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As filed with the Securities and Exchange Commission on July 9, 1999
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PRELIMINARY COPY
SCHEDULE 14A
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
UNIVERSAL AMERICAN FINANCIAL CORP.
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(Name of Registrant as Specified in Its Charter)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies:
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(2) Aggregate number of securities to which transaction applies:
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(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:
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(4) Proposed maximum aggregate value of transaction:
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(5) Total fee paid:
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form, Schedule or Registration Statement No.:
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(4) Date Filed:
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PRELIMINARY COPY
U N I V E R S A L A M E R I C A N
F I N A N C I A L C O R P .
JULY 12, 1999
TO OUR SHAREHOLDERS:
We invite you to attend the special meeting of shareholders of Universal
American Financial Corp. to be held on July 27, 1999, at 9:00 a.m., local time,
at The Penn Club, 30 West 44th Street, New York, New York 10036. THIS IS A VERY
IMPORTANT MEETING THAT AFFECTS YOUR INVESTMENT IN UNIVERSAL AMERICAN. At the
special meeting, among other things, you will be asked to consider and vote on
three proposals: one proposal to approve the issuance and sale of Universal
American common stock for sale to Capital Z Financial Services Fund II, L.P.
("Capital Z"), some agents and members of management of the Penn Union Companies
and some holders of preemptive rights, a second proposal containing six proposed
amendments to Universal American's certificate of incorporation, including an
amendment to increase the number of authorized shares of common stock and other
corporate governance amendments and a third proposal to amend Universal
American's 1998 Incentive Compensation Plan to provide for the issuance of stock
options with an exercise price below the common stock's fair market value to a
limited number of individuals. The proposals are being made in connection with
an acquisition by Universal American and American Exchange Life Insurance
Company, one of its insurance subsidiaries, of a number of insurance company
subsidiaries and other assets (the "Penn Union Companies") from PennCorp
Financial Group, Inc. ("PFG"), an insurance holding company listed on the New
York Stock Exchange.
The details of all proposals to be considered and voted upon by you at the
special meeting are described in the enclosed proxy materials. To assist you in
understanding the proposals, a question and answer section appears on page 1.
Your vote is important. EVEN IF YOU PLAN ON ATTENDING THE SPECIAL MEETING
IN PERSON, PLEASE READ THE PROXY STATEMENT AND FILL OUT YOUR PROXY CARD IN FULL
AND RETURN IT TO UNIVERSAL AMERICAN IN THE ENVELOPE PROVIDED. PLEASE DO NOT
DELAY IN REGISTERING YOUR VOTE. You may revoke your proxy at any time, or you
may appear at the special meeting and cast your vote, in which case your proxy
would be ignored.
Before you review the body of the proxy statement and the accompanying
annexes, please take a few moments to read the summary that begins on page 4.
Please do not hesitate to call the Senior Vice President and Chief
Financial Officer of Universal American, Robert A. Waegelein, with any
questions. Mr. Waegelein may be reached at (914) 934-5200, generally between 9
a.m. and 5 p.m. Eastern Time on weekdays.
Sincerely,
/s/ Richard A. Barasch
---------------------------------------------
Richard A. Barasch
Chairman and Chief Executive Officer
of Universal American Financial Corp.
YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, SIGN, DATE AND
PROMPTLY RETURN THE ENCLOSED PROXY IN THE ENVELOPE PROVIDED.
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UNIVERSAL AMERICAN FINANCIAL CORP.
SIX INTERNATIONAL DRIVE
RYE BROOK, NEW YORK 10573-1068
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NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON JULY 27, 1999
TO THE SHAREHOLDERS OF
UNIVERSAL AMERICAN FINANCIAL CORP.:
The special meeting of shareholders of Universal American Financial Corp.
will be held at 9:00 a.m., local time, on July 27, 1999 at The Penn Club, 30
West 44th Street, New York, New York 10036 to consider and vote on the following
proposals:
1. To approve the issuance and sale to Capital Z, some agents and members
of the management of the Penn Union Companies and some holders of preemptive
rights to purchase common stock of up to 28,888,888 shares of common stock for
$3.15 per share and the payment of part of a transaction fee to an affiliate of
Capital Z in Universal American common stock. The number of shares issued and
purchased and the price paid for the shares may be adjusted under the terms of
the share purchase agreement between Universal American and Capital Z.
2. To amend Universal American's certificate of incorporation to:
(a) Increase the number of authorized shares of common stock from 20
million shares to 80 million shares.
(b) Provide for shareholder action by written consent instead of a
meeting of shareholders. Written consent would only need to be given
by shareholders holding the number of shares required to approve the
action being taken by written consent.
(c) Eliminate the requirement that holders of 66 2/3% of Universal
American's outstanding voting capital stock approve amendments to
some provisions of the certificate of incorporation, which means
only majority approval will be necessary for those amendments.
(d) Remove the provision in the certificate of incorporation which
requires the vote by holders of 66 2/3% of the outstanding voting
capital stock to call a special meeting of the shareholders. The
board will amend the by-laws to allow special meetings of the
shareholders to be called at the request of holders of 50% of the
outstanding voting capital stock.
(e) Replace the present method of electing directors and the length of
the term each director serves with a system in which all directors
are elected at one time for a term expiring at the next annual
meeting. Directors are currently elected to three-year staggered
terms.
(f) Require 66 2/3% of Universal American's board of directors to
approve some important corporate actions.
3. To amend Universal American's 1998 Incentive Compensation Plan to allow
a limited number of agents and members of management of the Penn Union Companies
and Universal American to be granted options to purchase shares of Universal
American
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common stock at the same per share purchase price to be paid by Capital Z. The
per share purchase price may be below the fair market value of the common stock
at the time the options are granted.
4. To conduct other business that properly comes before the special
meeting or any adjournment or postponement of the special meeting.
Additional information relating to the matters described above and the
business to be considered at the special meeting is described in the
accompanying proxy materials, which you should read carefully and in their
entirety.
By order of the board of directors,
/s/ JOAN M. FERRARONE
------------------------------------------
Joan M. Ferrarone
Secretary
July 12, 1999
Rye Brook, New York
YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, SIGN, DATE AND PROMPTLY RETURN THE
ENCLOSED PROXY IN THE ENVELOPE PROVIDED.
-------------------------
YOU MAY REQUEST ADDITIONAL COPIES OF PROXY MATERIALS OR UNIVERSAL
AMERICAN'S ANNUAL REPORT TO SHAREHOLDERS BY WRITING TO ROBERT A. WAEGELEIN,
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, AT THE PRINCIPAL EXECUTIVE
OFFICES OF UNIVERSAL AMERICAN, SIX INTERNATIONAL DRIVE, RYE BROOK, NEW YORK
10573.
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UNIVERSAL AMERICAN FINANCIAL CORP.
PROXY STATEMENT
TABLE OF CONTENTS
PAGE
----
TABLE OF CONTENTS.......................... i
EXPLANATORY NOTE........................... ii
QUESTIONS AND ANSWERS ABOUT THE
PROPOSALS................................ 1
SUMMARY.................................... 4
Universal American....................... 4
Capital Z................................ 4
The Capital Z Issuance................... 4
The Penn Union Companies................. 4
Financing of the Acquisition of the Penn
Union Companies........................ 5
Reasons for the Acquisition and the
Capital Z Issuance..................... 5
Board of Directors' Approval............. 5
Interests of Persons Involved in the
Capital Z Issuance and the Acquisition
That May Be Different from Yours....... 6
Material Terms of the Share Purchase
Agreement.............................. 6
Material Terms of the Acquisition
Agreement Relating to the Penn Union
Companies.............................. 7
Regulatory Approvals..................... 8
Other Information........................ 9
Forward-Looking Statements............... 9
Proposal No. 1 -- The Capital Z
Issuance............................... 10
Proposal No. 2 -- Amendments to the
Certificate of Incorporation........... 11
Proposal No. 3 -- Amendment to the 1998
Incentive Compensation Plan............ 12
Summary Historical and Pro Forma
Financial Information.................. 13
THE CAPITAL Z ISSUANCE AND THE ACQUISITION
OF THE PENN UNION COMPANIES.............. 31
Background............................... 31
Universal American Financial Corp........ 36
Capital Z Financial Services Fund II,
L.P.................................... 37
The Penn Union Companies................. 37
Financing of the Acquisition of the Penn
Union Companies........................ 38
Reasons for the Acquisition and the
Capital Z Issuance..................... 39
Capital Z Issuance....................... 43
Material Terms of the Share Purchase
Agreement.............................. 44
Material Terms of the Acquisition
Agreement and Related Transactions..... 51
PAGE
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The Voting Agreement..................... 55
OPINION OF ADVEST.......................... 57
UNAUDITED PRO FORMA FINANCIAL
INFORMATION.............................. 62
SPECIAL MEETING OF SHAREHOLDERS OF
UNIVERSAL AMERICAN....................... 77
Time, Date, Place and Purpose............ 77
Record Date, Shareholders Entitled to
Vote and Quorum Requirements........... 77
Effect of Broker Non-Votes............... 77
Nasdaq Listing and Accountants........... 78
PROPOSAL NO. 1 -- THE CAPITAL Z ISSUANCE... 79
PROPOSAL NO. 2 -- AMENDMENTS TO THE
CERTIFICATE OF INCORPORATION............. 81
PROPOSAL NO. 3 -- AMENDMENT TO THE 1998
INCENTIVE COMPENSATION PLAN.............. 85
INTERESTS OF PERSONS INVOLVED IN THE
CAPITAL Z ISSUANCE AND THE ACQUISITION
THAT MAY BE DIFFERENT FROM YOURS......... 87
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT.................... 92
EXECUTIVE COMPENSATION..................... 95
MARKET FOR UNIVERSAL AMERICAN'S COMMON
STOCK AND RELATED MATTERS................ 100
UNIVERSAL AMERICAN FINANCIAL CORP. SELECTED
CONSOLIDATED FINANCIAL INFORMATION....... 101
UNIVERSAL AMERICAN FINANCIAL CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................... 104
PENN UNION COMPANIES SELECTED COMBINED
FINANCIAL INFORMATION.................... 120
PENN UNION COMPANIES MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...... 122
WHERE YOU CAN FIND MORE INFORMATION........ 141
PROXIES AND SOLICITATION................... 141
ANNEXES.................................... 142
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EXPLANATORY NOTE
Universal American and PFG entered into the original acquisition agreement,
dated as of December 31, 1998, pursuant to which Universal American agreed to
pay $175 million to purchase the Penn Union Companies, consisting of $136
million in cash and $39 million in the form of a subordinated note issued to
PFG. However, subsequent to the execution of that agreement, the parties agreed
to amend the acquisition agreement to reflect, among other things, a reduction
in the purchase price to $130.5 million in cash. In addition, immediately prior
to the closing an affiliate of PFG that is not being purchased by Universal
American or American Exchange will receive $6.5 million in the form of a cash
dividend payable by Union Bankers. This reduction is the result of negotiations
that took place in late April, May and early June of 1999 among Universal
American, Capital Z and PFG which the parties held to address certain issues
including the level of Pennsylvania Life's reserves. In deciding on the purchase
price, Universal American agreed, among other things, to eliminate the
subordinated note, add additional reserves to Pennsylvania Life at closing and
eliminate the purchase price adjustment based on the adequacy of reserves. A
potential negative consequence of the proposed amendments to the acquisition
agreement is that the reserves may be deficient in excess of Universal
American's estimates, and there will be no further recourse to PFG for reserve
inadequacy. The parties have entered into the amended and restated acquisition
agreement.
Universal American believes it was able to negotiate a purchase price lower
than the fair value of the net tangible assets of the Penn Union Companies for
the following reasons:
- PFG had previously announced that it would be in default on certain terms
of its senior debt if it failed, by December 31, 1998, to close one or
more transactions or enter into one or more definitive agreements which
would result in debt reduction of at least $100 million. Therefore, PFG
was under time pressure to make its best deal with a buyer who had the
financial ability to close the transaction;
- PFG offered to sell the Penn Union Companies to a number of potential
buyers through an orderly process conducted by its investment advisor.
Universal American, along with Capital Z, was one of only two buyers to
make an offer, and Universal American has a history of successfully
completing acquisitions in the insurance industry;
- In response to a state insurance regulatory examination, Pennsylvania
Life increased reserves which had the effect of reducing its regulatory
capital and surplus. Further reserve adjustments could have required
certain actions (including limitations on writing new business due to RBC
trends) to be taken by the Pennsylvania Department of Insurance and PFG
was under pressure to address the adequacy of Pennsylvania Life's
regulatory capital and surplus; and
- The Pennsylvania Life distribution force had been deteriorating in the
previous three years. There existed, and still exists, uncertainty as to
whether this distribution system can be revitalized. In the event the
distribution force cannot be revitalized and the field force does not
adequately service the in force business, it is possible that lapse rates
will increase in excess of what has been anticipated.
Simultaneously with the execution of the amended and restated acquisition
agreement, Universal American and Capital Z amended the share purchase agreement
to extend the closing date so it can take place concurrently with the
acquisition, to allow Capital Z to invest up to $91 million in Universal
American, as opposed to the $82 million originally anticipated; and to allow
some holders of preemptive rights to purchase shares at the same price as
Capital Z in the Capital Z Issuance.
For a more detailed discussion of the amendments to the acquisition and
share purchase agreements, please see "The Capital Z Issuance and the
Acquisition of the Penn Union Companies -- Background."
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QUESTIONS AND ANSWERS ABOUT THE PROPOSALS
Q. WHAT IS THE PURPOSE OF THE SPECIAL MEETING?
A. The special meeting is being held for you to consider and vote on proposals
that relate to the acquisition by Universal American and American Exchange,
one of its insurance subsidiaries, of the Penn Union Companies for $130.5
million from PFG. In addition, immediately prior to the closing Union Bankers
will pay a $6.5 million cash dividend to an affiliate of PFG that is not
being purchased by Universal American or American Exchange.
We are asking you to approve the issuance and sale of shares of common stock
to Capital Z, some agents and members of management of the Penn Union
Companies and some holders of preemptive rights and the payment in shares of
common stock of part of a transaction fee to an affiliate of Capital Z. The
proceeds from the issuance and sale are expected to be approximately $91
million. The proceeds will be used to partially finance the acquisition of
the Penn Union Companies.
We are also asking you to approve the increase in the number of authorized
shares Universal American can issue under its certificate of incorporation
together with some other amendments to the certificate of incorporation.
Without the approval to increase the authorized shares, Universal American
will not be able to issue the shares to Capital Z.
For your ease of reading, we will refer to the issuance of Universal American
common stock to Capital Z, some agents and members of management of the Penn
Union Companies and some holders of preemptive rights together with part of
the transaction fee paid to an affiliate of Capital Z in common stock, as the
"Capital Z Issuance" in this proxy statement.
Because the shares of common stock to be issued in the Capital Z Issuance
will have voting power equal to or greater than 20% of the voting power
outstanding before the Capital Z Issuance, shareholders must approve the
Capital Z Issuance before it can occur. YOU ARE NOT BEING ASKED TO APPROVE
THE ACQUISITION OF THE PENN UNION COMPANIES; you are being asked to approve
the Capital Z Issuance and amendments to the certificate of incorporation.
Q. WHAT HAPPENS IF THE CAPITAL Z ISSUANCE IS NOT APPROVED OR IS NOT COMPLETED?
A. If the Capital Z Issuance is not approved or completed, then Universal
American and American Exchange will not acquire the Penn Union Companies.
Similarly, if the acquisition of the Penn Union Companies is not consummated,
then Universal American will not complete the Capital Z Issuance.
Q. WHEN DO YOU EXPECT THE CAPITAL Z ISSUANCE AND THE ACQUISITION OF THE PENN
UNION COMPANIES TO BE COMPLETED?
A. Universal American hopes to complete the Capital Z Issuance and the
acquisition of the Penn Union Companies in July 1999.
