1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 2000
COMMISSION FILE #0-11321
UNIVERSAL AMERICAN FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
NEW YORK 11-2580136
---------------------------- -------------------------------
(State of Incorporation) (I.R.S. Employer I.E. No.)
Six International Drive, Suite 190, Rye Brook, NY 10573
--------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 934-5200
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------------ ---------
The number of shares outstanding of the Registrant's Common Stock as of
October 31, 2000 was 46,821,024.
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UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Consolidated Balance Sheets at September 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations for the nine months ended September 30, 2000 4
and September 30, 1999
Consolidated Statements of Operations for the three months ended September 30, 2000 5
and September 30, 1999
Consolidated Statements of Cash Flows for the nine months ended September 30, 2000 6
and September 30, 1999
Notes to Consolidated Financial Statements 7-16
Management's Discussion and Analysis of Financial Condition and Results of Operations 17-33
PART II - OTHER INFORMATION 34
Signature 34
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3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS September 30, 2000 Dec. 31, 1999
---------------------- ----------------------
Investments: (unaudited)
Fixed maturities available for sale, at fair value
(amortized cost: 2000, $744,664; 1999, $734,466) $ 734,242 $ 717,560
Equity securities, at fair value (cost: 2000, $5,235; 1999, $5,120) 4,937 4,838
Policy loans 25,363 25,640
Other invested assets 2,094 2,763
Mortgage loans 2,413 2,743
---------------------- ----------------------
Total investments 769,049 753,544
Cash and cash equivalents 38,385 58,753
Accrued investment income 10,845 11,506
Deferred policy acquisition costs 47,520 34,943
Amounts due from reinsurers 214,007 196,960
Due and unpaid premiums 62,954 3,578
Deferred income tax asset 63,484 70,968
Goodwill 9,578 4,201
Present value of future profits 6,631 1,226
Other assets 24,484 17,742
---------------------- ----------------------
Total assets 1,187,439 1,153,421
====================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 229,962 238,665
Reserves for future policy benefits 577,033 560,777
Policy and contract claims - life 6,760 5,644
Policy and contract claims - health 78,604 72,261
Loan payable 71,500 70,000
Amounts due to reinsurers 2,261 85
Restructuring accrual 5,358 9,980
Negative goodwill 2,001 9,622
Other liabilities 56,236 52,422
---------------------- ----------------------
Total liabilities 1,069,715 1,019,456
---------------------- ----------------------
STOCKHOLDERS' EQUITY
Common stock (Authorized, 80,000, issued and outstanding: 2000, 46,832,
1999, 45,914) 468 459
Additional paid-in capital 128,329 122,924
Accumulated other comprehensive income (5,242) (6,887)
Retained earnings 34,169 17,469
---------------------- ----------------------
Total stockholders' equity 157,724 133,965
---------------------- ----------------------
Total liabilities and stockholders' equity $ 1,187,439 $ 1,153,421
====================== ======================
See notes to unaudited consolidated financial statements.
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UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
------------------- -----------------------
Revenues: (in thousands, per share amounts in dollars)
Gross premium and policyholder fees earned $ 334,315 $ 147,737
Reinsurance premiums assumed 2,210 1,524
Reinsurance premiums ceded (170,277) (87,235)
------------------- -----------------------
Net premium and policyholder fees earned 166,248 62,026
Net investment income 42,693 15,103
Net realized gains/(losses) on investments 144 18
Fee income 4,982 1,604
------------------- -----------------------
Total revenues 214,067 78,751
------------------- -----------------------
Benefits, claims and expenses:
Increase in future policy benefits 2,423 1,192
Claims and other benefits 113,895 40,115
Interest credited to policyholders 7,596 5,846
Increase in deferred acquisition costs (13,013) (2,592)
Amortization of present value of future profits 2,305 131
Amortization of goodwill/negative goodwill (254) (217)
Commissions 60,041 26,283
Interest expense 5,262 1,265
Other operating costs and expenses 58,427 24,061
Commission and expense allowances on reinsurance ceded (48,531) (24,659)
------------------- -----------------------
Total benefits, claims and other deductions 188,151 71,425
------------------- -----------------------
Operating income before taxes 25,916 7,326
Federal and foreign income tax expense 9,216 2,681
------------------- -----------------------
Net income 16,700 4,645
Redemption accrual on Series C and Series D Preferred Stock -- 179
------------------- -----------------------
Net income applicable to common shareholders $ 16,700 $ 4,466
=================== =======================
Earnings per common share:
Basic $ 0.36 $ 0.27
=================== =======================
Diluted $ 0.35 $ 0.22
=================== =======================
See notes to unaudited consolidated financial statements
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UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30,
2000 1999
------------------- -----------------------
Revenues: (in thousands, per share amounts in dollars)
Gross premium and policyholder fees earned $ 113,126 $ 80,921
Reinsurance premiums assumed 812 544
Reinsurance premiums ceded (58,311) (41,186)
------------------- -----------------------
Net premium and policyholder fees earned 55,627 40,279
Net investment income 13,977 9,433
Net realized gains/(losses) on investments (5) 33
Fee income 1,870 443
------------------- -----------------------
Total revenues 71,469 50,188
------------------- -----------------------
Benefits, claims and expenses:
Increase in future policy benefits 1,193 349
Claims and other benefits 38,759 25,637
Interest credited to policyholders 2,505 2,184
Increase in deferred acquisition costs (4,986) (1,172)
Amortization of present value of future profits 790 44
Amortization of goodwill/negative goodwill 93 (293)
Commissions 19,685 12,870
Interest expense 1,861 1,265
Other operating costs and expenses 19,623 13,173
Commission and expense allowances on reinsurance ceded (16,320) (9,055)
------------------- -----------------------
Total benefits, claims and other deductions 63,203 45,002
------------------- -----------------------
Operating income before taxes 8,266 5,186
Federal and foreign income tax expense 2,853 1,953
------------------- -----------------------
Net income $ 5,413 $ 3,233
=================== =======================
Earnings per common share:
Basic $ 0.12 $ 0.10
=================== =======================
Diluted $ 0.12 $ 0.09
=================== =======================
See notes to unaudited consolidated financial statements
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UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
------------------ ---------------------
(In thousands)
Cash flows from operating activities:
Net income $ 16,700 $ 4,645
Adjustments to reconcile net income to net cash used by operating activities:
Deferred income taxes 6,778 1,059
Change in reserves for future policy benefits 5,086 4,424
Change in policy and contract claims 7,459 679
Change in deferred policy acquisition costs (12,558) (2,592)
Change in deferred revenue (24) (40)
Amortization of present value of future profits 2,305 131
Amortization of goodwill/negative goodwill (254) (216)
Change in policy loans 277 147
Change in accrued investment income 667 574
Change in reinsurance balances (12,505) (4,360)
Change in due and unpaid premium (408) (477)
Realized (gains)/losses on investments (144) (18)
Change in income taxes payable 653 8,517
Other, net (5,417) (7,143)
------------------ ---------------------
Net cash provided by operating activities 8,615 5,330
------------------ ---------------------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for sale 65,342 12,270
Proceeds from redemption of fixed maturities available for sale 9,447 14,675
Cost of fixed maturities purchased available for sale (88,688) (72,385)
Change in amounts held in trust by reinsurer (1,140) (910)
Proceeds from sale of equity securities 138 374
Cost of equity securities purchased (408) (144)
Change in other invested assets 999 2,588
Change in amounts due to/(from) broker (30) 7,604
Purchase of business, net of cash held (6,365) (5,348)
------------------ ---------------------
Net cash used in investing activities (20,705) (41,276)
------------------ ---------------------
Cash flows from financing activities:
Prepaid acquisition costs
Net proceeds from issuance of common stock 157 89,600
Net proceeds from issuance of Series D Preferred Stock 0 1,750
Increase (decrease) in policyholder account balances (8,703) 1,877
Change in reinsurance balances related to policyholder account balances (1,226) (1,063)
Increase in loan payable 1,500 70,000
Principal payment on notes payable 0 (4,750)
------------------ ---------------------
Net cash provided by/(used in) financing activities (8,272) 157,414
------------------ ---------------------
Net increase (decrease) in cash and cash equivalents (20,362) 121,468
Cash and cash equivalents at beginning of period 58,753 17,093
------------------ ---------------------
Cash and cash equivalents at end of period $ 38,385 $ 138,561
================== =====================
Supplemental cash flow information:
Cash paid during the period for interest $ 5,262 $ 1,265
================== =====================
Cash paid during the period for income taxes $ 125 $ 25
================== =====================
See notes to unaudited consolidated financial statements
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UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim financial information herein is unaudited, but in the
opinion of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results of operations for the nine months ended
September 30, 2000 are not necessarily indicative of the results to be expected
for the full year. The consolidated financial statements should be read in
conjunction with the Form 10-K for the year ended December 31, 1999. Certain
reclassifications have been made to prior year's financial statements to conform
with current period classifications.
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
("GAAP") and consolidate the accounts of Universal American Financial Corp.
("Universal" or the "Parent Company") and its subsidiaries (collectively the
"Company"), American Progressive Life & Health Insurance Company of New York
("American Progressive"), American Pioneer Life Insurance Company ("American
Pioneer"), American Exchange Life Insurance Company ("American Exchange") and
WorldNet Services Corp. ("WorldNet"). On July 30, 1999, Universal acquired all
of the outstanding shares of common stock of certain direct and indirect
subsidiaries of PennCorp Financial Group ("PFG"), including the following six
insurance companies (the "Penn Union Companies"): Pennsylvania Life Insurance
Company ("Pennsylvania Life"), Peninsular Life Insurance Company ("Peninsular"),
Union Bankers Insurance Company ("Union Bankers"), Constitution Life Insurance
Company ("Constitution"), Marquette National Life Insurance Company
("Marquette") and PennCorp Life Insurance Company, a Canadian company ("PennCorp
Canada"). On January 6, 2000, Universal acquired American Insurance
Administration Group ("AIAG"). On August 31, 2000, Universal acquired Capitated
Healthcare Services, Inc. ("CHCS").
