---------
F-39
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note X - Related Party Transactions
Legal fees to the law firm of a former director and general counsel and
secretary of the Company in 1998, 1997 and 1996, approximated $332, $282 and
$298, respectively.
Consulting expenses paid to a shareholder of the Company and former
Chief Executive Officer of REF amounted to $300 each in 1998, 1997 and 1996. The
shareholder provided the Company with exclusive marketing, sales and product
design services as part of a 36-month consulting agreement which expired
December 1998.
Computer software development and consulting expense paid to an entity
controlled by a former employee of the Company in 1998 amounted to $1,759.
Lynx beneficially owns 5.7% (including options) of the outstanding
shares of PAMCO. The Manager of LCG, is also serving as the Chief Executive
Officer and President of HealthAxis and a director of the Company. LCG is party
to a consulting agreement with Provident whereby LCG provided various services
during 1998 approximately$23 in fees and expenses as well as options to purchase
400,000 shares of PAMCO common stock.
Note Y - Reconciliation From Statutory Basis (Unaudited) To GAAP Basis
The accompanying financial statements are prepared in conformity with
GAAP which differs in some respects from the statutory accounting practices
prescribed or permitted by insurance regulatory authorities. The Pennsylvania
Department of Insurance permitted PILIC the following statutory accounting
practices: (1) since 1989, the statutory carrying value of the home office at
the value transferred from PAMCO to PILIC in 1988 in satisfaction of
intercompany debt, less depreciation since that time; and (2) to continue
PILIC's statutory reserve methodology which, up until January 1, 1996, had not
considered the impact of policy provisions pertaining to increasing the face
amount of pre-need life insurance for anticipated future Consumer Price Index
increases. Starting in 1996 PILIC modified its statutory reserve methodology on
1996 issued business which now considers the impact of policy provisions
pertaining to increasing the face amount of pre-need life insurance for
anticipated future Consumer Price Index increases. Furthermore, PILIC increased
reserves by $200 in 1998, 1997 and 1996 for 1995 and prior issues in recognition
of the increasing face amount of pre-need life insurance for anticipated future
Consumer Price Index increases. The potential effects of this permitted practice
has not been determined but could be material to statutory surplus.
F-40
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Note Z - HPS Outsourcing Agreement
In October 1997 the Company and HealthPlan Services Corporation ("HPS")
entered into a 5 year agreement under which the Company outsourced to HPS all of
its health insurance policy issuance, billing, and claims, effective February
1998 for certain claim processing and February 1998 for all remaining outsourced
functions (the "Outsourcing Agreement"). The Company's life and stop-loss
operations are unaffected by the Agreement.
The Company received $5,000 from HPS in the fourth quarter of 1997 as
an inducement to enter into the Outsourcing Agreement which is accounted for as
a loan payable discounted at a rate of 9.25% resulting in a reported
liability of $3,865 which is being amortized over 5 years at the rate of $95,000
including principal and interest. As a result of entering into the Outsourcing
Agreement in 1997 the Company incurred transition and related expenses
approximating $3,134, including accelerated depreciation and amortization of
goodwill.
Note AA - Changes in Web Alliance
On March 29, 1999, the Company and AOL entered into the Second
Amendment (the "Second Amendment") to the Amended and Restated Interactive
Marketing Agreement with AOL, dated as of February 1, 1998, which provides that
the Company will be the exclusive third-party direct marketer of managed-care
and indemnity health insurance policies, dental insurance, vision insurance,
prescription coverage, critical care insurance and long-term care insurance
coverage and, subject to certain restrictions, the non-exclusive third party
marketer of life and long-term disability (collectively, the "Products") for
individuals and groups of less than fifty individuals in the United States via
AOL's online service. The Second Amendment provides HealthAxis with access to
CompuServe and Netscape Netcenter, which the Company believes will expand its
marketing scope. The Second Amendment also provides for a four month "wind down"
period in the event the Company elects not to exercise its option to renew its
agreement with AOL for an additional term. In the event of nonrenewable, AOL has
agreed to continue to market and support HealthAxis on a non-exclusive basis
until May 31, 2000. In the event the Company elects to renew its agreement with
AOL for a second term, the Second Amendment extends the renewal term from 24 to
28 months beginning on February 1, 2000 and ending on May 31, 2002. The Second
Amendment also modifies the payment schedule due to AOL for the renewal term
from a single payment of $33.5 million on February 1, 2000 to a payment schedule
of:
$5.0 million due on February 1, 2000;
$5.9 million due on May 1, 2000;
$5.9 million due on August 1, 2000;
$8.4 million due on January , 2001; and
$8.4 million due on April 1, 2001.
Additionally, the Second Amendment provides for certain modifications
and enhancements with regard to the placement of the Company's impressions on
AOL.
AOL has verbally acknowledged that HealthAxis has met all of the
requirements regarding the "official launch" as of March 29, 1999 and has agreed
to amend the terms of the Series B Preferred Stock. See Note BB.
Note BB - Subsequent Events
In connection with the issuance of Series C Preferred Stock (see Note
D, P, and Q) HealthAxis has amended the terms of the Series A and Series B
Preferred Stock to, among other things, provide for the preference of Series C
Preferred Stock over the Series A Preferred Stock, to clarify the priorities of
the Series A, B and C Preferred Stock in the event of a liquidation, to delete
the dividend currently payable on the Series A and B Preferred Stock, to delete
the optional redemption provision related to the Series A Preferred Stock, to
revise the optional and mandatory conversion provisions applicable to the Series
A and B Preferred Stock and to revise the definition of excluded Shares
applicable to the Series A Preferred Stock.
F-41
Provident American Corporation and Subsidiaries
Notes to Consolidated Financial Statements - (Continued)
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
In December 1997, the Company's former independent accountants, Coopers
& Lybrand, LLP, resigned. Their report on the financial statements for 1996 did
not contain an adverse opinion or a disclaimer of opinion, nor was it qualified
as to uncertainty, audit scope, or accounting principles. There were no
disagreements on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure. In February 1998, the
Company engaged BDO Seidman, LLP, as its new independent auditors.
61
PART III
Item 10. Directors and Executive Officers of the Registrant.
Director or
Principal Occupation Executive Year Term
Name Age For Past Five Years Officer Since Will Expire
---- --- ------------------- ------------- -----------
Michael Ashker 46 Director; President, Chief Executive Officer and 1998 1999
Director of HealthAxis.com, Inc. since March 1998;
Managing Director of Lynx Capital Group LLC, an
independent investment advisor and fund management
firm, from September 1995 to February 1998; Money
Manager for Kidder Peabody & Co. from 1991 to
1995, Bateman, Eichler, Hill and Richards from
1988 to 1991, and Shearson/American Express from
1984 to 1988.
Alvin H. Clemens 61 Director; Chairman of the Board and Chief 1989 1999
Executive Officer of the Company and subsidiary
companies since October 1989 and President of the
Company and PILIC 1993 - 1996; President of Maine
National 1989-1995; Owner and Chairman of the
Board of Maine National 1985 - 1989; President and
Director of Academy Life Insurance Co. and Pension
Life Insurance Co. 1970 - 1985; Chairman/Chief
Executive Officer of Academy Insurance Group Inc.
1967 - 1985.
Harold M. Davis 63 Director; Chairman of the Board of Realen Homes, 1989 1999
Inc. since 1968.
Francis L. Gillan III 44 Chief Financial Officer and Treasurer of the 1999 N/A
Company and PILIC since January 1999; Treasurer of
PILIC and PALHIC 1998; Controller of PILIC and
PALHIC 1996 - 1998; Director of P&C Planning and
Expense Analysis, Providian Direct Insurance
1994-1996. Assistant Controller, Providian Direct
Insurance 1986 - 1994, Assistant Director of
Financial Planning and Analysis, Providian Direct
Insurance 1981 1986.
Henry G. Hager 64 Director; Partner in the law firm of Stradley, 1996 1999
Ronon, Stevens and Young since 1994; President and
Chief Executive Officer of The Insurance
Federation of Pennsylvania since 1985.