Q. DO I NEED TO VOTE ON EACH PROPOSAL, INCLUDING EACH ITEM OF PROPOSAL NO. 2?
A. Universal American has entered into a voting agreement under which holders of
more than 50% of Universal American's voting stock have already agreed to
vote in favor of Proposal No. 1, which contains the Capital Z Issuance, and
item (a) of Proposal No. 2 which would increase the number of authorized
shares permitted under Universal American's certificate of incorporation.
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Even though shareholders owning over 50% of the outstanding voting stock have
agreed to vote in favor of Proposal No. 1 and item (a) of Proposal No. 2, WE
ASK THAT YOU VOTE ON ALL OF THE PROPOSALS, INCLUDING EACH ITEM OF PROPOSAL
NO. 2, INCLUDED IN THIS PROXY STATEMENT. You must vote separately on each
item of Proposal No. 2, but you do not have to vote the same way on each
item.
You are being asked to vote on these Proposals because Universal American's
current certificate of incorporation does not permit shareholders to vote by
written consent; all shareholder actions must be taken by a vote of
shareholders at a duly held meeting of shareholders.
IN ADDITION, THE VOTING AGREEMENT DOES NOT COVER ITEMS (b) THROUGH (f).
THEREFORE, YOUR VOTE IS PARTICULARLY IMPORTANT TO THE APPROVAL OF THOSE ITEMS
AND YOU ARE REQUESTED TO COMPLETE AND RETURN YOUR BALLOT. IF YOU DO NOT
RETURN YOUR BALLOT, IT WILL BE CONSIDERED A VOTE AGAINST ALL OF THE ITEMS IN
PROPOSAL NO. 2.
Q. WHAT ARE MY RIGHTS IF I VOTE AGAINST A PROPOSAL, BUT THE PROPOSAL PASSES
ANYWAY?
A. You are not entitled to rights of appraisal or similar rights for any matter
to be acted on at the meeting.
Q. WHAT IS REQUIRED FOR THE PROPOSALS TO PASS?
A. Proposal No. 1 requires the vote by holders of 50% of the outstanding voting
shares represented and voting at a meeting where a quorum is present; items
(b) through (e) of Proposal No. 2 require the vote by holders of 66 2/3% of
the outstanding voting shares entitled to vote on these proposals; items (a)
and (f) of Proposal No. 2 and Proposal No. 3 requires the vote by holders of
50% of the outstanding shares entitled to vote on these proposals.
Q. WHAT ARE THE INCOME TAX CONSEQUENCES TO ME OF THE CAPITAL Z ISSUANCE AND THE
ACQUISITION OF THE PENN UNION COMPANIES?
A. There will be no income tax consequences to you as a direct result of the
Capital Z Issuance or the acquisition of the Penn Union Companies. Your tax
treatment upon the sale of your Universal American common stock will not
differ as a result of these transactions.
Q. WHAT DO I NEED TO DO NOW?
A. After carefully reading and considering the information contained in this
proxy statement, please indicate on your proxy card how you want to vote and
mail your signed and dated form in the enclosed return envelope as soon as
possible.
Q. WHAT DO I DO IF I WANT TO CHANGE MY VOTE?
A. Just send in a later-dated, signed proxy card to the Secretary of Universal
American before the special meeting or attend the meeting in person and vote.
Q. IF MY SHARES ARE HELD IN "STREET NAME" BY MY BROKER, WILL MY BROKER VOTE MY
SHARES FOR ME WITHOUT MY INSTRUCTIONS?
A. No. Your broker will not be able to vote your Universal American shares
without instructions from you. You should instruct your broker to vote your
shares, following the directions provided by your broker. Your failure to
instruct your broker to vote your shares will in some cases be the equivalent
of voting against a proposal.
Q. WHAT IF I PLAN TO ATTEND THE SPECIAL MEETING IN PERSON?
A. We recommend that you send in your proxy card whether or not you intend to
attend the special meeting in person.
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WHO CAN HELP ANSWER YOUR QUESTIONS?
If you have more questions about the proposals, you should contact:
Robert A. Waegelein
Universal American Financial Corp.
Six International Drive
Rye Brook, New York 10573-1068
Telephone: (914) 934-5200, ext. 206
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SUMMARY
This summary highlights selected information from this proxy statement and
may not contain all of the information that is important to you. To understand
the proposals fully and for a more complete description of the terms of the
Capital Z Issuance and the acquisition of the Penn Union Companies, you should
carefully read this entire document, including the annexes. See "Where You Can
Find More Information" (page 141). We have included page references
parenthetically to direct you to more complete descriptions of the topics
presented in this summary.
UNIVERSAL AMERICAN (PAGE 36)
Universal American was incorporated in New York in 1981. Universal American
is an insurance holding company that operates through its subsidiaries. Through
its subsidiaries, Universal American markets and underwrites accident and health
insurance products aimed at the senior market, including Medicare supplement,
long term care and home health care, as well as life insurance and annuities.
American Exchange is one of Universal American's insurance subsidiaries.
CAPITAL Z (PAGE 37)
Capital Z is a $1.8 billion fund that was formed to make investments in
securities of a diversified global portfolio of insurance, financial services
and healthcare services companies and other related businesses.
THE CAPITAL Z ISSUANCE (PAGE 43)
Under the terms of the share purchase agreement between Universal American
and Capital Z, Capital Z, some agents and members of management of the Penn
Union Companies and some holders of preemptive rights will purchase up to
28,888,888 shares of Universal American common stock for $3.15 per share for a
total of approximately $91 million. If an adjustment is required under the share
purchase agreement, more than 28,888,888 shares may be sold at a price less than
$3.15 per share. In any case, the aggregate purchase price to be paid by Capital
Z is expected to be approximately $85.5 million. Universal American will also
issue common stock to an affiliate of Capital Z as partial payment of a
transaction fee. The Capital Z Issuance is conditioned on shareholder approval.
After the Capital Z Issuance, Capital Z or its affiliates will hold between
61.2% and 65.0% of the outstanding voting shares.
The share purchase agreement and the amendment to the share purchase
agreement are attached as Annex A to this proxy statement. We encourage you to
read the share purchase agreement and the amendment to the share purchase
agreement because they, and not the proxy statement, are the legal documents
that govern the Capital Z Issuance. References to the "share purchase agreement"
and the "amended share purchase agreement" mean the share purchase agreement as
originally executed together with the amendment to the originally executed share
purchase agreement.
THE PENN UNION COMPANIES (PAGE 37)
The Penn Union Companies consist of Pennsylvania Life Insurance Company
("Pennsylvania Life"), Penncorp Life Insurance Company, Union Bankers Insurance
Company ("Union Bankers"), Constitution Life Insurance Company, Marquette
National Life Insurance Company, Peninsular Life Insurance Company, PennCorp
Financial, Inc. and selected assets of PennCorp Financial Services, Inc. The
Penn Union Companies underwrite and market, through a distribution system of
approximately 1,400 career agents and a network of producers throughout the
United States and Canada, fixed-benefit accident and health insurance policies
and life insurance and asset accumulation products.
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FINANCING OF THE ACQUISITION OF THE
PENN UNION COMPANIES (PAGE 38)
Universal American and American Exchange have entered into an acquisition
agreement with PFG and some of PFG's subsidiaries to purchase the Penn Union
Companies for a purchase price equal to $130.5 million in cash. In addition,
immediately prior to the closing an affiliate of PFG that is not being purchased
by Universal American or American Exchange will receive $6.5 million in the form
of a cash dividend payable by Union Bankers. The $130.5 million purchase price
may be increased or decreased under circumstances specified in the acquisition
agreement between Universal American, American Exchange and PFG.
The amended and restated acquisition agreement is attached as Annex B to
this proxy statement. We encourage you to read the amended and restated
acquisition agreement because it, and not this proxy statement, is the legal
document that governs the acquisition of the Penn Union Companies. The amended
and restated acquisition agreement is referred to as the "acquisition agreement"
or the "amended and restated acquisition agreement" in this proxy statement. In
order to obtain the proceeds to complete this acquisition, Universal American
proposes to raise both equity and debt funding. SHAREHOLDERS ARE NOT BEING ASKED
TO APPROVE THE ACQUISITION OF THE PENN UNION COMPANIES.
SENIOR DEBT FINANCING
Universal American intends to obtain senior debt financing of approximately
$80 million through a bank credit facility provided by a syndicate of banks led
by The Chase Manhattan Bank ("Chase Bank") and Chase Securities Inc. ("CSI").
Seventy million dollars of the senior debt financing will be in the form of a
term loan and $10 million will be in the form of a revolving credit facility.
The amounts obtained from the term loan and the Capital Z Issuance in excess of
$130.5 million will be used to finance transaction-related costs, to repay $4.5
million of existing Universal American debt and to make a capital contribution
to Pennsylvania Life. The senior debt financing is more fully described on page
39 of this proxy statement.
REASONS FOR THE ACQUISITION AND
THE CAPITAL Z ISSUANCE (PAGE 39)
Through the acquisition of the Penn Union Companies, Universal American
expects to expand its policyholder, product and capital base and to achieve
long-term economies of scale and cost savings. By financing part of the
acquisition through an equity investment rather than through additional debt,
Universal American will be able to incur less debt, while simultaneously
developing a relationship with Capital Z that is expected to bring a number of
benefits.
There are drawbacks related to the acquisition and the Capital Z Issuance,
including the concentration of ownership by Capital Z and the additional debt
Universal American will have to service. However, after considering these and
other factors, the board determined that the Capital Z Issuance and the
acquisition will be beneficial to Universal American's shareholders.
BOARD OF DIRECTORS' APPROVAL (PAGE 32)
CSI, in its capacity as financial advisor, prepared an analysis of the
Capital Z Issuance and the potential acquisition of the Penn Union Companies by
Universal American.
In addition, Advest, Inc. ("Advest"), a financial advisor to Universal
American's board, delivered a written opinion, dated December 31, 1998, to the
board stating that the financial terms and effects of (i) the purchase price
Universal American agreed to pay to purchase the Penn Union Companies and (ii)
the controlling-interest investment in Universal American by Capital Z, together
with the additional investment by UAFC, L.P., ("AAM") and
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some agents and members of the management of the Penn Union Companies, both
individually and in the aggregate, are fair, from a financial point of view to
Universal American and its shareholders. On May 24, 1999, Advest subsequently
revised its opinion to provide that the terms and effects of the Capital Z
investment and the acquisition, as reflected in the amended and restated
acquisition agreement and the amended share purchase agreement, both
individually and in the aggregate, are fair, from a financial point of view, to
Universal American and its shareholders. Advest subsequently revised its opinion
to provide that as of the date of the mailing of this proxy statement, the terms
and effects of the Capital Z investment and the acquisition, both individually
and in the aggregate, are fair, from a financial point of view, to Universal
American and its shareholders.
The full text of Advest's written opinion, delivered on May 24, 1999, is
attached as Annex C to this proxy statement. WE URGE YOU TO READ CAREFULLY THE
ENTIRE ADVEST OPINION for a description of the procedures followed, assumptions
made, matters considered and qualifications and limitations on Advest's review
in connection with the delivery of its written opinion. Advest's opinion is not
a recommendation as to how any Universal American shareholder should vote.
After considering the results of CSI's analysis and the potential benefits
and risks of the acquisition and the Capital Z Issuance, the board approved the
Capital Z Issuance and the acquisition of the Penn Union Companies. The board
approval was subject to the receipt by a designated committee of the board of
Advest's opinion. The board committee has received and approved Advest's opinion
and forwarded it to the full board. Prior to approving the revised terms of the
amended and restated acquisition agreement and the amended share purchase
agreement, the board received and accepted a revised opinion of Advest.
INTERESTS OF PERSONS INVOLVED IN THE
CAPITAL Z ISSUANCE AND THE ACQUISITION
THAT MAY BE DIFFERENT FROM YOURS
(PAGE 87)
Some directors or executive officers or their affiliates may have interests
in the share purchase agreement, the acquisition agreement and the related
agreements that may be different from, or in addition to, your interests. For
example, following the transactions, some of the present executive officers will
have employment agreements with Universal American under which their
compensation will be increased. The board of directors of Universal American was
aware of these interests and took them into account in approving the share
purchase agreement, the acquisition agreement and the related agreements.
MATERIAL TERMS OF THE SHARE PURCHASE
AGREEMENT (PAGE 44)
CONDITIONS TO THE CAPITAL Z ISSUANCE
Universal American and Capital Z will not complete the Capital Z Issuance
unless they satisfy or waive a number of conditions. The material conditions
are:
- - a majority of Universal American's shareholders must approve the Capital Z
Issuance and the amendment to Universal American's certificate of
incorporation to increase the number of authorized shares;
- - the closing of the acquisition of the Penn Union Companies must occur at the
same time as the closing of the Capital Z Issuance;
- - Universal American must obtain insurance and other regulatory approvals
relating to the Capital Z Issuance and the acquisition of the Penn Union
Companies;
- - Richard A. Barasch, Chief Executive Officer and Chairman of the Board of
Universal American, must enter into an employment agreement with Universal
6
13
American, the terms of which already have been agreed to; and
- - Universal American must enter into a shareholders' agreement and a
registration rights agreement with some shareholders of Universal American,
the terms of which already have been agreed to.
The board of directors does not intend to waive any conditions to the share
purchase agreement, the waiver of which would be materially harmful to Universal
American or its shareholders. Therefore, the board of directors believes that
the failure to resolicit the vote of the shareholders in case of a waiver does
not create any additional material risk to the shareholders.
TERMINATION OF THE SHARE PURCHASE
AGREEMENT
Universal American and Capital Z, at any time after July 31, 1999, can
agree to terminate the share purchase agreement without completing the Capital Z
Issuance. Either Universal American or Capital Z can terminate the share
purchase agreement under some circumstances, including:
- - if the acquisition of the Penn Union Companies has not occurred by July 31,
1999; or
- - if the shareholders of Universal American fail to approve the Capital Z
Issuance or the amendment to the certificate of incorporation to increase the
authorized shares of common stock.
To review the terms of the share purchase agreement in greater detail, see
page 44.
MATERIAL TERMS OF THE ACQUISITION
AGREEMENT RELATING TO THE
PENN UNION COMPANIES (PAGE 51)
CONDITIONS TO THE ACQUISITION OF THE
PENN UNION COMPANIES
Universal American, American Exchange and PFG will not complete the
acquisition and sale of the Penn Union Companies unless they satisfy or waive a
number of conditions. The material conditions are:
- - Universal American's shareholders must approve the Capital Z Issuance and the
amendment to the certificate of incorporation to increase the number of
authorized shares of common stock that Universal American is permitted to
issue;
- - Universal American and PFG must obtain insurance and other regulatory
approvals relating to the acquisition of the Penn Union Companies and, in the
case of Universal American, relating to the Capital Z Issuance;
- - Universal American must be satisfied with the reports being prepared based
upon a review of certain reserves of Pennsylvania Life;
- - PFG must complete specified restructuring and other transactions; and
- - Universal American must enter into agreements with selected agents and members
of management of the Penn Union Companies regarding compensation and equity
investments.
In negotiating the acquisition agreement, Universal American recognized
that additional reserves in Pennsylvania Life may be required. Accordingly,
Universal American included provisions in the agreement to ensure certain
reserves are adequate. First, Universal American is required to receive reports
from independent reserve consultants prior to the closing of the acquisition as
to the adequacy of active life reserves of Pennsylvania Life. The results of
these reports must be reasonably satisfactory to Universal American. If
Universal American is not satisfied with the reserve consultants' reports, it is
not required to close the acquisition. Second, selected Penn Union Companies,
including Pennsylvania Life, must each meet minimum capital and surplus
requirements. For example, Penn-
7
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sylvania Life must have capital and surplus equal to at least $36 million,
excluding amounts attributable to a note issued by PennCorp Financial, Inc. in
favor of Pennsylvania Life. In addition, the aggregate capital and surplus
amounts of selected Penn Union Companies must equal at least $65.8 million plus
the earnings, as described in the acquisition agreement, of those companies from
January 1, 1999 to the closing. If the estimated capital and surplus amounts do
not equal or exceed the minimum capital and surplus requirements at closing,
Universal American and American Exchange are not obligated to close the
acquisition. Finally, the acquisition agreement requires a post-closing purchase
price adjustment based on the actual capital and surplus of the selected Penn
Union Companies. PFG will pay Universal American the difference between the
actual capital and surplus amounts and the required capital and surplus amounts.