Universal is a life and accident and health insurance holding company
whose principal insurance subsidiaries noted above traditionally, through a
general agency system, marketed and underwrote products aimed at the senior
market, including Medicare supplement, long-term care, home health care, life
insurance and annuities. With the acquisition of the Penn Union Companies, the
Company has expanded its issuance of fixed benefit accident and health insurance
products. The acquisition expanded the Company's general agency system and
generated a new distribution system consisting of career agents. The career
agent distribution system operates through a network of regional managers that
operate branch offices throughout the United States and Canada. These career
agents focus only on sales for Pennsylvania Life and PennCorp Canada. Universal,
through its acquisitions of AIAG and CHCS in 2000, has expanded its insurance
services segment to include independent third party administrative service
contracts.
2. BUSINESS COMBINATION
Penn Union Acquisition
On July 30, 1999, Universal acquired all of the outstanding shares of
common stock of the Penn Union Companies and other related assets.
The purchase price of $130.5 million in cash was financed with $92.8
million of proceeds generated from the sale of 29.5 million shares of common
stock and from the term loan portion of an $80 million credit facility entered
into on July 30, 1999 consisting of a $70 million term loan and a $10 million
revolving loan facility. The proceeds of the financing in excess of the $130.5
million purchase price were used to pay transaction costs of the acquisition and
the financing, to retire an existing Universal bank loan, to contribute to the
surplus of Pennsylvania Life and for working capital.
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The acquisition of the Penn Union Companies was accounted for using
the purchase method and, accordingly, the operating results generated by the
acquired companies after July 30, 1999 are included in Universal's consolidated
financial statements. In addition to the purchase price, the Company incurred
costs totaling $18.3 million including a restructuring accrual of $10.4 million
and $3.8 million in stock compensation expense related to shares purchased by
agents and certain members of management at prices discounted from the market.
At the time of closing, the fair value of net assets of the acquired companies
amounted to $151.7 million resulting in a negative goodwill amount of $2.9
million, which will be amortized on a straight line basis over a ten year
period. During the third quarter of 2000, the Company finalized its purchase
accounting adjustments for the PennUnion acquisition. The final adjustments
related primarily to certain policy reserves and contingencies with regard to
the true-up of the purchase price settlement with the seller. As a result of
these adjustments, the business equity acquired and corresponding negative
goodwill was reduced by $7.1 million from the amount reported as of
December 31, 1999.
The consolidated pro forma results of operations for the nine months
ended September 30, 1999, as if the companies described above had been purchased
on January 1, 1999, are as follows:
Nine Months Ended September
30, 1999
-----------------------------
(In thousands)
Total revenue $205,420
Operating income before taxes $ 23,539
Net income $ 13,585
Earnings per common share:
Basic $ 0.34
Diluted $ 0.30
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired with the Penn Union Companies into its
locations in Toronto, Canada, Pensacola, Florida, and Orlando, Florida in order
to improve operating efficiencies and capabilities. The plan to consolidate this
location was being formulated at the date of acquisition. Accordingly, the
Company recorded a $10.4 million restructuring liability in its accounting for
the Penn Union acquisition.
This liability was accounted for under EITF No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3").
The liability consisted of employee separation costs ($3.2 million), employee
relocation costs ($2.6 million), and other relocation and exit costs and during
the nine months ended September 30, 2000, the Company paid $5.1 million in
restructuring charges. The Company expects the consolidation to be completed in
early 2001.
Acquisition of American Insurance Administration Group ("AIAG")
In January 2000, Universal acquired all of the outstanding shares of
AIAG, a privately held third party administrator located in Clearwater, Florida,
for $2.875 million in cash, 809,860 shares on Universal common stock and certain
contingent future cash payments. AIAG is the third party administrator of
approximately $123 million of senior supplemental health insurance,
approximately $97 million of which is administered for Union Bankers and
Constitution. Total revenue for the nine months ended September 30, 2000 totaled
$7.6 million of which $5.6 million related to Union Bankers and Constitution and
was eliminated in the accompanying consolidated financial statements.
Acquisition of CHCS, Inc. ("CHCS")
In August 2000, Universal acquired all of the outstanding shares of
CHCS, a privately held third party administrator located in Weston, Florida, for
$3.3 million in cash, 64,820 shares on Universal common stock and future cash
payments totaling $1.0 million over 18 months. CHCS is the third party
administrator of long term care and home health care insurance products for over
21 unaffiliated insurance companies. For the two months ended September 30,
2000, CHCS received administrative fees of $870 thousand on contracts with
expected annual fees of $5.2 million.
3. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the
nine-month periods ended September 30, 2000 and 1999 are as follows:
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FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------------------
2000 1999
------------------- -------------------
(In thousands)
Net income $16,700 $4,646
------------------- -------------------
Other comprehensive income:
Unrealized gain/(loss) on securities 3,943 (2,428)
Foreign currency translation adjustment (2,298) 1,054
------------------- -------------------
Other comprehensive income/(loss) 1,645 (1,374)
------------------- -------------------
Comprehensive income/(loss) $ 18,345 $3,272
=================== ===================
The components of comprehensive income, net of related tax, for the
three-month periods ended September 30, 2000 and 1999 are as follows:
FOR THE THREE MONTHS
ENDED SEPTEMBER 30,
--------------------------------------------
2000 1999
------------------- -------------------
(In thousands)
Net income $5,413 $3,233
------------------- -------------------
Other comprehensive income:
Unrealized gain/(loss) on securities 4,365 (413)
Foreign currency translation adjustment (1,004) 1,054
------------------- -------------------
Other comprehensive income/(loss) 3,361 641
------------------- -------------------
Comprehensive income/(loss) $8,774 $3,874
=================== ===================
4. EARNINGS PER SHARE
Per share amounts for net income from operations are shown in the
income statement using i) an earnings per common share basic calculation and ii)
an earnings per common share-assuming dilution calculation. A reconciliation of
the numerators and the denominators of the basic and diluted EPS for the nine
months ended September 30, 2000 and 1999 is as follows:
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FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
---------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------ -------------------- ---------------
(In thousands, per share amounts in dollars)
Basic EPS
Net income applicable to common shareholders $ 16,700 $ 46,739 $ 0.36
Effect of Dilutive Securities
Incentive stock options 1,044
Director stock options 112
Agents and others stock options 642
Treasury stock assumed from proceeds of
options and warrants (1,407)
------------------ --------------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $ 16,700 $ 47,130 $ 0.35
================== ==================== ===============
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
---------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------ -------------------- ---------------
(In thousands, per share amounts in dollars)
Net income $4,645
Less: Redemption accrual on Series C Preferred
Stock (179)
------------------
Basic EPS
Net income applicable to common shareholders 4,466 16,581 $ 0.27
===============
Effect of Dilutive Securities
Series B Preferred Stock 1,383
Series C Preferred Stock 180 725
Series D Preferred Stock 992
Non-registered warrants 2,016
Registered warrants 641
Incentive stock options 1,408
Director stock options 51
Agents and others stock options 263
Treasury stock assumed from proceeds of
options and warrants (2,419)
------------------ --------------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $4,646 21,641 $ 0.22
================== ==================== ===============
A reconciliation of the numerators and the denominators of the basic
and diluted EPS for the three months ended September 30, 2000 and 1999 is as
follows:
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FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
---------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------ -------------------- ---------------
(In thousands, per share amounts in dollars)
Basic EPS
Net income applicable to common shareholders $ 5,413 $ 46,793 $ 0.12
Effect of Dilutive Securities
Incentive stock options 1,208
Director stock options 124
Agents and others stock options 804
Treasury stock assumed from proceeds of
options and warrants (1,766)
------------------ --------------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $ 5,413 $ 47,163 $ 0.12
================== ==================== ===============
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999
---------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------ -------------------- ---------------
(In thousands, per share amounts in dollars)
Basic EPS
Net income applicable to common shareholders $ 3,233 32,066 $ 0.10
===============
Effect of Dilutive Securities
Series B Preferred Stock 593
Series C Preferred Stock -
Series D Preferred Stock 463
Non-registered warrants 2,016
Registered warrants 621
Incentive stock options 2,639
Director stock options 51
Agents and others stock options 263
Treasury stock assumed from proceeds of
options and warrants (2,701)
------------------ --------------------
Diluted EPS
Net income applicable to common
shareholders plus assumed conversions $ 3,233 36,011 $ 0.09
================== ==================== ===============
5. INVESTMENTS
As of September 30, 2000 and December 31, 1999, fixed maturity
securities are classified as investments available for sale and are carried at
fair value, with the unrealized gain or loss, net of tax and other adjustments
(deferred policy acquisition costs), included in accumulated other comprehensive
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income.