George W. Karr, Jr. 61 Director; Co-Chairman of Karr Barth Associates, 1996 1999
Inc. since 1998; Chief Executive Officer of Karr
Barth Associates 1984-1998.
62
Director or
Principal Occupation Executive Year Term
Name Age For Past Five Years Officer Since Will Expire
---- --- ------------------- ------------- -----------
Edward W. LeBaron 69 Director; Director of Lynx Capital Group, LLC 1998 1999
since January 1997; Partner in the law firm of
Pillsbury Madison & Sutro since 1997; Attorney
with Pillsbury Madison & Sutro 1989-1997; Chief
Executive Officer of Pacific Casino Management
1995-1996.
Douglas F. Manchester 56 Director; Chairman of the Board Manchester Resorts 1998 1999
& Affiliated Companies since 1970.
Theophile Joseph Mignatti, 63 Director; Chairman of Mignatti Construction 1998 1999
Jr. Company since 1998; President and Chief Executive
Officer of Mignatti Ventures since
1989; President of Historic Venture
Associates 1984-1989; President
Mignatti Construction Company
1966-1984.
P. Glenn Moyer 63 Director; Private Practice Attorney since 1992; 1989 1999
Director, Maine National 1985-1995; Partner in the
law firm of Butera, Beausang, Moyer & Cohen from
1968 through 1992.
Anthony R. Verdi 50 Chief Operating Officer of the Company since 1990 N/A
December 1997, PILIC and PALHIC 1997-1998;
President of PILIC since December 1998; Treasurer
and Chief Financial Officer of the Company, PILIC
and PALHIC 1990-1997; Vice President and
Controller of Inter-County Hospitalization Plan
Inc. 1986-1990; Assistant Controller Academy
Insurance Group Inc. 1971-1986.
During 1998, the Company's Board of Directors held eight (8) meetings.
All Directors attended at least 75% of the aggregate meetings of the Board and
the Committees on which they served.
Messrs. Alvin H. Clemens, Francis L. Gillan III and Anthony R. Verdi
are the executive officers of the Company. Mr. James O. Bowles served as an
executive officer of the Company until December 31, 1998.
63
Committees of the Board of Directors
The Company's Board of Directors has standing an
Executive/Compensation/Nominating Committee and an Audit Committee.
The Executive/Compensation/Nominating Committee, on which Messrs.
Clemens, Ashker, Manchester and Moyer currently serve, is appointed to act when
a meeting of the full Board of Directors is not feasible, administers the
Company's compensation matters and also nominate directors and determine
replacements for directors when membership on the Board of Directors ends prior
to the expiration of a term. The Executive/Compensation/Nominating Committee
held one (1) meeting during 1998.
The Audit Committee is appointed to recommend the selection of the
Company's auditors, review the scope and results of audits, review the adequacy
of the Company's accounting, financial and operating systems and supervise
special investigations. The Audit Committee held two (2) meetings in 1998. The
Audit Committee is currently comprised of Messrs. Hager, Karr and Mignatti. Mr.
Ashker serves as an alternate.
The Option Administration Committee was established by the Board of
Directors on July 16, 1996 and currently consists of Messrs. Clemens, Ashker,
Hager, Karr, Moyer, and Verdi. Any options to be granted to Messrs., Clemens, or
Verdi are subject to the approval of only Messrs. Ashker, Hager, Karr and Moyer,
who are outside directors of the Company and as such are disinterested persons.
The Option Administration Committee held no meetings during 1998.
Director Compensation
Directors who are not employees of the Company are paid a fee of $1,000
for attendance at each meeting of the Board of Directors of the Company, with no
fee being paid for attendance at meetings of any of the Companys subsidiaries,
and $500 for attendance at each meeting of any committee of the Board. During
1998 the Company did not grant any options to Directors.
Mr. John T. Gillin, a director through December 17, 1998, also serves
as a consultant for the Company. The Company paid Mr. Gillin $ 143,484 in 1998
for his consulting services.
64
Item 11. Executive Compensation.
Employment and Other Agreements
Effective February 19, 1997, the Company and Mr. Clemens entered into
an employment agreement (Agreement) which replaced Mr. Clemens prior Employment
Contract dated as of January 1, 1993. Pursuant to the Agreement, Mr. Clemens is
employed as Chief Executive Officer of the Company for a five-year term ending
December 31, 2002 (the Term), and unless otherwise terminated, the Term shall
automatically be extended at the end of each year after December 31, 1997, in
order that at all times, on each December 31st during the duration of the
Agreement, there shall be an unexpired five-year term. Mr. Clemens was paid a
base salary in 1998 of $417,453, plus an annual cost of living increase, and
such additional incentive or bonus compensation as shall be deemed appropriate
from time to time by the Board of Directors of the Company. The Agreement
further provides for group life, health, disability, major medical, and other
insurance coverages for Mr. Clemens and his family, and upon termination,
provides termination benefits which include the provision of health insurance
for Mr. Clemens and his spouse for life, a salary benefit of five times base
salary in the event of Mr. Clemens death, disability, or termination without
cause, and includes certain restrictions on Mr. Clemens competition and
disclosure of confidential information.
In addition, pursuant to an Agreement to grant options dated as of
March 10, 1997 (the Option Contract), the Company agreed to grant Mr. Clemens an
option to successively purchase up to 3,300,000 shares of the Companys Series A
Cumulative Convertible Preferred Stock (Series A Preferred), which option or
options will be granted upon any exercise by Mr. Clemens of any previously
granted option to purchase Series A Preferred, and each subsequently granted
option to purchase shares of Series A Preferred from time-to-time. The rights
set forth in the Option Contract are limited as follows: (1) the number of
shares of Series A Preferred Stock issuable upon each exercise of the Option
Contract shall be limited by the number of Series A Preferred which shall, as of
the date of any such exercise, be authorized and unissued; (2) the number of
shares of Series A Preferred issuable upon the exercise of all of the Options
granted to Mr. Clemens under the Option Contract and under a previously granted
option to purchase 550,000 shares of Series A Preferred shall not in the
aggregate exceed 3,850,000 shares of Series A Preferred; and (3) except upon the
occurrence of a change in control (as defined in the Option Contract), Mr.
Clemens shall not be permitted to exercise an option granted under the Option
Contract (i) to purchase more than 550,000 shares of Series A Preferred in any
six-month period, or (ii) to purchase shares which would result in Mr. Clemens
controlling more than 55% of the outstanding voting rights for all classes of
the Companys stock.
Upon the occurrence of a change in control of the Company, Mr. Clemens
shall have the right to immediately exercise all options (3,850,000) to purchase
shares of Series A Preferred, and the Company will make a loan to him in an
amount equal to the aggregate exercise price of all options to purchase shares
of Series A Preferred which Mr. Clemens may then be entitled to exercise, plus
an amount equal to all federal and state income taxes incurred by Mr. Clemens in
connection with the exercise (the Loan). The Loan shall be unsecured, and shall
bear interest at the then applicable federal short-term rate, but not less than
six (6%) percent per annum, with interest and principal due and payable in full
five (5) years from the date of the Loan.
65
For this purpose a change of control shall mean the acquisition by any
individual, entity or group or more of either the then outstanding shares of the
Common Voting Stock of the Company, or the combined voting power of the then
outstanding voting securities of the Company entitled to vote generally in the
election of directors.
Mr. Bowles was employed as President pursuant to an Amended and
Restated Employment Contract (the Employee Contract) dated as of November 7,
1996 for a term commencing as of October 1, 1996 through December 17, 1998,
which provided for a base salary of $195,000, with an annual cost of living
increase, and such additional incentive or bonus compensation and certain
insurance and other fringe benefits as shall be deemed appropriate from
time-to-time by the Executive Committee or the Board of Directors of the
Company. The Employment Contract terminated on December 17, 1998. Mr. Bowles
left the employment of the Company as part of the transactions with CRLC.
The following three tables show information relating to the Chairman of
the Board, President and Chief Executive Officer and the most highly compensated
executive officers during the calendar years specified therein.
