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 JUNE 30, 2002
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
August 5, 2002 was 52,910,515.
UNIVERSAL AMERICAN FINANCIAL CORP.
FORM 10-Q
CONTENTS
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets at June 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations for the six months ended June 30, 2002 4
and June 30, 2001
Consolidated Statements of Operations for the three months ended June 30, 2002 and 5
June 30, 2001
Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 6
and June 30, 2001
Notes to Consolidated Financial Statements 7-15
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16-31
Item 3. Quantitative and Qualitative Disclosure of Market Risk 31-32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities and Use of Proceeds 32
Item 3. Defaults upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
Signature 33
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS JUNE 30, DECEMBER 31,
2002 2001
----------- -------------
(Unaudited)
(In thousands)
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: 2002, $816,904; 2001, $786,844) $ 837,486 $ 799,218
Equity securities, at fair value (cost: 2002, $3,776; 2001, $4,339) 3,675 4,199
Policy loans 23,902 24,043
Other invested assets 3,032 3,773
----------- -------------
Total investments 868,095 831,233
Cash and cash equivalents 22,706 47,990
Accrued investment income 13,326 12,663
Deferred policy acquisition costs 79,046 66,025
Amounts due from reinsurers 216,461 212,532
Due and unpaid premiums 4,022 3,385
Deferred income tax asset 52,883 59,952
Present value of future profits and goodwill 11,089 11,921
Other assets 24,644 24,515
----------- -------------
Total assets 1,292,272 1,270,216
=========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances 244,555 236,742
Reserves for future policy benefits 601,634 591,453
Policy and contract claims - life 6,991 6,282
Policy and contract claims - health 85,619 79,596
Loan payable 56,225 61,475
Amounts due to reinsurers 4,490 6,680
Other liabilities 43,277 57,218
----------- -------------
Total liabilities 1,042,791 1,039,446
----------- -------------
STOCKHOLDERS' EQUITY
Common stock (Authorized: 80 million shares, issued and outstanding:
2002, 53.1 million shares; 2001, 52.8 million shares) 531 528
Additional paid-in capital 157,247 155,746
Accumulated other comprehensive income 12,109 5,603
Retained earnings 80,094 69,279
Less: Treasury Stock (2002, 0.1 million shares; 2001, 0.1 million shares) (500) (386)
----------- -------------
Total stockholders' equity 249,481 230,770
----------- -------------
Total liabilities and stockholders' equity $ 1,292,272 $ 1,270,216
=========== =============
See notes to unaudited consolidated financial statements.
3
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
2002 2001
--------------- ---------------
(In thousands, per share amounts in dollars)
Revenues:
Gross premium and policyholder fees earned $ 291,605 $ 253,853
Reinsurance premiums assumed 2,085 1,370
Reinsurance premiums ceded (163,127) (139,757)
--------------- ---------------
Net premium and policyholder fees earned 130,563 115,466
Net investment income 28,761 28,547
Net realized (losses) gains on investments (6,457) 1,853
Fee income 5,989 5,569
--------------- ---------------
Total revenues 158,856 151,435
--------------- ---------------
Benefits, claims and expenses:
Increase in future policy benefits 6,531 5,365
Claims and other benefits 85,286 79,064
Interest credited to policyholders 5,213 4,989
Increase in deferred acquisition costs (12,856) (8,371)
Amortization of present value of future profits and goodwill 832 1,360
Commissions 57,425 48,294
Commission and expense allowances on reinsurance ceded (49,364) (42,599)
Interest expense 1,588 3,013
Other operating costs and expenses 48,103 39,933
--------------- ---------------
Total benefits, claims and other deductions 142,758 131,048
--------------- ---------------
Operating income before taxes 16,098 20,387
Federal income tax expense 5,282 7,277
--------------- ---------------
Net income $ 10,816 $ 13,110
=============== ===============
Earnings per common share:
Basic $ 0.20 $ 0.28
=============== ===============
Diluted $ 0.20 $ 0.28
=============== ===============
See notes to unaudited consolidated financial statements
4
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED JUNE 30,
--------------------------------------------
2002 2001
--------------- ---------------
(In thousands, per share amounts in dollars)
Revenues:
Gross premium and policyholder fees earned $ 144,169 $ 127,640
Reinsurance premiums assumed 1,147 548
Reinsurance premiums ceded (79,665) (70,315)
--------------- ---------------
Net premium and policyholder fees earned 65,651 57,873
Net investment income 14,434 14,090
Net realized (losses) on investments (6,600) (237)
Fee income 3,205 3,038
--------------- ---------------
Total revenues 76,690 74,764
--------------- ---------------
Benefits, claims and expenses:
Increase in future policy benefits 3,961 1,602
Claims and other benefits 42,640 40,026
Interest credited to policyholders 2,606 2,477
Increase in deferred acquisition costs (6,924) (4,043)
Amortization of present value of future profits and goodwill 410 636
Commissions 28,868 24,026
Commission and expense allowances on reinsurance ceded (24,627) (21,197)
Interest expense 782 1,395
Other operating costs and expenses 24,501 20,376
--------------- ---------------
Total benefits, claims and other deductions 72,217 65,298
--------------- ---------------
Operating income before taxes 4,473 9,466
Federal income tax expense 1,155 3,392
--------------- ---------------
Net income $ 3,318 $ 6,074
=============== ===============
Earnings per common share:
Basic $ 0.06 $ 0.13
=============== ===============
Diluted $ 0.06 $ 0.13
=============== ===============
See notes to unaudited consolidated financial statements
5
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------------------
2002 2001
--------------- ---------------
(In thousands)
Cash flows from operating activities:
Net income $ 10,816 $ 13,110
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes 3,006 5,968
Change in reserves for future policy benefits 4,719 20,697
Change in policy and contract claims 6,731 7,149
Change in deferred policy acquisition costs (12,856) (8,371)
Amortization of present value of future profits and goodwill 832 1,360
Change in policy loans 141 244
Change in accrued investment income (663) (1,152)
Change in reinsurance balances (5,134) (14,453)
Realized losses (gains) on investments 6,457 (1,853)
Change in restructuring liability -- (2,264)
Change in income taxes payable (2,396) (864)
Other, net (5,206) (10,039)
--------------- ---------------
Net cash provided by operating activities 6,447 9,532
--------------- ---------------
Cash flows from investing activities:
Proceeds from sale or maturity of fixed maturities available for sale 93,476 151,918
Cost of fixed maturities purchased available for sale (121,385) (159,626)
Change in amounts held in trust by reinsurer (1,830) (1,013)
Proceeds from sale of equity securities 1,293 11
Cost of equity securities purchased (639) (1,092)
Change in other invested assets 742 269
Change in due from/to broker (5,863) --
Cost of equipment purchased (1,091) --
--------------- ---------------
Net cash provided (used) by investing activities (35,297) (9,533)
--------------- ---------------
Cash flows from financing activities:
Net proceeds from issuance of common stock 858 156
Cost of treasury stock purchases (699) (460)
Change in policyholder account balances 7,813 (2,157)
Change in reinsurance balances on policyholder account balances 844 136
Principal repayment on loan payable (5,250) (3,700)
--------------- ---------------
Net cash used by financing activities 3,566 (6,025)
--------------- ---------------
Net decrease in cash and cash equivalents (25,284) (6,026)
Cash and cash equivalents at beginning of period 47,990 40,250
--------------- ---------------
Cash and cash equivalents at end of period $ 22,706 $ 34,224
=============== ===============
Supplemental cash flow information:
Cash paid during the period for interest $ 1,069 $ 2,994
=============== ===============
Cash paid during the period for income taxes $ 4,762 $ 1,233
=============== ===============
See notes to unaudited consolidated financial statements
6
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 reported in these consolidated
financial statements should not be regarded as necessarily indicative of the
results that may be expected for the entire year. The consolidated financial
statements should be read in conjunction with the Form 10-K for the year ended
December 31, 2001. 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
American" 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"),
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"), PennCorp Life Insurance Company,
a Canadian company ("PennCorp Life (Canada)"), and CHCS Services, Inc.
The Company offers life and accident and health insurance designed for
the senior market and self-employed market in all fifty states, the District of
Columbia and all the provinces of Canada. It also provides administrative
services to other insurers by servicing their senior market products. The
Company's principal insurance products are Medicare supplement, fixed benefit
accident and sickness disability insurance, long term care, home health care,
senior life insurance and annuities. The Company distributes these products
through an independent general agency system and a career agency system. The
career agents focus only on sales for Pennsylvania Life and PennCorp Life
(Canada) while the independent general agents sell for American Pioneer,
American Progressive and Constitution.
2. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the six
months ended June 30, 2002 and 2001 are as follows:
SIX MONTHS ENDED JUNE 30,
-------------------------------------
2002 2001
--------------- ---------------
(in thousands)
Net income $ 10,816 $ 13,110
Other comprehensive income (loss) 6,506 (2,375)
--------------- ---------------
Comprehensive income $ 17,322 $ 10,735
=============== ===============
7
SIX MONTHS ENDED JUNE 30, 2002 SIX MONTHS ENDED JUNE 30, 2001
----------------------------------- -------------------------------------
Before Tax Net of Before Tax Net of
Tax Expense Tax Tax Expense Tax
Amount (Benefit) Amount Amount (Benefit) Amount
--------- --------- --------- --------- --------- ---------
(in thousands)
Net unrealized gain (loss)
arising during the year (net of deferred
acquisition costs) $ 1,391 $ 485 $ 906 $ (478) $ (167) $ (311)
Reclassification adjustment for (gains)
losses included in net income 6,457 2,261 4,196 (1,853) (649) (1,204)
--------- --------- --------- --------- --------- ---------
Net unrealized gains (losses) 7,848 2,746 5,102 (2,331) (816) (1,515)
Currency translation adjustments 2,160 756 1,404 (945) (85) (860)
--------- --------- --------- --------- --------- ---------
Other comprehensive income (loss) $ 10,008 $ 3,502 $ 6,506 $ (3,276) $ (901) $ (2,375)
========= ========= ========= ========= ========= =========
The components of comprehensive income, net of related tax, for the
three months ended June 30, 2002 and 2001 are as follows:
THREE MONTHS ENDED JUNE 30,
-----------------------------------
2002 2001
--------------- ---------------
(in thousands)
Net income $ 3,318 $ 6,074
Other comprehensive income (loss) 15,310 (4,392)
--------------- ---------------
Comprehensive income $ 18,628 $ 1,682
=============== ===============
The components of other comprehensive income and the related tax
effects for each component for the three months ended June 30, 2002 and 2001 are
as follows:
THREE MONTHS ENDED JUNE 30, 2002 THREE MONTHS ENDED JUNE 30, 2001
-------------------------------- ----------------------------------
Before Tax Net of Before Tax Net of
Tax Expense Tax Tax Expense Tax
Amount (Benefit) Amount Amount (Benefit) Amount
------ --------- ------ ------ --------- ------
(in thousands)
Net unrealized gain (loss)
arising during the year (net of deferred
acquisition costs) $14,834 $ 5,192 $ 9,642 $(9,160) $(3,206) $(5,954)
Reclassification adjustment for (gains)
losses included in net income 6,600 2,309 4,291 237 83 154
------- ------- ------- ------- ------- -------
Net unrealized gains (losses) 21,434 7,501 13,933 (8,923) (3,123) (5,800)
Currency translation adjustments 2,108 731 1,377 2,166 758 1,408
------- ------- ------- ------- ------- -------
Other comprehensive income
(loss) $23,542 $ 8,232 $15,310 $(6,757) $(2,365) $(4,392)
======= ======= ======= ======= ======= =======
8
3. EARNINGS PER SHARE
A reconciliation of the numerators and the denominators of the basic
and diluted EPS for the six months ended June 30, 2002 and 2001 is as follows:
SIX MONTHS ENDED JUNE 30, 2002
----------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- ---------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 52,979
Less: Weighted average treasury shares (93)
------
Net income applicable to common shareholders $ 10,816 52,886 $ 0.20
============= =========
Effect of Dilutive Securities
Incentive stock options 3,908
Director stock options 214
Agents and others stock options 1,006
Treasury stock assumed from proceeds of options (3,635)
------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 10,816 54,379 $ 0.20
============= ====== =========
SIX MONTHS ENDED JUNE 30, 2001
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- --------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 46,898
Less: Weighted average treasury shares (66)
-------------
Basic EPS
Net income applicable to common shareholders $ 13,110 46,832 $ 0.28
============= ==============
Effect of Dilutive Securities
Incentive stock options 2,585
Director stock options 128
Agents and others stock options 793
Treasury stock assumed from proceeds of options (2,811)
-------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 13,110 47,527 $ 0.28
============= ============= ===============
9
A reconciliation of the numerators and the denominators of the basic
and diluted EPS for the three months ended June 30, 2002 and 2001 is as follows:
THREE MONTHS ENDED JUNE 30, 2002
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- --------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 53,065
Less: Weighted average treasury shares (64)
------------
Basic EPS
Net income applicable to common shareholders $ 3,318 53,001 $ 0.06
Effect of Dilutive Securities
Incentive stock options 3,912
Director stock options 223
Agents and others stock options 992
Treasury stock assumed from proceeds of options (3,581)
------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 3,318 54,547 $ 0.06
============= ============ =============
THREE MONTHS ENDED JUNE 30, 2001
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
------------- ------------- --------------
(in thousands, per share amounts in dollars)
Weighted average common stock outstanding 46,952
Less: Weighted average treasury shares (36)
-------------
Basic EPS
Net income applicable to common shareholders $ 6,074 46,916 $ 0.13
============== ==============
Effect of Dilutive Securities
Incentive stock options 3,668
Director stock options 167
Agents and others stock options 789
Treasury stock assumed from proceeds of options (3,601)
-------------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions $ 6,074 47,939 $ 0.13
============== ============= ==============
10
4. INVESTMENTS
As of June 30, 2002 and December 31, 2001, fixed maturity securities
are classified as investments available for sale and are carried at fair value,
with the unrealized gain or loss, net of tax and other adjustments (deferred
policy acquisition costs), included in accumulated other comprehensive income.
JUNE 30, 2002
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ------------------------------------- --------- ---------- ---------- ---------
(In thousands)
US Treasury securities
and obligations of US government $ 41,815 $ 1,322 $ -- $ 43,137
Corporate debt securities 387,598 14,528 (3,675) 398,451
Foreign debt securities (1) 164,437 2,357 (1,484) 165,310
Mortgage- and asset-backed securities 223,054 7,936 (402) 230,588
--------- ---------- ---------- ---------
$ 816,904 $ 26,143 $ (5,561) $ 837,486
========= ========== ========== =========
(1) Primarily Canadian denominated bonds supporting our Canadian Insurance
reserves.
DECEMBER 31, 2001
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Classification Cost Gains Losses Value
- ------------------------------------- --------- ---------- ---------- ---------
(In thousands)
US Treasury securities
and obligations of US government $ 35,719 $ 1,262 $ (11) $ 36,970
Corporate debt securities 357,431 8,990 (1,805) 364,616
Foreign debt securities (1) 157,077 2,225 (1,640) 157,662
Mortgage- and asset-backed securities 236,617 5,700 (2,347) 239,970
--------- ---------- ---------- ---------
$ 786,844 $ 18,177 $ (5,803) $ 799,218
========= ========== ========== =========
(1) Primarily Canadian denominated bonds supporting our Canadian Insurance
reserves.
The amortized cost and fair value of fixed maturities at June 30, 2002
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 $ 42,146 $ 43,296
Due after 1 year through 5 years 106,267 109,514
Due after 5 years through 10 years 283,386 290,886
Due after 10 years 162,051 163,202
Mortgage- and asset-backed securities 223,054 230,588
--------------- ---------------
$ 816,904 $ 837,486
=============== ===============
During the six months ended June 20, 2002 we wrote down the value of
certain fixed maturity securities by $7.4 million (0.9% of investments),
primarily as a result of the impairment of our WorldCom holdings. During the six
months ended June 30, 2001, we wrote down the value of certain fixed maturity
securities by $1.6 million (0.2% of investments). These write downs represent
management's estimate of other than temporary declines in value and were
included in net realized gains (losses) on investments in our consolidated
statement of operations.
11
5. STOCKHOLDERS' EQUITY
Common Stock
The par value of common stock is $.01 per share with 80,000,000 shares
authorized for issuance. Changes in the number of shares of common stock
outstanding, from December 31, 2001 through June 30, 2002, were as follows:
Common stock outstanding at December 31, 2001 52,799,899
Stock options exercised 224,302
Agent stock award 69,789
Stock purchases pursuant to Agents' Stock Purchase Plan 21,950
---------------
Common stock outstanding at June 30, 2002 53,115,940
===============
Treasury Stock
During 2001, the Board of Directors approved a plan to repurchase up to
0.5 million shares of Company stock in the open market. In March 2002, the Board
of Directors approved an amendment of the plan to increase the amount of shares
available for repurchase from 0.5 million to 1.0 million shares. The purpose of
the plan is to fund employee stock bonuses. During the six months ended June 30,
2002, the Company acquired 104,295 shares on the open market for a cost of $0.7
million at a weighted average market price of $6.70 per share. The Company
distributed 103,216 shares in the form of officer and employee bonuses at a
weighted average market price of $6.45 per share, at the date of distribution.
6. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS
American Progressive, American Pioneer, American Exchange,
Constitution, Marquette, Peninsular, PennCorp Life (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 June 30, 2002 the statutory capital and
surplus, including asset valuation reserve, of the U.S. insurance subsidiaries
totaled $100.3 million.