SEPTEMBER 30, 2000
-----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------------- ----------------------- ------------------ ------------------- ------------------
(In thousands)
US Treasury securities
and obligations of
US government $ 35,472 $ 169 $ 143 $ 35,498
Corporate debt securities 447,399 2,155 7,877 441,677
Mortgage-backed securities 261,793 814 5,540 257,067
-------- -------- -------- --------
$744,664 $ 3,138 $ 13,560 $734,242
======== ======== ======== ========
DECEMBER 31, 1999
-----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ---------------------------------------- ----------------------- ------------------ ------------------- ------------------
(In thousands)
US Treasury securities
and obligations of
US government $ 63,968 $ 10 $ (587) $ 63,391
Corporate debt securities 446,630 420 (10,693) 436,357
Mortgage-backed securities 223,868 190 (6,246) 217,812
----------------------- ------------------ ------------------- ------------------
$ 734,466 $ 620 $ (17,526) $717,560
======================= ================== =================== ==================
The amortized cost and fair value of fixed maturities at September
30, 2000 by contractual maturity are shown below. Expected maturities may differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
--------------------- ---------------------
(In thousands)
Due in 1 year or less $ 27,601 $ 27,442
Due after 1 year through 5 years 160,139 159,398
Due after 5 years through 10 years 215,788 211,712
Due after 10 years 76,844 76,150
Mortgage-backed securities 264,292 259,540
--------------------- ---------------------
$ 744,664 $ 734,242
===================== =====================
6. STOCKHOLDERS' EQUITY
Common Stock
The par value of common stock is $.01 per share with 80,000,000
shares authorized for issuance. The shares issued and outstanding at September
30, 2000 and December 31, 1999 were 46,831,543 and
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45,914,327, respectively. Changes in the number of shares of common stock
outstanding were as follows:
Balance at December 31, 1999 45,914,327
Stock issued for purchase of AIAG 809,860
Stock issued for purchase of CHCS 64,820
Stock options exercised 8,000
Stock purchases pursuant to Agents' Stock Purchase Plan 11,750
Stock issued under employee/agent benefit plans 22,786
-----------------
Balance at September 30, 2000 46,831,543
=================
7. IMPACT OF THE YEAR 2000
The Year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information in years subsequent to 1999. Prior to 2000,
the Company underwent a corporate-wide program to address the Year 2000 issue,
as it relates to its own computer systems, as well as to instances in which
computer systems of third parties may have a significant impact on the Company's
operations, such as suppliers, business partners, customers, facilities and
telecommunications. In addressing the Year 2000 issue, the Company did not incur
any significant expenses other than the allocation of internal resources to test
and monitor this issue. The Company has not experienced any significant
disruptions of business operations related to the Year 2000 issue to date and
believes that the risk of such disruption in the future is low, although no
assurance can be given in this regard. It is possible that Year 2000 problems
that are not currently apparent may arise in the future. Accordingly, the
Company will continue to monitor its systems for the Year 2000 issue.
8. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS
American Progressive, American Pioneer, American Exchange,
Constitution Life, Marquette, Peninsular Life, PennCorp Canada, Pennsylvania
Life and Union Bankers (collectively, the "Insurance Subsidiaries") are required
to maintain minimum amounts of capital and surplus as determined by statutory
accounting. Each of the Insurance Subsidiaries' statutory capital and surplus
exceeds its respective minimum requirement. However, substantially more than
such minimum amounts are needed to meet statutory and administrative
requirements of adequate capital and surplus to support the current level of the
Insurance Subsidiaries' operations. At September 30, 2000 and December 31, 1999
the statutory capital and surplus, including asset valuation reserve, of the
U.S. insurance subsidiaries totaled $89.9 and $89.2 million, respectively.
Beginning in 1993, the National Association of Insurance
Commissioners ("NAIC") imposed regulatory risk-based capital ("RBC")
requirements on life insurance enterprises. At December 31, 1999 all of the
Insurance Subsidiaries maintained ratios of total adjusted capital to RBC in
excess of the Authorized Control Level.
PennCorp Canada and Pennsylvania Life's Canadian branch reports to
Canadian regulatory authorities based upon Canadian statutory accounting
principles that vary in some respects from U.S. statutory accounting principles.
Canadian net assets based upon Canadian statutory accounting principles were
$63.3 and $63.9 million as of September 30, 2000 and December 31, 1999,
respectively. PennCorp Canada maintained a Minimum Continuing Capital and
Surplus Requirement Ratio ("MCCSR") in excess of the minimum requirement and
Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in
Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at
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September 30, 2000 and December 31, 1999.
9. BUSINESS SEGMENT INFORMATION
During the third quarter of 1999 and with the acquisition of the Penn
Union companies, Universal changed its segment structure. Under the new
structure, the insurance businesses are reviewed by management of the Company
along distribution lines, and decisions regarding the operation of the Company
are made accordingly. In addition, due to the vast difference in the nature of
the operations from the insurance businesses, management reviews and evaluates
the results of the Insurance Services and Corporate Segment separately.
Under the new segment structure, the Company considers itself to have
four distinct business segments: Career Agents, Senior Market Brokerage, Special
Markets and Insurance Services and Corporate Segment. Products distributed
through the Career Sales segment are sold through a network of regional
managers who operate branch offices throughout the U.S. and Canada. The career
agents focus only on sales for Pennsylvania Life and PennCorp Canada and sell
primarily fixed benefit accident and health insurance. Total revenue and
operating income before taxes generated by Canadian operations through PennCorp
Canada and Pennsylvania Life's Canadian branch totaled $42.8 million and $9.2
million, respectively, for the nine month period ended September 30, 2000. The
career agents began to offer Universal's senior market products discussed below
in 2000. Business in the Senior Market Brokerage Segment is sold through a
traditional general agency system which focuses on the sale of various senior
market products including Medicare supplement, home health care, nursing home
and hospital indemnity products. Agents in this segment do not sell exclusively
for the Company. The Special Markets segment consists of blocks of business that
were acquired through the acquisitions of various companies or are not currently
produced through the career or Senior Market brokerage agency distribution
channels as well as some specialty life insurance and accident and health
products. The information previously reported under "Life Insurance Segment" and
"Other Accident and Health Insurance Segment" has been combined under the
Special Markets Segment. The Insurance Services and Corporate Segment consists
mainly of the Parent Company, WorldNet, AIAG and CHCS operations. Prior year
segment information has been restated to conform with the current segment
structure.
Financial data by segment as of and for the nine months ended
September 30, 2000 and 1999 is as follows:
September 30, 2000
-------------------------------------------------------------------------------------
(In thousands)
Insurance
Career Senior Market Special Services and
Sales Brokerage Markets Corporate Total
---------------- ---------------- -------------- ----------------- ----------------
Net premiums and policyholder fees earned $ 99,844 31,810 34,595 (1) 166,248
Net investment income 23,631 1,120 17,800 142 42,693
Realized gains - 136 8 - 144
Fee and other income 417 - 259 4,306 4,982
---------------- ---------------- -------------- ----------------- ----------------
123,892 33,066 52,662 4,447 214,067
---------------- ---------------- -------------- ----------------- ----------------
Policyholder benefits 64,285 24,329 35,300 - 123,914
Increase in deferred acquisition costs (9,789) (2,947) (277) - (13,013)
Commissions and general expenses 47,529 7,214 13,933 8,574 77,250
---------------- ---------------- -------------- ----------------- ----------------
Total benefits, claims and other deductions 102,025 28,596 48,956 8,574 188,151
---------------- ---------------- -------------- ----------------- ----------------
Operating income before taxes 21,867 4,470 3,706 (4,127) 25,916
================ ================ ============== ================= ===============
ASSETS
Cash and investments 451,064 20,828 329,221 6,321 807,434
Deferred policy acquisition costs 12,614 14,519 20,387 - 47,520
14
15
Accrued investment income 5,699 215 4,931 - 10,845
Goodwill - 3,568 517 5,493 9,578
Present value of future profits - 727 321 5,583 6,631
Due and unpaid premiums 2,866 292 828 - 3,986
Reinsurance recoverable 5,325 125,513 83,169 - 214,007
Deferred income tax asset - - - 63,484 63,484
Other assets 4,616 2,569 4,204 13,095 24,484
---------------- ---------------- -------------- ----------------- ----------------
Total assets $ 482,184 $ 168,231 $ 443,578 $ 93,976 $ 1,187,969
================ ================ ============== ================= ================
September 30, 1999
-------------------------------------------------------------------------------------
Insurance
Career Senior Market Special Services and
Sales Brokerage Markets Corporate Total
---------------- ---------------- -------------- ----------------- ----------------
Net premiums and policyholder fees earned 21,664 21,383 18,980 - 62,027
Net investment income 4,565 546 10,022 (30) 15,103
Realized gains 18 - 29 (30) 17
Fee and other income (59) - (93) 1,756 1,604
---------------- ---------------- -------------- ----------------- ----------------
26,188 21,929 28,938 1,696 78,751
Policyholder benefits 12,594 15,939 18,620 - 47,153
Increase in deferred acquisition costs (406) (2,454) 268 - (2,592)
Commissions and general expenses 10,180 6,471 6,885 3,328 26,864
---------------- ---------------- -------------- ----------------- ----------------
Total benefits, claims and other deductions 22,368 19,956 25,773 3,328 71,425
Operating income before taxes 3,820 1,973 3,165 (1,632) 7,326
================ ================ ============== ================= ================
ASSETS
Cash and investments 443,681 9,871 357,920 7,897 819,369
Deferred policy acquisition costs 407 9,693 20,243 - 30,343
Accrued investment income 4,447 223 5,926 - 10,596
Goodwill - 3,703 536 - 4,239
Present value of future profits - 963 476 - 1,439
Due and unpaid premiums 3,544 436 1,106 - 5,086
Reinsurance recoverable 4,890 35,922 153,115 - 193,927
Deferred income tax asset - - - 63,092 63,092
Other assets 11,776 - 2,586 6,878 21,240
---------------- ---------------- -------------- ----------------- ----------------
Total assets $ 468,745 $ 60,811 $ 541,908 $ 77,867 $ 1,149,331
================ ================ ============== ================= ================
Financial data by segment for the three months ended September 30,
2000 and 1999 is as follows:
September 30, 2000
-------------------------------------------------------------------------------------
(In thousands)
Insurance
Career Senior Market Special Services and
Sales Brokerage Markets Corporate Total
---------------- ---------------- -------------- ----------------- ----------------
Net premiums and policyholder fees earned 33,660 11,058 10,910 (1) 55,627
Net investment income 7,928 567 5,434 48 13,977
Realized gains (80) 132 (57) - (5)
Fee and other income 144 - 32 1,694 1,870
---------------- ---------------- -------------- ----------------- ----------------
41,652 11,757 16,319 1,741 71,469
Policyholder benefits 22,696 8,155 11,606 - 42,457
Increase in deferred acquisition costs (3,565) (1,320) (101) - (4,986)
Commissions and general expenses 15,693 2,689 3,673 3,677 25,732
---------------- ---------------- -------------- ----------------- ----------------
Total benefits, claims and other deductions 34,824 9,524 15,178 3,677 63,203
Operating income before taxes 6,828 2,233 1,141 (1,936) 8,266
================ ================ ============== ================= ================
15
16
September 30, 1999
-------------------------------------------------------------------------------------
Insurance
Career Senior Market Special Services and
Sales Brokerage Markets Corporate Total
---------------- ---------------- -------------- ----------------- ----------------
Net premiums and policyholder fees earned 21,665 7,969 10,645 - 40,279
Net investment income 4,565 147 4,785 (64) 9,433
Realized gains 18 2 43 (30) 33
Fee and other income (59) - (116) 618 443
---------------- ---------------- -------------- ----------------- ----------------
26,189 8,118 15,357 524 50,188
Policyholder benefits 12,595 5,976 9,599 - 28,170
Increase in deferred acquisition costs (406) (824) 58 - (1,172)
Commissions and general expenses 10,180 2,068 3,161 2,595 18,004
---------------- ---------------- -------------- ----------------- ----------------
Total benefits, claims and other deductions 22,369 7,220 12,818 2,595 45,002
Operating income before taxes 3,820 898 2,539 (2,071) 5,186
================ ================ ============== ================= ================
16
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company cautions readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this report
and in any other oral or written statements, either made by, or on behalf of the
Company, whether or not in future filings with the Securities and Exchange
Commission ("SEC"). Forward-looking statements are statements not based on
historical information. They relate to future operations, strategies, financial
results or other developments. In particular, statements using verbs such as
"expect," "anticipate," "believe" or similar words generally involve
forward-looking statements. Forward-looking statements include statements that
represent the Company's products, investment spreads or yields, or the earnings
or profitability of the Company's activities.