66
SUMMARY COMPENSATION TABLE
================================================================================================================================
Long-Term Compensation
------------------------- ---------------------
Annual Compensation Awards Payouts
- - --------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Restricted Securities Long Term
Other Annual Stock Underlying Incentive All Other
Name and Principal Salary Bonus Compensation Award(s) Options Plan Payouts Compensation(3)
Position(1) Year ($) ($) ($) ($) (#) ($) ($)
- - --------------------------------------------------------------------------------------------------------------------------------
Alvin H. Clemens, 1998 413,896 309,000 (2) 17,714
Chairman of the Board and 1997 417,453 305,850 18,288
CEO 1996 386,662 50,000 (6) 15,748
- - --------------------------------------------------------------------------------------------------------------------------------
Michael Ashker, 1998 61,226 80,000 991,000 (2)
HealthAxis 1997
President(7) 1996
- - --------------------------------------------------------------------------------------------------------------------------------
James O. Bowles (4) 1998 196,050 66,127 (10,000) 4,188
President 1997 195,000 64,945
1996 130,000 125,000
- - --------------------------------------------------------------------------------------------------------------------------------
William C. Fay III 1998 121,459 174,696 4,000
Sr. Vice President 1997 125,625 177,386 50,000 4,000
Sales 1996 111,958 173,570 160,000 3,080
- - --------------------------------------------------------------------------------------------------------------------------------
Benedict Iacovetti (5) 1998 155,749 100,000
HealthAxis 1997
Chief Financial Officer 1996
- - --------------------------------------------------------------------------------------------------------------------------------
Anthony R. Verdi, 1998 151,392 10,144
Chief Operating Officer 1997 151,335 9,295
1996 128,072 50,000 (6) 10,406
================================================================================================================================
(1) Includes Chairman of the Board, President and Chief Executive Office
the most highly compensated executive officers whose total annual salary
and bonus exceeded $100,000.
(2) Includes an option to purchase HealthAxis shares.
(3) Includes for 1998, 1997 and 1996, respectively, (a) Company contributions
to savings plan (Mr. Clemens $4,000, $4,000 and $3,750; Mr. Bowles $4,188;
Mr. Fay $4,000, $4,000 and 3,080; Mr. Verdi $3,317, $3,595 and $3,150),
and (b) automobile expense allowances (Mr. Clemens $11,280, $11,998 and
$11,998; and Mr. Verdi $5,700, $5,700 and $7,256).
(4) Mr. Bowles ceased being President of the Company, PILIC and PALHIC on
December 17, 1998 as a result of the transactions with CRLC.
(5) Mr. Iacovetti joined the Company on December 22, 1997 as Chief Financial
Officer and Treasurer. He held this position through August 12, 1998, at
which time he became Chief Financial Officer for HealthAxis through March
19, 1999.
(6) Grant reduced during 1998 to reflect election taken to reduce 50,000
shares to 25,000 shares at a price half the initial grant.
(7) Mr. Ashker joined HealthAxis as President and CEO on April 1, 1998.
67
Provident American Corporation and HealthAxis.com, Inc.
Aggregate Option Exercises in 1998 and Year-End Values
- - ------------------------------------------------------------------------------------------
Number of Value of
Shares Underlying Unexercised
Acquired Value Unexercised In-the-Money
On Exercise Realized Options Options at
Name (#) ($) At 12/31/98 12/31/98
- - ------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e)
- - ------------------------------------------------------------------------------------------
Alvin H. Clemens
Chairman of the Board, CEO
Exercisable (1) 0 $0 35,000 $62,500
Unexercisable 15,000 $56,250
Exercisable (HealthAxis) 0 $0 309,000 $811,527
Unexercisable (HealthAxis) 0 $0
Michael Ashker
President HealthAxis
Exercisable (HealthAxis) 0 $0 991,000 $2,602,663
Unexercisable (HealthAxis) 0 $0
James O. Bowles
Former President
Exercisable 0 $0 85,000 $56,250
Unexercisable 30,000 $0
William C. Fay III
Sr. Vice President, Sales
Exercisable 35,000 $231,875 71,000 $191,250
Unexercisable 104,000 $357,500
Benedict J. Iacovetti
HealthAxis CFO
Exercisable 0 $0 20,000 $145,600
Unexercisable 80,000 $582,400
Anthony R. Verdi
COO
Exercisable 0 $0 47,000 $249,500
Unexercisable 25,000 $108,750
==========================================================================================
(1) Excludes non-compensatory stock options to purchase 1,253,376 shares of
common stock at $0.9091 issued to Mr. Clemens in 1989 of which Mr. Clemens
disclaims beneficial ownership of 703,720 shares owned by a partnership of
which Mr. Clemens is a partner; excludes an option to purchase 550,000
shares of Series A Cumulative Preferred Stock at $3.64 issued on April 1,
1993 in connection with the purchase by Mr. Clemens of other shares of
Preferred Stock at such time, and also excludes any options which could be
granted to Mr. Clemens under the Option Contract dated March 10, 1997
described in Item 11-"Employment and Other Agreements".
68
Provident American Corporation and HealthAxis.com, Inc.
Option Grants in 1998
======================================================================================================================
Potential Realizable Value
At Assumed Annual Rates
Number of % of Total Of Stock Appreciation for
Securities Options Exercise Option Term
Options Granted to Price Expiation Alternative to
Name Granted Employees $/Share Date 5% 10% f & g (1)
- - ----------------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e) (f) (g) (h)
- - ----------------------------------------------------------------------------------------------------------------------
Alvin H. Clemens
Chairman and CEO (2)
309,000 (3) 15.79% $1.77 7/13/08 $151,107 $333,906 $11,124
Michael Ashker
President - 991,000 (3) 50.65% $1.77 7/13/08 $484,617 $1,070,877 $356,676
HealthAxis
Anthony R. Verdi
COO (2)
======================================================================================================================
(1) Based on the Black-Scholes option pricing model assuming: 0% dividend
yield, no adjustments for forfeitures and the following expected stock
volatility, length of time for exercise and risk free interest rate:
57.208%, five years and 4.5%, respectively.
(2) Election was taken in 1998 by officer, open to all 1996 Employee Stock
Option Plan option recipients, to reduce previously granted shares by half
at a price half the initial grant price. The previous grant was amended to
reduce the number of options from 50,000 to 25,000 and reduce the exercise
price from $10.00 to $5.00; the vesting provisions remain unchanged. The
time remaining on the options on March 13, 1998 (the date of amendment)
was approximately 8.5 years.
(3) Granted under the HealthAxis.com, Inc. 1998 Stock Plan to purchase
HealthAxis common stock.
69
Stock Option Plans
The Company maintains the stock option plans for executives, officers,
employees or directors of the Company and its subsidiaries and affiliates.
HealthAxis also maintains a stock option plan that includes grants to
executives, directors, employees and consultants.
The 1993 Incentive Stock Option Plan for Employees was discontinued,
and effective July 16, 1996, the Companys Board of Directors adopted the 1996
Employee Incentive Stock Option Plan (1996 Employee Plan), which was approved by
the Companys shareholders at the 1997 Annual Meeting of Shareholders. The 1996
Employee Plan was amended in 1997 to increase the number of shares issuable
thereunder from 950,000 shares to 1,250,000 shares of the Companys common voting
stock to key employees of the Company and its subsidiaries and affiliates,
exercisable for up to five years from the effective date of the grant at a price
not less than the fair market value of the shares on the effective date of
grant. All options granted under the 1996 Employee Plan have been granted at
100% of the fair market value of the shares on the effective date of the grant,
with the exception of an option granted Mr. Clemens, which was granted at 110%
of the fair market value on the date of the grant. During 1998, the Company
granted incentive stock options to purchase an aggregate of 167,500 shares of
the Companys common stock at prices ranging from $4.4375 to $6.00 per share
under the 1996 Employee Plan. During 1998 a total of 25,000 options were
exercised under the 1993 Employee plan. On March 13, 1998 the employees owning
options under the 1996 Employee Plan were given the right to reduce the grant by
half in consideration of the reduction of the exercise price by one half. Of the
total grants under the 1996 Employee plan for 1998, 115,000 were as a result of
this election.