See "The Capital Z Issuance and the Acquisition of the Penn Union
Companies--Material Terms of the Acquisition Agreement and the Related
Transactions--Purchase Price Adjustment."
Based on its own analysis and that of an outside actuarial consultant,
Universal American believes that the reserves of the Penn Union Companies will
be adequate as of the closing. Universal American, however, cannot give
assurances that such reserves will be adequate over the long term.
The board of directors does not intend to waive conditions to the
acquisition agreement the waiver of which, in the aggregate, would be materially
harmful to Universal American or its shareholders.
TERMINATION OF THE ACQUISITION AGREEMENT
Universal American and PFG can together agree to terminate the acquisition
agreement before completing the acquisition of the Penn Union Companies. Either
Universal American or PFG can terminate the share purchase agreement under some
circumstances, including the failure of the acquisition of the Penn Union
Companies to close by July 31, 1999.
To review the terms of the acquisition agreement of the Penn Union
Companies in greater detail, see page 51.
REGULATORY APPROVALS (PAGE 43)
The New York state insurance department has approved the Capital Z Issuance
and the acquisition. The regulatory authorities in Florida, Texas, Pennsylvania
and North Carolina must approve the Capital Z Issuance and the acquisition. The
transactions also require approval under some Canadian federal and provincial
laws. In addition, both the Capital Z Issuance and the acquisition are subject
to compliance with applicable state and federal securities laws and approvals
from or notices to various states.
The Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act")
applies to both the Capital Z Issuance and the acquisition of the Penn Union
Companies. The HSR Act prohibits Universal American and PFG from completing the
acquisition of the Penn Union Companies until Universal American, Capital Z and
PFG have furnished the required information and materials to the Antitrust
Division of the Department of Justice and the Federal Trade Commission and the
required waiting period has ended or been terminated.
Universal American, Capital Z and the Penn Union Companies have made all
required Form A filings, made presentations to applicable insurance departments
and are providing additional information as requested. The terms of the amended
and restated acquisition agreement and the amended share purchase agreement have
been filed with the various insurance departments. Universal American, Capital Z
and the Penn Union Companies continue to make all other regulatory filings as
required. Universal American, Capital Z and the Penn
8
15
Union Companies expect to receive all required regulatory approvals. Most
required notices have been filed as of the date of this proxy statement and
additional notices will continue to be filed as required. All required HSR Act
approvals which are required as a condition to complete the acquisition and the
Capital Z Issuance have been received.
OTHER INFORMATION
Unless otherwise indicated, all financial information and operating
statistics applicable to Universal American and the Penn Union Companies in this
proxy statement are based on generally accepted accounting principles ("GAAP")
and not statutory accounting practices ("SAP"). In conformity with industry
practice, information derived from A.M. Best Company, Inc. ("A.M. Best") and the
National Association of Insurance Commissioners ("NAIC") and used in this proxy
statement for industry comparisons is based on SAP.
PFG has furnished the financial and other information set forth in this
proxy statement concerning PFG and the Penn Union Companies. We have no reason
to believe that the information provided by PFG is incorrect. However, in the
event that this information is materially inaccurate, Universal American's
recourse may be limited in some respects by the terms of the acquisition
agreement. Based on information obtained from PFG, Universal American prepared
descriptions of PFG and the Penn Union Companies.
FORWARD-LOOKING STATEMENTS (PAGE 31)
Statements in this proxy statement are or may be forward-looking statements
that involve risks and uncertainties. Actual results may differ materially from
those expressed in such statements depending on a variety of factors discussed
more fully in this proxy statement. You should carefully review all information,
including the financial statements and the notes to the financial statements,
included in this proxy statement.
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PROPOSALS
PROPOSAL NO. 1 -- THE CAPITAL Z
ISSUANCE (PAGE 79)
THE CAPITAL Z ISSUANCE. Proposal No. 1 asks you to approve the Capital Z
Issuance. Capital Z does not currently own any capital stock of Universal
American.
EFFECT OF THE CAPITAL Z ISSUANCE. After the Capital Z Issuance, Capital Z
will hold approximately 65.5% of Universal American's outstanding common stock.
If all of the securities of Universal American that could be converted into
common stock were converted or exercised, Capital Z would own 59.5% of the
outstanding common stock.
If the acquisition of the Penn Union Companies and the Capital Z Issuance
had been completed on January 1, 1998, pro forma earnings per share of Universal
American for the year ended December 31, 1998 would have been $0.06 per share,
assuming that all of Universal American's securities that could be converted or
exercised into common stock had been converted or exercised, which compares to
$0.20 reported by Universal American for the year ended December 31, 1998 or a
$0.14 per share decrease. The results of the Penn Union Companies for the year
ended December 31, 1998 included reserve strengthenings which resulted in a
reduction of $21.5 million in net income after tax, or $0.52 per share. See
"Penn Union Companies Management's Discussion and Analysis of Financial
Condition and Results of Operations" on page 122 and "-- Universal American
Financial Corp. Unaudited Pro Forma Condensed Consolidated Statement of
Operations -- Year Ended December 31, 1998."
ADVANTAGES AND DISADVANTAGES OF THE CAPITAL Z ISSUANCE. The board of
directors of Universal American approved the Capital Z Issuance to ensure that
Universal American and American Exchange have the opportunity to complete the
acquisition of the Penn Union Companies. The board of directors considered the
extent of Capital Z's ownership following the Capital Z Issuance. The board of
directors, however, views the relationship with Capital Z as beneficial to
Universal American's ability to continue its growth and take advantage of
opportunities to complete acquisitions as they arise. The relationship may also
provide Universal American with greater access to capital markets and enhance
shareholder value. In addition, funding the acquisition of the Penn Union
Companies in part through the issuance of equity will allow Universal American
to maintain a more conservative debt-to-equity ratio and satisfy rating agency
considerations. The board decided these advantages outweighed the concerns
raised by Capital Z's ability to control elections of Universal American's
directors, the potential depressive effect on the trading market for Universal
American's common stock by the concentration of Capital Z's ownership, and the
fact that Capital Z's ownership could delay or prevent an advantageous change in
control.
CORPORATE GOVERNANCE. As a condition to the Capital Z Issuance, Universal
American, Capital Z, Richard A. Barasch, and AAM, and some other shareholders of
Universal American will enter into a shareholders' agreement. The shareholders'
agreement provides that initially after the closing, Capital Z may nominate four
directors, Richard A. Barasch may nominate two directors, AAM may nominate one
director, and Universal American will nominate the remaining two directors of
Universal American. Capital Z, Richard Barasch and AAM are each required to vote
for the director(s) nominated by the others. The number of directors each
shareholder can nominate may change, depending on future share ownership. As
long as Capital Z owns over 50% of the outstanding voting stock after the
Capital Z Issuance, it will have the ability to select Universal American's two
designated directors. As a
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consequence, Capital Z will effectively be able to select 6 of the 9 directors
on Universal American's board. See "The Capital Z Issuance and the Acquisition
of the Penn Union Companies -- Terms of the Share Purchase
Agreement -- Shareholders' Agreement."
CONSEQUENCES IF THE CAPITAL Z ISSUANCE IS NOT APPROVED. Under the terms of
the share purchase agreement, if the shareholders do not approve the Capital Z
Issuance, Universal American and American Exchange will not be able to complete
the acquisition of the Penn Union Companies and Universal American cannot
otherwise purchase or acquire any of the businesses or assets of PFG for a
period of two years after the termination of the share purchase agreement.
EVEN THOUGH SHAREHOLDERS OWNING OVER 50% OF THE OUTSTANDING VOTING STOCK
HAVE AGREED TO VOTE IN FAVOR OF PROPOSAL NO. 1, WE ASK THAT YOU COMPLETE AND
RETURN YOUR BALLOT.
ADVANTAGES AND DISADVANTAGES OF THE ACQUISITION OF THE PENN UNION
COMPANIES. Through the acquisition of the Penn Union Companies, Universal
American will be able to expand its product and policyholder base. Universal
American expects that the growth that will result from the acquisition will
allow it to achieve long-term economies of scale and to cut costs and increase
profits.
There is no guarantee that these benefits will materialize. It is possible
that Universal American may have difficulty consolidating the operations of the
Penn Union Companies with its own business. However, after considering all the
advantages and disadvantages, the board determined that the acquisition will
ultimately increase shareholder value. See "The Capital Z Issuance and the
Acquisition of the Penn Union Companies -- Reasons for the Acquisition and the
Capital Z Issuance."
THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE CAPITAL Z ISSUANCE AND
RECOMMENDS A VOTE FOR PROPOSAL NO. 1.
PROPOSAL NO. 2 -- AMENDMENTS TO THE
CERTIFICATE OF INCORPORATION (PAGE 81)
Each of the following amendments to Universal American's certificate of
incorporation are proposed:
a. Increase the number of authorized shares of Universal American common stock
from 20 million to 80 million shares in order to effect the Capital Z
Issuance.
b. Provide for shareholder action by written consent instead of a meeting of
shareholders. Written consent would only need to be given by shareholders
holding the number of shares required to approve the action being taken by
written consent.
c. Eliminate the requirement that holders of 66 2/3% of Universal American's
outstanding voting capital stock approve amendments to some provisions of the
certificate of incorporation, which means only majority approval will be
necessary for those amendments.
d. Remove the provision in the certificate of incorporation which requires the
vote of holders of 66 2/3% of the outstanding voting capital stock to call a
special meeting of the shareholders. The board will amend the by-laws to
allow special meetings of the shareholders to be called at the request of
holders of 50% of the outstanding voting capital stock.
e. Replace the present method of electing directors and the length of their
terms with a system in which all directors are elected at one time for a term
expiring at the next annual meeting. Directors are currently elected to three
year staggered terms.
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f. Require 66 2/3% of Universal American's board of directors to approve some
important corporate actions.
YOU MUST VOTE ON EACH ITEM OF PROPOSAL NO. 2 SEPARATELY, BUT YOU DO NOT
HAVE TO VOTE THE SAME WAY ON EACH ITEM.
EVEN THOUGH SHAREHOLDERS OWNING OVER 50% OF THE OUTSTANDING VOTING STOCK
HAVE AGREED TO VOTE IN FAVOR OF ITEM (a) OF PROPOSAL NO. 2, THE VOTING AGREEMENT
DOES NOT COVER THE APPROVAL OF ITEMS (b) THROUGH (f) OF PROPOSAL NO. 2. IN
ADDITION, ITEMS (b) THROUGH (e) REQUIRE APPROVAL BY HOLDERS OF 66 2/3% OF THE
TOTAL OUTSTANDING VOTING SHARES ENTITLED TO VOTE ON THOSE ITEMS. ACCORDINGLY,
YOUR VOTE IS VERY IMPORTANT TO THE APPROVAL OF THE AMENDMENTS TO THE
CERTIFICATION OF INCORPORATION AND YOU ARE REQUESTED TO COMPLETE AND RETURN YOUR
BALLOT. Failure to return your ballot will be considered a vote against each
item of Proposal No. 2.
THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THESE AMENDMENTS TO THE
CERTIFICATE OF INCORPORATION AND RECOMMENDS A VOTE FOR EACH ITEM OF PROPOSAL NO.
2.
PROPOSAL NO. 3 -- AMENDMENT TO THE 1998 INCENTIVE COMPENSATION PLAN (PAGE 85)
Proposal No. 3 asks you to authorize an amendment to Universal American's
1998 Incentive Compensation Plan to create an exception to the plan's
prohibition against the grant of options which may be exercised at a price per
share less than fair market value on the day of the grant. This exception would
allow Universal American to grant options to members of management of the Penn
Union Companies and Universal American following the acquisition of the Penn
Union Companies which may be exercised at the same price per share that Capital
Z will pay in the Capital Z Issuance. The amendment would only apply to options
granted to a limited number of agents and members of management following the
proposed acquisition of the Penn Union Companies.
THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE AMENDMENT TO THE 1998
INCENTIVE COMPENSATION PLAN AND RECOMMENDS A VOTE FOR PROPOSAL NO. 3.
YOU ARE URGED TO REVIEW CAREFULLY THE MORE DETAILED INFORMATION INCLUDED IN
THIS PROXY STATEMENT AND THE ACCOMPANYING ANNEXES.
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SUMMARY HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL INFORMATION
We are providing the following historical financial information to aid you
in your analysis of the financial aspects of the Capital Z Issuance and the
acquisition of the Penn Union Companies. This information is only a summary and
you should read it in conjunction with the historical financial statements and
other financial information contained in Universal American's most recent annual
and quarterly reports filed with the SEC, the historical financial information
and more detailed financial information provided in Annex E to this proxy
statement, and the historical financial information in the other documents to
which we refer. See "Where You Can Find More Information" on page 141.
The summary historical financial information for Universal American is
derived from consolidated financial statements of Universal American and was
prepared in accordance with GAAP. The financial statements for Universal
American as of December 31, 1996, 1997 and 1998 and each of the three years in
the period ended December 31, 1998 have been audited by Ernst & Young LLP,
independent auditors. The financial statements for Universal American as of
December 31, 1994 and 1995 and for the years ended December 31, 1994 and 1995
have been audited by KPMG LLP, independent auditors. The summary financial
information for Universal American as of March 31, 1999 and for the three month
periods ended March 31, 1998 and 1999 was derived from unaudited consolidated
financial statements of Universal American that include all adjustments,
including normally occurring accruals, that we consider necessary for a fair
presentation of the results of operations for the periods presented. The results
for three months ended March 31, 1999 are not necessarily indicative of the
results of Universal American's fiscal year ended December 31, 1999.
The combined financial statements for the Penn Union Companies for the
years ended December 31, 1995, 1996, 1997 and 1998 have been audited by KPMG
LLP, independent auditors. The summary financial information for the Penn Union
Companies as of December 31, 1994 and March 31, 1999 and the year ended December
31, 1994 and the three months ended March 31, 1998 and 1999 was derived from
unaudited combined financial statements of the Penn Union Companies that include
all adjustments, including normally occurring accruals, that the Penn Union
Companies consider necessary for their presentation of the results of operations
for the periods presented. The results for three months ended March 31, 1999 are
not necessarily indicative of the results of Universal American's fiscal year
ended December 31, 1999.
The Universal American Financial Corp. Unaudited Pro Forma Condensed
Consolidated Statement of Operations for the three months ended March 31, 1999
and the year ended December 31, 1998 present results for Universal American as
if the acquisition and the financing of the acquisition had been consummated as
of January 1, 1998. The Universal American Financial Corp. Unaudited Pro Forma
Condensed Consolidated Balance Sheet as of March 31, 1999 gives effect to the
acquisition of the Penn Union Companies by Universal American as if it had
occurred on the balance sheet date, March 31, 1999. The unaudited pro forma
financial information has been derived from and should be read in conjunction
with the Notes to Unaudited Pro Forma Financial Information that follow on page
21, as well as the historical Consolidated Financial Statements and Notes of
Universal American as of December 31, 1998 and for the year ended December 31,
1998 and the historical Combined Financial Statements and Notes of the Penn
Union Companies of PFG as of December 31, 1998 and for year ended December 31,
1998 set forth in Annex E to this proxy statement. See "Universal American
Financial Corp. Management's Discussion and Analysis of Financial Condition and
Results of Operations" on page 104 and "Penn Union Companies
13
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Management's Discussion and Analysis of Financial Condition and Results of
Operations" on page 122.