Forward-looking statements are based upon estimates and assumptions
that are subject to significant business, economic and competitive
uncertainties, many of which are beyond the Company's control and are subject to
change. These uncertainties can affect actual results and could cause actual
results to differ materially from those expressed in any forward-looking
statements made by, or on behalf of the Company. Whether or not actual results
differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable events or developments, some of which may be
national in scope, such as general economic conditions and interest rates. Some
of these events may be related to the insurance industry generally, such as
pricing competition, regulatory developments and industry consolidation. Others
may relate to Universal specifically, such as credit, volatility and other risks
associated with the Company's investment portfolio, and other factors. Universal
disclaims any obligation to update forward-looking information.
The following analysis of the consolidated results of operations and
financial condition of the Company should be read in conjunction with the
Consolidated Financial Statements and related consolidated footnotes included
elsewhere.
The Company owns nine insurance companies (collectively, the
"Insurance Subsidiaries"): American Progressive Life & Health Insurance Company
of New York ("American Progressive"), American Pioneer Life Insurance Company
("American Pioneer"), American Exchange Life Insurance Company ("American
Exchange"), Constitution Life Insurance Company ("Constitution Life"), Marquette
National Life Insurance Company ("Marquette"), Peninsular Life Insurance Company
("Peninsular Life"), Pennsylvania Life Insurance Company ("Pennsylvania Life"),
PennCorp Life Insurance Company ("PennCorp Canada") and Union Bankers Insurance
Company ("Union Bankers"). Six of these companies, Pennsylvania Life, PennCorp
Canada, Peninsular, Union Bankers, Constitution and Marquette, as well as
certain other related assets, were acquired on July 30, 1999. In addition to the
Insurance Subsidiaries, Universal owns three third party administrators:
American Insurance Administration Group, Inc. ("AIAG"), which was purchased
January 6, 2000, Capitated Health Care Services, Inc., ("CHCS"), which was
purchased August 31, 2000 and WorldNet Services Corp. ("WorldNet") that process
the Company's brokerage senior market policies, as well as business for
unaffiliated insurance companies.
In January 2000, the Company announced that it had approved a plan to
consolidate the Raleigh location acquired on July 30, 1999 into its locations in
Toronto (Canada), Pensacola (Florida), and Orlando (Florida) in order to improve
operating efficiencies and capabilities. The plan to consolidate this location
was being formulated at the date of acquisition. Accordingly, the Company
recorded a $10.4 million restructuring liability in its accounting for the
acquisition.
This liability was accounted for under EITF No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3").
The liability consisted of employee separation costs ($3.2 million), employee
relocation costs ($2.6 million), and other relocation and exit costs. During the
nine months ended September 30, 2000, the Company paid $5.1 million in
restructuring charges.
17
18
Subsequent to the acquisition of the Penn Union Companies, the
Company redefined its operating segments with primary emphasis on its
distribution channels. Currently, the Company manages its business through four
operating segments, Senior Market Brokerage, Career Sales, Special Markets and
Insurance Services and Corporate.
SENIOR MARKET BROKERAGE - This distribution channel consists of a general agency
system and insurance brokerage system that focus on the sale of products in the
senior market segment, including Medicare Supplement, Medicare Select and
Long-term Care.
CAREER SALES SYSTEM - The Career Sales segment is comprised of a career agency
field force, which distributes fixed benefit accident and sickness, life
insurance and supplemental senior health insurance in the United States and
Canada. The Career Agents are under exclusive contract with Pennsylvania Life
and PennCorp Canada.
SPECIAL MARKETS - Through its own operating history and through prior
acquisitions, Universal has accumulated various lines of business that it
manages in its Special Markets segments. These products include annuities,
interest-sensitive and group life insurance, individual medical and other
accident and health insurance.
INSURANCE SERVICES AND CORPORATE - This segment is primarily made up of the
insurance administrative service companies that process certain business for the
Insurance Subsidiaries, as well as unaffiliated insurers. It also includes the
corporate operations of the holding company, including interest on debt.
Prior to the Penn Union Transaction, the Company reported its results
through four segments, with primary emphasis on major product lines. These
segments were Senior Market Accident and Health Insurance, Other Accident and
Health Insurance, Life Insurance and Non-insurance Business.
The new Senior Market Brokerage Segment includes substantially all of
the former Senior Market Accident and Health Insurance Segment business.
The Career Sales segment includes only business which is new to the
Company as a result of the acquisition of Pennsylvania Life and PennCorp Canada.
The Special Markets segment includes a combination of existing
Universal business from the Other Accident and Health and Life Insurance
segments, as well as new business resulting from the acquisition of the
Peninsular, Marquette, Union Bankers and Constitution.
The Insurance Services and Corporate Segment includes all businesses
previously included in the Non-insurance Business Segment. Results of operations
for the nine months ended September 30, 2000 include the results of AIAG and
CHCS (from their respective dates of purchase).
RESULTS OF OPERATIONS
Nine Months Ended September, 2000 and 1999
Consolidated net income after federal income taxes increased by $12.2
million to $16.7 million ($0.35 per diluted share) in 2000, compared to $4.5
million ($0.22) in 1999. Operating income before income tax increased by $18.6
million to $25.9 million in 2000 compared to $7.3 million in 1999.
The Senior Market Brokerage segment operating results increased by
$2.5 million in addition to the $18.0 million increase by the Career Sales
segment. The Special Markets segment improved its results by $0.5 million. These
increases are offset by a reduction of $2.5 million in the results from the
Insurance service and Corporate segment. Discussion of the details by segment
follows.
18
19
SENIOR MARKET BROKERAGE SEGMENT
The Senior Market Brokerage Segment focuses on the sale of senior
market products through a network of independent agents. The results of
operations for the nine months ended September 30, 2000 and 1999 include the
results of the sales of products such as Medicare Supplement, Medicare Select
and Long Term Care products through this distribution channel.
REVENUES. Total revenues for the Senior Market Brokerage Segment
increased approximately $11.2 million to approximately $33.1 million for the
nine months ended September 30, 2000, compared to total revenues of
approximately $21.9 million in the prior year. This increase results from the
increase in internally generated production and not from the acquisition of the
Penn Union Companies.