The National Association of Insurance Commissioners ("NAIC") has
developed, and state insurance regulators have adopted, risk-based capital
("RBC") requirements on life insurance enterprises. At June 30, 2002 all of the
Insurance Subsidiaries maintained ratios of total adjusted capital to RBC in
excess of the Authorized Control Level.
PennCorp Life (Canada) 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 $39.4 million as of June 30, 2002. PennCorp
Life (Canada) maintained a Minimum Continuing Capital and Surplus Requirement
Ratio ("MCCSR") in excess of the minimum requirement at June 30, 2002.
12
7. EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In June, 2001, The Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", effective for fiscal years beginning after December 15,
2001. Under the new rules, goodwill, and intangible assets deemed to have
indefinite lives, will no longer be amortized but will be subject to annual
impairment tests in accordance with the Statement. Other intangible assets will
continue to be amortized over their useful lives.
The Company applied the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. Application of the
non-amortization provisions of the Statement resulted in an increase in net
income of $0.2 million (less than $0.01 per diluted share) for the six months
ended June 30, 2002. The Company performed the first of the required impairment
tests of goodwill and indefinite lived intangible assets as of January 1, 2002
and has determined that, based on these tests, goodwill and indefinite lived
intangibles were not impaired.
8. BUSINESS SEGMENT INFORMATION
The Company offers life and health insurance designed for the senior
market and the self-employed market in all 50 states, the District of Columbia
and all of the provinces of Canada. The Company also provides administrative
services to other issuers by servicing their senior market products. Our
principal insurance products are Medicare supplemental health insurance, fixed
benefit accident and sickness disability insurance, long term care insurance,
senior life insurance, annuities and other individual life insurance. Our
principal business segments are: Career Agency, Senior Market Brokerage and
Administrative Services. The Company also reports the corporate activities of
our holding company in a separate segment. During 2002 we modified the way we
report segment information by combining our previously defined Senior Market
Brokerage and Special Markets segments into one segment, Senior Market
Brokerage. Our decision to combine the two segments was based on the significant
reduction in the insurance in force in the Special Markets segment as a result
of our exit from the major medical line of business. Reclassifications have been
made to conform prior year amounts to the current year presentation. A
description of these segments follows:
CAREER AGENCY -- The Career Agency segment is comprised of the
operations of Pennsylvania Life and PennCorp Life (Canada), both of
which we acquired in 1999. PennCorp Life (Canada) operates exclusively
in Canada, while Pennsylvania Life operates in the United States. The
Career Agency segment includes the operations of a career agency field
force, which distributes fixed benefit accident and sickness disability
insurance, life insurance and supplemental senior health insurance in
the United States and Canada. The career agents are under exclusive
contract with either Pennsylvania Life or PennCorp Life (Canada).
SENIOR MARKET BROKERAGE -- This segment includes the operations of
general agency and insurance brokerage distribution systems that focus
on the sale of insurance products to the senior market, including
Medicare Supplement/Select, long term care, senior life insurance and
annuities. In 2002, we combined our Special Markets segment with our
Senior Market Brokerage segment.
ADMINISTRATIVE SERVICES -- The Company acts as a third party
administrator and service provider for both affiliated and unaffiliated
insurance companies, primarily with respect to various senior market
products and a growing portion of non-insurance products. The services
that we perform include policy underwriting, telephone verification,
policyholder services, claims adjudication, clinical case management,
care assessment and referral to health care facilities.
13
CORPORATE -- This segment reflects the corporate activities of our
holding company, including the payment of interest on our debt and our
public company administrative expenses.
Intersegment revenues and expenses are reported on a gross basis in
each of the operating segments but eliminated in the consolidated results. These
eliminations affect the amounts reported on the individual financial statement
line items, but do not change operating income before taxes. The significant
items eliminated include intersegment revenue and expense relating to services
performed by the administrative services segment for the Career Agency and
Senior Market Brokerage segments and interest on notes issued by the Corporate
segment to the other operating segments.
Financial results by segment for the six months ended June 30, 2002 and
2001 are as follows:
Income Income
(Loss) (Loss)
Before Before
Income Income
Revenue Taxes Revenue Taxes
--------- --------- --------- ---------
June 30, 2002 June 30, 2001
------------------------- -------------------------
(in thousands)
Career Agency $ 79,788 $ 14,965 $ 81,215 $ 14,719
Senior Market Brokerage 79,843 7,246 64,034 5,373
Administrative Services 19,712 3,676 15,998 3,121
--------- --------- --------- ---------
Subtotal 179,343 25,887 161,247 23,213
Corporate 222 (3,332) 158 (4,679)
Intersegment revenues (14,252) -- (11,823) --
--------- --------- --------- ---------
Segment total 165,313 22,555 149,582 18,534
Adjustments to segment total
Net realized (losses) gains (6,457) (6,457) 1,853 1,853
--------- --------- --------- ---------
$ 158,856 $ 16,098 $ 151,435 $ 20,387
========= ========= ========= =========
Financial results by segment for the three months ended June 30, 2002
and 2001 are as follows:
Income Income
(Loss) (Loss)
Before Before
Income Income
Revenue Taxes Revenue Taxes
--------- --------- --------- ---------
June 30, 2002 June 30, 2001
------------------------- -------------------------
(in thousands)
Career Agency $ 40,024 $ 7,758 $ 40,680 $ 7,353
Senior Market Brokerage 40,167 3,091 32,144 2,972
Administrative Services 10,016 1,800 7,952 1,611
--------- --------- --------- ---------
Subtotal 90,207 12,649 80,776 11,936
Corporate 3 (1,576) 131 (2,233)
Intersegment revenues (6,920) -- (5,906) --
--------- --------- --------- ---------
Segment total 83,290 11,073 75,001 9,703
Adjustments to segment total
Net realized (losses) (6,600) (6,600) (237) (237)
--------- --------- --------- ---------
$ 76,690 $ 4,473 $ 74,764 $ 9,466
========= ========= ========= =========
14
Identifiable assets by segment as of June 30, 2002 and December 31,
2001 are as follows:
June 30, 2002 December 31, 2001
--------------- -----------------
Career Agency 650,907 $ 605,758
Senior Market Brokerage 658,349 663,069
Administrative Services 20,677 30,930
--------------- -----------------
Subtotal 1,329,933 1,229,757
--------------- -----------------
Corporate 346,995 313,709
Intersegment assets (1) (384,656) (343,250)
--------------- -----------------
$ 1,292,272 $ 1,270,216
=============== =================
(1) Intersegment assets include the elimination of the parent holding
company's investment in its subsidiaries as well as the elimination of
other intercompany balances.
9. FOREIGN OPERATIONS
A portion of the Company's career agency segment is conducted in Canada
through Penn Corp Life (Canada). The assets and liabilities of the Canadian
business are located in Canada where the insurance risks are written. Revenues,
excluding capital gains, of the career agency segment by geographic area are as
follows:
For the six months ended For the three months ended
June 30, June 30,
------------------------ --------------------------
2002 2001 2002 2001
---------- ---------- ---------- -----------
(in thousands)
Revenues
United States $ 52,156 $ 52,961 $ 26,134 $ 26,863
Canada 27,632 28,254 13,890 13,817
---------- ---------- ---------- -----------
Total $ 79,788 $ 81,215 $ 40,024 $ 40,680
========== ========== ========== ===========
15
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
We caution 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 our
products, investment spreads or yields, or the earnings or profitability of our
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 our 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
us, or on our behalf. 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 us specifically,
such as credit, volatility and other risks associated with our investment
portfolio, and other factors. We disclaim any obligation to update
forward-looking information.
INTRODUCTION
The following analysis of our consolidated results of operations and
financial condition should be read in conjunction with the consolidated
financial statements and related consolidated footnotes included elsewhere.
We own 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"), Marquette National Life
Insurance Company ("Marquette"), Peninsular Life Insurance Company
("Peninsular"), Pennsylvania Life Insurance Company ("Pennsylvania Life"),
PennCorp Life Insurance Company of Canada ("PennCorp Life (Canada)") and Union
Bankers Insurance Company ("Union Bankers"). In addition to the Insurance
Subsidiaries, we own a third party administrator, CHCS Services, Inc. that
processes our senior market policies, as well as business for unaffiliated
insurance companies.