The Non-Qualified Stock Option Plan for Directors (Directors Plan) was
amended and restated effective as of July 16, 1996 in order to increase the
number of shares authorized for the issuance thereunder by 356,500 shares and to
incorporate prior amendments. Options granted under the Directors Plan are
exercisable for up to ten years from the date of grant at a price of not less
than the fair market value of the shares on the date of the grant. All options
granted under the Directors Plan have been granted at 100% of the fair market
value of the shares on the date of grant. During 1998, there were no grants
under the Directors Plan. During 1998 no options were exercised under the
Directors Plan.
The Stock Option Plan for Executives (Executive Plan) was amended and
restated effective December 11, 1996 and authorizes the granting of options to
purchase up to 3,850,000 shares of the Companys Series A Cumulative Convertible
Preferred Stock (Series A Preferred Stock), which are exercisable for up to ten
years from the effective date of grant at a price of not less than the fair
market value of the shares on the date of grant. No options were granted under
the Executive Plan during 1998.
The HealthAxis.com, Inc. 1998 Stock Plan (1998 Stock Plan), as amended,
was approved by the HealthAxis Board of Directors and shareholder on June 30,
1998 (and an amendment on October 15, 1998) and authorizes the granting of
options to HealthAxis employees, directors, consultants and executives to
purchase up to 2,900,000 shares of HealthAxis common stock, which are
exercisable for either five or ten years from the effective date. During 1998
HealthAxis granted stock options to purchase an aggregate of 1,956,500 shares of
the HealthAxis Class A stock at prices ranging from $1.77 to $4.00 per share.
70
The Company's Stock Option Plans are administered by the Board of
Directors and the Option Administration Committee. The respective administrators
of the Stock Option Plans are authorized to select optionees, determine the
number of shares for which options are granted to each optionee, the exercise
price of the options, and the other terms and conditions of the options.
71
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth, as of March 16, 1999, the amount and
percentage of the Company's outstanding common stock beneficially owned by (i)
each person who is known by the Company to be the beneficial owner of more than
5% of the Company's outstanding common stock; (ii) each director; (iii) each
executive officer and (iv) all officers and directors of the Company as a group.
Series A
Cumulative Convertible
Common Stock Preferred Stock
No. of Shares Percent No. of Shares Percent
Name of Beneficially of Beneficially of
Beneficial Owner Owned(1) Class(2) Owned(1) Class(2)
- - ---------------- -------- -------- -------- --------
Alvin H. Clemens 3,470,244(3) 26.6% 1,100,000(4) 99.4%
907 Exeter Crest
Villanova, PA 19085
Michael Ashker 962,200(5) 8.0%
c/o HealthAxis.com, Inc.
2500 DeKalb Pike
Norristown, PA 19404
Richard E. Field 310,000(6) 2.6%
134 Medinah Drive
Blue Bell, PA 19422-3212
Harold M. Davis 165,000(7) 1.4%
Francis L. Gillan III 10,000(8) (9)
Henry G. Hager 55,000(7) (9)
George W. Karr, Jr. 67,000(7) (9)
Edward W. LeBaron 31,571(10)
Douglas F. Manchester 357,143(11) 3.1%
Theophile J. Mignatti, Jr. 30,000(12) (9)
P. Glenn Moyer 49,000(7) (9)
Anthony R. Verdi 76,600(13) (9) 5,500 1.0%
ALL DIRECTORS AND OFFICERS
AS A GROUP (27 PERSONS FOR
COMMON STOCK AND 2 PERSONS
FOR PREFERRED STOCK) 5,751,716(14) 42.5% 1,106,600(4) 99.3%
72
(1) Information furnished by directors and officers.
(2) Calculated as a percentage of outstanding shares plus each individuals
options to purchase common shares (or all Directors and Officers as a
Group).
(3) Includes options granted to Mr. Clemens to purchase an additional 291,376
shares of the Company's common stock at a price of $.91 per share granted
pursuant to the Amended and Restated Stock Option Agreement dated as of
February 27, 1989, includes 550,000 shares of Series A Cumulative
Convertible Preferred Stock purchased by Mr. Clemens on March 31, 1993 and
also includes 550,000 options at $3.64 per share to purchase Series A
Cumulative Convertible Preferred Stock granted to Mr. Clemens pursuant to a
Stock Option Agreement dated April 1, 1993. Includes options to purchase
25,000 shares of the Companys Common Stock at $8.75 per share and 10,000
shares of the Companys common stock at $6.00 per share. Mr. Clemens
disclaims beneficial ownership of 616,200 shares of the Company's Common
Stock given by him to The Mark Twain Trust in 1991 and 962,000 options to
purchase additional shares of the Companys common stock owned by a
partnership in which Mr. Clemens is a partner. Excludes shares of Series A
Cumulative Convertible Preferred Stock, which may be issued under the
Option Contract. See Item 11. Employment and Other Agreements. The Series A
Cumulative Convertible Preferred Stock is voted on an as converted basis at
the rate of 4 votes per share. Each share of Class A Common Stock is
entitled to 4 votes and each share of common stock is entitled to 1 vote in
connection with matters coming to a vote of the shareholders. Excludes the
option to purchase 309,000 shares of HealthAxis Class A stock.
(4) Includes options granted to Mr. Clemens to purchase 550,000 shares of
Series A Cumulative Convertible Preferred Stock at $3.64 per share. This
does not include shares of Series A Cumulative Convertible Stock which may
be issued under the Option Contract. See Item 11. Employment and Other
Agreements.
(5) The information in regard to Mr. Ashker has been derived from filings with
the Securities and Exchange Commission as of the Record Date. Mr. Ashker is
presently serving as President, CEO and a director of one of the Companys
subsidiaries, HealthAxis.com, Inc. Sole voting and dispositive power is
claimed with regard to 61,000 shares and shared voting power is claimed
with regard to 1,038,680 shares and shared dispositive power is claimed
with regard to 1,467,120 shares. See also Certain Relationships and Related
Transactions for a description of transactions between Mr. Ashker, Lynx
Capital Group, LLC and the Company. Amendment No. 1 to Schedule 13D was
filed on behalf of Mr. Ashker and others on November 11, 1998, indicating
that Mr. Ashker beneficially owned less than ten percent (10%) of the
Companys outstanding Common Stock as of such date. The Schedule 13D is also
filed on behalf of Lynx Capital Group, LLC, a California limited liability
company of which Mr. Ashker is the sole manager; Van Kasper & Company, a
broker-dealer and California corporation; Lynx Private Partners, L.P. and
Lynx Tech Fund, L.P., both investment limited partnerships of which Lynx
Capital Group, LLC, serves as investment advisor; and Lynx Healthtech Fund,
L.P., which Lynx Capital Group, LLC, serves as investment advisor and
manager. Each of the above entities also claims beneficial ownership of
various amounts of the Companys Common Stock. Excludes the option to
purchase 991,000 shares of HealthAxis Class A stock.
(6) Includes warrants and options to purchase 300,000 shares of the Companys
common stock.
73
(7) Includes an option to purchase 45,000 shares of the Companys common stock.
(8) Includes an option to purchase 10,000 shares of the Companys common stock.
(9) Less than 1%.
(10) Includes 28,571 shares from a fund of 250,000 shares held in Lynx Private
Equity Partners 1, LLC whose sole manager is Mr. LeBaron.
(11) Includes shares held in the name of Interhotel Co., Ltd., which is owned by
Mr. Manchester.
(12) Includes 20,000 shares held in wifes name (deceased).
(13) Includes 5,500 shares of Series A Cumulative Convertible Preferred Stock.
Includes an option to purchase 47,000 shares of the Company's common stock.
(14) Includes stock and options of all officers and directors to purchase an
aggregate of 1,203,472 shares and 1,039,000 shares, respectively, and
options granted to Mr. Clemens to (1) purchase an additional 291,376 shares
of the Company's common stock at a price of $.91 per share granted pursuant
to the Amended and Restated Stock Option Agreement dated as of February 27,
1989 and (2) purchase an additional 25,000 shares of the Companys common
stock at $8.75 per share and 10,000 shares of the Companys common stock at
$6.00 per share; includes 550,000 shares of Series A Cumulative Convertible
Preferred Stock and also includes 550,000 options at $3.64 per share to
purchase Series A Cumulative Convertible Preferred Stock granted to Mr.