Gross premium and policyholder fees earned and reinsurance assumed
In the nine months ended September 30, 2000, the Senior Market
Brokerage Segment gross premium and policyholder fees earned (including
reinsurance assumed) amounted to $176.3 million, a $82.6 million increase over
the $93.7 million amount in 1999. The gross earned premiums on the Company's
senior market products increased as follows:
PREMIUM INCREASE/ 2000 TOTAL
DESCRIPTION (DECREASE) PREMIUM EARNED
- ----------------------------------------------------- --------------------------- -------------------------
(in millions) (in millions)
Medicare Supplement/Select $ 30.8 $ 67.0
Freedom Care 2.3 6.5
Hospital Indemnity, Home Health Care and Nursing
Home 1.0 5.0
First National business acquired (2.1) 31.3
Union Bankers Medicare Supplement 37.8 50.2
Constitution Medicare Supplement 12.8 15.4
Other 0 0.9
--------------------------- -------------------------
Totals $ 82.6 $ 176.4
=========================== =========================
The Medicare Supplement insurance issued by Union Bankers and
Constitution is 100% reinsured with an unaffiliated reinsurer.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the nine months ended
September 30, 2000 for the Senior Market Brokerage Segment amounted to $147.3
million, a $77.1 million increase from the 1999 amount of $70.2 million. Details
of the changes in reinsurance premiums ceded are as follows:
19
20
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE/ (DECREASE) PREMIUM CEDED
- ----------------------------------------------------- ---------------------------- -----------------------
(in millions) (in millions)
Business acquired:
First National $2.4 $28.1
Dallas General (1.0) 5.2
Medicare Supplement 23.5 43.3
Union Bankers Medicare Supplement 37.8 50.2
Constitution Medicare Supplement 12.8 15.4
Freedom Care 1.1 2.4
Hospital Indemnity, Home Health Care and Nursing 0.5
Home 2.3
Other lines 0.0 0.4
---------------------------- -----------------------
Totals $77.1 $147.3
============================ =======================
Investment related revenue
Net investment income of the Senior Market Brokerage Segment
increased $0.6 million to $1.1 million for the nine months ended September 30,
2000, compared to 1999. Realized gains on investments increased slightly from
the prior year.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and
other deductions in the Senior Market Brokerage Segment increased approximately
$8.6 million to $28.6 million for the nine months ended September 30, 2000,
compared to $20.0 million for the nine months ended September 30, 1999.
Claims and other benefits increased $8.4 million to $23.1 million for
the nine months ended September 30, 2000 compared to $13.4 million in the prior
year. The change in reserves for the nine months ended September 30, 2000
amounted to an increase of $1.2 million compared to an increase of $2.5 million
in 1999 generating a variance of $1.4 million. These increases in claims and
change in reserves are primarily the result of the $5.5 million increase in net
premiums earned for the nine months ended September 30, 2000 discussed above.
The change in deferred acquisition costs for the nine months ended
September 30, 2000 reflected net capitalization of $2.9 million for the nine
months ended September 30, 2000 compared to $2.5 million in the prior year.
Commissions in the Senior Market Brokerage Segment increased $1.8
million in the nine months ended September 30, 2000 to $28.1 million, compared
to $26.3 million in 1999. This increase is the direct result of the $94.3
million increase in gross premium discussed above. Commissions and expense
allowances on reinsurance ceded increased $16.1 million in the nine months ended
September 30, 2000 to $40.8 million, compared to $24.7 million in 1999. This
increase is the direct result of the $89.2 million increase in reinsurance
premium ceded discussed above.
Other operating costs and expenses increased $16.3 million in the
nine months ended September 30, 2000 to $19.9 million, compared to $2.7 million
in 1999 due in part to the increase in expenses incurred in generating new
business as well as the increase in premium taxes associated with the growth in
new business in this segment.
20
21
CAREER SALES SEGMENT
The Career Sales Segment was acquired in the Penn Union Acquisition
and comprises the operations of Pennsylvania Life Insurance Company
("Pennsylvania Life") and PennCorp Life Insurance Company of Canada ("PennCorp
Canada"). The Career Agents market life and health insurance products focusing
primarily on fixed benefit accident and sickness products. Penn Corp Canada
operates exclusively in Canada, while Pennsylvania Life operates in both the
U.S. ("Pennsylvania Life U.S.") and Canada. The results for 1999 reflect only
the activity from the date of purchase
REVENUES. Total net revenues for the Career Sales segment amounted to
$123.9 million, an increase of $97.7 over the same period of the prior year, of
which $81.1 million was generated by Pennsylvania Life U.S. and $42.8 million
was generated by the Canadian operations. Gross premium totaled $102.7 million,
$64.0 million derived from Pennsylvania Life U.S. and $38.7 million derived from
the Canadian operations. The Company reinsures a portion of these premiums to
outside parties. Total ceded premiums for the nine months ended September 30,
2000 were $0.6 million at the Canadian operations and $2.2 million at
Pennsylvania Life U.S. Investment income of $23.6 million consists mostly of
interest on bonds held by the Company.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and
other deductions in the Career Sales Segment totaled $102.0 million for the nine
months ended September 30, 2000, compared to $22.4 million for the prior year.
Claims and other benefits amounted to $64.2 million for the nine
months ended September 30, 2000. Of this amount, $43.5 million related to claims
incurred at Pennsylvania Life U.S. and $20.0 million related to the Canadian
operations. The change in reserves for the nine months ended September 30, 2000
amounted to $9.1 million.
Deferred acquisition costs increased $9.8 million for the nine months
ended September 30, 2000 compared to an increase of $0.4 in the prior year.
Acquisition costs capitalized at Pennsylvania Life U.S. totaled $6.5 million net
of amortization. Canadian costs capitalized, net of amortization amounted to
$3.1 million.
Commissions in the Career Sales Segment for the nine months ended
September 30, 2000 amounted to $23.1 million, of which $16.7 million related to
Pennsylvania Life U.S. Commissions and expense allowances on reinsurance ceded
totaled $0.5 million in the nine months ended September 30, 2000. Other
operating costs and expenses totaled $24.9 million for the nine months ended
September 30, 2000.
SPECIAL MARKETS SEGMENT
The Special Markets Segment consists of blocks of business that were
acquired through the acquisitions of various companies or are not currently
produced through the career or brokerage agency distribution systems as well as
some specialty life and accidental insurance products. The results of operations
for the nine months ended September 30, 2000 and 1999 include the results of the
sales of such products.
REVENUES. Total revenues for the Special Markets Segment increased
approximately $23.8 million to approximately $52.7 million for the nine months
ended September 30, 2000, compared to total revenues of approximately $28.9
million in the prior year.
21
22
Gross premium and policyholder fees earned and reinsurance assumed
In the nine months ended September 30, 2000, the Special Markets
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $56.3 million, a $25.2 million increase over the $31.1
million amount in 1999. The gross earned premiums on the Company's special
market products increased as follows:
2000 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
- ----------------------------------------------------- --------------------------- -------------------------
Acquired Businesses: (in millions) (in millions)
Constitution $ 1.8 $ 1.8
Union Bankers 19.5 19.5
International Medical 0.3 4.3
Major Medical 0.2 9.8
Life and annuity products 0.0 11.3
Other Health Products 3.4 9.6
--------------------------- -------------------------
Totals $ 25.2 $ 56.3
=========================== =========================
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the nine months ended
September 30, 2000 for the Special Markets Segment amounted to $19.0 million, a
$3.2 million increase from the 1999 amount of $18.7 million. Details of the
changes in reinsurance premiums ceded is as follows:
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE /(DECREASE) PREMIUM CEDED
- ----------------------------------------------------- ----------------------------- -------------------------
(in millions) (in millions)
Business acquired
Constitution $0.7 $0.7
Union Bankers 0.3 0.4
Life and annuity products (0.4) 5.2
Major Medical (0.1) 6.1
International Medical 0.5 4.2
Other lines (0.7) 5.3
----------------------------- --------------------------
----------------------------- -------------------------
Totals $ 0.3 $ 21.9
============================= =========================
Investment related revenue
Net investment income of the Special Markets Segment increased $7.8
million to $17.8 million for the nine months ended September 30, 2000, compared
to $10.0 million in 1999. This increase is attributable to the increase in
invested assets in this segment during 2000 compared to 1999 as a result of the
Penn Union Transaction.
22
23
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and
other deductions in the Special Markets Segment increased approximately $23.2
million to $49.0 million for the nine months ended September 30, 2000, compared
to $25.8 million for the nine months ended September 30, 1999.
Claims and other benefits increased $24.3 million to $37.6 million
for the nine months ended September 30, 2000 compared to $13.3 million in 1999.
$28.3 million of this increase is attributable to the Penn Union Transaction.
The change in reserves for the nine months ended September 30, 2000 amounted to
an increase of $9.2 million compared to a decrease of $0.5 million in 1999
generating a variance of $9.7 million. The change in reserves for Penn Union
Companies for the nine months ended September 30, 2000 amounted to a decrease of
$8.3 million. Interest credited to policyholders increased $1.8 million from
$5.8 million in 1999 to $7.6 million in 2000. Approximately $2.5 million of the
increase relates to the acquired companies which is offset by a slight decrease
in the core businesses.
The change in deferred acquisition costs increased by $0.5 million
for the nine months ended September 30, 2000 compared to the same period in
1999. The amount of acquisition costs capitalized increased $0.2 million from
$1.2 million for the nine months ended September 30, 1999 to $1.3 million for
the nine months ended September 30, 2000. The deferred acquisition costs
decreased in relation to the increase in net earned premium primarily due to the
fact that the increase in net earned premium related mainly to renewal business
of the Penn Union companies. New business production is the main driver of
deferred acquisition costs. The amortization of deferred acquisition costs
decreased $0.2 million from $1.3 million for the nine months ended September 30,
1999 to $1.2 million for the nine months ended September 30, 2000.
Commissions in the Special Markets Segment increased $0.6 million in
the nine months ended September 30, 2000 to $8.6 million, compared to $8.0
million in 1999. This increase is due largely to the acquisition of the Penn
Union Companies which increase of $0.5 million was offset by a decrease of $0.1
million in some of the life products no longer marketed. Premiums on products in
this segment are generally renewal premiums as little new business is being
written. Commissions on renewal business are at lower rates than new business.