OVERVIEW
We offer life and health insurance designed for the senior market and
the self-employed market in all 50 states, the District of Columbia and all of
the provinces of Canada. We also provide administrative services to other
insurers by servicing their senior market products. Our principal insurance
products are Medicare Supplement/Select health insurance, fixed benefit accident
and sickness disability insurance, long term care insurance, senior life
insurance, annuities and other individual life insurance. Our principal business
segments are: Career Agency, Senior Market Brokerage and Administrative
Services. We also report the corporate activities of our holding company in a
separate segment. During 2002 we modified the way we report segment information
by combining our previously defined Senior Market Brokerage and Special Markets
segments into one segment, Senior Market Brokerage. Our decision to combine the
two segments was based on the significant reduction in the insurance in force in
the Special Markets segment as a result of our exit from the major medical line
of business. Reclassifications have been made to conform prior year amounts to
the current year presentation. A description of these segments follows:
16
CAREER AGENCY -- The Career Agency segment is comprised of the
operations of Pennsylvania Life and PennCorp Life (Canada). PennCorp
Life (Canada) operates exclusively in Canada, while Pennsylvania Life
operates in the United States. The Career Agency segment includes the
operations of a career agency field force, which distributes fixed
benefit accident and sickness disability insurance, life insurance and
supplemental senior health insurance in the United States and Canada.
The career agents are under exclusive contract with either Pennsylvania
Life or PennCorp Life (Canada).
SENIOR MARKET BROKERAGE -- This segment includes the operations of
general agency and insurance brokerage distribution systems that focus
on the sale of insurance products to the senior market, including
Medicare Supplement/Select, long term care, senior life insurance and
annuities. In 2002, we combined our Special Markets segment with our
Senior Market Brokerage segment.
ADMINISTRATIVE SERVICES -- We act as a third party administrator and
service provider for both affiliated and unaffiliated insurance
companies, primarily with respect to various senior market products and
a growing portion of non-insurance products. The services that we
perform include policy underwriting, telephone verification,
policyholder services, claims adjudication, clinical case management,
care assessment and referral to health care facilities.
CORPORATE -- This segment reflects the corporate activities of our
holding company, including the payment of interest on our debt and our
public company administrative expenses.
Intersegment revenues and expenses are reported on a gross basis in
each of the operating segments. These eliminations affect the amounts reported
on the individual financial statement line items, but do not change operating
income before taxes. The significant items eliminated include intersegment
revenue and expense relating to services performed by the Administrative
Services segment for the Career Agency and Senior Market Brokerage segments and
interest on notes issued by the Corporate segment to the other operating
segments.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States ("GAAP"). The
preparation of our financial statements in conformity with GAAP requires us to
make estimates and assumptions that affect the amounts of assets and liabilities
and disclosures of assets and liabilities reported by us at the date of the
financial statements and the revenues and expenses reported during the reporting
period. As additional information becomes available or actual amounts become
determinable, the recorded estimates may be revised and reflected in operating
results. Actual results could differ from those estimates. Accounts that, in our
judgment, are most critical to the preparation of our financial statements
include policy liabilities and accruals, deferred policy acquisition costs,
valuation of certain investments and deferred taxes. There have been no changes
in our critical accounting policies during the current quarter.
17
RESULTS OF OPERATIONS - CONSOLIDATED OVERVIEW
The following table presents operating income by segment along with a
reconciliation to net income:
For the quarters ended For the six months ended
June 30, June 30,
----------------------- ------------------------
2002 2001 2002 2001
-------- -------- -------- ---------
(in thousands)
Career agency $ 7,758 $ 7,353 $ 14,965 $ 14,719
Senior market brokerage 3,091 2,972 7,246 5,373
Administrative services 1,800 1,611 3,676 3,121
-------- -------- -------- ---------
Segment operating income 12,649 11,936 25,887 23,213
Corporate (1,576) (2,233) (3,332) (4,679)
-------- -------- -------- ---------
Operating income before realized gains and federal
income taxes 11,073 9,703 22,555 18,534
Federal income taxes on operating items (3,465) (3,475) (7,542) (6,628)
-------- -------- -------- ---------
Net operating income 7,608 6,228 15,013 11,906
Realized (losses) gains net of tax (4,290) (154) (4,197) 1,204
-------- -------- -------- ---------
Net income $ 3,318 $ 6,074 $ 10,816 $ 13,110
======== ======== ======== =========
Per share data (diluted):
Net operating income (1) $ 0.14 $ 0.13 $ 0.28 $ 0.25
Realized (losses) gains net of tax (0.08) -- (0.08) 0.03
-------- -------- -------- ---------
Net income $ 0.06 $ 0.13 $ 0.20 $ 0.28
======== ======== ======== =========
(1) We evaluate the results of operations of our segments based on
operating income by segment. Operating income excludes realized gains
(losses). This differs from generally accepted accounting principles,
which includes the effect of realized gains (losses) in the
determination of net income. The schedule above reconciles our
operating income to net income in accordance with generally accepted
accounting principles.
Quarters ended June 30, 2002 and 2001
Consolidated net income after Federal income taxes decreased by $2.8
million to $3.3 million ($0.06 per share diluted) in the first quarter of 2002,
compared to $6.1 million ($0.13 per share diluted) in 2001. During the second
quarter of 2002, we reported realized investment losses of $4.3 million after
tax or $0.08 per share, relating to the impairment of our WorldCom holdings. The
effective tax rate for the Company was 25.8% for 2002 as compared to 35.8% in
2001. The decrease in the effective rate relates to the true up of the provision
for Canadian taxes identified in conjunction with the filing of our Canadian tax
return for the year ended December 31, 2001.
Operating income before realized (losses) gains and Federal income
taxes increased by $1.4 million to $11.1 million in 2002 compared to $9.7
million in 2001. A summary of the operating results by segment is presented
below, with additional detail by segment in the sections that follow.
Operating income from the Career Agency segment increased by $0.4
million, or 6%, compared to the second quarter of 2001. This reflects an
increase in new sales and improved loss ratios primarily for our disability
business.
18
Operating results for the Senior Market Brokerage segment improved by
$0.1 million or 4%, compared to the second quarter of 2001. This improvement is
the result of continued internally generated growth of Medicare
supplement/select business combined with improved loss ratios. However, this was
partially offset by an increase in claims relating to a block of home health
care policies that we stopped selling last year.
Operating income for the Administrative Services segment improved by
$0.2 million or 12%, compared to the second quarter of 2001. This improvement is
primarily as a result of the increase in Medicare premiums being serviced by our
administrative services company.
The operating loss from the Corporate segment decreased by 29%,
compared to the second quarter of 2001, primarily due to a decrease in the
interest cost relating to our outstanding debt.
Six Months ended June 30, 2002 and 2001
Consolidated net income after Federal income taxes decreased by $2.3
million to $10.8 million ($0.20 per share diluted) in the first six months of
2002, compared to $13.1 million ($0.28 per share diluted) in 2001. The realized
losses for 2002 relate primarily to the impairment of our WorldCom holdings.
Realized gains for 2001 were generated during the first quarter of 2001 as a
result of efforts to utilize tax capital loss carry forwards, and to limit
exposure to foreign exchange risk. The effective tax rate for the Company was
33.4% for 2002 as compared to 35.8% in 2001.
Operating income before realized (losses) gains and Federal income
taxes increased by $4.0 million to $22.6 million in 2002 compared to $18.5
million in 2001. A summary of the operating results by segment is presented
below, with additional detail by segment in the sections that follow.
Operating income from the Career Agency segment increased by $0.2
million compared to the six months ended June 30, 2001. This reflects an
increase in new sales and improved loss ratios for our disability business.
The Senior Market Brokerage segment improved its operating results by
35% or $1.9 million compared to the first six months of 2001. This improvement
is the result of continued internally generated growth of Medicare
supplement/select business combined with improved loss ratios. However, this was
partially offset by an increase in claims relating to a block of home health
care policies that we stopped selling last year.
Operating income for the Administrative Services segment improved by
$0.5 million or 18%, compared to the first six months of 2001. This improvement
is primarily as a result of the increase in Medicare premiums being serviced by
our administrative services company.
The operating loss from the Corporate segment decreased by $1.3 million
or 29% over the first six months of 2001. This increase is primarily due to a
decrease in the interest cost relating to our outstanding debt.
19
SEGMENT RESULTS - CAREER AGENCY
For the quarters ended For the six months ended
June 30, June 30,
------------------------- -------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands)
Net premiums and policyholder fees:
Life and annuity $ 3,589 $ 3,483 $ 7,334 $ 7,140
Accident & health 27,923 28,595 55,718 57,290
---------- ---------- ---------- ----------
Net premiums 31,512 32,078 63,052 64,430
Net investment income 8,343 7,838 16,487 15,888
Other income 169 764 249 897
---------- ---------- ---------- ----------
Total revenue 40,024 40,680 79,788 81,215
---------- ---------- ---------- ----------
Policyholder benefits 19,912 21,463 40,094 42,858
Interest credited to policyholders 671 568 1,307 956
Change in deferred acquisition costs (3,781) (2,994) (7,008) (6,119)
Commissions and general expenses, net of
Allowances 15,464 14,290 30,430 28,801
---------- ---------- ---------- ----------
Total benefits, claims and other deductions 32,266 33,327 64,823 66,496
---------- ---------- ---------- ----------
Segment operating income $ 7,758 $ 7,353 $ 14,965 $ 14,719
========== ========== ========== ==========
Quarters ended June 30, 2002 and 2001
Operating income from the Career Agency segment increased by $0.4
million, or 6%, compared to the second quarter of 2001. This reflects an
increase in new sales and improved loss ratios primarily for our disability
business.