The unaudited pro forma combined financial information reflects
management's best estimate based upon currently available information. The pro
forma adjustments and combined amounts are provided for informational purposes
only, and if the acquisition of the Penn Union Companies is consummated,
Universal American's consolidated financial statements will reflect the effects
of the acquisition only from the date the transaction occurs. The pro forma
adjustments are applied to the historical financial statements of Universal
American and the Penn Union Companies to account for the acquisition of the Penn
Union Companies by Universal American under the purchase method of accounting in
accordance with APB Opinion No. 16. Under this method of accounting, the total
purchase cost will be allocated to the Penn Union Companies' assets and
liabilities based on their relative fair values. These allocations are subject
to valuations as of the date of the acquisition based upon appraisals and other
information available at that time. For example, it is not possible to fully
estimate the reserves for future policy benefits and certain components of
claims reserves as the assumptions have not been unlocked and analyzed for
current circumstances (e.g. current interest rates) and experience (e.g. current
morbidity and termination experience). Such assumptions cannot be determined
with certainty until the acquisition of the Penn Union Companies has been
consummated. Statement of Financial Accounting Standards ("SFAS") No. 38
"Accounting for Preacquisition Contingencies of Purchased Entities" allows a
period of one year to complete the purchase accounting allocations for business
combinations. Management believes it will complete this recalculation of
reserves within that period of time. Management has provided its best estimate
of what the likely fair values of assets and liabilities for the purpose of
these pro forma financial statements; management cannot predict the potential
adjustments resulting from actual final purchase assumptions which could result
in differences from these pro forma estimates. It is reasonably likely that the
reserve amounts will increase, which difference could be material and impact
future results of operations. For example, an increase in the final fair value
reserve amount would decrease negative goodwill and the positive effects of its
amortization on future results of operations. Accordingly, the final purchase
price adjustments will be different from the amounts reflected in this proxy
statement. However, it is management's opinion that the allocation of the
purchase price reflected in the unaudited pro forma financial information is not
expected to be materially different from the final amounts.
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the results of operations or financial
position that would have occurred had the acquisition been consummated on the
dates assumed, nor is the pro forma information intended to be indicative of
Universal American's future results of operations.
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UNIVERSAL AMERICAN FINANCIAL CORP.
INCOME STATEMENT INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1999
----------- -----------
(UNAUDITED) (UNAUDITED)
Direct premium and policyholder fees........................ $ 31,405 $ 32,066
Reinsurance premium assumed................................. 203 249
Reinsurance premium ceded................................... (21,124) (21,891)
-------- --------
Net premium and other policyholder fees................... 10,484 10,424
Net investment income....................................... 2,708 2,799
Realized gain/(loss) on investments......................... (26) 47
Fee income.................................................. 633 569
Other income................................................ 16 11
-------- --------
Total revenues............................................ 13,815 13,850
-------- --------
Total benefits, claims and other deductions................. 13,040 12,783
-------- --------
Operating income before taxes............................... 775 1,067
Net income after taxes...................................... 533 711
Net income applicable to common shareholders................ $ 425 $ 531
======== ========
Earnings per common share:
Basic..................................................... $ 0.06 $ 0.07
======== ========
Diluted................................................... $ 0.04 $ 0.05
======== ========
YEAR ENDED DECEMBER 31,
------------------------------------------------
1994 1995 1996(2) 1997(3) 1998
------- ------- ------- ------- --------
Direct premium and policyholder fees......... $40,652 $46,145 $55,287 $99,339 $131,044
Reinsurance premium assumed.................. 13,564 8,866 10,522 998 998
Reinsurance premium ceded.................... (13,892) (18,200) (25,664) (62,623) (89,546)
------- ------- ------- ------- --------
Net premium and other policyholder fees.... 40,324 36,811 40,145 37,714 42,496
Net investment income........................ 9,239 8,945 9,850 10,023 10,721
Realized gains on investments................ 42 674 240 1,133 256
Fee income................................... 4,126 3,137 2,872 2,368 2,553
Other income................................. 219 244 280 93 63
------- ------- ------- ------- --------
Total revenues............................. 53,950 49,811 53,387 51,331 56,089
------- ------- ------- ------- --------
Total benefits, claims and other
deductions................................. 51,712 47,161 53,014 48,119 52,157
------- ------- ------- ------- --------
Operating income before taxes................ 2,238 2,650 373 3,212 3,932
Net income after taxes....................... 2,228 2,642 104 2,119 2,607
Net income applicable to common
shareholders(1)............................ $ 3,173 $ 2,642 $ 104 $ 1,870 $ 2,174
======= ======= ======= ======= ========
Earnings per share:
Basic...................................... $ 0.59 $ 0.42 $ 0.01 $ 0.26 $ 0.29
======= ======= ======= ======= ========
Diluted.................................... $ 0.37 $ 0.25 $ 0.01 $ 0.18 $ 0.20
======= ======= ======= ======= ========
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BALANCE SHEET INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
AS OF DECEMBER 31, AS OF
---------------------------------------------------- MARCH 31,
1994 1995 1996 1997 1998 1999
-------- -------- -------- -------- -------- ---------
Total cash and investments... $125,487 $135,603 $144,681 $159,429 $164,674 $158,382
Total assets................. 164,862 182,994 242,237 272,575 283,302 284,215
Policyholder account
balances................... 108,777 118,609 134,539 145,085 154,886 156,196
Series C preferred stock..... -- -- -- 5,168 5,168 5,168
Series D preferred stock..... -- -- -- -- 2,250 4,000
Series B preferred stock..... 4,000 4,000 4,000 4,000 4,000 4,000
Stockholders' equity......... 15,321 24,114 22,079 25,706 28,318 28,403
Stockholders' equity per
share of common stock
Basic(4)................... $ 1.83 $ 2.89 $ 2.53 $ 2.96 $ 3.18 $ 3.14
Diluted(5)................. $ 1.66 $ 2.30 $ 2.12 $ 2.39 $ 2.59 $ 2.55
- -------------------------
(1) After provision for Series A preferred stock dividends of $576,000 for the
year ended December 31, 1994, Series C preferred stock dividends of $250,000
and $433,000 for the years ended December 31, 1997 and 1998, respectively,
and Series C and Series D preferred stock dividends of $180,000 for the
three months ended March 31, 1999.
(2) Includes the results of the First National Life Insurance Company block of
business since its acquisition on October 1, 1996. See "Universal American
Financial Corp. Management's Discussion and Analysis of Financial Condition
and Results of Operations".
(3) Includes the results of American Exchange Life Insurance Company since its
acquisition on December 1, 1997. See "Universal American Financial Corp.
Management's Discussion and Analysis of Financial Condition and Results of
Operations".
(4) Basic stockholders' equity per share of common stock represents
stockholders' equity less the financial statement value of Series B
preferred stock divided by outstanding shares of common stock.
(5) Diluted stockholders' equity per share of common stock represents
stockholders' equity plus the financial statement value of the Series C
preferred stock, redemption accrual on the Series C preferred stock, the
Series D Preferred Stock, the proceeds from the exercise of outstanding
options and warrants divided by outstanding shares of common stock plus the
stock issued pursuant to the conversion of the Series B preferred stock,
Series C preferred stock and Series D Preferred Stock and the exercise of
the options and warrants outstanding.
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THE PENN UNION COMPANIES
COMBINED FINANCIAL INFORMATION
INCOME STATEMENT INFORMATION
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
--------------------- -----------------------------------------------------
1998 1999 1994(1)
UNAUDITED UNAUDITED UNAUDITED 1995(2) 1996 1997 1998
--------- --------- --------- -------- -------- -------- --------
Direct premium and
policyholder fees..... 78,008 67,828 158,385 $161,188 $329,871 $326,096 $299,846
Reinsurance premiums
assumed............... 2,637 595 6,266 9,156 22,514 5,029 2,495
Reinsurance premiums
ceded................. (24,452) (22,703) (1,677) (4,058) (56,123) (106,121) (102,785)
-------- -------- ------- -------- -------- -------- --------
Net premium and
policyholder fees
earned............. $ 56,193 $ 45,720 162,974 166,286 296,262 225,004 199,556
Net investment income... 12,332 11,868 28,971 30,572 48,113 47,405 47,938
Realized gains (losses)
on sale of
investments........... (606) 92 (3,018) (278) (616) 4,795 6,207
Other income............ 3,193 3,371 908 3,717 9,252 17,550 11,408
-------- -------- ------- -------- -------- -------- --------
Total revenues........ 71,112 61,051 189,835 200,297 353,011 294,754 265,109
-------- -------- ------- -------- -------- -------- --------
Total benefits, claims
and other deductions.. 73,317 61,358 137,675 153,792 310,970 276,370 374,224
-------- -------- ------- -------- -------- -------- --------
Operating income (loss)
before taxes.......... (2,205) (307) 52,160 46,505 42,041 18,384 (109,115)
Net income (loss) after
taxes................. $ (2,495) $ (667) 32,569 $ 27,037 $ 24,435 $ 10,795 $(73,858)
BALANCE SHEET INFORMATION
(IN THOUSANDS)
AS OF DECEMBER 31, AS OF
------------------------------------------------------------- MARCH 31,
1994(1) 1999
UNAUDITED 1995 1996 1997 1998 UNAUDITED
--------- ---------- ---------- ---------- ---------- ----------
Total cash and
investments......... 368,391 $ 760,690 $ 651,061 $ 674,749 $ 706,278 $ 684,870
Total assets.......... 653,502 1,226,883 1,226,372 1,266,182 1,144,026 1,119,057
Policy liabilities and
accruals............ 362,585 734,748 638,991 666,598 635,302 631,485
Business equity....... 263,291 371,841 364,179 385,840 336,881 336,380
- -------------------------
(1) Does not include results of Constitution, Union Bankers and Marquette which
were not acquired until December 14, 1995.
(2) Includes results of Constitution Life Insurance Company, Union Bankers and
Marquette National Life Insurance Company since their acquisition on
December 14, 1995. See "Note 3 -- Acquisitions" to the financial statements
of the Penn Union Companies.
17
24
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
---------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
--------- ---------- ---------------- ------------------ ------------
REVENUES:
Net premium and policyholder fees
earned............................... $10,424 $45,720 $ (842) $ -- $55,302
Net investment income.................. 2,799 11,868 (636) -- 14,031
Realized gains on investments.......... 47 92 -- -- 139
Other income........................... 579 3,371 (120) -- 3,830
------- ------- ------- ------- -------
Total revenues......................... 13,849 61,051 (1,598) -- 73,302
------- ------- ------- ------- -------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.................. 9,172 32,944 (1,267) -- 40,849
Change in deferred acquisition costs... (856) (1,437) (33) (3,168)(2) (5,494)
Amortization of present value of future
profits.............................. 44 2,829 (121) (2,708)(3) 44
Amortization of goodwill............... 39 1,383 -- (1,383)(3) 39
Amortization of negative goodwill...... -- -- -- (1,353)(4) (1,353)
Interest expense on the senior secured
note................................. -- -- -- 1,641(5) 1,641
Interest expense on affiliated surplus
notes................................ -- 2,530 -- (2,530)(6) --
Other operating costs and expenses..... 4,383 23,109 (925) -- 26,567
------- ------- ------- ------- -------
Total benefits, claims and other
deductions........................... 12,782 61,358 (2,346) (9,501) 62,293
------- ------- ------- ------- -------
Operating income before taxes.......... 1,067 (307) 748 9,501 11,009
Federal income tax expense............. 356 360 257 2,492(7) 3,465
------- ------- ------- ------- -------
Net income............................. 711 (667) 491 7,009 7,544
Redemption accrual on Series C
preferred stock...................... 180 -- -- (180)(8) --
------- ------- ------- ------- -------
Net income applicable to common
shareholders......................... $ 531 $ (667) $ 491 $ 7,189 $ 7,544
======= ======= ======= ======= =======
EARNINGS PER COMMON SHARE:
Basic.............................. $ 0.07 $ 0.19
======= =======
Diluted............................ $ 0.05 $ 0.17
======= =======
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic.............................. 7,706 32,890(9) 40,596
Diluted............................ 14,894 30,714(9) 45,568
18
25
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
---------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
--------- ---------- ---------------- ------------------ ------------
REVENUES:
Net premium and policyholder fees
earned............................... $42,496 $199,556 $(13,968) $ -- $228,084
Net investment income.................. 10,721 47,938 (6,255) -- 52,404
Realized gains on investments.......... 256 6,207 (43) -- 6,420
Other income........................... 2,616 11,408 (120) -- 13,904
------- -------- -------- --------- --------
Total revenues......................... 56,089 265,109 (20,386) -- 300,812
------- -------- -------- --------- --------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.................. 38,235 174,646 (11,122) -- 201,758
Change in deferred acquisition costs... (3,530) 53,030 (245) (87,001)(2) (37,746)
Amortization of present value of future
profits.............................. 174 10,842 (1,194) (9,648)(3) 174
Amortization of goodwill............... 171 5,547 -- (5,547)(3) 171
Amortization of negative goodwill...... -- -- -- (4,749)(4) (4,749)
Interest expense on the senior secured
note................................. -- -- -- 6,630(5) 6,630
Interest expense on affiliated surplus
notes................................ -- 10,948 -- (10,948)(6) --
Other operating costs and expenses..... 17,107 119,211 (5,984) -- 130,335
------- -------- -------- --------- --------
Total benefits, claims and other
deductions........................... 52,157 374,224 (18,545) (111,263) 296,573
------- -------- -------- --------- --------
Operating income (loss) before taxes... 3,932 (109,115) (1,841) 111,263 4,239
Federal income tax expense (benefit)... 1,325 (35,257) (361) 35,863(7) 1,570
------- -------- -------- --------- --------
Net income (loss)...................... 2,607 (73,858) (1,480) 75,400 2,669
Redemption accrual on Series C
preferred stock...................... 433 -- -- (433)(8) --
------- -------- -------- --------- --------
Net income (loss) applicable to common
shareholders......................... $ 2,174 $(73,858) $ (1,480) $ 75,833 $ 2,669
======= ======== ======== ========= ========
EARNINGS PER COMMON SHARE:
Basic.............................. $ 0.29 $ 0.07
======= ========
Diluted............................ $ 0.20 $ 0.06
======= ========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic.............................. 7,533 32,890(9) 40,423
Diluted............................ 13,155 30,714(9) 43,869
19
26
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1999
(IN THOUSANDS)
PRO FORMA
ADJUSTMENTS
FINANCING RELATING TO PURCHASE
UNIVERSAL ACCOUNTING PENN UNION TRANSFER OF ACCOUNTING PRO FORMA
AMERICAN ADJUSTMENTS(10) COMPANIES CERTAIN LINES ADJUSTMENT(11) CONSOLIDATED
--------- --------------- ---------- ------------- --------------- ------------
ASSETS:
Total investments.... $149,456 $ -- $ 669,150 $ (65,581) -- $ 753,025
Cash................. 8,926 15,000 15,720 -- (6,500) 33,146
Deferred policy
acquisition
costs.............. 26,368 -- 117,105 (485) (116,620) 26,368
Goodwill............. 4,316 -- 95,697 -- (95,697) 4,316
Present value of
future
profits............ 1,526 -- 85,823 (5,094) (80,729) 1,526
Other assets......... 93,623 6,250 133,361 -- -- 233,234
-------- -------- ---------- --------- --------- ----------
Total assets......... 284,215 21,250 1,116,856 (71,160) (299,546) 1,051,615
======== ======== ========== ========= ========= ==========
LIABILITIES, SERIES C
AND D PREFERRED
STOCK AND
STOCKHOLDERS'
EQUITY:
Reserves for future
policy benefits.... 230,080 -- 631,485 (61,387) -- 800,178
Loan payable......... 4,500 (4,500) -- -- -- --
Affiliated surplus
notes.............. -- -- 98,500 -- (98,500) --
Senior secured note
payable............ -- 70,000 -- -- -- 70,000
Deferred income tax
(asset)
liability.......... 1,127 -- (410) (3,421) (69,129) (71,833)
Negative goodwill.... -- -- -- -- 74,111 74,111
Other liabilities.... 10,074 -- 50,901 -- -- 60,975
-------- -------- ---------- --------- --------- ----------
Total
liabilities...... 245,781 72,000 780,476 (64,808) (93,518) 933,431
-------- -------- ---------- --------- --------- ----------
Series C and D
preferred stock
(including
redemption accrual
thereon)........... 10,031 (10,031) -- -- -- --
-------- -------- ---------- --------- --------- ----------
Total stockholders'
equity............. 28,403 96,281 336,380 (6,352) (336,528) 118,184
-------- -------- ---------- --------- --------- ----------
Total liabilities,
Series C and D
preferred stock and
stockholders'
equity............. $284,215 $158,250 $1,116,856 $ (71,160) $(430,046) $1,051,615
======== ======== ========== ========= ========= ==========
20
27
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION
(IN THOUSANDS)
Universal American and American Exchange have entered into an amended and
restated acquisition agreement with PFG and some of PFG's subsidiaries to
purchase the Penn Union Companies for an aggregate price of 130.5 million in
cash. In addition, immediately prior to the closing an affiliate of PFG that is
not being purchased by Universal American or American Exchange will receive $6.5
million in the form of a cash dividend payable by Union Bankers. For a
description of the transaction and the companies to be acquired, see "The
Capital Z Issuance and the Acquisition of the Penn Union Companies" on page 31
of this proxy statement. The purchase price may be adjusted to reflect
differences between the capital and surplus set forth in the closing statement
and the amounts required by the purchase agreement. This adjustment must be made
within 90 days of the closing date of the acquisition. For a further discussion
of the purchase price adjustment, see "Material Terms of the Acquisition
Agreement and Related Transactions -- Purchase Price Adjustment" on page 51 of
this proxy statement. The purchase price was determined based upon many factors,
including:
- the statutory capital base of the Penn Union Companies;
- the historical statutory earnings of the Penn Union companies;
- the uncertainty of the adequacy of the statutory reserves held by the
Penn Union Companies;
- the status of the sales force at the time of negotiating the transaction;
and
- the anticipated rate of return on the investment.