Clemens pursuant to a Stock Option Agreement dated as of April 1, 1993.
Item 13. Certain Relationships and Related Transactions.
Notes Receivable - Officers and Directors
The Company has loans receivable from related parties with: Mr. Alvin
Clemens, Chairman of the Board, Chief Executive Officer and a shareholder of the
Company, which is collateralized by 128,478 shares of the Companys common stock
(Shares) owned by Mr. Clemens; Mr. John Gillin, a former Director and
shareholder of the Company, which is collateralized by 10,000 shares and a stock
option grant to purchase 30,000 shares, both owned by Mr. Gillin; and Mr.
Richard Field, with whom the Company had a Marketing and Consulting Agreement in
1998, which is collateralized by 157,500 shares, a second mortgage on real
estate, and unpaid amounts on the Marketing and Consulting Agreement, all owned
by Mr. Field.
Mr. Clemens loan is due in April 2000. Mr. Gillins loan was repaid in
full during January 1999. Mr. Fields loan was repaid in full during February
1999.
74
The following table details the loan receivable at December 31, 1998.
Clemens Gillin Field
------- ------ -----
Amounts due at December 31, 1998
Loan principal $600,000 $140,900 $422,280
Accrued interest 75,693 24,823 63,965
Balance due and highest outstanding balance
$675,693 $165,723 $486,245
1998 Interest income $ 34,500 $ 9,873 $ 30,087
Interest rate 5.33% 8.50% 9.50%
Business transactions with related parties
Lynx Capital Group, LLC LCG beneficially owns 5.7% (including options)
of the outstanding shares of Provident. Michael Ashker, Manager of LCG, is also
serving as the Chief Executive Officer and President of HealthAxis. Mr. Ashker
is also a director of Provident. LCG is party to a consulting agreement with
Provident whereby LCG provided various services with regard to the Company and
in return the Company paid $23,000 in fees and expenses and options to purchase
400,000 shares of Provident common stock during 1998.
Michael F. Beausang, Jr., Esquire, Secretary and General Counsel,
Director of the HealthAxis and a former director of Provident, is a partner in
the law firm of Butera, Beausang, Cohen & Brennan. Such law firm performs legal
services for the Company for which the Company paid such law firm approximately
$332,000 during 1998.
For a description of the consulting services rendered by John T.
Gillin, a former Director of the Company through December 17, 1998, see Item 11
Executive Compensation.
75
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The materials set forth below are filed as part of this report.
(1) List of Financial Statements: Page
----
Report of Current Independent Accountants F-1
Report of Previous Independent Accountants F-2
Consolidated Financial Statements:
Consolidated Balance Sheets -
December 31, 1998 and 1997 F-3
Consolidated Statements of Operations -
Years ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Changes in
Stockholders' Equity -
Years ended December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flow -
Years ended December 31, 1998, 1997 and 1996 F-6 to F-7
Notes to Consolidated Financial Statements F-8 to F-41
(2) Financial Statement Schedules: Page
----
Schedule II - Condensed Financial
Information of the Company S-1 to S-3
Schedule III - Supplementary
Insurance Information S-4
All other Financial Statement Schedules are omitted because they are not
applicable or the required information is shown in the Financial Statements or
Notes thereto.
76
(3) Exhibits:
The Exhibits listed on the accompanying Exhibit Index
immediately following the Financial Statement Schedules are
filed as part of, or incorporated by reference into, this
Report.
(b) Reports on Form 8-K:
December 23, 1998 - Item 5 - Other Events
Item 7 - Financial Statement and Exhibits
December 31, 1998 - Item 2 - Acquisition or Disposition of Assets
Item 5 - Other Events
Item 7 - Financial Statements and Exhibits
77
PROVIDENT AMERICAN CORPORATION (Parent Company Only)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(Dollars in thousands) December 31,
Assets 1998 1997
---- ----
Investment in subsidiaries * $ 11,567 $ 11,158
Equipment, net 560 526
Loans receivable from officer, director and stockholder 1,328 1,243
Cash 2
Other assets 1,710 788
-------- --------
Total Assets $ 15,165 $ 13,717
======== ========
Liabilities and Stockholders' Equity
Liabilities
Accounts payable to subsidiaries * $ 3,285 $ 1,687
Accrued expenses 944 1,463
Accrued federal income tax 444 1,518
Notes payable - other 3,865 4,040
Notes payable-bank 1,000
-------- --------
Total Liabilities 8,538 9,708
-------- --------
Commitments and Contingencies:
Minority Interest-Healthaids Common Stock 1,132
Stockholders' Equity
Preferred stock Series A 557 580
Preferred stock Series B
Common stock 1,149 1,021
Additional paid-in capital 26,309 13,767
Net unrealized appreciation of stocks (3)
Net unrealized appreciation (depreciation) of bonds held by
subsidiaries 666 188
Retained earnings (deficit) (including undistributed net
income (loss) of subsidiaries of $(28,161) and $(14,052)) (23,186) (11,468)
Treasury stock, at cost (76)
-------- --------
Total Stockholders' Equity 5,495 4,009
-------- --------
Total Liabilities and Stockholders' Equity $ 15,165 $ 13,717
======== ========
* Eliminated in consolidation.
The condensed financial information should be read in conjunction with
the Provident American Corporation and subsidiaries December 31, 1998
Consolidated Financial Statements and notes thereto.
S-1
PROVIDENT AMERICAN CORPORATION (Parent Company Only)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF COMPANY
STATEMENTS OF OPERATIONS
Years Ended December 31,
Revenue: 1998 1997 1996
---- ---- ----
Interest income $ - $ 93 $ 23
Investment income 26 -
Litigation settlement - 5,320
Realized gain on investments 950 699
Other 92 93 18
--------- --------- --------
92 1,162 6,060
--------- --------- --------
Expenses:
Depreciation 189 863 -
Operating and administrative 370 1,045 744
Interest 174 35 54
--------- --------- --------
733 1,943 798
--------- --------- --------
Income (loss) before income taxes and undistributed
income (loss) of subsidiaries (641) (781) 5,262
Provision for income taxes (1,074) - 1,476
--------- --------- --------
Income (loss) after income taxes 432 (781) 3,786
Undistributed income (loss) of subsidiaries * (12,612) (17,644) 12,334
Minority interest in net loss of subsidiary 716
Net income (loss) (11,463) (18,425) 16,120
Dividends declared on preferred stock 254 148 194
--------- --------- --------
Net income (loss) applicable to common stock $ (11,717) $ (18,573) $ 15,926
========= ========= ========
* Eliminated in consolidation.
The condensed financial information should be read in conjunction with
the Provident American Corporation and subsidiaries December 31, 1998
Consolidated Financial Statements and notes thereto.
S-2
PROVIDENT AMERICAN CORPORATION (Parent Company Only)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF CASH FLOWS
Years Ended December 31,
1998 1997 1996
Operating Activities
Net income (loss) $ (12,156) $ (18,425) $ 16,120
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Undistributed (income) loss of subsidiaries * 12,612 17,644 (12,334)
Depreciation 189 863 -
Issuance of warrants 880
Net realized gain on investments (950) (699)
Common stock received from litigation settlement - (4,320)
Changes in assets and liabilities:
Decrease in other assets (922)
Other liabilities (519) (38) 99
Income taxes 327 1,234 333
--------- --------- --------
Net cash from operating activities (5,024) 328 (801)
--------- --------- --------
Investing Activities
Sale of investments 3,839 2,130
Repayments of loans receivable 3 250
Loans to officer, director and shareholder (88) (1,032) (461)
Decrease in receivables 60 59
Acquisition of equipment (223) (680) -
Acquisition of businesses, net - (35)
Other - - -
--------- --------- --------
Net cash from investing activities (308) 2,437 1,693
--------- --------- --------
Financing Activities
Proceeds from notes payable - bank 1,000 78
Proceeds from notes payable - other (1,176) 3,978 -
Repayment of notes payable - bank and other (200) (708)
Issuance of common stock 3,336 835 800
Dividends paid on preferred stock (148) (148) (194)
Capital contribution to subsidiary * (3,000) (8,000) -
Increase (decrease) in accounts payable subsidiaries * 1,598 (228) (869)
--------- --------- --------
Net cash from financing activities 610 (2,763) (893)
--------- --------- --------
Change in cash (2) 2 (1)
Cash, beginning of year 2 - 1
--------- --------- --------
Cash, end of year $ 0 $ 2 $ -
========= ========= ========
Supplemental disclosure of cash information:
Interest paid $ 5 $ 5 $ 56
Income taxes paid (refunded) $ (1,128) $ (1,128) $ 1,119
Non-cash investing activities:
Issuance of common stock in connection with acquisition of businesses $ - $ - $ 1,879
Issuance of warrants $ 4,469 - -
=========
Exercise of warrants for subscriptions $ 1,400 - -
=========
Increase in net assets in Healthaxis.com, Inc $ 4,210 - -
=========
The condensed financial information should be read in conjunction with
the Provident American Corporation and subsidiaries December 31, 1998
Consolidated Financial Statements and notes thereto.