Revenues. Net premiums for the quarter fell by approximately 2% for the
segment compared to the second quarter of 2001. Canadian operations accounted
for approximately 35% of the net premiums for the second quarter of 2002 and 34%
of the net premiums for the second quarter of 2001. New sales during the second
quarter of 2002 increased by 9% over the second quarter of 2001. This increase
was driven by sales of our senior market products, such as senior life, long
term care and Medicare supplement, which accounted for 49% of the new sales in
the U.S. New sales include more than $5.3 million of annuities in the second
quarter of 2002. New sales do not have a direct impact on net premium due to the
fact that our retention on most of the new premium is only 50% and annuity
deposits are not reported as premium.
Net investment income increased by approximately 6% compared to the
second quarter of 2001. This is due to an increase in the invested asset base,
primarily as a result of the increased sales of annuity products.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, decreased by approximately 7% over the second quarter of
2001. This was due primarily to improved loss ratios on our disability and long
term care lines of business, which resulted in a decrease in the segment's
overall loss ratios from 67% for the second quarter of 2001 to 63% for the
second quarter of 2002.
The increase in deferred acquisition costs was approximately $0.8
million more in the second quarter of 2002, compared to the increase in the
second quarter of 2001. This increase is primarily the result of an increase in
the underwriting and issue costs for the Career Agency segment associated with
the increase in new business.
Commissions and other operating expenses increased by approximately
$1.2 million or 8% in the second quarter of 2002 compared to 2001. The increase
is directly related to the increase in new business.
20
Six Months ended June 30, 2002 and 2001
Operating income from the Career Agency segment increased $0.2 million
compared to the six months ended June 30, 2001. This reflects an increase in new
sales and improved loss ratios primarily for our disability business.
Revenues. Net premiums for the first six months of 2002 fell by
approximately 2% for the segment compared to the first six months of 2001.
Canadian operations accounted for approximately 35% of the net premiums in both
2001 and 2002. New sales during the first six months of 2002 increased by 13%
over the first six months of 2001.
Net investment income increased by approximately 4% compared to the
first six months of 2001. This is due to an increase in the invested asset base,
primarily as a result of the increased sales of annuity products.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, decreased by approximately 6% over the first six months
of 2001. This was due primarily to improved loss ratios on our disability and
long term care lines of business, which resulted in a decrease in the segment's
overall loss ratios from 67% for the first six months of 2001 to 64% for the
first six months of 2002.
The increase in deferred acquisition costs was approximately $0.9
million more in the first six months of 2002, compared to the increase in 2001.
This increase is primarily the result of an increase in the underwriting and
issue costs for the Career Agency segment associated with the increase in new
business.
Commissions and other operating expenses increased by approximately
$1.6 million or 6% in the first six months of 2002 compared to 2001. The
increase is directly related to the increase in new business.
SEGMENT RESULTS - SENIOR MARKET BROKERAGE
For the quarters ended For the six months ended
June 30, June 30,
------------------------- -------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(in thousands)
Net premiums and policyholder fees:
Life and annuity $ 4,936 $ 4,128 $ 9,538 $ 8,496
Accident & health 29,203 21,667 57,973 42,540
---------- ---------- ---------- ----------
Net premiums 34,139 25,795 67,511 51,036
Net investment income 5,980 6,352 12,107 12,928
Other income 48 (3) 225 70
---------- ---------- ---------- ----------
Total revenue 40,167 32,144 79,843 64,034
---------- ---------- ---------- ----------
Policyholder benefits 26,689 20,165 51,723 41,571
Interest credited to policyholders 1,935 1,909 3,906 4,033
Change in deferred acquisition costs (3,143) (1,040) (5,848) (2,243)
Amortization of present value of future
profits and goodwill 32 69 75 219
Commissions and general expenses, net
of allowances 11,563 8,069 22,741 15,081
---------- ---------- ---------- ----------
Total benefits, claims and other deductions 37,076 29,172 72,597 58,661
---------- ---------- ---------- ----------
Segment operating income $ 3,091 $ 2,972 $ 7,246 $ 5,373
========== ========== ========== ==========
21
The table below details the gross premiums and policyholder fees
before reinsurance for the major product lines in the Senior Market brokerage
segment and the corresponding average amount of premium retained. The Company
reinsures its senior market brokerage products to unaffiliated third party
reinsurers under various quota share agreements. Medicare Supplement/Select
written premium is reinsured under quota share reinsurance agreements ranging
between 50% and 75% based upon the geographic distribution. During the first
quarter of 2002, we increased our retention on certain new business written from
25% to 50%. We are considering to further increase our retention on new business
further by the end of the year. The Company has also acquired various blocks of
Medicare Supplement premium, which are reinsured under quota share reinsurance
agreements ranging from 75% to 100%. Under these reinsurance agreements, the
Company reinsures the claims incurred and commissions on a pro rata basis and
receives additional expense allowances for policy issue, administration and
premium taxes.
For the quarters ended June 30,
2002 2001
------------------------- -------------------------
Gross Net Gross Net
Premiums Retained Premiums Retained
-------- -------- -------- --------
(in thousands)
Medicare supplement acquired $ 35,870 4% $ 37,404 6%
Medicare supplement/select
written 61,031 37% 38,189 31%
Other senior supplemental health 6,328 59% 5,516 62%
Other health 2,520 65% 8,269 51%
Senior life insurance 3,275 73% 1,898 66%
Other life 3,199 69% 3,910 74%
-------- --------
Total gross premiums $112,223 30% $ 95,186 27%
======== ========
For the six months ended June 30,
2002 2001
------------------------- -------------------------
Gross Net Gross Net
Premiums Retained Premiums Retained
-------- -------- -------- --------
(in thousands)
Medicare supplement acquired $ 75,310 6% $ 75,922 6%
Medicare supplement/select
written 120,058 36% 73,203 30%
Other senior supplemental health 12,415 60% 11,402 61%
Other health 7,069 48% 16,637 52%
Senior life insurance 5,552 71% 3,834 67%
Other life 7,225 76% 7,896 75%
-------- --------
Total gross premiums $227,629 30% $188,894 27%
======== ========
Quarters ended June 30, 2002 and 2001
Operating results for the Senior Market Brokerage segment improved by
4% or $0.1 million, compared to the second quarter of 2001. This improvement is
the result of continued internally generated growth of Medicare
supplement/select business combined with improved loss ratios. However, this was
partially offset by an increase in claims relating to a block of home health
care policies that we stopped selling last year.
Revenues. Gross premium written increased $17.0 million, or 18% over
2001 as a result of
22
continued strong sales of our Senior Market products. New production of our
Senior Market products amounted to $23.6 million in the current quarter compared
to $22.5 million in the same period of the prior year. The increase in gross
premium written over the second quarter of 2001 was primarily due to a 60%
increase, or $22.8 million, on Medicare supplement/select business written by
the Insurance Subsidiaries. Medicare supplement/select written premium grew as a
result of the increase in number of general agents under contract, expansion of
sales into more states in the northeast and by the dis-enrollment of
policyholders from several Health Maintenance Organizations ("HMO's"). In
addition, premiums increased due to normal rate increases implemented by the
Company on a periodic basis, offset by expected lapses. We also experienced a
15% increase, or $0.8 million in other senior supplemental health premium and a
73% increase, or $1.4 million in senior life insurance premium. These increases
are offset by a decrease of $5.7 million in other health premium - primarily as
a result of our decision to exit the major medical line of business, a decrease
of $1.5 million on Medicare supplement premium acquired though acquisition and a
decrease of $0.7 million in other life premium.
Net premiums for the second quarter of 2002 increased by approximately
$8.3 million, or 32%, compared to 2001. The net premiums did not increase in
line with the gross premiums due to the change in the mix of annualized premium
in force. The amount of premium retained increased from 27% in 2001 to 30% in
2002 due to the increase in Medicare supplement/select premiums written, which
we retain 30% on average, as well as our decision to increase retention on new
business.
Net investment income decreased by $0.4 million compared to the second
quarter of 2001. This is due to a decrease in investment yields and a decreasing
asset base.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, increased by approximately $6.5 million, or 32%,
compared to the second quarter of 2001 due primarily to higher annualized
premium in force, primarily Medicare supplement. Overall, loss ratios of the
segment were flat for the quarter, compared to the second quarter of 2001.
During the current quarter, we experienced an improvement in loss ratios on our
Medicare supplement business. However, that improvement was offset by an
increase in claims in a block of home health care business that we stopped
selling last year.
Interest credited to policyholders remained flat compared to the second
quarter of 2001.