For a discussion of the reasons why the terms of the acquisition agreement
were renegotiated to provide for a reduction in the purchase price, the
elimination of PFG's representation as to the adequacy of reserves and the
elimination of the purchase price adjustment based on adequacy of reserves see
"The Capital Z Issuance and the Acquisition of the Penn Union
Companies -- Background" beginning on page 31.
Adjustments to the unaudited pro forma condensed consolidated statements of
operations to give effect to the acquisition of the Penn Union Companies as of
January 1, 1998 are summarized below:
(1) The acquisition agreement contains certain pre-closing restructuring
provisions, of which material provisions include the termination of the
reinsurance agreements between Peninsular Life Insurance Company
("Peninsular") and Occidental Life Insurance Company of North Carolina
("Occidental")(both are subsidiaries of PFG); reinsurance of 100% of the
Peninsular direct business and the reinsurance of 100% of the unreinsured
Medicare supplement business of Union Bankers. The termination of the
existing reinsurance between Peninsular and Occidental and the reinsurance
of 100% of the Peninsular direct business are currently contemplated to be
effected through a single reinsurance treaty (collectively, the "Peninsular
Reinsurance"). The pro forma income statement effects of the reinsurance
transactions for the three
21
28
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
months ended March 31, 1999 and the year ended December 31, 1998, by line
item, of each of the above-mentioned reinsurance transactions are as
follows:
MARCH 31, 1999
--------------------------------------------------
REINSURANCE
OF THE REINSURANCE
UNREINSURED PRO FORMA
MEDICARE ADJUSTMENTS
SUPPLEMENT RELATING TO
PENINSULAR BUSINESS OF TRANSFER OF
REINSURANCE(a) UNION BANKERS(b) CERTAIN LINES
-------------- ----------------- -------------
Revenues:
Net premium and policyholder fees earned....... $ (842) -- (842)
Net investment income.......................... (636) -- (636)
Realized gains on investments.................. -- -- --
Other income................................... (120) -- (120)
------- ------ ------
Total revenues................................. (1,598) -- (1,598)
------- ------ ------
Benefits, claims and expenses:
Policyholder benefits incurred................. (1,267) -- (1,267)
Change in deferred acquisition costs........... (33) -- (33)
Amortization of present value of future
profits..................................... (121) -- (121)
Amortization of goodwill....................... -- -- --
Amortization of negative goodwill.............. -- -- --
Interest expense on the senior secured note.... -- -- --
Other operating costs and expenses............. (925) -- (925)
------- ------ ------
Total benefits, claims and other deductions.... (2,346) -- (2,346)
------- ------ ------
Operating income (loss) before taxes............. 748 -- 748
Federal income tax expense (benefit)............. 257 -- 257
------- ------ ------
Net income (loss)................................ $ 491 -- 491
======= ====== ======
22
29
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
DECEMBER 31, 1998
----------------------------------------------------
REINSURANCE
OF THE REINSURANCE
UNREINSURED PRO FORMA
MEDICARE ADJUSTMENTS
SUPPLEMENT RELATING TO
PENINSULAR BUSINESS OF TRANSFER OF
REINSURANCE(1a) UNION BANKERS(1b) CERTAIN LINES
--------------- ------------------ -------------
Revenues:
Net premium and policyholder fees earned...... $(3,105) (10,863) (13,968)
Net investment income......................... (5,117) (1,138) (6,255)
Realized gains on investments................. (43) -- (43)
Other income.................................. (120) -- (120)
------- ------- -------
Total revenues................................ (8,385) (12,001) (20,386)
------- ------- -------
Benefits, claims and expenses:
Policyholder benefits incurred................ (5,807) (5,315) (11,122)
Change in deferred acquisition costs.......... (113) (132) (245)
Amortization of present value of future
profits.................................... (523) (671) (1,194)
Amortization of goodwill...................... -- -- --
Amortization of negative goodwill............. -- -- --
Interest expense on the senior secured note... -- -- --
Other operating costs and expenses............ (1,831) (4,153) (5,984)
------- ------- -------
Total benefits, claims and other deductions... (8,274) (10,271) (18,545)
------- ------- -------
Operating income (loss) before taxes............ (111) (1,730) (1,841)
Federal income tax expense (benefit)............ 245 (605) (360)
------- ------- -------
Net income (loss)............................... $ (356) (1,125) (1,481)
======= ======= =======
23
30
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(a) Termination of the reinsurance agreements between Peninsular and
Occidental: This business is separately tracked for reinsurance
disclosure purposes, including premiums earned, policyholder benefits
incurred, change in deferred acquisition costs, amortization of present
value of future profits and the related taxes on these items. Net
investment income earned on the reserves held and expenses are
allocated to lines of business based on the pro-rata share of the mean
reserves and premiums, respectively. All of these impacts have been
removed. No new third party reinsurance agreements will be consummated
to replace the reinsurance between Peninsular and Occidental. However,
a related party reinsurance agreement between Peninsular and
Constitution is currently being drafted but would not impact the
combined results.
Reinsurance of 100% of the Peninsular direct business: This business is
separately tracked for disclosure purposes, including premiums earned,
policyholder benefits incurred, change in deferred acquisition costs,
amortization of present value of future profits and the related taxes
on these items. Net investment income earned on the reserves held and
expenses are allocated to lines of business based on the pro-rata share
of the mean reserves and premiums, respectively. This activity as
recorded by the Penn Union Companies prior to the acquisition has been
eliminated. After the cancellation of the agreements as described
above, all direct business is identified and removed on a historical
basis, totally eliminating all business of Peninsular which is tracked
as a separate company for reporting purposes.
All adjustments to realized gains (losses) and other income are related
to the removal of the actual direct and assumed Peninsular business.
Assets are transferred backing the reserves for the business reinsured
and thus the related realized gains and losses and the investment
income are adjusted in the pro forma information.
For all direct business of Peninsular, this reinsurance is on a full
assumption basis, which results in the legal replacement of the
insurance carrier, Peninsular, with Occidental Life Insurance Company
upon completion of the transaction. This line of business is to be
fully transferred to Occidental Life via this legal replacement prior
to close and thus the business will not be acquired in this
transaction. Therefore, it has been removed in the pro forma
presentation.
Both the termination of the reinsurance agreements between Peninsular
and Occidental Life and the reinsurance of 100% of the direct business
of Peninsular will be settled at amounts equal to the statutory
reserves at the date the new agreements become effective. Net GAAP
reserves, net of deferred policy acquisition costs and present value of
insurance in force of approximately $55,808, as of March 31, 1999, will
be transferred to Occidental Life along with cash and investments
totaling approximately $65,581. Accordingly, it is anticipated that
Peninsular will recognize a pre-tax loss of approximately $9,773, as a
result of the above transaction. Additionally, this transaction will
result in a reduction in future total revenues, net income and total
assets of approximately $8,000, $300 and $71,000, respectively.
24
31
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(b) Reinsurance of the unreinsured Medicare supplement business of Union
Bankers: During the fourth quarter of 1998, Union Bankers and
Constitution ceded the remaining 20% of the Medicare supplement
business to Cologne Life Reinsurance Company ("Cologne"). This business
is separately tracked for disclosure purposes, including premiums
earned, policyholder benefits incurred, change in deferred acquisition
costs, amortization of present value of future profits and the related
taxes on these items. Net investment income earned on the reserves held
is allocated to this line of business based on the pro-rata share of
the mean reserves. Certain identifiable expenses (i.e., fees paid to
third parties for the administration of the block of business) are
directly assigned to this line. Other expenses are allocated based on
premium. However, these expenses are offset in part by expense
allowances, based on specified percentages of premiums, which are
recovered from Cologne. This activity, as recorded by the Penn Union
Companies prior to the coinsurance of the remaining 20%, has been
eliminated on a pro forma basis.
Both the initial cession of 80% of the Medicare supplement business, as
well as the subsequent cession of the remaining 20%, resulted in gains
to Union Bankers which were deferred and are amortized into income over
the life of the business. The combined amortization of these gains
amounted to $9.6 million during 1998 and has not been eliminated on a
pro forma basis, as it relates to the Penn Union Companies' profit on
the sales transactions and is not part of the operating results for the
Medicare supplement line of business.
The removal of the remaining 20% of unreinsured Medicare supplement
business of Union Bankers and Constitution relates to the coinsurance
transaction with Cologne. Upon completion of this transaction during
the fourth quarter of 1998, the entire block of business is coinsured
with Cologne. This transaction does not result in the legal replacement
of Union Bankers and Constitution, however, the block of business is
transferred to Cologne under coinsurance and is presented accordingly
in the pro forma financial information. The income statement effects of
this line of business were removed for the portion of 1998 prior to the
execution of the remaining 20%. Under coinsurance, the liabilities are
transferred to Cologne. Cologne is contractually responsible for the
liabilities of this block. If, however, they fail to meet their
contractual obligation, Union Bankers and Constitution would be
obligated under the insurance contracts with the policyholders.
Other than the Medicare supplement business of Union Bankers as noted
above, these planned reinsurance transactions to transfer lines of
business not acquired have not been consummated as of December 31,
1998.
25
32
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(2) The components of the Penn Union historical amounts for the change in
deferred acquisition costs for the three months ended March 31, 1999 and
the year ended December 31, 1998 consisted of the following:
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
Capitalized acquisition costs............. $ 7,887 $ 40,337
Amortization of amounts capitalized in
1998 and later.......................... (3,249) (6,121)
Amortization of DAC balances prior to
1998.................................... (3,168) (87,001)
Amortization of DAC balance on lines of
business transferred.................... (33) (245)
------- --------
Total change in deferred acquisition
costs................................ $ 1,437 $(53,030)
======= ========
The amortization of deferred acquisition costs recorded by the Penn Union
Companies prior to 1998 was eliminated. However, the capitalization of
acquisition costs and the related amortization which occurred during 1998
and 1999 were recorded.
(3) The amortization of the present value of future profits and goodwill
recorded by the Penn Union Companies prior to the acquisition was
eliminated.
(4) Amortization of the excess of estimated fair values of net assets acquired
over the purchase price (negative goodwill) is recognized over a ten-year
period on a straight-line basis. See Note 11 in "Notes to Unaudited Pro
Forma Financial Information" on page 28.
(5) Interest expense was recorded to reflect the issuance of $70,000 of senior
bank debt with an annual interest rate of 8.69%.
(6) The interest expense recorded by the Penn Union Companies relating to the
affiliated surplus notes, which will be settled at the date of acquisition,
has been eliminated.
(7) Income taxes were adjusted at a rate of 35% to reflect the effect on taxes
of notes (2) through (6).
(8) The redemption accrual on the Series C preferred stock of Universal
American accumulated prior to the acquisition was eliminated since these
securities were converted into common stock of Universal American in April
1999.
(9) Basic and diluted weighted average number of common shares outstanding at
March 31, 1999 were adjusted to reflect the issuance of 27.857 million
shares of Universal American's common stock as if they were issued on
January 1, 1998 and outstanding for the entire year. These shares would be
issued pursuant to the proposed transaction as follows:
$
SHARES AMOUNT
DESCRIPTION --------- -------
Capital Z Issuance........................................ 28,888 $91,000
Transaction fees.......................................... 437 1,375
Series D-1 preferred stock................................ 833 2,250
Series D-2 preferred stock................................ 556 1,750
--------- -------
Total............................................. 30,714 $96,375
========= =======
26
33
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
As of March 31, 1999, the Series C preferred stock was outstanding.
Therefore, the shares that are issuable upon conversion of the Series C
preferred stock were not included in determining the basic weighted
average number of common shares outstanding but were included in the
determination of the diluted weighted average number of common shares
outstanding for the historical Universal American financial statements for
the three months ended March 31, 1999. Thus, to arrive at the amount of
basic weighted average number of common shares outstanding after the
transaction, the 2,176 shares issuable upon conversion of the Series C
preferred stock need to be added to the 30,714 shares issuable pursuant to
the proposed transaction resulting in the adjustment of 32,890.
Adjustments to the unaudited pro forma condensed consolidated balance sheet
to give effect to the purchase of the Penn Union Companies as of December
31, 1998 are summarized as follows:
(10) The financing of this acquisition consists of the following:
Issuance of common stock.............................. $ 96,375
Senior secured term note.............................. 70,000
--------
Total sources of financing.......................... $160,375
========
The uses of the financing consists of the following:
Acquisition of the Penn Union Companies (see Note
12).................................................. $130,500
Refinancing of Universal American's outstanding
loan................................................. 4,500
Capital infusion to Pennsylvania Life................. 15,000
Cash to be held at Universal American's parent company
for corporate purposes from the sale of the Series D
Preferred Stock...................................... 4,000
Expenses incurred in issuance of equity............... 6,125
Expenses incurred on the senior debt financing........ 6,250
--------
Total uses of the financing......................... $160,375
========
In addition to the financing described above, the Series C preferred stock
was converted into the common stock of Universal American in April 1999. As
of March 31, 1999, Universal American had $5,168 of Series C preferred
stock outstanding and $800 of redemption accruals on the Series C preferred
stock. The Series C preferred stock was converted into common stock at a
price of $2.375 per common share (2,176 shares) and the elimination of the
redemption accrual will be reflected in the retained earnings account of
Universal American.
As of March 31, 1999, Universal American had $4,000 of Series D Preferred
Stock outstanding and $63 of redemption accruals on the Series D Preferred
Stock. The Series D Preferred Stock will be converted to 1,389 shares of
common stock at the closing of the transaction. The $4,000 of proceeds from
the issuance of Series D Preferred Stock will be held at the holding
company for corporate purposes.