S-3
PROVIDENT AMERICAN CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
(in thousands)
- - ----------------------------------------------------------------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN F
- - ----------------------------------------------------------------------------------------------------
Years Ended Segment Deferred Policy Future Policy Unearned Premium
December 31, Acquisition Cost Benefits, Premiums Revenue
Losses, Claims
And Loss
Expenses
- - ----------------------------------------------------------------------------------------------------
1996: Individual Life
And Annuity $ 1,468 $ 44,782 $ - $ 10,814
Group Life
And Health 1,672 15,469 1,356 33,892
- - ----------------------------------------------------------------------------------------------------
Total $ 3,140 $ 60,251 $ 1,356 $ 44,706
- - ----------------------------------------------------------------------------------------------------
1997: Individual Life
And Annuity $ 1,499 $ 46,418 $ - $ 6,520
Group Life
And Health - 29,884 2,022 47,733
- - ----------------------------------------------------------------------------------------------------
Total $ 1,499 $ 76,302 $ 2,022 $ 54,253
- - ----------------------------------------------------------------------------------------------------
1998: Individual Life
And Annuity $ 2,106 $ 47,575 $ - $ 6,754
Group Life
And Health - 42,323 - 62,863
- - ----------------------------------------------------------------------------------------------------
Total $ 2,106 $ 89,898 $ - $ 69,617
- - ----------------------------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------------------------------------
COLUMN A COLUMN G COLUMN H COLUMN I COLUMN J
- - --------------------------------------------------------------------------------------------------------------
Years Ended Segment Net Investment Benefits, Claims, Amortization Other Operating
December 31, Income (1) Losses And Of Deferred Expenses
Settlement Policy
Expenses Acquisition
Costs
- - --------------------------------------------------------------------------------------------------------------
1996: Individual Life
And Annuity $ 2,831 $ 10,528 $ 170 $ 3,682
Group Life
And Health 449 20,442 414 16,394
- - ------------------------------------------------------------------------------------------------------------------
Total $ 3,280 $ 30,970 $ 584 $ 20,076
- - --------------------------------------------------------------------------------------------------------------
1997: Individual Life
And Annuity $ 2,887 $ 7,534 $ 82 $ 3,745
Group Life
And Health 600 40,192 10,861 22,630
- - --------------------------------------------------------------------------------------------------------------
Total $ 3,487 $ 47,726 $ 10,943 $ 26,375
- - --------------------------------------------------------------------------------------------------------------
1998: Individual Life
And Annuity $ 1,992 $ 7,163 $ 577 $ 2,994
Group Life
And Health 1,772 48,217 1,472 30,987
- - --------------------------------------------------------------------------------------------------------------
Total $ 3,764 $ 55,380 $ 2,049 $ 33,972
- - ---------------------------------------------------------------------------------------------------------------
(1) Investment income by segment is allocated based on liabilities for future
policy benefits and policy claims.
S-4
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by undersigned, thereunto duly authorized.
PROVIDENT AMERICAN CORPORATION
By: /s/ ALVIN H. CLEMENS
-------------------------------------
Alvin H. Clemens, Chairman of
the Board and Chief Executive Officer
March 26, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities and on the dates indicated.
/s/ ALVIN H. CLEMENS March 26, 1999
- - ------------------------------------------------
Alvin H. Clemens, Chairman of the Board
and Chief Executive Officer
(Principal Executive Officer)
/s/ ANTHONY R. VERDI March 26, 1999
- - ------------------------------------------------
Anthony R. Verdi, Chief Operating Officer
/s/ FRANCIS L. GILLAN III March 26, 1999
- - ------------------------------------------------
Francis L. Gillan III, Chief Financial Officer,
Treasurer (Principal Financial and Accounting Officer)
/s/ MICHAEL ASHKER March 26, 1999
Michael Ashker, Director
/s/ HAROLD M. DAVIS March 29, 1999
- - -------------------------------------------------
Harold M. Davis, Director
/s/ HENRY G. HAGER March 29, 1999
- - --------------------------------------------------
Henry G. Hager, Director
/s/ GEORGE W. KARR March 27, 1999
- - --------------------------------------------------
George W. Karr, Jr., Director
/s/ EDWARD W. LEBARON March 26, 1999
- - -------------------------------------------
Edward W. LeBaron, Director
/s/ DOUGLAS F. MANCHESTER March 28, 1999
- - ---------------------------------------
Douglas F. Manchester, Director
/s/ THEOPHILE J. MIGNATTI, JR. March 28, 1999
- - -----------------------------------------
Theophile J. Mignatti, Jr., Director
/s/ P. GLENN MOYER March 27, 1999
- - -------------------------------------------------
P. Glenn Moyer, Director
78
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS TO FORM 10-K
ANNUAL REPORT OF
PROVIDENT AMERICAN CORPORATION
For the Fiscal Year Ended December 31, 1998
Filed pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(2)(A) Purchase Agreement, dated November 30,
1995 among Registrant and UBL Financial
Corporation. Incorporated by reference
to Exhibit (2)(A) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1995.
(2)(B) Agreement and Plan of Reorganization,
dated August 15, 1996 among Registrant
and Saul Rose and Joan Rose relating to
the capital stock of Coastal Services,
Eastern, Inc. Incorporated by reference
to Exhibit (2)(B) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1996.
(2)(C) Purchase Agreement, dated May 1, 1996
among Registrant, MidAmerica Mutual Life
Insurance Corporation and MidAmerica
Enterprises, Inc. Incorporated by
reference to Exhibit (2)(C) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(2)(D) Stock Exchange Agreement, dated June 18,
1996 among Registrant, Richard E. Field,
Arthur J. Ivey and Richard E. Field &
Associates, Inc. Incorporated by
reference to Exhibit (2)(D) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(3)(A) Articles of Incorporation of the
Registrant, as amended, incorporated by
reference to Exhibit (3)(A) to
Registrant's Form 10 Registration
Statement No. 0-13591, as amended.
Amendment to Registrants Articles of
Incorporation dated December 5, 1989,
incorporated by reference to Exhibit
(C)(2) to Registrant's Form 8-K dated
December 29, 1989.
(3)(B) By-laws of Registrant, as amended,
incorporated by reference to Exhibit
(3)(B) to Registrant's Form 10
Registration Statement No. 0-13591, as
amended.
79
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(4)(A)* Form of Registrant's Common Stock
Certificate incorporated by reference to
Exhibit (4)(A) to Registrant's Form S-1
Registration Statement No. 33-5884, as
amended.
(4)(B) Amended and Restated Statement With
Respect To Shares - Domestic Business
Corporation For Provident American
Corporation. Series A Cumulative
Convertible Preferred Stock, $1.00 Par
Value. Incorporated by reference to
Exhibit (4)(A) to Registrant's Quarterly
Report on Form 10-Q for the Quarterly
period ended September 30, 1993.
(4)(C) Amended and Restated Statement With
Respect To Shares - Domestic Business
Corporation For Provident American
Corporation. Series B Cumulative
Convertible Preferred Stock, $1.00 Par
Value. Incorporated by reference to
Exhibit (4)(B) to Registrant's Quarterly
Report on Form 10-Q for the Quarterly
period ended September 30, 1993.