The increase in deferred acquisition costs was approximately $2.1
million more in the second quarter of 2002, compared to the increase in the
second quarter of 2001. The increase in deferred acquisition costs relates to
the increase in premiums issued during 2002 compared to 2001.
Commissions and other operating expenses increased by approximately
$3.5 million or 43% in the second quarter of 2002 compared to 2001. The
following table details the components of commission and other operating
expenses:
For the quarters ended June 30,
2002 2001
------------ ------------
(in thousands)
Commissions $ 20,355 $ 16,547
Other operating costs 15,159 12,351
Reinsurance allowances (23,951) (20,829)
------------ ------------
Commissions and general expenses, net of allowances $ 11,563 $ 8,069
============ ============
The ratio of commissions to gross premiums increased to 18.1% during
the second quarter of 2002, from 17.4% in 2001. Other operating costs as a
percentage of gross premiums increased to 13.5% during the second quarter of
2002 from 13.0% in 2001. The increase in the percentage of commissions and
operating costs to gross premiums are primarily the result of the decrease in
the major medical premium. Commission and expense allowances received from
reinsurers as a percentage of the premiums ceded increased slightly to 30.7%
during the second quarter of 2002 compared to 30.0% in 2001.
23
Six Months ended June 30, 2002 and 2001
The Senior Market Brokerage segment improved its operating results by
35% or $1.9 million compared to the first six months of 2001. This improvement
is the result of continued internally generated growth of Medicare
supplement/select business combined with improved loss ratios. However, this was
partially offset by an increase in claims relating to a block of home health
care policies that we stopped selling last year.
Revenues. Gross premium written increased $38.7 million, or 21% over
the first six months of 2001 as a result of continued strong sales of our Senior
Market products. New production of our Senior Market products amounted to $59.4
million in the current quarter compared to $56.4 million in the same period of
the prior year. The increase in gross premium written over the first six months
of 2001 was primarily due to a 64% increase, or $46.9 million, on Medicare
supplement/select business written by the Insurance Subsidiaries. Medicare
supplement/select written premium grew as a result of the increase in number of
general agents under contract, expansion of sales into more states in the
northeast and by the dis-enrollment of policyholders from several Health
Maintenance Organizations ("HMO's"). In addition, premiums increased due to
normal rate increases implemented by the Company on a periodic basis, offset by
expected lapses. We also experienced a 9% increase, or $1.0 million in other
senior supplemental health premium and a 45% increase, or $1.7 million in senior
life insurance premium. These increases are offset by a decrease of $9.6 million
in other health premium - primarily as a result of our decision to exit the
major medical line of business, a decrease of $0.6 million on Medicare
supplement premium acquired though acquisition and a decrease of $0.7 million in
other life premium.
Net premiums for the first six months of 2002 increased by
approximately $16.5 million, or 32%, compared to 2001. The net premiums did not
increase in line with the gross premiums due to the change in the mix of
annualized premium in force. The amount of premium retained increased from 27%
in 2001 to 30% in 2002 due to the increase in Medicare supplement/select
premiums written, which we retain 30% on average, as well as our decision to
increase retention on new business.
Net investment income decreased by $0.8 million compared to the first
six months of 2001. This is due to a decrease in investment yields and a
decreasing asset base.
Benefits, Claims and Other Deductions. Policyholder benefits, including
the change in reserves, increased by approximately $10.2 million, or 24%,
compared to the first six months of 2001 due primarily to higher annualized
premium in force, primarily Medicare supplement. Overall, loss ratios of the
segment improved over the first six months of 2001, due primarily to the
implementation of rate increases on our Medicare supplement business.
Interest credited to policyholders was relatively flat compared to the
first six months of 2001.
The increase in deferred acquisition costs was approximately $3.6
million more in the first six months of 2002, compared to the increase in the
first six months of 2001. The increase in deferred acquisition costs relates to
the increase in premiums issued during 2002 compared to 2001.
24
Commissions and other operating expenses increased by approximately
$7.7 million, or 51%, in the first six months of 2002 compared to 2001. The
following table details the components of commission and other operating
expenses:
For the six months ended June 30,
2002 2001
--------------- ---------------
(in thousands)
Commissions $ 40,580 $ 32,511
Other operating costs 30,211 24,330
Reinsurance allowances (48,050) (41,760)
--------------- ---------------
Commissions and general expenses, net of allowances $ 22,741 $ 15,081
=============== ===============
The ratio of commissions to gross premiums increased to 17.8% during
the first six months of 2002, from 17.2% in 2001. Other operating costs as a
percentage of gross premiums increased to 13.3% during the first six months of
2002 from 12.9% in 2001. The increase in the percentage of commissions and
operating costs to gross premiums are primarily the result of the decrease in
the major medical premium. Commission and expense allowances received from
reinsurers as a percentage of the premiums ceded decreased to 30.0% during the
first six months of 2002 compared to 30.3% in 2001.
SEGMENT RESULTS - ADMINISTRATIVE SERVICES
For the quarters ended For the six months ended
June 30, June 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(In thousands)
Service fee and other income $ 9,907 $ 7,893 $ 19,474 $ 15,873
Net investment income 109 59 238 125
------------ ------------ ------------ ------------
Total revenue 10,016 7,952 19,712 15,998
------------ ------------ ------------ ------------
Amortization of present value of future profits
and goodwill 378 567 757 1,134
General expenses 7,838 5,774 15,279 11,743
------------ ------------ ------------ ------------
Total expenses 8,216 6,341 16,036 12,877
------------ ------------ ------------ ------------
Segment operating income 1,800 1,611 3,676 3,121
------------ ------------ ------------ ------------
Depreciation, amortization and interest 698 759 1,387 1,513
------------ ------------ ------------ ------------
Earnings before interest, taxes, depreciation and
amortization (1) $ 2,498 $ 2,370 $ 5,063 $ 4,634
============ ============ ============ ============
(1) For our Administrative Services segment, we evaluate results based on
earnings before interest, taxes, depreciation and amortization, which
is not in accordance with generally accepted accounting principles.
25
The table below details service fee revenue earned by our
Administrative Services segment:
For the quarters ended For the six months ended
June 30, June 30,
------------------------------ --------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(In thousands)
Affiliated Fee Revenue
Medicare supplement $ 4,289 $ 3,108 $ 8,423 $ 6,069
Long term care 630 366 1,238 747
Nurse Navigator(TM) 284 45 659 51
Other health insurance 20 120 46 296
Life insurance 95 95 190 199
------------ ------------ ------------ ------------
Total Affiliated Fee Revenue 5,318 3,734 10,556 7,362
------------ ------------ ------------ ------------
Unaffiliated Fee Revenue
Medicare supplement 2,232 2,396 4,574 4,797
Long term care 1,861 1,241 3,386 2,780
Other health insurance 111 170 235 309
Non-insurance assistance 385 352 723 625
------------ ------------ ------------ ------------
Total Unaffiliated Fee Revenue 4,589 4,159 8,918 8,511
------------ ------------ ------------ ------------
Total Administrative Service Fee Revenue $ 9,907 $ 7,893 $ 19,474 $ 15,873
============ ============ ============ ============
Quarters ended June 30, 2002 and 2001
Operating income for the Administrative Services segment improved by
$0.2 million, or 12%, over the second quarter of 2001, primarily as the result
of the increase in Medicare supplement premiums being serviced by our
administrative services company and the reduction in the amortization of the
present value of future profits ("PVFP"). Earnings before interest, taxes,
depreciation and amortization ("EBITDA") for this segment increased $0.1 million
or 5% to $2.5 million, compared to the second quarter of 2001.
During the second quarter of 2002, we completed the closing of our
Clearwater office and the consolidation of those functions into our Pensacola
operations. Operating results for the second quarter of 2002 were reduced by
approximately $0.3 million as a result of the cost of this transition, but we
expect to see increased efficiency and cost savings during the second half of
2002.
Service fee revenue increased by $2.0 million, or 26%, as compared to
the first quarter of 2001. In 2002, approximately 46% of the total fees earned
were from non-affiliated companies compared to 53% in 2001. The relative
decrease in the non-affiliated fees is the result of continued growth of
business from our Senior Market Brokerage segment. Affiliated fee revenue
increased $1.6 million compared to the second quarter of 2001. Additionally,
during the second quarter of 2002, we reported our first revenues from
underwriting support work we are now performing for the consortium that is
offering long term care to the employees of the federal government and their
families. We anticipate that this program will generate additional revenue over
the remainder of this year and next year.
General expenses for the segment increased by $2.1 million, or 36%,
compared to the second quarter of 2001. The increase is due to the increase in
business, costs incurred in the Clearwater transition, and costs incurred to
bring new clients on line.