Commissions and expense allowances on reinsurance ceded was $8.6 million for the
nine months ended September 30, 2000 compared to $6.8 million for the nine
months ended September 30, 1999, an increase of $1.8 million.
Other operating costs and expenses decreased $0.6 million in the nine
months ended September 30, 2000 to $5.7 million, compared to $6.3 million in
1999. This increase is due mainly to expenses related to the newly acquired Penn
Union lines of business. This increase is offset by a decrease in the cost of
generating new business as some of the lines of business in this segment run
off.
INSURANCE SERVICES AND CORPORATE
The Insurance Services and Corporate Segment consists of WorldNet,
PFI, Inc ("PFI")(an internal servicing company acquired in July, 1999), the
Parent Company, AIAG which was acquired in January, 2000, CHCS which was
acquired in August 2000, as well as a minority interest in Security Health.
Fees and other income increased $2.6 million due to revenue generated
at AIAG. General expenses increased $5.2 million from $3.3 million in 1999 to
$8.6 million in 2000. This increase is due to an increase in interest expense of
$4.1 million related to a loan with Chase Manhattan to finance the purchase of
the Penn Union Companies. In addition, the Parent Company incurred compensation
expenses of approximately $0.6 million related to the issue of stock options and
bonuses to employees and agents.
RESULTS OF OPERATIONS
23
24
Three Months Ended September 30, 2000 and 1999
Consolidated net income after federal income taxes increased by $2.2
million to $5.4 million ($0.12 per diluted share) in 2000, compared to $3.2
million ($0.10) in 1999. Operating income before income tax increased by $3.1
million to $8.3 million in 2000 compared to $5.2 million in 1999.
The Senior Market Brokerage segment more than doubled its operating
results, increasing by $1.3 million to $2.2 million in 2000. The Career Sales
segment increased its results by $3.0 million to $6.8 million in 2000. These
increases are offset by a reduction of $1.4 million in the Special Markets
segment. Results for the Non-insurance segment were consistent with the prior
year. Discussion of the details by segment follows.
SENIOR MARKET BROKERAGE SEGMENT
The Senior Market Brokerage Segment focuses on the sale of senior
market products through a network of independent agents. The results of
operations for the three months ended September 30, 2000 and 1999 include the
results of the sales of products such as Medicare Supplement, Medicare Select
and Long Term Care products through this distribution channel.
REVENUES. Total revenues for the Senior Market Brokerage Segment
increased approximately $3.7 million to approximately $11.8 million for the
three months ended September 30, 2000, compared to total revenues of
approximately $8.1 million in the prior year. This increase results from the
increase in internally generated production and not from the acquisition of the
Penn Union Companies.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended September 30, 2000, the Senior Market
Brokerage Segment gross premium and policyholder fees earned (including
reinsurance assumed) amounted to $59.9 million, a $31.5 million increase over
the $28.4 million amount in 1999. The gross earned premiums on the Company's
senior market products increased as follows:
PREMIUM INCREASE/ 2000 TOTAL
DESCRIPTION (DECREASE) PREMIUM EARNED
- ----------------------------------------------------- --------------------------- -------------------------
(in millions) (in millions)
Medicare Supplement/Select $ 11.0 $ 24.8
Freedom Care 0.8 2.2
Hospital Indemnity, Home Health Care and Nursing
Home 10.0 2.0
First National business acquired (3.2) 8.6
Union Bankers Medicare Supplement 16.2 16.2
Constitution Medicare Supplement 5.7 5.7
Other (0.0) .4
--------------------------- -------------------------
Totals $ 31.5 $ 59.5
=========================== =========================
The Medicare Supplement insurance issued by Union Bankers and
Constitution is 100% reinsured with an unaffiliated reinsurer.
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for
24
25
the three months ended September 30, 2000 for the Senior Market Brokerage
Segment amounted to $52.0 million, a $16.7 million increase from the 1999 amount
of $35.3 million. Details of the changes in reinsurance premiums ceded are as
follows:
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE /(DECREASE) PREMIUM CEDED
- ----------------------------------------------------- ----------------------------- -----------------------
(in millions) (in millions)
Business acquired:
First National $1.0 $10.0
Dallas General (0.4) 1.6
Medicare Supplement 8.3 16.2
Union Bankers Medicare Supplement 3.8 16.2
Constitution Medicare Supplement 3.1 5.7
Freedom Care 0.5 1.0
Hospital Indemnity, Home Health Care and Nursing
Home 0.4 1.1
Other lines 0.0 0.2
----------------------------- -----------------------
Totals $16.7 $52.0
============================= =======================
Investment related revenue
Net investment income of the Senior Market Brokerage Segment
increased $0.5 million to $0.6 million for the three months ended September 30,
2000, compared to 1999. Realized gains on investments increased slightly from
the prior year.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and
other deductions in the Senior Market Brokerage Segment increased approximately
$3.5 million to $9.5 million for the three months ended September 30, 2000,
compared to $6.0 million for the three months ended September 30, 1999.
Claims and other benefits increased $3.2 million to $7.5 million for
the three months ended September 30, 2000 compared to $4.3 million in the prior
year. The change in reserves for the three months ended September 30, 2000
amounted to an increase of $1.0 million compared to an increase of $0.6 million
in 1999 generating a variance of $0.4 million. These increases in claims and
change in reserves are the result of the $3.8 million increase in net premiums
earned for the three months ended September 30, 2000 discussed above.
The change in deferred acquisition costs reflected an increase in the
net capitalization of $1.3 million, an increase of $0.6 over the prior year.
Commissions in the Senior Market Brokerage Segment increased $5.7
million in the three months ended September 30, 2000 to $10.0 million, compared
to $4.3 million in 1999. This increase is the direct result of the $33.7 million
increase in gross premium discussed above. Commissions and expense allowances on
reinsurance ceded increased $8.0 million in the three months ended September 30,
2000 to $13.4 million, compared to $5.4 million in 1999. This increase is the
direct result of the $30.0 million increase in reinsurance premium ceded
discussed above.
Other operating costs and expenses increased $2.2 million in the
three months ended September 30, 2000 to $5.6 million, compared to $3.4 million
in 1999 due in part to the increase in expenses incurred in generating new
business as well as the increase in premium taxes associated with the growth in
new
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business in this segment.
CAREER SALES SEGMENT
The Career Sales Segment was acquired in the Penn Union Acquisition
and comprises the operations of Pennsylvania Life Insurance Company
("Pennsylvania Life") and PennCorp Life Insurance Company of Canada ("PennCorp
Canada"). The Career Agents market life and health insurance products focusing
primarily on fixed benefit accident and sickness products. Penn Corp Canada
operates exclusively in Canada, while Pennsylvania Life operates in both the
U.S. ("Pennsylvania Life U.S.") and Canada.
REVENUES. Total net revenues for the Career Sales segment amounted to
$41.7 million, an increase of $15.5 over the prior year. Gross premium totaled
$33.9 million. The Company reinsures a portion of these premiums to outside
parties. Total ceded premiums for the three months ended September 30, 2000 were
$0.1. Investment income of $4.6 million consists mostly of interest on bonds
held by the company.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and
other deductions in the Career Sales Segment totaled $34.8 million for the three
months ended September 30, 2000 compared to $22.4 million in the prior year.
Claims and other benefits amounted to $17.6 million for the three
months ended September 30, 2000. Of this amount, $13.9 million related to claims
incurred at Pennsylvania Life U.S. and $3.7 million related to the Canadian
operations. The change in reserves for the three months ended September 30, 2000
amounted to $3.2 million.
The change in deferred acquisition costs reflected net capitalization
of $3.6 million for the three months ended September 30, 2000, compared to $0.4
in the prior year
Commissions in the Career Sales Segment for the three months ended
September 30, 2000 amounted to $7.1 million, of which $5.7 million related to
Pennsylvania Life U.S. Commissions and expense allowances on reinsurance ceded
totaled $0.1 million in the three months ended September 30, 2000. Other
operating costs and expenses totaled $9.5 million for the three months ended
September 30, 2000.
SPECIAL MARKETS SEGMENT
The Special Markets Segment consists of blocks of business that were
acquired through the acquisitions of various companies or are not currently
produced through the career or brokerage agency distribution systems as well as
some specialty life and accidental insurance products. The results of operations
for the three months ended September 30, 2000 and 1999 include the results of
the sales of such products.
REVENUES. Total revenues for the Special Markets Segment increased
approximately $0.9 million to approximately $16.3 million for the three months
ended September 30, 2000, compared to total revenues of approximately $15.4
million in the prior year.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended September 30, 2000, the Special Markets
Segment gross premium and policyholder fees earned (including reinsurance
assumed) amounted to $19.7 million, a $9.3 million increase over the $10.7
million amount in 1999. The gross earned premiums on the Company's special
market products increased as follows:
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2000 TOTAL
DESCRIPTION PREMIUM INCREASE PREMIUM EARNED
----------------------------------------------------- --------------------------- -------------------------
Acquired Businesses: (in millions) (in millions)
Constitution $ 0.61 $ 0.61
Union Bankers 6.49 6.49
International Medical 0.02 1.58
Major Medical 0.06 3.23
Life and annuity products 0.55 4.30
Other Health Products 1.52 3.49
--------------------------- -------------------------
Totals $ 9.25 $ 19.70
=========================== =========================
Reinsurance premiums ceded
While the Company was able to increase its gross premium revenue from
its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
September 30, 2000 for the Special Markets Segment amounted to $8.0 million, a
$1.6 million increase from the 1999 amount of $6.4 million. Details of the
changes in reinsurance premiums ceded is as follows:
CEDED PREMIUM 2000 TOTAL
DESCRIPTION INCREASE/ (DECREASE) PREMIUM CEDED
- ----------------------------------------------------- ------------------------------ --------------------------
(in millions) (in millions)
Business acquired
Constitution $ 0.11 $ 0.11
Union Bankers 0.17 0.17
Life and annuity products (0.03) 1.90
Major Medical (0.01) 2.02
International Medical 0.03 1.51
Other lines 1.37 2.34
------------------------------ --------------------------
Totals $ 1.64 $ 8.05
============================== ==========================
Investment related revenue
Net investment income of the Special Markets Segment increased $0.6
million to $5.4 million for the three months ended September 30, 2000, compared
to $4.8 million in 1999. This increase is attributable to the increase in
invested assets outstanding in this segment during 2000 compared to 1999 as a
result of the Penn Union Transaction.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and
other deductions in the Special Markets Segment increased approximately $2.4
million to $15.2 million for the three months ended September 30, 2000, compared
to $12.8 million for the three months ended September 30, 1999.