(4)(D) Stock Purchase Agreement dated March 31,
1993 by and among the Registrant, Alvin
H. Clemens and the group of investors
known as "The Brumley Group" for the
purchase of 387,500 shares of Series B
Cumulative Convertible Preferred Stock.
Incorporated by reference to Exhibit
(4)(C) to Registrant's Quarterly Report
on Form 10-Q for the Quarterly period
ended September 30, 1993.
(4)(E) Insurion, Inc. 5.5% Convertible Note due
June 30, 2003, the principal amount of
$5,000,000 received on May 29, 1998.
(10)(A)* Employment Contract dated April 1, 1991
among Registrant, Provident Indemnity
Life Insurance Company, Maine National
Life Insurance Company and Alvin H.
Clemens incorporated by reference to
Exhibit (10)(A) to Registrant's
Quarterly Report on Form 10-Q for the
quarterly period ended September 30,
1993.
(10)(B)* Premium Production and Stock Option
Agreement dated January 19, 1991 among
Registrant, Provident Indemnity Life
Insurance Company and Premarco, Inc.
incorporated by reference to Exhibit
(10)(E) to Registrant's Annual Report on
Form 10-K for the year ended December
31, 1990.
80
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(C) Escrow Agreement dated January 1, 1991
between Network America Life Insurance
Company, Provident Indemnity Life
Insurance Company and Harleysville
National Bank and Trust Company
incorporated by reference to Exhibit
(10)(G) to Registrant's Annual Report on
Form 10-K for the year ended December
31, 1990.
(10)(D)* Registrant's 1983 Incentive Stock Option
Plan and Management Contracts
thereunder, incorporated by reference to
Exhibit (10)(C)(17) to Registrant's Form
10 Registration Statement No. 0-13591,
as amended.
(10)(E)* Registrant's 1985 Non-Qualified Stock
Option Plan, incorporated by reference
to Exhibit (10)(C)(1) to Registrant's
Form 10 Registration Statement No.
0-13591, as amended.
(10)(F) Quota Share Reinsurance Agreement
effective as of October 1, 1989 among
Provident Indemnity Life Insurance
Company, Continental Assurance Company,
First Equicor Life Insurance Company,
The Mercantile and General Reinsurance
Company, Limited, The Manufacturers Life
Insurance Company, Ltd. and Gerling
Global Life Insurance Company
incorporated by reference to Exhibit
(10)(L) to Registrant's Form S-1
Registration Statement No. 33-40842, as
amended.
(10)(G)* Registrant's 1991 Executive Stock Option
Plan incorporated by reference to
Exhibit (10)(O) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1991.
(10)(H)* Registrant's 401(k) Profit Sharing Plan
and Trust incorporated by reference to
Exhibit (10)(P) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1991.
(10)(I)* Amendment dated November 17, 1992 to
Premium Production and Stock Option
Agreement dated January 19, 1991 among
Registrant, Provident Indemnity Life
Insurance Company and Premarco, Inc.,
incorporated by reference to Exhibit
(10)(S) to Registrant's Annual Report on
Form 10-K for the year ended December
31, 1992.
81
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10(J)* Amended and Restated Provident American
Corporation Incentive Stock Option Plan
for Field Representatives and Agents
dated January 1, 1991, incorporated by
reference to Exhibit (10)(T) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1992.
(10)(K)* Third Amendment to the Amended and
Restated Stock Option Agreement dated
April 1, 1993 among Registrant,
Provident Indemnity Life Insurance
Company and Alvin H. Clemens,
incorporated by reference to Exhibit
(10)(B) to Registrant's Quarterly Report
on Form 10-Q for the Quarterly period
ended September 30, 1993.
(10)(L)* Option Agreement dated as of April 1,
1993 granting Alvin H. Clemens the right
to purchase 500,000 shares of Series A
Preferred Stock, incorporated by
reference to Exhibit (10)(C) to
Registrant's Quarterly Report on Form
10-Q for the Quarterly period ended
September 30, 1993.
(10)(M) Stock Purchase Agreement dated February
16, 1995 by and among Blue Alliance
Mutual Insurance Company, Registrant and
Provident Indemnity Life Insurance
Company as to the sale of all of the
outstanding stock of Maine National Life
Insurance Company. Incorporated by
reference to Exhibit (10)(W) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1994.
(10)(N) Stock Purchase Agreement, dated January
2, 1995 among Maine National Life
Insurance Company, Provident Indemnity
Life Insurance Company and PAMCO Realty
Co., Inc. Incorporated by reference to
Exhibit (10)(X) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1994.
(10)(O) Reinsurance Agreement, dated December
31, 1995 between Provident Indemnity
Life Insurance Company and London Life
Reinsurance Company. Incorporated by
reference to Exhibit (10)(Y) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
82
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(P) Warrant, dated November 1, 1995 granting
Thomas A. Bruderman the right to
purchase up to 50,000 shares of the
common stock of Registrant. Incorporated
by reference to Exhibit (10)(Z) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
(10)(Q)* Fourth Amendment to Registrant's
Incentive Stock Option Plan for Field
Representatives and Agents, effective
January 1, 1995. Incorporated by
reference to Exhibit (10)(CC) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
(10)(R) Settlement Agreement and Mutual General
Release, effective February 12, 1996
among Registrant, Provident Indemnity
Life Insurance Company, The Loewen Group
Inc., and Loewen Group International,
Inc. Incorporated by reference to
Exhibit (10)(EE) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1995.
(10)(S)* Registrant's Life and Health Insurance
Agent Non-Qualified Stock Option Plan,
effective January 2, 1996. Incorporated
by reference to Exhibit (10)(EE) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(10)(T)* Employment Contract, dated April 1, 1996
among Registrant, Provident Indemnity
Life Insurance Company and Edward
Bolton. Incorporated by reference to
Exhibit (10)(FF) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1996.
(10)(U)* Amended and Restated Employment
Contract, dated November 7, 1996 among
Registrant, NIA Corporation, Provident
American Life & Health Insurance Company
and James O. Bowles. Incorporated by
reference to Exhibit (10)(GG) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(10)(V)* Employment Contract, dated February 19,
1997 among Registrant, Provident
Indemnity Life Insurance Company,
Provident American Life & Health
Insurance Company and Alvin H. Clemens.
Incorporated by reference to Exhibit
(10)(HH) to Registrant's Annual Report
on Form 10-K for the year ended December
31, 1996.
83
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(W) Promissory Note; Pledge and Security
Agreement, dated April 8, 1996 between
Registrant and Alvin H. Clemens.
Incorporated by reference to Exhibit
(10)(II) to Registrant's Annual Report
on Form 10-K for the year ended December
31, 1996.
(10)(X)* Amendment and Restatement of the
Registrant's Stock Option Plan for
Directors, effective July 16, 1996.
Incorporated by reference to Exhibit
(10)(JJ) to Registrant's Annual Report
on Form 10-K for the year ended December
31, 1996.
(10)(Y)* Registrant's 1996 Employee Incentive
Stock Option Plan, effective July 16,
1996. Incorporated by reference to
Exhibit (10)(KK) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1996.
(10)(Z)* Registrant's Amended and Restated Stock
Option Plan for Executives, dated
December 11, 1996. Incorporated by
reference to Exhibit (10)(LL) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(10)(AA) Promissory Note with Amendments; Pledge
and Security Agreement; and Escrow
Agreement, dated April 2, 1996 between
Registrant and John T. Gillin.
Incorporated by reference to Exhibit
(10)(MM) to Registrant's Annual Report
on Form 10-K for the year ended December
31, 1996.
(10)(BB) Warrant for the Purchase of Shares of
Common Stock, dated July 18, 1996
granting Ladenburg, Thalmann & Co. Inc.
the right to purchase 100,000 shares of
the common stock of Registrant.
Incorporated by reference to Exhibit
(10)(OO) to Registrant's Annual Report
on Form 10-K for the year ended December
31, 1996.