The amortization of PVFP relates primarily to the acquisition of
American Insurance Administration Group, Inc. ("AIAG"). Approximately $7.7
million of PVFP was established when AIAG was acquired in January, 2000. It is
being amortized in proportion to the expected profits from the contracts in
force on the date of acquisition. A large portion of the contracts had a
remaining term of three years at the date of acquisition; accordingly, the
amortization is heavily weighted to those periods. During the second
26
quarter of 2002, approximately $0.4 million was amortized compared to $0.6
million in 2001. As of June 30, 2002, $2.0 million or 26%, of the original
amount remains unamortized.
Six Months ended June 30, 2002 and 2001
Operating income for the Administrative Services segment for the first
six months of 2002 increased by $0.6 million or 18% compared to the first six
months of 2001.
Service fee revenue increased by $3.7 million, or 23%, in the first six
months of 2002 as compared to 2001. The growth in business from affiliates added
$3.2 million of fees during the period, while fees from unaffiliated clients
grew by $0.4 million.
General expenses for the segment increased by $3.5 million, or 30%,
compared to the first six months of 2001. The increase is due to the increase in
business, costs incurred in the Clearwater transition, and costs incurred to
bring new clients on line.
The reduction of $0.4 million in the amortization of PVFP relates
primarily to a decrease in the amounts related to the acquisition of AIAG.
SEGMENT RESULTS - CORPORATE
The following table presents the primary components comprising the segment's
operating loss:
For the quarters ended For the six months ended
June 30, June 30,
----------------------- ------------------------
2002 2001 2002 2001
---------- ----------- ------------ ----------
(in thousands)
Interest cost on outstanding debt $ 782 $ 1,395 $ 1,588 $ 3,013
Amortization of capitalized loan origination fees 133 133 265 265
Stock-based compensation expense 160 160 320 410
Other parent company expenses, net 501 545 1,159 991
---------- ----------- ------------ ----------
Segment operating loss $ 1,576 $ 2,233 $ 3,332 $ 4,679
========== =========== ============ ==========
Quarters ended June 30, 2002 and 2001
The net loss from the Corporate segment decreased by $0.7 million, or
29%, compared to the second quarter of 2001, due primarily to a reduction in
interest cost. The decrease in the interest cost is due to a combination of a
reduction in the weighted average interest rate and lower average outstanding
balance as a result of principal repayments, compared to 2001. (See "Liquidity
and Capital Resources" for additional information regarding our credit
facility).
Six Months ended June 30, 2002 and 2001
The net loss from the Corporate segment decreased by $1.3 million, or
29%, compared to the first six months of 2001, due to primarily to a reduction
in interest cost, as noted above.
LIQUIDITY AND CAPITAL RESOURCES
We use capital primarily to maintain or increase the surplus of our
insurance company subsidiaries and to support our parent company as an insurance
holding company. In addition, we require capital to fund our anticipated growth
through acquisitions of other companies or blocks of insurance or administration
business.
27
We require cash at our parent company to meet our obligations under our
credit facility and our outstanding debentures held by our subsidiary, American
Progressive. We also require cash to pay the operating expenses necessary to
function as an insurance holding company (applicable insurance department
regulations require us to bear our own expenses), and to meet the costs involved
in being a public company.
We believe that our current cash position, the availability of the
revolving credit facility, the expected cash flows of our administrative service
company and the surplus note interest payments from American Exchange can
support our parent company obligations for the foreseeable future. However,
there can be no assurance as to our actual future cash flows or to the continued
availability of dividends from our insurance company subsidiaries.
Contractual Obligations and Commercial Commitments
Our $80 million credit facility consists of a $70 million term loan and
a $10 million revolving loan facility. The loans call for interest at LIBOR for
one, two, three or six months plus 350 basis points (5.3% beginning July 31,
2002). Principal repayments are due on a quarterly basis over a seven-year
period that commenced on July 31, 2000. The final maturity date of the facility
is July 31, 2006. We pay a commitment fee of 50 basis points on the unutilized
portion of the revolving facility. The term loan is secured by a first priority
security interest in 100% of the outstanding common stock of American Exchange,
American Progressive, and WorldNet Services and 65% of the outstanding under
common stock of UAFC (Canada) Inc. (the parent of PennCorp Life (Canada)) and a
subordinate interest in 100% of the outstanding common stock of American
Pioneer. As of June 30, 2002, $53.2 million was outstanding under the term loan
and $3.0 million was outstanding under the revolving loan facility. We incurred
the revolving indebtedness in connection with our acquisition of CHCS in August
2000. During the six months ended June 30, 2002, we paid $1.0 million in
interest and repaid $5.3 million in principal on the term loan. Additionally,
during July 2002, we made a regularly scheduled repayment that further reduced
the term loan to $50.6 million. During the six months ended June 30, 2001, we
paid $2.9 million in interest and repaid $3.7 million in principal on the term
loan.
The following table shows the schedule of remaining principal payments, as of
August 1, 2002, on the Company's outstanding term loan, with the final payment
in July 2006:
(In thousands)
2002 $ 2,825
2003 11,525
2004 12,400
2005 13,275
2006 10,575
---------
Total $ 50,600
=========
We are obligated under certain lease arrangements for our executive and
administrative offices in New York, Florida, Texas, and Ontario, Canada. Annual
minimum rental commitments, subject to escalation clauses under non-cancelable
operating leases are as follows:
(In thousands)
2002 $ 1,737
2003 1,516
2004 1,435
2005 947
2006 and thereafter 5,686
---------
Total $ 11,321
=========
Other than the lease obligations noted above, we do not have any
contractual or other commitments involving off-balance sheet arrangements.
28
Administrative Service Company
Liquidity for our administrative service company is measured by its
ability to pay operating expenses. The primary source of liquidity is fees
collected from clients. We believe that the sources of cash for our
administrative service company exceed scheduled uses of cash and results in
amounts available to dividend to our parent holding company. We measure the
ability of the administrative service company to pay dividends based on its
earnings before interest, taxes, depreciation and amortization ("EBITDA"). For
the six months ended June 30, 2002, EBITDA for our administrative services
segment was $5.1 million. For the year ended December 31, 2001, EBITDA for our
administrative services segment was $9.7 million.
Insurance Subsidiary - Surplus Note
Cash generated by our insurance company subsidiaries will be made
available to our holding company, principally through periodic payments of
principal and interest on surplus notes. As of June 30, 2002, the principal
amount of surplus notes owed to our holding company from our American Exchange
subsidiary totaled $70 million. The notes pay interest to our parent holding
company at LIBOR plus 375 basis points. We anticipate that the surplus notes
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 that are wholly owned by American Exchange and file a consolidated
Federal income tax return. During the six months ended June 30, 2002, American
Exchange made interest payments of $2.0 million relating to the surplus notes.
American Exchange made no principal payments on the surplus notes to our parent
holding company during the six months ended June 30, 2002.
Insurance Subsidiaries
Our insurance subsidiaries are required to maintain minimum amounts of
capital and surplus as determined by statutory accounting practices. As of June
30, 2002, each insurance company subsidiary's statutory capital and surplus
exceeded its respective minimum requirement. However, substantially more than
these minimum amounts are needed to meet statutory and administrative
requirements of adequate capital and surplus to support the current level of our
insurance subsidiaries' operations. As of June 30, 2002 the statutory capital
and surplus, including asset valuation reserves, of our U.S. domiciled insurance
subsidiaries totaled $100.3 million.
The National Association of Insurance Commissioners has developed, and
state insurance regulators have adopted, risk-based capital requirements on life
insurance enterprises. As of June 30, 2002 all of our insurance company
subsidiaries maintained ratios of total adjusted capital to risk-based capital
in excess of the minimum trigger point for regulatory action.
PennCorp Life (Canada) is subject to Canadian capital requirements and
reports results 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 $39.4 million as of June 30, 2002. PennCorp Life (Canada)
maintained a minimum continuing capital and surplus requirement ratio in excess
of the minimum requirement as of June 30, 2002.
Dividend payments by our insurance companies to our parent holding
company or to intermediate subsidiaries 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 (to assist in the service of
the surplus note held by American Exchange) without the prior approval of the
Pennsylvania Department of Insurance is restricted to the greater of 10% of the
Pennsylvania Life's surplus as regards policyholders as of the preceding
December 31 or the net gain from operations during the preceding year, but such
dividends can be paid only out of unassigned surplus. Thus, future earnings of
Pennsylvania Life would be available for dividends without prior approval,
subject to the restrictions noted above. During the second quarter of 2002,
Pennsylvania Life
29
paid a dividend of $1.5 million to its parent, American Exchange. Based upon the
current dividend regulations of the respective states, Pennsylvania Life would
be able to pay ordinary dividends of up to $6.9 million and Constitution Life
would be able to pay ordinary dividends of approximately $1.7 million to
American Exchange (their direct parent) without the prior approval from their
respective insurance departments in the remainder of 2002. Additionally, in
2002, Peninsular Life would be able to pay ordinary dividends of up to $0.7
million to American Pioneer without approval from the Florida Department. We do
not expect that our remaining subsidiaries will be able to pay ordinary
dividends in 2002.