27
34
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
The components of the pro forma adjustment to total stockholders' equity
are as follows:
Capital Z Issuance of common stock.................... $ 91,000
Transaction fees taken as common stock................ 1,375
--------
Total common stock issued............................. 92,375
Expenses incurred in issuance of equity............... (6,125)
--------
Net proceeds from issuance of common stock............ 86,250
Conversion of Series C and D preferred stock.......... 10,031
Total adjustment to stockholders' equity.............. $ 96,281
========
(11) The purchase price for the Penn Union Companies is $130,500 in cash. In
addition, an affiliate of PFG that is not being purchased by Universal
American or American Exchange will receive a $6,500 dividend from Union
Bankers immediately prior to the closing. Cash is reduced by $6,500 in the
purchase accounting adjustments in the pro forma balance sheet to reflect
the payment of this dividend immediately prior to the closing. The
following table reflects the adjustments made to the acquired business
equity of the Penn Union Companies:
Net asset value acquired.................................... $336,380
--------
Increase (decrease) in the Penn Union net asset value to
reflect estimated fair value:
Elimination of the affiliated surplus notes (Note 11a).... 98,500
Elimination of the historical deferred policy acquisition
costs.................................................. (116,620)
Elimination of the historical present value of future
profits................................................ (80,729)
Elimination of the historical goodwill.................... (95,697)
Elimination of the deferred tax liability related to the
historical adjustments................................. 69,129
Elimination of effect of the Peninsular reinsurance
transactions described in note 1a (Note 11b)........... (6,352)
--------
Total estimated fair value adjustments.............. (131,769)
--------
Estimated fair value of net assets acquired................. 204,611
Purchase price (cash)....................................... 130,500
--------
Excess of estimated fair value of net assets acquired over
purchase price (negative goodwill)(see Note 12)........... $ 74,111
========
- -------------------------
(a) The surplus notes at Constitution principally supported the acquisition
of Southwestern Life Insurance Company ("Southwestern Life"), an
insurer not acquired in this transaction. The business of Southwestern
Life provided Constitution with the primary means of servicing these
obligations. The principal balance of the surplus notes must be re-paid
in connection with the sale of Southwestern Life to Constitution's
parent Southwestern Financial Corporation as a condition precedent to
the closing of the Penn Union Companies acquisition.
This surplus component will no longer be needed to support the
ownership of Southwestern Life by Constitution. The statutory capital
restructuring and related capital infusions that will occur prior or
simultaneous to closing are designed to place each of the companies at
or above 300% of the authorized control level risk based capital. This
planned level of capital is sufficient to support the intended
operations of each of the insurers as presented in requisite financial
plans delivered to each regulatory required to approve all facets of
the purchase of the Penn Union Companies.
28
35
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(b)The following table highlights the affect of the Peninsular reinsurance
transaction described in Note 1.
MARCH 31, 1999
-------------------------------------------
REINSURANCE
OF THE REINSURANCE
UNREINSURED PRO FORMA
MEDICARE ADJUSTMENTS
SUPPLEMENT RELATING TO
PENINSULAR BUSINESS OF TRANSFER OF
REINSURANCE UNION BANKERS CERTAIN LINES
----------- ------------- -------------
Assets:
Total Investments.............................. $(65,581) -- (65,581)
Cash........................................... -- -- --
Deferred policy acquisition costs.............. (485) -- (485)
Goodwill....................................... -- -- --
Present value of future profits................ (5,094) -- (5,094)
Other assets................................... -- -- --
-------- ------- --------
Total assets................................... $(71,160) -- (71,160)
======== ======= ========
Liabilities, Series C and D Preferred
Stock and Stockholders' Equity:
Reserve for future policy
benefits.................................... $(61,387) -- (61,387)
Loan payable................................... -- -- --
Senior secured note payable.................... -- -- --
Dividend from Union Bankers.................... -- -- --
Deferred income tax (asset) liability.......... (3,421) -- (3,421)
Negative goodwill.............................. -- -- --
Other liabilities.............................. -- -- --
-------- ------- --------
Total liabilities.............................. (64,808) -- (64,808)
-------- ------- --------
Series C and D preferred stock (including
redemption accrual thereon).................... -- -- --
-------- ------- --------
Total stockholders' equity....................... (6,352) -- (6,352)
-------- ------- --------
Total liabilities, Series C and D preferred stock
and stockholders' equity....................... $(71,160) -- (71,160)
======== ======= ========
(12) The pro forma information presents a preliminary allocation of the purchase
price that will be finalized when the purchase accounting work is
completed. It is not possible to fully estimate the reserves for future
policy benefits and certain components of claims reserves as the
assumptions have not been unlocked and analyzed for current circumstances
(e.g., current interest rates) and experience (e.g., current morbidity and
termination experience). Such assumptions cannot be determined with
certainty
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36
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
until the acquisition of the Penn Union Companies has been consummated.
SFAS No. 38 allows a period of one year to complete the purchase accounting
allocations for business combinations. Management believes it will complete
this recalculation of reserves within that period of time. Management has
provided its best estimate of what the likely fair values of assets and
liabilities for the purpose of these pro forma financial statements;
management cannot predict the potential adjustments resulting from actual
final purchase assumptions which could result in differences from these pro
forma estimates. It is reasonably likely that the reserve amounts will
increase, which difference could be material and impact future results of
operations. For example, an increase in the final reserve amount would
decrease negative goodwill and the positive effects of its amortization on
future results of operations.
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THE CAPITAL Z ISSUANCE AND THE
ACQUISITION OF THE PENN UNION COMPANIES
Some statements in this proxy statement are forward-looking and are
identified by the use of forward-looking words or phrases such as "intended,"
"will be positioned," "expects," is or are "expected," "anticipates," and
"anticipated." These forward-looking statements are based on Universal
American's current expectations. To the extent any of the information contained
in this proxy statement is a "forward-looking statement" as defined in Section
27A(i)(1) of the Securities Act of 1933, the considerations set forth below are
cautionary statements identifying important factors that could cause results to
differ materially from those in the forward-looking statement. Realization of
management's beliefs and projections will depend on a number of factors,
including management's successful execution of its business plan for integrating
the Penn Union Companies into Universal American; the insurance market's
reception to the acquisition; Universal American's success in obtaining,
retaining and selling additional services to clients; the pricing of products
and services; overall economic trends, including interest rate trends; impact of
the Year 2000; stock market activity; employment levels; changes in technology;
changes in insurance laws and regulations; and other factors beyond Universal
American's control.
BACKGROUND
On February 18, 1998, PFG announced that it had engaged Salomon Smith
Barney and Fox-Pitt Kelton Inc. to review strategic alternatives for maximizing
value for shareholders of PFG, including the sale of the Penn Union Companies.
In the spring of 1998, management of PFG and Salomon Smith Barney approached
Capital Z to discuss a possible acquisition of the Penn Union Companies by
Capital Z. On May 29, 1998, Capital Z and PFG executed a confidentiality
agreement to facilitate the sharing of confidential information for the purpose
of evaluating a potential acquisition.
On March 26, 1998, CSI approached Universal American and suggested that
Universal American consider bidding for the Penn Union Companies. CSI indicated
that it would help raise the equity and debt financing necessary for any
acquisition. On May 29, 1998, Universal American engaged CSI as a financial
advisor in connection with the possible acquisition of the Penn Union Companies.
The terms of CSI's engagement were later revised. In May of 1998, Universal
American and PFG executed a confidentiality agreement to facilitate the sharing
of confidential information for the purpose of evaluating a potential
acquisition.
Universal American began limited due diligence on the Penn Union Companies
after receiving informational materials from Salomon Smith Barney in June 1998.
Thereafter, Universal American, through CSI, held a series of meetings with PFG
executives to discuss the possibility of working with members of a
management-led buyout group. These discussions terminated in June 1998.
While Capital Z and Universal American were each independently engaging in
discussions about the possibility of acquiring the Penn Union Companies, in July
of 1998, CSI, some affiliates of which have a variety of business relationships
with Capital Z, introduced management of Universal American to Capital Z.
Capital Z and Universal American then began discussions about the
possibility of working together to acquire the Penn Union Companies. On August
13, 1998, Richard Barasch informed the board of Universal American that
Universal American had begun to consider a transaction with Capital Z to
purchase the Penn Union Companies.
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38
On August 21, 1998, Capital Z and PFG executed a non-binding indication of
interest setting forth the preliminary proposed terms of a possible acquisition
by Capital Z of the Penn Union Companies. The indication of interest included an
exclusivity agreement in which PFG agreed that for 45 days it would not
entertain offers from any other person to purchase the Penn Union Companies.
This exclusivity period was eventually extended to December 21, 1998. The
indication of interest also stated that Capital Z was considering including
Universal American in the transaction to acquire the Penn Union Companies.
On September 14, 1998, an initial draft of the acquisition agreement was
delivered to Capital Z and its legal advisors, and Capital Z and PFG began to
negotiate the terms of the definitive agreement in connection with the potential
acquisition, including the purchase price, which PFG and Capital Z agreed would
be in the form of cash and debt securities. Universal American and its advisors
later joined in the negotiations of the terms of the acquisition agreement and
Universal American intensified its due diligence.
During the following weeks, representatives of the parties, through
face-to-face meetings and telephonic conference calls, discussed various issues
raised by the draft acquisition agreement and related documentation. On October
29, 1998 and November 9, 1998, the board of directors of Universal American met
to discuss the potential transactions and authorized management to continue to
proceed with discussions on the proposed acquisition and the Capital Z Issuance.
In November 1998, representatives of Capital Z and Universal American and
their legal advisors began negotiations of the terms of the agreements relating
to the Capital Z Issuance. Through face-to-face meetings and telephonic
conference calls, representatives of Capital Z and Universal American and their
respective legal advisors discussed various issues raised by the draft share
purchase agreement and related documentation, including the per share purchase
price and, in particular, indemnification issues related to the acquisition of
the Penn Union Companies. Negotiations of the acquisition agreement and the
share purchase agreement continued until December 31, 1998, at which time both
agreements were executed.
During the period when the acquisition agreement and the share purchase
agreement were being negotiated, the board of directors of Universal American
held meetings to discuss the potential acquisition of the Penn Union Companies
and the potential investment by Capital Z. At a meeting held on December 8,
1998, CSI and one of Universal American's legal advisors, Simpson Thacher &
Bartlett, made presentations to the board about the acquisition and the
investment. On December 8, 1998, Universal American hired Advest to analyze the
transaction and provide a fairness opinion as to both the acquisition and the
Capital Z Issuance. Over several weeks the board of directors, in consultation
with CSI and subsequently Advest, analyzed the proposed acquisition and the
effect on Universal American of the Capital Z Issuance, the senior debt
financing and the issuance of the subordinated notes. At a meeting held on
December 17, 1998, the terms of the acquisition agreement and the share purchase
agreement were described in detail to the board. At a meeting held on December
23, 1998, the board approved, subject to the receipt of a favorable fairness
opinion of Advest by a designated committee of the board, the execution and
delivery of the share purchase agreement and the acquisition agreement. For a
discussion of the reasons for the board's decision to approve the transactions
contemplated by the acquisition agreement and the share purchase agreement and
the factors considered by the board, see "-- Reasons for the Acquisition and the
Capital Z Issuance" on page 39. At a meeting held on December 24, 1998, a
designated committee of the board met to discuss Advest's fairness opinion. At
that time, the committee accepted Advest's affirmative
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39
opinion that (i) the purchase price Universal American agreed to pay to purchase
the Penn Union Companies and (ii) the controlling-interest investment in
Universal American by Capital Z, together with the additional investment by AAM
and some agents and members of the management of the Penn Union Companies, both
individually and in the aggregate, are fair from a financial point of view to
Universal American and its shareholders. The Advest opinion was subsequently
delivered to the full board. Advest subsequently updated its opinion to provide
that as of the date of this proxy statement, these transactions, as reflected in
the amended and restated acquisition agreement and share purchase agreement,
individually and in the aggregate, are fair from a financial point of view, to
Universal American and its shareholders.
After the acquisition agreement and the share purchase agreement were
executed on December 31, 1998, Universal American publicly announced the planned
acquisition of the Penn Union Companies and the Capital Z Issuance on January 4,
1999. The low sales prices for shares of Universal American common stock on the
trading day immediately preceding this public announcement, December 31, 1998,
was 2 5/8. The high trading price on December 31, 1998 was 2 13/16. The closing
price was 2 5/8.
Under the terms of the acquisition agreement initially approved by the
board, Universal American agreed to pay $175 million to purchase the Penn Union
Companies, consisting of $136 million in cash and $39 million in the form of a
subordinated note issued to PFG.
Universal American believes it was able to negotiate a purchase price lower
than the fair value of the net tangible assets of the Penn Union Companies for
the following reasons:
- PFG had previously announced that it would be in default on certain terms
of its senior debt if it failed, by December 31, 1998, to close one or
more transactions or enter into one or more definitive agreements which
would result in debt reduction of at least $100 million. Therefore, PFG
was under time pressure to make its best deal with a buyer who had the
financial ability to close the transaction;
- PFG offered to sell the Penn Union Companies to a number of potential
buyers through an orderly process conducted by its investment advisor.
Universal American, along with Capital Z, was one of only two buyers to
make an offer, and Universal American has a history of successfully
completing acquisitions in the insurance industry;
- In response to a state insurance regulatory examination, Pennsylvania
Life increased reserves which had the effect of reducing its regulatory
capital and surplus. Further reserve adjustments could have required
certain actions (including limitations on writing new business due to RBC
trends) to be taken by the Pennsylvania Department of Insurance and PFG
was under pressure to address the adequacy of Pennsylvania Life's
regulatory capital and surplus; and
- The Pennsylvania Life distribution force had been deteriorating in the
previous three years. There existed, and still exists, uncertainty as to
whether this distribution system can be revitalized. In the event the
distribution force cannot be revitalized and the field force does not
adequately service the in force business, it is possible that lapse rates
will increase in excess of what has been anticipated.
Subsequent to the execution of the original acquisition agreement on
December 31, 1998, the parties amended the acquisition agreement to reflect,
among other things, the addition of American Exchange as a party, and a
reduction in the purchase price to $130.5 million in cash. In addition,
immediately prior to the closing Union Bankers will pay a $6.5 million cash
dividend to an affiliate of PFG that is not being purchased by Universal
American or American Exchange. The revised acquisition agreement was approved by
each of Universal American's and PFG's board of directors and by PFG's senior
lenders.
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40
The agreement to reduce the purchase price resulted from Universal American
and Capital Z's concern about Pennsylvania Life's reserve levels, which had
developed during their initial diligence review. The original acquisition
agreement contained certain provisions intended to protect Universal American
against deficiencies in those reserves. Pursuant to the terms of the original
agreement, PFG was required to provide Universal American with a complete
review, performed by a qualified independent actuary, of the adequacy of all
reserves of Pennsylvania Life, excluding life insurance reserves, based upon
statutory accounting principles. Upon receipt, Universal American then had a
period of time during which to review and approve or disapprove of the report.
After the initial execution of the acquisition agreement, the seller
submitted to Universal American a report from a nationally recognized actuarial
firm covering the claims portion of the disability reserves, the largest and
most sensitive portion of the reserves in question. This report indicated a
deficiency, based on statutory accounting, of $20.8 million, over and above the
additional reserves posted by Pennsylvania Life as of December 31, 1998. This
included a deficiency of $17.1 million in the claims reserve and a deficiency of
$3.7 million in the reserve for loss adjustment expenses. In addition, based
upon the review of the report conducted by Universal American and its advisors,
it was determined that an additional reserve deficiency of up to $3.5 million
might develop under Pennsylvania Life's current reserving methodology over the
next 18-24 months. The study of the disability income claims reserves for
Pennsylvania Life was principally a review based on SAP. The remaining
deficiency discussed in this proxy statement and in the combined financial
statements is a SAP financial statement accounting issue and does not affect the
GAAP results of the Penn Union Companies. SAP requires insurers to hold certain
reserves on a basis prescribed by regulatory authorities with assumptions based
on statutorily mandated interest rates, morbidity and termination rates. GAAP
principles require the recognition of estimated actual experience. SFAS No. 60,
paragraphs 18-21, discuss estimating ultimate claim costs using past experience
adjusted for current trends. Disability income claims are especially sensitive
to mortality and termination rates. SFAS No. 60 defines such assumptions as
estimates of the expected experience. Thus, SAP and GAAP form two different
basis of accounting and, with respect to claims reserves, statutory mandated
assumptions often result in higher SAP claim reserves.
On April 16, 1999, representatives of Universal American and PFG met to
discuss these reserve deficiencies. While PFG agreed that some reduction of the
purchase price was warranted, PFG did not agree with all of Universal American's
findings. Therefore, Universal American, Capital Z and PFG entered into
negotiations to determine:
- the extent of the purchase price reduction based on the reserves report
and other findings,
- the manner in which the reduction would be taken, and
- revision of other terms.