(10)(CC)* Marketing and Consulting Agreement,
dated June 18, 1996 between Provident
Indemnity Life Insurance Company and
Richard E. Field. Incorporated by
reference to Exhibit (10)(PP) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
84
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(DD)* Stock Option/Warrant Agreement, dated
January 1, 1996 between Registrant and
Richard E. Field. Incorporated by
reference to Exhibit (10)(QQ) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.
(10)(EE) Amendment to Promissory Note, dated
April 8, 1997 between Registrant and
Alvin H. Clemens. Incorporated by
reference to Exhibit (10)(GG) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997.
(10)(FF) Promissory Note, dated July 28, 1997
between Registrant and Alvin H. Clemens.
Incorporated by reference to Exhibit
(10)(HH) to Registrant's Annual Report
on Form 10-K for the year ended December
31, 1997.
(10)(GG) Second Amendment to Promissory Note,
dated February 1, 1997; Third Amendment
to Promissory Note, dated April 30,
1997, between Registrant and John T.
Gillin. Incorporated by reference to
Exhibit (10)(II) to Registrant's Annual
Report on Form 10-K for the year ended
December 31, 1997.
(10)(HH) Services Agreement with Amendment to
Services Agreement, dated February 1,
1998 between Provident Indemnity Life
Insurance Company, Provident American
Life and Health Insurance Company,
HealthPlan Services Corporation and
HealthPlan Services, Inc. Incorporated
by reference to Exhibit (10)(JJ) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997.
(10)(II) Inducement Agreement, dated October 16,
1997 between Registrant and HealthPlan
Services, Inc. Incorporated by reference
to Exhibit (10)(KK) to Registrant's
Annual Report on Form 10-K for the year
ended December 31, 1997.
85
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(JJ) The Provident and HealthPlan Services
E-Commerce Agreement, dated May 29, 1998
and effective February 1, 1998 between
Registrant, Insurion, Inc., Provident
Health Services, Inc. and HealthPlan
Services, Inc. Incorporated by reference
to Exhibit (10)(LL) to Registrant's
Annual Report on Form 10-K for the year
ended December 31, 1997.
(10)(KK) Amended and Restated Interactive
Marketing Agreement, dated February 1,
1998 between Provident Health Services,
Inc. and American Online, Inc.
Incorporated by reference to Exhibit 1
to Registrant's Form 8-K/A dated June 8,
1998.
(10)(LL) MGU Stock Purchase Agreement, dated
February 27, 1998 between Montgomery
Management Corporation and HealthPlan
Services, Inc. Incorporated by reference
to Exhibit (10)(NN) to Registrant's
Annual Report on Form 10-K for the year
ended December 31, 1997.
(10)(MM) Lynx Capital Group, LLC Consulting
Agreement, dated March 31, 1998 between
Provident Indemnity Life Insurance
Company, Provident American Life and
Health Insurance Company and Lynx
Capital Group, LLC. Incorporated by
reference to Exhibit (10)(OO) to
Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997.
(10)(NN) Interactive Marketing Agreement between
Registrant's wholly owned subsidiary,
Provident Health Services, Inc. and
American Online, Inc., dated March 20,
1998. Incorporated by reference to
Exhibit 1 to Registrant's Form 8-K/A
dated June 12, 1998.
(10)(OO) Share Purchase Agreement dated November
13, 1998 between Registrant, Lynx
Private Equity Partners I, LLC, James
Burke, Craig Gitlitz and Interhotel
Company Ltd. Incorporated by reference
to Exhibit 10.1 to Registrant's Form 8-K
dated December 23, 1998.
86
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(PP) Agreement dated September 15, 1998
between Registrant's wholly owned
subsidiaries, Provident Indemnity Life
Insurance Company and Health Axis
related to the Series A Convertible
Preferred Shares. Incorporated by
reference to Exhibit 10.5 to
Registrant's Form 8-K dated December 23,
1998.
(10)(QQ) Certificate of Designations related to
the Series A Convertible Preferred Stock
of Registrant's subsidiary, HealthAxis.com,
Inc. Incorporated by reference to Exhibit
10.6 to Registrant's Form 8-K dated
December 23, 1998.
(10)(RR) Certificate of Designations related to
the Series B convertible Preferred Stock
of Registrant's subsidiary, HealthAxis.com,
Inc. Incorporated by reference to Exhibit
10.7 to Registrant's Form 8-K dated
December 23, 1998.
(10)(SS) Stock Purchase Agreement, dated December
29, 1998, between Central Reserve Life
Corporation, Registrant and Registrant's
wholly owned subsidiary, Provident
Indemnity Life Insurance Company.
Incorporated by reference to Exhibit
99.1 to Registrant's Form 8-K dated
January 15, 1999.
(10)(TT) Guarantee Agreement, dated December 29,
1998, by Registrant in favor of RCH as
agent on behalf of itself and CRCL.
Incorporated by reference to Exhibit
99.2 to Registrant's Form 8-K dated
January 15, 1999.
(10)(UU) Stock Pledge Agreement dated, December
29, 1998, by Registrant in favor of RCH
as agent for itself and CRLC.
Incorporated by reference to Exhibit
99.3 to Registrant's Form 8-K dated
January 15, 1999.
(10)(VV) Reinsurance Agreement among PILIC, RCH
and CRLC (effective date December 31,
1998). Incorporated by reference to
Exhibit 99.4 to Registrant's Form 8-K
dated January 15, 1999.
87
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(WW) Reinsurance Agreement among PALHIC and
PILIC (effective date December 31,
1998). Incorporated by reference to
Exhibit 99.5 to Registrant's Form 8-K
dated January 15, 1999.
(10)(XX) Assignment and Assumption of Contracts
dated December 31, 1998 among CRLC,
Registrant, PILIC and Provident Health
Services, Inc. Incorporated by reference
to Exhibit 99.6 to Registrant's Form 8-K
dated January 15, 1999.
(10)(YY) Individual Medical Products Carrier
Partner Agreement, dated December 29,
1998, among and between HealthAxis.com,
Inc., PALHIC and CRLC. Incorporated by
reference to Exhibit 99.7 to
Registrant's Form 8-K dated January 15,
1999.
(10)(ZZ) First Amendment to the Amended and
Restated Interactive Marketing Agreement
between America Online, Inc. and
Registrant's wholly owned subsidiaries,
Provident Health Services, Inc. and
HealthAxis.com, Inc. Incorporated by
reference to Exhibit 10.2 to
Registrant's Form 8-K/A dated January
19, 1999.
(10)(AAA) Promotion Agreement dated June 27, 1998
between Insurion, Inc. and CNET, Inc.
(This document has been redacted to
remove certain portions for which
confidential treatment has been
requested by the Company pursuant to
Rule 24b-2) and the First Amendment
thereto dated November 13, 1998.
Incorporated by reference to Exhibit
10.3 to Registrant's Form 8-K/A dated
January 19, 1999.
(10)(BBB) Amended and Restated Agreement dated
November 13, 1998 between LYCOS, Inc.
and Insurion, Inc. (This document has
been redacted to remove certain portions
for which confidential treatment has
been requested by the Registrant
pursuant to Rule 24b-2). Incorporated by
reference to Exhibit 10.4 to
Registrant's Form 8-K/A dated January
19, 1999.
(10)(CCC) Revolving Promissory Note between
Registrant and PILIC dated July 1, 1998.
88
Exhibit Sequentially
Number Description of Exhibits Numbered Page
------ ----------------------- -------------
(10)(DDD) Consulting Agreement between Registrant
and Robinson, Lerer & Montgomery, LLC
dated January 25, 1999.
(10)(EEE) Second Amendment to Promissory Note
dated as of the 24th day of March 1999,
by and between Alvin H. Clemens and
Registrant.
(10)(FFF) Second Amendment to Pledge And Security
Agreement dated as of the 24th day of
March 1999, by and between Alvin H.
Clemens and Registrant.
(11) Computation of Earnings Per Share.
(16) Letter re: change in certifying
accountant.
(22) Subsidiaries of Registrant.
(23)(A) Consent of Current Independent
Accountants.
(23)(B) Consent of Previous Independent
Accountants.
(27) Financial Data Schedule.
* Indicates management contract or compensatory plan or arrangement.
89