Claims and other benefits increased $9.7 million to $13.0 million for
the three months ended September 30, 2000 compared to $3.3 million in 1999. $9.7
million of this increase is attributable to the Penn Union Transaction. The
change in reserves for the three months ended September 30, 2000 amounted to a
decrease of $3.1 million compared to a decrease of $0.1 million in 1999
generating a variance of $3.0 million. The change in reserves for Penn Union
Companies for the three months ended September 30, 2000 amounted to a decrease
of $3.3 million. Interest credited to policyholders increased
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$0.8 million from $1.7 million in 1999 to $2.5 million in 2000. Approximately
$1.2 million of the increase relates to the acquired companies with an
offsetting decrease of $0.4 million in the core businesses.
The change in deferred acquisition costs reflected amortization of
$0.1 million for the three months ended September 30, 2000 compared to $0.1
million the same period in 1999. The deferred acquisition costs decreased in
relation to the increase in net earned premium primarily due to the fact that
the increase in net earned premium related mainly to renewal business of the
Penn Union companies. New business production is the main driver of deferred
acquisition costs. The amortization of deferred acquisition costs decreased $0.1
million from $0.6 million for the three months ended September 30, 1999 to $0.5
million for the three months ended September 30, 2000.
Commissions in the Special Markets Segment increased $0.5 million in
the three months ended September 30, 2000 to $3.3 million, compared to $2.8
million in 1999. This increase is due largely to the acquisition of the Penn
Union Companies. Premiums on products in this segment are generally renewal
premiums as little new business is being written. Commissions on renewal
business are at lower rates than new business. Commissions and expense
allowances on reinsurance ceded increased $0.2 million in the three months ended
September 30, 2000 to $3.0 million, compared to $2.8 million in 1999.
Other operating costs and expenses increased $3.0 million in the
three months ended September 30, 2000 to $4.6 million, compared to $1.6 million
in 1999. This increase is due mainly to expenses related to the newly acquired
Penn Union lines of business. This increase is offset by a decrease in the cost
of generating new business as some of the lines of business in this segment run
off.
INSURANCE SERVICES AND CORPORATE
The Insurance Services and Corporate Segment consists of WorldNet,
PFI, Inc ("PFI") (an internal servicing company acquired in July, 1999), the
Parent Company, AIAG which was acquired in January, 2000, CHCS which was
acquired in August, 2000, as well as a minority interest in Security Health.
Fees and other income increased $1.1 million due to revenue generated
at AIAG. General expenses increased $1.1 million from $2.6 million in 1999 to
$3.7 million in 1999. This increase is due to an increase in interest expense of
$1.5 million related to a loan with Chase Manhattan to finance the purchase of
the Penn Union Companies. In addition, the Parent Company incurred compensation
expenses of approximately $0.2 million related to the issue of stock options and
bonuses to employees and members of management related to the acquisition of the
Penn Union Companies.
LIQUIDITY AND CAPITAL RESOURCES
The Company's need for capital is primarily to maintain or increase
the surplus of its Insurance Subsidiaries and to support the Company as an
insurance holding company, including the maintenance of its status as a public
company. In addition, the Company requires capital to fund its anticipated
growth through acquisitions of other companies and blocks of insurance business.
The Company
The Company requires cash to pay the operating expenses necessary to
function as an insurance holding company (which under applicable Insurance
Department regulations must bear its own expenses), and to meet the cost
involved in being a publicly owned company. In addition, it requires cash to
meet Universal's obligations under the loan agreement discussed below, the
debentures outstanding with American Progressive and to fund the planned
reorganization of the Company being performed in connection with the acquisition
of the Penn Union Companies.
Management believes that the current cash position, the availability
of the revolving loan facility,
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the expected cash flows of the non-insurance companies (including AIAG), the
surplus note interest payments from American Exchange and the availability of
dividends from its Insurance Subsidiaries can support the obligations of
Universal noted above for the foreseeable future. However, there can be no
assurance as to the expected future cash flows or to the availability of
dividends from the Insurance Subsidiaries.
Loan Agreements
As of September 30, 2000 and December 31, 1999, the Company had an
$80 million credit facility consisting of a $70 million term loan and a $10
million revolving loan facility. The term loan calls for interest at the London
Interbank Offering Rate ("LIBOR") plus 350 basis points (currently 10.13%) with
principal repayment over a seven-year period and a final maturity date of July
31, 2006. To fund the CHCS acquisition in August 2000, the Company drew down
$3.0 million of the revolving loan facility, which amount currently incurs
interest at 10.13%, and pays a commitment fee of 50 basis points on the
unutilized facility, currently $7.0 million. For the nine months ended September
30, 2000, the Company paid $5.3 million in interest and fees in connection with
the credit facility. The Company paid $1.5 million in principal on July 31, 2000
and $1.9 million in principal on October 31, 2000.
In connection with an agreement entered into 1996 whereby American
Pioneer became a direct subsidiary of Universal, rather than an indirect
subsidiary owned through American Progressive, Universal has $7.9 million in
debentures outstanding to its subsidiary, American Progressive. The debentures
pay interest quarterly at 8.50% and are due between September 2002 and May 2003.
During the nine months ended September 30, 2000 the Company paid $0.5 million in
interest on these debentures to American Progressive, which was eliminated in
consolidation.
Acquisition of American Insurance Administration Group ("AIAG")
In January 2000, Universal acquired all of the outstanding shares of
AIAG, a privately held third party administrator located in Clearwater, Florida,
for $2.875 million in cash, 809,860 shares on Universal common stock and certain
contingent future cash payments. AIAG is the third party administrator of
approximately $123 million of senior supplemental health insurance,
approximately $97 million of which is administered for Union Bankers. For the
nine months ended September 30, 2000, AIAG, Inc. received administrative fees of
$7.6 million of which $5.6 million related to Union Bankers and was eliminated
in the consolidated financial statements of the Company.
Acquisition of CHCS, Inc. ("CHCS")
In August 2000, Universal acquired all of the outstanding shares of
CHCS, a privately held third party administrator located in Weston, Florida, for
$3.3 million in cash, 64,820 shares on Universal common stock and future cash
payments totaling $1.0 million over 18 months. CHCS is the third party
administrator of long term care and home health care insurance products for over
21 unaffiliated insurance companies. For the two months ended September 30,
2000, CHCS received administrative fees of $870 thousand on contracts with
expected annual fees of $5.2 million.
Insurance Subsidiaries
The Insurance Subsidiaries are required to maintain minimum amounts
of capital and surplus as determined by statutory accounting. Each of the
Insurance Subsidiaries' statutory capital and surplus exceeds its respective
minimum requirement. At September 30, 2000 and December 31, 1999 the statutory
capital and surplus, including asset valuation reserves, of the U.S. Insurance
Subsidiaries totaled $89.9 million and $89.2 million, respectively.
Beginning in 1993, the National Association of Insurance
Commissioners ("NAIC") imposed
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regulatory risk-based capital ("RBC") requirements on life insurance
enterprises. At September 30, 2000 all of the Insurance Subsidiaries maintained
ratios of total adjusted capital to RBC in excess of the Authorized Control
Level.
PennCorp Canada and Pennsylvania Life's Canadian branch report to
Canadian regulatory authorities based upon Canadian statutory accounting
principles that vary in some respects from U.S. statutory accounting principles.
Canadian net assets based upon Canadian statutory accounting principles were
$63.3 million and $63.9 million as of September 30, 2000 and December 31, 1999,
respectively. PennCorp Canada maintained a Minimum Continuing Capital and
Surplus Requirement Ratio ("MCCSR") in excess of the minimum requirement and
Pennsylvania Life's Canadian branch maintained a Test of Adequacy of Assets in
Canada and Margin Ratio ("TAAM") in excess of the minimum requirement at
September 30, 2000.
Cash generated by the Insurance Subsidiaries will be made available
to Universal, the ultimate parent, principally through periodic payments of
principal and interest on surplus debentures. Currently, the surplus notes
between Universal and American Exchange total $70 million and it is anticipated
that it will be primarily serviced by dividends from Pennsylvania Life, a wholly
owned subsidiary of American Exchange, and by tax-sharing payments among the
insurance companies which are wholly owned by American Exchange and file a
consolidated Federal income tax return. During 2000, $4.8 million of taxes have
been paid to American Exchange pursuant to the tax-sharing agreement.