The principal amendments to the acquisition agreement, other than the
reduction of the purchase price by $44.5 million, include:
- permitting Union Bankers, immediately prior to the closing, to pay a $6.5
million cash dividend to an affiliate of PFG that is not being purchased
by Universal American or American Exchange;
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- eliminating any representation by PFG or its affiliates as to the
adequacy of the reserves of the Penn Union Companies;
- excluding from the Pennsylvania Life target capital amount the surplus
from a note with a principal amount of $6.4 million issued by PennCorp
Financial, Inc. in favor of Pennsylvania Life and that note will remain
payable to Pennsylvania Life;
- eliminating the closing condition relating to the sale of a certain block
of business in Union Bankers;
- eliminating a purchase price adjustment based on the adequacy of reserves
which was going to take place five years after the closing of the
acquisition;
- eliminating a review of PFG's unaudited financial statements for the
period ended September 30, 1998;
- adding two additional automatic thirty-day extensions to the closing
date, which extends the ultimate closing date to July 31, 1999; and
- adding American Exchange as a party to the acquisition agreement.
The modifications to the acquisition agreement that were finally agreed to
were a result of a series of compromises on all of the issues. Most of the
discussion at the negotiations centered on the form of consideration, including
the subordinated note payable by Universal American to PFG under the original
agreement, in light of PennCorp's need to raise as much cash as possible from
this transaction to pay down bank debt.
Universal American was able to reduce the purchase price by $44.5 million
in part, by allowing Union Bankers to pay a $6.5 million cash dividend to an
affiliate of PFG that is not being purchased by Universal American or American
Exchange immediately prior to the closing. In addition, Universal American will
keep an additional asset in Pennsylvania Life, a note payable by PennCorp
Financial, Inc., worth approximately $6.4 million. Finally, under the original
acquisition agreement, if there were more reserves than necessary reflected in a
report to be prepared five years after closing, PFG could recoup the amount of
this redundancy by increasing the amount payable by Universal American to PFG
under the subordinated note. By eliminating the subordinated note payable by
Universal American, Universal American does not have any recourse to PFG for any
reserve deficiency.
As part of negotiating these amendments, Universal American agreed to:
- take on additional reserve liability of up to $24 million. Universal
American will cause the necessary reserves to be posted as of the
closing;
- retain in Union Bankers a block of business that PFG had originally
agreed to assume, with possible negative results for 2-4 years amounting
to $5-7 million pre-tax in the aggregate;
- give up its right to seek indemnification from PFG for reserve
deficiencies; and
- pay $1 million of additional cash to PFG.
There were three primary reasons why Universal American was able to
negotiate a reduction in the purchase price which is greater than the claimed
liability:
- All of the purchase price reduction comes from the subordinated note. The
subordinated note would have had uncertain value to PFG, and would have
created an uncertain liability for Universal American, due to
contingencies contained in the note;
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- Universal American gave up certain rights to seek indemnification from
PFG in the event of reserve deficiencies; and
- Universal American agreed to take on a block of business that has an
uncertain negative value.
Universal American was willing to give up its right to seek indemnification
from PFG for a reserve deficiency because the extensive review conducted by a
nationally recognized actuarial firm and its actuaries and accountants led
Universal American to conclude that Pennsylvania Life would be adequately
reserved once the additional $24 million of reserves are posted as of the
closing. Universal American also believes it is being adequately compensated by
the reduction of the purchase price.
A potential negative consequence of the proposed amendments to the
acquisition agreement is that the reserves may be deficient in excess of
Universal American's estimates, and there will be no further recourse to PFG for
reserve inadequacy.
In separate discussions, Universal American and Capital Z renegotiated some
of the terms of the share purchase agreement. In addition to providing for two
more automatic extension dates, which would extend the deadline for closing to
July 31, 1999, the two parties agreed that the maximum amount of Capital Z's
investment in Universal American would be increased from a maximum of $82
million to a maximum of $91 million. In addition, one of the amendments to the
share purchase agreement provides that some holders of preemptive rights to
purchase Universal American common stock will be able to exercise those rights
simultaneously with Capital Z's purchase of shares at the same price to be paid
by Capital Z in the Capital Z Issuance. The amendments also provide that the
number of shares to be purchased by Capital Z in the Capital Z Issuance will be
reduced by the number of shares purchased by the holders of preemptive rights.
Universal American's board of directors has approved these amendments
conditioned upon approval of the amendments to the acquisition agreement and
that agreement's execution. The amendments to the share purchase agreement were
executed simultaneously with the amended and restated acquisition agreement.
Prior to approval of the amendments to the share purchase agreement and the
acquisition agreement, the board received a fairness opinion of Advest stating
that the terms and effects of the Capital Z investment and the acquisition, both
individually and in the aggregate, are fair, from a financial point of view, to
Universal American and its shareholders.
UNIVERSAL AMERICAN FINANCIAL CORP.
Universal American was incorporated in New York in 1981. Universal American
is a life and accident and health insurance holding company, whose principal
subsidiaries are American Pioneer Life Insurance Company ("American Pioneer"),
American Progressive Life and Health Insurance Company of New York ("American
Progressive"), American Exchange and WorldNet Services Corp. ("WorldNet"), a
third party administrator that provides communication, managed care and claims
adjudication services to its subsidiaries and non-affiliated insurance companies
and affinity groups. American Pioneer, American Progressive and American
Exchange are referred to in this proxy statement as the "Insurance
Subsidiaries." Through its insurance subsidiaries, Universal American markets
and underwrites accident and health insurance products aimed at the senior
market, including Medicare supplement, long-term care and home health care.
Universal American also underwrites life insurance and annuities. For additional
information about American
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Exchange, see "Universal American Financial Corp. Management's Discussion and
Analysis and Results of Operations."
CAPITAL Z FINANCIAL SERVICES FUND II, L.P.
Capital Z is a $1.8 billion fund that was formed to make investments in
securities of a diversified global portfolio of insurance, financial services
and healthcare services companies and other related businesses. Capital Z
focuses primarily on opportunities within the United States and Western Europe
and, to a lesser extent, the emerging markets of Asia, Latin America and Eastern
Europe.
Capital Z is managed by Capital Z Partners, L.P., a global alternative
asset investment management firm headquartered in New York with offices or
affiliates in London and Hong Kong. The investment professionals of Capital Z
Partners, L.P. were formerly with three organizations: International Insurance
Investors, L.P., Insurance Partners, L.P. and Zurich Centre Investments, Inc.
Between 1990 and 1997, these three organizations have invested in such companies
as: National Reinsurance Corporation, Superior National Insurance Group, Inc.,
Provident Companies, Inc., Kemper Corporation, Transport Holdings, Inc., USI
Insurance Services Corp., and CAT Limited, as well as many others.
THE PENN UNION COMPANIES
PFG, incorporated in Delaware in 1989, is a holding company. The principal
subsidiaries of PFG are insurance companies. During 1997, PFG restructured its
operating units into three primary business units: the Penn Union Companies, the
Payroll Sales Division, and the Financial Services Division.
The Penn Union Companies include the operations of Pennsylvania Life,
Penncorp Life Insurance Company, a Canadian company ("Penncorp Life"),
Peninsular, Union Bankers, Constitution Life Insurance Company ("Constitution"),
Marquette National Life Insurance Company ("Marquette"), PennCorp Financial,
Inc. and selected assets of PennCorp Financial Services, Inc. Pennsylvania Life,
Penncorp Life and Peninsular are referred to in this proxy statement as the
"PennLife Companies." Union Bankers, Constitution and Marquette are referred to
as the "ConLife Companies." The principal executive offices of the Penn Union
Companies are located at 2610 Wycliff Road, Raleigh, NC 27607.
The Penn Union Companies, through a distribution system of career agents
and a network of producers, market fixed benefit accident and health insurance
policies and life insurance and asset accumulation products. Following is a
description of the types of agents, the numbers of producers and the revenue
derived from these producers. Revenues in this case are best measured by the
amount of annualized new business premiums derived from production sources.
CAREER AGENTS. The Pennsylvania Life and Penncorp Life sales force is a
network of regional managers that operate branch offices throughout the United
States and Canada. Each branch office includes career agents that focus only on
sales for Pennsylvania Life and
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Penncorp Life. Following are the number of active agents and submitted
annualized new business premium for 1998:
SUBMITTED
ACTIVE ANNUALIZED
CAREER NEW BUSINESS
AGENTS PREMIUM
------------- --------------------
Pennsylvania Life............................ 931 2$3,826,000
Penncorp Life (US$).......................... 459 1$2,794,000
NETWORK OF PRODUCERS. Union Bankers and Constitution contract with
brokerage agents. Unlike career agents, brokerage agents normally represent many
different insurance companies. During 1998 there were 2,902 brokerage agents
under contract that produced submitted annualized new business premium of
$13,856,000. Because of the de-emphasis on this business and the curtailment of
certain products, most of this premium was produced during the first half of
1998. Union Bankers and Constitution primarily sell senior-related supplemental
health products such as major medical, Medicare supplement, long term care and
home health care through a network of managing general agents. The de-emphasis
was a result of assessment by management of the Penn Union Companies that the
product lines sold by the agents were not meeting required rates of return. New
senior market accident and health products were developed in Constitution,
which, Universal American believes, will provide adequate return and be
attractive to the network of producers.
The Penn Union Companies have entered into a marketing services agreement
with Ameri-Life and Health Services. Universal American intends to work closely
with Ameri-Life to reactivate the agents of Union Bankers and Constitution, to
reinstitute products and to increase sales.
FINANCING OF THE ACQUISITION OF THE PENN UNION COMPANIES
Universal American and American Exchange will acquire the Penn Union
Companies for total consideration equal to $130.5 million in cash. In addition,
immediately prior to the closing an affiliate of PFG that is not being purchased
by Universal American or American Exchange will receive $6.5 million in the form
of a cash dividend paid by Union Bankers. The purchase price was determined as a
result of an arms-length negotiation with PFG after Universal American, Capital
Z and their respective legal, accounting and actuarial advisors conducted
extensive due diligence on the Penn Union Companies, and after Universal
American and Capital Z continued to analyze Pennsylvania Life's statutory
reserves subsequent to the execution of the acquisition agreement on December
31, 1998. In determining this aggregate purchase price Universal American, along
with Capital Z, took into account the following factors:
- Capital base of the Penn Union Companies;
- Present value of future profits of the business of the Penn Union
Companies;
- Quality of the field force;
- Recent financial performance of PFG and the Penn Union Companies; and
- Anticipated rate of return on investment.
Capital Z Issuance. If completed, the Capital Z Issuance will provide an
aggregate amount up to approximately $91 million to Universal American, a
portion of which will be
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contributed to American Exchange, to finance a portion of the acquisition price
of the Penn Union Companies.
Senior Debt Financing. Universal American intends to incur senior debt
financing with estimated proceeds of approximately $80 million, $70 million in
the form of a term loan and $10 million in the form of a revolving credit
facility. The interest rate, due date, and other terms of the senior debt
financing have been determined in arm's length negotiations between Universal
American and Chase Bank and CSI, as agents to the lenders under the credit
facility.
Sources and Uses of Funds. The sources and uses of funds in the acquisition
are summarized as follows:
SOURCES OF FUNDS:
Equity investment.................................... $96.375 million
Term loan............................................ 70.000 million
------------------
Total.............................................. $166.375 million
==================
USES OF FUNDS:
Acquisition of the Penn Union Companies.............. $130.500 million
Refinancing existing debt............................ 4.500 million
Capital infusion to Pennsylvania Life................ 15.000 million
Cash to be held at Universal American's parent
company for corporate purposes..................... 4.000 million
Expenses incurred in equity issuance................. 6.125 million
Expenses incurred in the senior debt financing....... 6.250 million
------------------
Total.............................................. $166.375 million
==================
REASONS FOR THE ACQUISITION AND THE CAPITAL Z ISSUANCE
After considering all the benefits and potential risks of the proposed
transactions, the board of directors approved the acquisition and the Capital Z
Issuance, reflecting its belief that the various risks and mitigating factors it
considered were outweighed by the substantial benefits it expected Universal
American to receive from these transactions.
Benefits from the Acquisition:
- Universal American will be able to diversify its products and increase
geographic distribution. Universal American and the Penn Union Companies
currently do not compete in any material way. Most of the Penn Union
Companies' current production comes from the sale of disability
income-type products. Universal American does not currently offer these
specific products. Universal American and the Penn Union Companies have
some similar products, including Medicare Supplement and Long Term Care,
but there is limited geographical overlap. Universal American operates
primarily in New York and Florida, where Penn Union has little or no
penetration. Universal American has a growing presence in Texas, where
Pennsylvania Life also has some production, but the products currently
sold in that state are not competitive with each other.
- Universal American will have the opportunity to market senior-related
insurance products to the policyholder base of the Penn Union Companies
through the career sales force of the Penn Union Companies.
- Universal American will benefit from economies of scale over a period of
years, potentially realizing cost savings as a result. Universal American
will have the
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opportunity to improve the financial performance of the Penn Union
Companies through a lower corporate cost structure and the introduction
of new products. Premiums collected and administered by Universal
American increased from $65.0 million in 1996 to $132 million in 1998,
largely as a result of the acquisition of four companies and blocks of
business. In that same period of time, the ratio of expenses to premiums
collected, which Universal American's management believes is the best
measure of economies of scale, has decreased from 17.8% in 1996 to 11.5%
in 1998. The Penn Union companies currently have an expense ratio in
excess of 25%. Management believes that elimination of PFG's corporate
overhead charges alone will reduce the expense ratio to less than 20%. In
addition, management believes that it can also reduce the expense ratio
of the Penn Union Companies by increasing the operating efficiency of the
Penn Union Companies. After the closing of the acquisition there will be
an opportunity to achieve further reductions in the expense ratio by
consolidating certain functions, such as information systems, finance,
actuarial, compliance and executive functions. In its prior transactions,
management believes Universal American has demonstrated an ability to
reduce costs and effect expense savings.
Benefits from the Capital Z Issuance:
- Universal American wanted to finance a substantial portion of the
acquisition through the issuance of equity, as opposed to additional debt
financing, to allow Universal American to maintain a more conservative
debt-to-equity ratio and satisfy rating agency considerations. Universal
American did not consider an all-debt acquisition structure.
- The per share consideration to be received by Universal American for its
common stock will be at a premium to the average daily market closing
price for 1998. The high and low prices during each month and the closing
price as of the last day of each month of Universal American common stock
during the period it was evaluating and negotiating the acquisition of
the Penn Union Companies are as follows:
MONTH HIGH LOW CLOSE
- ----- ---- --- -----
April............................................. 2 3/4 2 3/8 2 9/16
May............................................... 2 15/16 2 3/8 2 9/16
June.............................................. 2 3/4 2 5/16 2 3/8
July.............................................. 2 3/4 2 3/8 2 3/4
August............................................ 2 3/4 2 3/16 2 3/8
September......................................... 2 7/8 2 1/2 2 13/16
October........................................... 2 13/16 2 2 5/8
November.......................................... 2 3/4 2 9/32 2 1/2
December.......................................... 2 7/8 2 3/16 2 5/8
The closing price on December 31, 1998, the most recent date prior to the
announcement of the acquisition of the Penn Union Companies, was $2.625.
- Universal American will benefit from a higher profile in the insurance
industry as a result of its relationship with Capital Z.
- The relationship with Capital Z may provide opportunities for additional
acquisitions and continued growth, greater access to capital markets and
enhanced shareholder value.
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Before approving the acquisition and the Capital Z Issuance, the board of
directors also considered a number of mitigating factors that could prevent
Universal American from realizing these benefits and could possibly materially
and adversely affect Universal American's financial condition and results of
operation, including that:
- Universal American may not be successful in coordinating and integrating
the operations and business enterprises of Universal American and the
Penn Union Companies and, consequently, Universal American may not
realize the expected benefits of the acquisition. Despite this inherent
risk, Universal American does not anticipate any unusual problems in
coordinating and integrating the operations of the Penn Union Companies
with its own. The Raleigh and Toronto locations of the Penn Union
Companies are fully functional units that will continue to operate while
Universal American implements plans to consolidate functions.