Liquidity for our insurance company 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. We believe that these sources of cash for
our insurance company subsidiaries exceed scheduled uses of cash.
Liquidity is also affected by unscheduled benefit payments including
death benefits, benefits under accident and health insurance 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 our in force life insurance policies and annuities give
the holders the right to surrender the policies and annuities, we impose
penalties for early surrenders. As of June 30, 2002 we held reserves that
exceeded the underlying cash surrender values of our inforce life insurance and
annuities by $16.8 million. Our insurance company subsidiaries, in our view,
have not experienced any material changes in surrender and withdrawal activity
in recent years.
Changes in interest rates may affect the incidence of policy surrenders
and withdrawals. In addition to the potential impact on liquidity, unanticipated
surrenders and withdrawals in a changed interest rate environment could
adversely affect earnings if we were required to sell investments at reduced
values in order to meet liquidity demands. We manage our asset and liability
portfolios in order to minimize the adverse earnings impact of changing market
rates. We seek to invest in assets that have duration and interest rate
characteristics similar to the liabilities that they support.
The net yields on our cash and invested assets increased slightly from
6.76% in 2001 to 6.80% in 2002. A significant portion of these securities are
held to support the liabilities for policyholder account balances, which
liabilities are subject to periodic adjustments to their credited interest
rates. The credited interest rates of the interest-sensitive policyholder
account balances are determined by us based upon factors such as portfolio rates
of return and prevailing market rates and typically follow the pattern of yields
on the assets supporting these liabilities.
As of June 30, 2002, our insurance company subsidiaries held cash and
cash equivalents totaling $17.7 million, as well as fixed maturity securities
that could readily be converted to cash with carrying values (and fair values)
of $836.3 million. The fair values of these holdings totaled more than $857.3
million as of June 30, 2002.
INVESTMENTS
Our investment policy is to balance the portfolio duration to achieve
investment returns consistent with the preservation of capital and maintenance
of liquidity adequate to meet payment of policy benefits and claims. We invest
in assets permitted under the insurance laws of the various states in which we
operate. However, we do not invest in partnerships, special purpose entities,
real estate, commodity contracts, or other derivative securities. Such laws
generally prescribe the nature, quality of and limitations on various types of
investments that may be made. We currently engage the services of two investment
advisors under the direction of the management of our insurance company
subsidiaries and in accordance with guidelines adopted by the Investment
Committees of their respective boards of directors. Conning Asset Management
Company manages our fixed maturity portfolio in the United States and Elliot &
Page, Limited manages our Canadian fixed maturity portfolio. Our policy is not
to invest in derivative programs or other hybrid securities, except for GNMA's,
FNMA's and investment grade corporate
30
collateralized mortgage obligations. We invest 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 Investor
Service), "BBB-" (Standard & Poor's Corporation) or higher. As of June 30, 2002,
99.0% of our fixed maturity investments had investment grade ratings from
Moody's Investors Service or Standard & Poor's Corporation. However, we do own
some investments that are rated "BB+" or below by Standard & Poor's (together
1.0% of total fixed maturities as of June 30, 2002). There were $2.1 million
non-income producing fixed maturities as of June 30, 2002. We wrote down the
value of certain fixed maturity securities by $9.1 million during the six months
ended June 30, 2002 (primarily as a result of the impairment of our WorldCom
holdings), and by $1.6 million during the six months ended June 30, 2001. In
each case, these write-downs represent our estimate of other than temporary
declines in value and were included in net realized gains (losses) on
investments in our consolidated statements of operations.
EFFECTS OF ACCOUNTING PRONOUNCEMENTS
In June, 2001, The Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", effective for fiscal years beginning after December 15,
2001. Under the new rules, goodwill, and intangible assets deemed to have
indefinite lives, will no longer be amortized but will be subject to annual
impairment tests in accordance with the Statement. Other intangible assets will
continue to be amortized over their useful lives.
The Company applied the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. Application of the
non-amortization provisions of the Statement resulted in an increase in net
income of $0.2 million (less than $0.01 per diluted share) for the six months
ended June 30, 2002. The Company performed the first of the required impairment
tests of goodwill and indefinite lived intangible assets as of January 1, 2002
and has determined that, based on these tests, goodwill and indefinite lived
intangibles were not impaired.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In general, market risk relates to changes in the value of financial
instruments that arise from adverse movements in interest rates, equity prices
and foreign exchange rates. We are exposed principally to changes in interest
rates that affect the market prices of our fixed income securities.
Interest Rate Sensitivity
Our profitability could be affected if we were required to liquidate
fixed income securities during periods of rising and/or volatile interest rates.
However, we attempt to mitigate our exposure to adverse interest rate movements
through a combination of active portfolio management and by staggering the
maturities of our fixed income investments to assure sufficient liquidity to
meet our obligations and to address reinvestment risk considerations. Our
insurance liabilities generally arise over relatively long periods of time,
which typically permits ample time to prepare for their settlement. To date, we
have not used various financial risk management tools on our investment
securities, such as interest rate swaps, forwards, futures and options to modify
our exposure to changes in interest rates. However, we may consider using them
in the future.
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. We monitor and adjust investment
portfolio mix to mitigate this risk.
We regularly conduct various analyses to gauge the financial impact of
changes in interest rate on our financial condition. The ranges selected in
these analyses reflect our assessment as being reasonably possible over the
succeeding twelve-month period. The magnitude of changes modeled in the
accompanying analyses should not 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 our financial results.
31
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 as of
June 30, 2002, and with all other variables held constant. A 100 basis point
increase in market interest rates would result in a pre-tax decrease in the
market value of our fixed income investments of $51.7 million and a 200 basis
point increase would result in a $100.1 million decrease. Similarly, a 100 basis
point decrease in market interest rates would result in a pre-tax increase in
the market value of our fixed income investments of $54.2 million and a 200
basis point decrease would result in a $111.5 million increase.
Currency Exchange Rate Sensitivity
Portions of our operations are transacted using the Canadian dollar as
the functional currency. As of and for the three months ended June 30, 2002,
approximately 13% of our assets, 18% of our revenues and 36% of our operating
income before taxes were derived from our Canadian operations. As of and for the
three months ended June 30, 2001, approximately 14% of our assets, 19% of our
revenues and 35% of our operating income before taxes were derived from our
Canadian operations. Accordingly, our earnings and shareholders' 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 our foreign operations are denominated in
Canadian dollars, we are still subject to translation losses.
We periodically conduct various analyses to gauge the financial impact
of changes in the foreign currency exchange rate on our financial condition. The
ranges selected in these analyses reflect our assessment of what is reasonably
possible over the succeeding twelve-month period.
A 10% strengthening of the U.S. dollar relative to the Canadian dollar
would result in a decrease in our operating income before taxes for the six
months ended June 30, 2002 of approximately $0.5 million and a decrease in
shareholders' equity as of June 30, 2002 of approximately $2.5 million. Our
sensitivity analysis of the effects of changes in currency exchange rates does
not factor in any potential change in sales levels, local prices or any other
variable.
The magnitude of changes reflected in the above analysis regarding
interest rates and foreign currency exchange rates 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 our financial results.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
A lawsuit has been commenced against Universal American, its subsidiary
American Progressive Life & Health Insurance Company, and Richard Barasch, by
Marvin Barasch, the former Chairman of American Progressive. The suit primarily
arises out of Marvin Barasch's employment with American Progressive and includes
other personal claims against Richard Barasch. The Company and Richard Barasch
believe that the allegations are totally without merit. It is the opinion of
counsel that the likelihood of material recovery by the plaintiff is remote.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a. The annual meeting of Stockholders of Universal American
Financial Corp. was held on May 29, 2002.
b. All director nominees were elected.
c. Certain matters voted upon at the meeting and votes cast with
respect to such matters are as follows:
ELECTION OF DIRECTORS:
VOTES VOTES
DIRECTOR RECEIVED WITHHELD
-------- -------- --------
Richard A. Barasch 46,778,776 1,485,357
Bradley E. Cooper 48,103,245 160,888
Susan S. Fleming 48,103,245 160,888
Mark M. Harmeling 47,394,624 869,509
Bertram Harnett 47,394,624 869,509
Patrick J. McLaughlin 48,103,245 160,888
Robert A. Spass 48,103,245 160,888
Francis S. Wilson 48,103,245 160,888
Robert F. Wright 48,103,245 160,888
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Exhibit 11. Computation of Per Share Earnings
Data required by Statement of Financial
Accounting Standards No. 128, Earnings Per
Share, is provided in Note 3 to the
Consolidated Financial Statements in this
report
Exhibit 99.1 Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
Exhibit 99.2 Certification pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K during the quarter ended June 30, 2002
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
Executive Vice President
Chief Financial Officer
Date: August 14, 2002
33