Dividend payments by insurance companies are limited by, or subject
to the approval of the insurance regulatory authorities of each insurance
company's state of domicile. Such dividend requirements and approval processes
vary significantly from state to state. The maximum amount of dividends which
can be paid to American Exchange from Pennsylvania Life without the prior
approval of the Pennsylvania Department of Insurance is restricted to the
greater of 10% of Pennsylvania Life's surplus as regards to policyholders as of
the preceding December 31 or the net gain from operations during the preceding
year, but such dividends can be paid only out of unassigned surplus. As part of
its approval of the Penn Union Acquisition, the Pennsylvania Insurance
Department approved a quasi reorganization of Pennsylvania Life's surplus in
which its previously negative unassigned surplus was reset to zero. Thus, future
earnings of the company would be available for dividends without prior approval,
subject to the restrictions noted above. As of September 30, 2000, $4.9 million
of dividends were be paid by the insurance subsidiaries of American Exchange to
American Exchange.
Liquidity for the life Insurance Subsidiaries is measured by their
ability to pay scheduled contractual benefits, pay operating expenses, and fund
investment commitments. Sources of liquidity include scheduled and unscheduled
principal and interest payments on investments, premium payments and deposits
and the sale of liquid investments. These sources of liquidity for the Insurance
Subsidiaries significantly exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including
death benefits, benefits under accident & health policies and interest-sensitive
policy surrenders and withdrawals. The amount of surrenders and withdrawals is
affected by a variety of factors such as credited interest rates for similar
products, general economic conditions and events in the industry that affect
policyholders' confidence. Although the contractual terms of substantially all
of the Company's in force life insurance policies and annuities give the holders
the right to surrender the policies and annuities, the Company imposes penalties
for early surrenders. At September 30, 2000 the Company held reserves that
exceeded the underlying cash surrender values of its in force life insurance and
annuities by more than $25.1 million. The insurance companies, in management's
view, have not experienced any material changes in surrender and withdrawal
activity in recent years.
Changes in interest rates may affect the incidence of policy
surrenders and withdrawals. In addition to the potential impact on liquidity,
unanticipated surrenders and withdrawals in a changed
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interest rate environment could adversely affect earnings if the Company were
required to sell investments at reduced values in order to meet liquidity
demands. The Company manages the asset and liability portfolios in order to
minimize the adverse earnings impact of changing market rates. The Company seeks
to invest in assets that have duration and interest rate characteristics similar
to the liabilities that they support.
At September 30, 2000, the Insurance Subsidiaries held cash and cash
equivalents totaling $38.4 million, as well as fixed maturity and equity
securities that could readily be converted to cash with carrying values (and
fair values) of $734.2 million. The fair values of these liquid holdings totaled
more than $772.6 million.
INVESTMENTS
The Company's investment policy is to balance the portfolio between
long-term and short-term investments so as to continue to achieve investment
returns consistent with the preservation of capital and maintenance of liquidity
adequate to meet payment of policy benefits and claims. The Company invests in
assets permitted under the insurance laws of the various states in which it
operates. Such laws generally prescribe the nature, quality of and limitations
on various types of investments that may be made. The Company currently engages
the services of two investment advisors, Conning Asset Management and Asset
Allocation and Management Company, to manage the Company's U.S. fixed maturity
portfolio, and Elliot and Page, a Canadian investment advisor to manage the
Canadian portfolio, under the direction of the management of the Insurance
Subsidiaries and in accordance with guidelines adopted by their respective
Boards of Directors. The Company's policy is not to invest in derivative
programs or other hybrid securities, except for GNMA's, FNMA's and investment
grade corporate collateralized mortgage obligations. It invests primarily in
fixed maturity securities of the U.S. Government and its agencies and in
corporate fixed maturity securities with investment grade ratings of "Baa3"
(Moody's), "BBB-" (Standard & Poor's) or higher. However, the Company does own
some investments that are rated "BB" or below (together 1.4% and 1.1% of total
fixed maturities as of September 30, 2000 and December 31, 1999, respectively).
As of September 30, 2000 all of the Company's securities were current in the
payment of principal and interest other than one bond with a carrying value of
$214 thousand.
FEDERAL AND FOREIGN INCOME TAXATION OF THE COMPANY
The provision for federal and foreign income taxes was $9.2 million
during the nine months ended September 2000 compared to $2.7 million for the
same period in 1999. These provisions resulted in effective tax rates of 35.6%
and 36.6%, respectively. The excess of the effective tax rate over the 35%
statutory rate relates primarily to the acquisition of the Penn Union companies
since certain business of the acquired companies is subject to income tax in
Canada at a corporate tax rate of approximately 42%.
At September 30, 2000 and December 31, 1999, the Company has
established valuation allowances of $11.3 million and $11.3 million,
respectively, with respect to net operating loss carryforwards. The Company
determines a valuation allowance based upon an analysis of projected taxable
income and through its ability to implement prudent and feasible tax planning
strategies. The tax planning strategies include the expense reductions
anticipated from the Company's recent reorganization and from the income
generated by its administration companies WorldNet, CHCS and AIAG. Management
believes it is more likely than not that the Company will realize the recorded
net deferred tax assets.
IMPACT OF YEAR 2000
The Year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information in years subsequent to 1999. Prior to 2000,
the Company underwent a corporate-wide program to address the Year 2000 issue,
as it relates to its own computer systems, as well as to instances
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in which computer systems of third parties may have a significant impact on the
Company's operations, such as suppliers, business partners, customers,
facilities and telecommunications. In addressing the Year 2000 issue, the
Company did not incur any significant expenses other than the allocation of
internal resources to test and monitor this issue. The Company has not
experienced any significant disruptions of business operations related to the
Year 2000 issue to date and believes that the risk of such disruption in the
future is low, although no assurance can be given in this regard. It is possible
that Year 2000 problems that are not currently apparent may arise in the future.
Accordingly, the Company will continue to monitor its systems for the Year 2000
issue.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In September 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," which is required to be
adopted in years beginning after September 15, 2000. The adoption of the new
statement did not have a significant impact on earnings or the financial
position of the Company.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relates, broadly, to changes in the value of financial
instruments that arise from adverse movements in interest rates, equity prices
and foreign exchange rates. The Company is exposed principally to changes in
interest rates that affect the market prices of its fixed income securities.
Interest Rate Risk
The Company could experience economic losses if it was required to
liquidate fixed income securities during periods of rising and/or volatile
interest rates. However, the Company attempts to mitigate its exposure to
adverse interest rate movements through a combination of active portfolio
management and by staggering the maturities of its fixed income investments to
assure sufficient liquidity to meet its obligations and to address reinvestment
risk considerations. The Company's insurance liabilities are generally long
tailed in nature, which generally permits ample time to prepare for their
settlement. To date, the Company has not utilized various financial risk
management tools on its investment securities, such as interest rate swaps,
forwards, futures and options to modify its exposure to changes in interest
rates. However, the Company may consider them in the future.
The Company is aware that certain classes of mortgage backed
securities are subject to significant prepayment risk due to the fact that in
periods of declining interest rates, individuals may refinance higher rate
mortgages to take advantage of the lower rates then available. The Company
monitors investment portfolio mix to mitigate this risk.
Sensitivity Analysis
The Company regularly conducts various analyses to gauge the
financial impact of changes in interest rates on it financial condition. The
ranges selected in these analyses reflect management's assessment as being
reasonably possible over the succeeding twelve-month period. The magnitude of
changes modeled in the accompanying analyses should, in no manner, be construed
as a prediction of future economic events, but rather, be treated as a simple
illustration of the potential impact of such events on the Company's financial
results.
The sensitivity analysis of interest rate risk assumes an
instantaneous shift in a parallel fashion across the yield curve, with scenarios
of interest rates increasing and decreasing 100 and 200 basis points from their
levels at September 30, 2000, and with all other variables held constant. A 100
and 200 basis point increase in market interest rates would result in a pre-tax
decrease in the market value of the Company's fixed income investments of $46.4
million and $80.5 million, respectively. Similarly, a 100 and
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200 basis point decrease in market interest rates would result in a pre-tax
increase in the market value of the Company's fixed income investments of $32.3
million and $70.6 million, respectively.
Foreign Currency Sensitivity
Portions of Universal's operations are transacted utilizing the
Canadian dollar as the functional currency. Approximately 14%, 20% and 36% of
Universal's assets, revenues and operating income before taxes, as of and for
the nine months ended September 30, 2000 respectively, are derived from the
Canadian operations. Accordingly, Universal's earnings and business equity are
affected by fluctuations in the value of the U.S. dollar as compared to the
Canadian dollar. Although this risk is somewhat mitigated by the fact that both
the assets and liabilities for Universal's foreign operations are denominated in
Canadian dollars, Universal is still subject to translation losses.
Universal periodically conducts various analyses to gauge the
financial impact of changes in the foreign currency exchange rate on their
financial condition. The ranges selected in these analyses reflect management's
assessment as being reasonably possible over the succeeding twelve-month period.
The magnitude of changes modeled in the following analysis should, in no manner,
be construed as a prediction of future economic events, but rather as a simple
illustration of the potential impact of such events on Universal's financial
results.
At September 30, 2000, a 10% strengthening of the U.S. dollar
relative to the Canadian dollar would result in a decrease to the operating
income before taxes of approximately $0.8 million and a decrease in equity of
$5.7 million. Universal's sensitivity analysis of the effects of changes in
foreign currency exchange rates does not factor in any potential change in sales
levels or local prices.
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PART II - OTHER INFORMATION
NONE
- --------------------------------------------------------------------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /S/ Robert A. Waegelein
-----------------------
Robert A. Waegelein
Senior Vice President
Chief Financial Officer
Date: November 14, 2000
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