- Universal American will have to service a greater amount of debt after
the acquisition which will require dividend payments from its insurance
subsidiaries and the ability of its subsidiaries to make such dividend
payments is subject to certain legal restrictions; and greater leverage
presents a greater degree of financial risk and the failure of Universal
American to meet its debt obligations would likely have a significant
adverse financial impact on Universal American.
- The primary strategic reason for the acquisition is to add a new
distribution channel to Universal American -- namely, the career agency
system of Pennsylvania Life. This career agency system, which will
continue to write its business with Pennsylvania Life, will operate
independently from the general agency system that will continue to write
business through the other subsidiaries of Universal American. The
addition of this new channel is expected to have no effect on the
compensation or operations of the general agency system. However, the
change in Universal American's operating strategy caused by the
utilization of the career sales force of the Penn Union Companies may not
be successful.
- The anticipated long-term economies of scale may fail to materialize,
adversely affecting Universal American's cash flow and earnings before
taxes.
- The concentration of ownership of Universal American by Capital Z could
delay or prevent an advantageous change in control of Universal American,
or have a depressive effect on the trading market for Universal
American's common stock.
In evaluating the above factors, the board of directors found particularly
important the prospect of increased sales through an enhanced field force and
increased geographic scope. While the board of directors was particularly
sensitive to change of control issues and other risks associated with the
ownership by Capital Z, the board determined that the opportunities for future
acquisitions and continued growth, together with the potential for greater
access to the capital markets and increased shareholder value, sufficiently
mitigated this concern.
The board also gave significant weight to its view that size and financial
strength are critical to success in the insurance industry. On a pro forma
basis, after the acquisition, Universal American would have had net premiums and
policyholder fees earned of $198 million for the year ending December 31, 1998,
and total assets of $1,134 million on a pro forma combined basis as of December
31, 1998. If the acquisition of the Penn Union Companies and the Capital Z
Issuance had been completed on January 1, 1998, pro forma earnings per share of
Universal American for the year ended December 31, 1998 would have been $0.06
per share assuming that all of Universal American's securities that could be
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converted or exercised into common stock had been converted or exercised, which
compares to $0.20 reported by Universal American for the year ended December 31,
1998 or a $0.14 per share decrease. The results of the Penn Union Companies for
the year ended December 31, 1998 included reserve strengthenings which resulted
in a reduction of $21.5 million in net income after tax, or $0.52 per share. See
"Penn Union Companies Management's Discussion and Analysis of Financial
Condition and Results of Operations" on page 122 and "Unaudited Pro Forma
Financial Information -- Universal American Financial Corp. Unaudited Pro Forma
Condensed Consolidated Statement of Operations -- Year Ended December 31, 1998."
Universal American received an opinion dated December 31, 1998 from Advest
that as of the date of the opinion the financial terms and effects of the
Capital Z Issuance, together with an additional investment by AAM, and the
acquisition of the Penn Union Companies by Universal American, both individually
and in the aggregate, are fair, from a financial point of view, to Universal
American and its shareholders. In addition, CSI made a presentation to the board
of Universal American in which it analyzed the Capital Z Issuance and the
acquisition of the Penn Union Companies by Universal American. Both Advest and
CSI received fees for their work and will be reimbursed for their expenses and
indemnified from and against certain liabilities in connection with their
engagements. For a description of the investment by AAM see "Interests of
Persons Involved in the Capital Z Issuance and the Acquisition That May Be
Different From Yours -- Investment by AAM in Universal American." Advest
subsequently delivered its revised opinion, dated May 24, 1999 -- the full text
of which, including the assumptions made, matters considered, and limits on the
reviews undertaken, is attached to the proxy statement as Annex C -- that, as of
the date of the opinion, the terms and effects of the Capital Z investment and
the acquisition, both individually and in the aggregate, are fair from a
financial point of view to Universal American and its shareholders. Advest
subsequently revised its opinion to provide that as of the date of the mailing
of this proxy statement, the terms and effects of the Capital Z investment and
the acquisition as reflected in the amended and restated acquisition agreement
and the amended share purchase agreement, both individually and in the
aggregate, are fair, from a financial point of view, to Universal American and
its shareholders.
Ultimately, after weighing the various risks and concerns against the
expected benefits and after evaluating the information provided by its financial
advisors, including Advest's fairness opinion, the board of directors determined
that completing the acquisition and the Capital Z Issuance are in the best
interests of Universal American and its shareholders.
The Chase Manhattan Corporation and its affiliates, including CSI
(collectively, "Chase"), in the ordinary course of business, have from time to
time provided commercial and investment banking services to Universal American
and to PFG and its subsidiaries, for which Chase received usual and customary
compensation, and in the future may continue to provide commercial and
investment banking services. In the ordinary course of business, Chase may trade
in the debt and equity securities of Universal American and/or PFG and their
subsidiaries for Chase's own accounts and for the accounts of their customers
and, accordingly, may at any time hold a long or short position in such
securities. In addition, CSI advised the board of directors of Universal
American of the following additional relationships among Chase, Universal
American, Capital Z and PFG: (a) Chase owns the second largest limited
partnership interest in Capital Z; (b) Chase is an investor in a fund managed by
AAM, which is a shareholder of Universal American, and a representative of AAM
is a member of the board of directors of Universal American; (c) Universal
American requested that Chase consider arranging financing in connection with
the transactions described in this proxy statement and Chase arranged this
financing and is a lender under the proposed
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senior debt financing; (d) Chase is a minority shareholder in Universal
American; (e) Chase is a minority shareholder of PFG; (f) Chase has made a loan
to PFG, which will be repaid, in part, from the proceeds of the acquisition; (g)
Chase is a lender to Universal American under its current credit facility in an
amount equal to $4.50 million, which amount will be paid in full with a portion
of the proceeds of the proposed transactions; and (h) Chase is a lender to other
companies affiliated with Capital Z.
The foregoing discussion of the information and factors considered by the
board of directors is not intended to be exhaustive, but we believe it includes
the material factors considered by the board. In light of the number and variety
of information and factors the board considered in connection with its
evaluation of the Capital Z Issuance and the acquisition of the Penn Union
Companies, the board did not find it practicable to, and did not, assign any
specific or relative weights to the foregoing factors, and individual directors
may have attached differing weights to different factors. For a discussion of
the interests of certain persons in the transactions, see "Interests of Persons
in the Acquisition Agreement and the Share Purchase Agreement That May Be
Different From Yours." The board recognized such interests and determined that
such interests neither supported nor detracted from its determination that the
Capital Z Issuance and the acquisition of the Penn Union Companies is in the
best interests of Universal American and its shareholders.
CAPITAL Z ISSUANCE
Upon approval of the shareholders of Universal American and the
satisfaction or waiver of the other conditions to the Capital Z Issuance,
Capital Z, some agents and members of management of the Penn Union Companies and
some holders of preemptive rights to purchase common stock will purchase up to
28,888,888 shares of common stock of Universal American for $3.15 per share, for
a total purchase price of up to approximately $91 million. Although, under the
terms of the amended share purchase agreement, the maximum investment by those
agents and members of management and holders of preemptive rights can be an
amount up to $10 million, or 3,174,603 shares of common stock, the investment by
those agents and members of management and holders of preemptive rights to
purchase common stock is expected to equal approximately $5.5 million. The
aggregate investment by Capital Z is expected to be approximately $85.5 million
and the total aggregate equity investment of Capital Z, together with those
agents and members of management and holders of preemptive rights, will be
approximately $91 million. At Capital Z's option, Universal American may also
pay a portion of a transaction fee in shares of common stock to an affiliate of
Capital Z.
The statements made in this proxy statement with respect to the terms of
the Capital Z Issuance and related transactions governed by the share purchase
agreement are qualified in their entirety by reference to the more complete
information set forth in Annex A.
Governmental and Regulatory Approvals. The Capital Z Issuance is subject
to: approval of the insurance regulatory authorities in New York, Florida,
Texas, Pennsylvania and North Carolina; approvals under Canadian federal and
provincial laws; compliance with applicable state and federal securities laws;
approvals from or notices to various states; and the expiration of the waiting
period under the HSR Act. Universal American, Capital Z and the Penn Union
Companies have made all required Form A filings, made presentations to
applicable insurance departments and are providing additional information as
requested. The New York State insurance department has approved the Capital Z
Issuance and the acquisition. The terms of the amended and restated acquisition
agreement and the amended share purchase agreement have been filed with the
various insurance departments.
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Universal American, Capital Z and the Penn Union Companies continue to make all
other regulatory filings as required. Universal American, Capital Z and the Penn
Union Companies expect to receive all required regulatory approvals. Most
required notices have been filed as of the date of this proxy statement and
additional notices will continue to be filed as required. All applicable waiting
periods under the HSR Act have expired. In addition, the shareholders must
approve the Capital Z Issuance and item (a) of Proposal No. 2.
Effect of Capital Z Issuance. Following the Capital Z Issuance and the
conversion into shares of common stock of the Series B preferred stock, the
Series D-1 preferred stock and the Series D-2 preferred stock (collectively the
"Convertible Preferred Stock"), and the payment of a portion of the transaction
fee to an affiliate of Capital Z in common stock, Capital Z and its affiliates
will own in the aggregate approximately 27,579,365 shares, representing
approximately 65.0% of Universal American's then-outstanding common stock. If
all of the securities of Universal American that could be converted or exchanged
into common stock were converted or exchanged, Capital Z and its affiliates
would own approximately 59.5% of the outstanding common stock. After the Capital
Z Issuance, Capital Z, pursuant to a shareholders' agreement, will have the
ability to nominate 4 of Universal American's 9 directors and Universal American
will have the ability to nominate two directors. However, since Capital Z will
own over 50% of Universal American's outstanding stock after the Capital Z
Issuance, it will effectively be able to select 6 of the 9 directors on the
board of Universal American.
MATERIAL TERMS OF THE SHARE PURCHASE AGREEMENT
Per Share Purchase Price Adjustment
There will be a per share purchase price adjustment if Universal American
is subject to an MAE Event before the closing. An "MAE Event" occurs if there is
one or a series of related event(s), condition(s), or circumstance(s) occurring
after the date of signing and before the closing that has had, or is reasonably
likely to have, an adverse impact on the business, results of operations or
financial condition of Universal American and its subsidiaries, taken as a
whole, that would reduce the value of Universal American and its subsidiaries,
taken as a whole, by an amount in excess of $3 million. If an MAE Event causes
the purchase price per share payable by Capital Z to be $2.25 per share or less,
calculated pursuant to a formula specified in the share purchase agreement,
(i.e., if the per share purchase price adjustment would be $0.90 or more),
Capital Z will have the absolute right, but not the obligation, (i) to cause
Universal American to assign to another person all of Universal American's
rights and obligations under the acquisition agreement and (ii) upon such
assignment and assumption, the parties' obligations under the share purchase
agreement, except for specified indemnification obligations, will terminate. If
the substitute buyer consummates the closing, Universal American will not be
liable for, and Capital Z will indemnify Universal American from, liabilities
relating to the acquisition agreement. Universal American's management does not
believe that any MAE event has occurred or is likely to occur before the
closing.
Representations and Warranties of Universal American
Except as otherwise specified or disclosed, Universal American makes
representations and warranties about: (i) the due organization and good standing
of Universal American and its subsidiaries, (ii) Universal American's
capitalization, (iii) the authorization of the share purchase agreement, (iv)
the valid issuance of the common stock to be issued under the share purchase
agreement, (v) pending or threatened litigation, (vi) that the share purchase
agreement does not violate any agreement, law, charter or by-law provision and
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no governmental or third-party consents are required to execute, deliver, and
perform the share purchase agreement, (vii) specified tax matters, (viii) the
accuracy of financial statements and filings with the SEC, (ix) the conduct of
business in the ordinary course and the absence of any material adverse change
in the financial condition, results of operations of Universal American since
December 31, 1997, (x) Universal American's and its subsidiaries' compliance
with the applicable laws, (xi) the existence and identity of brokers and finders
and (xii) potential conflicts of interest.
Representations and Warranties of Capital Z
Capital Z makes representations and warranties about: (i) its organization
and good standing and authorization of the share purchase agreement, (ii) the
share purchase agreement's non-contravention of any agreement, law or charter
provision, except to the extent contravention would not have a materially
adverse impact on Capital Z's ability to consummate the transactions or perform
its obligations, and, except as specified, the ability of Capital Z to execute,
deliver, and perform the share purchase agreement without obtaining any
additional governmental or third-party consents, (iii) the existence and
identity of brokers and finders, (iv) the availability of funds to meet such
entity's obligation to purchase the shares of common stock, and (v) state and
federal securities laws matters.
Material Covenants
The share purchase agreement contains the following material covenants:
Conduct of Business Prior to Closing; Management of Universal
American. During the period from the date of the share purchase agreement to
the closing, except as otherwise contemplated by the share purchase agreement,
by the acquisition agreement, or as Capital Z otherwise agrees in writing in
advance, Universal American has agreed not to:
- except in the ordinary course of business, incur or issue any
indebtedness or assume, guarantee or endorse the obligations of any other
person;
- except in the ordinary course of business, including the managing by
Universal American of its investment assets, (a) sell, transfer or
otherwise dispose of any of its property or assets, (b) mortgage or
encumber any of its property or assets or (c) enter into any material
contracts;
- repurchase any of its capital stock or any capital stock of any of its
subsidiaries;
- declare, set aside or pay any dividend or other distribution on its
capital stock;
- amend its certificate of incorporation or by-laws or merge with or into
or be consolidated with any other person;
- split, combine or reclassify its capital stock;
- other than in connection with ordinary course exercises of outstanding
options or grants under existing stock option plans, issue or sell any of
its equity securities or any options, warrants, conversion or other
rights to purchase any such securities or agree to grant any such rights;
- increase the rates of compensation, including bonuses, payable to any of
its officers, employees, agents, independent contractors or consultants
other than increases made in the ordinary course of business consistent
with past practice;
- enter into or amend existing employment contracts, severance agreements
or consulting contracts; or, other than in the ordinary course of
business, institute any
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increase in benefits or alter its employment practices or the terms and
conditions of employment;
- except as may be required by applicable laws, change in any material way
its underwriting, actuarial or tax or financial accounting methods,
principles or practices;
- enter into, amend or terminate any transaction or contract the result of
which is reasonably likely to have a material adverse effect; or
- enter into any joint ventures or partnerships of any kind.
Proxy Statement/Board of Directors Recommendation. Universal American has
agreed to take actions to cause the due preparation and timely mailing of this
proxy statement to its shareholders.
Further Assurances. Universal American and Capital Z have agreed to use
their reasonable efforts to obtain all necessary waivers, consents and approvals
of all third parties and governmental authorities necessary to complete the
transactions contemplated by the share purchase agreement and all related
agreements. The Capital Z Issuance cannot be effected until (i) the applicable
waiting periods under the HSR Act have terminated and (ii) Form A filings have
been made by each party with the department of each state as required. Universal
American and Capital Z are in the process of making the required filings.
Universal American Actions Relating to the Acquisition
Agreement. Universal American may not amend or terminate the acquisition
agreement without the prior written consent of Capital Z. In addition, Universal
American cannot, without Capital Z's consent, (i) acknowledge fulfillment of or
waive any of the closing conditions in the acquisition agreement or (ii) with
respect to any conditions in the acquisition agreement that require that an
event, action or circumstance occur or be performed to the satisfaction of
Universal American, indicate or acknowledge Universal American's satisfaction to
such occurrence or performance. Capital Z may give or withhold its consent in
its sole discretion.
Indemnification Generally. Universal American and Capital Z have agreed
that if the closing occurs, each will indemnify the other and each of the
other's affiliates and their directors, officers, partners, members, employees,
agents and representatives against all claims, obligations, costs and expenses
arising out of a breach of any representation, warranty, covenant or agreement
by the other party in the share purchase agreement. Neither party is obligated
to make any indemnification payment until the amount of any claim exceeds
$500,000, and then only for the amount in excess of $500,000. Indemnification
for breaches of representations and warranties cannot be in excess of the
purchase price.
Additional Indemnification Obligations for Potential Liabilities to PFG for
Failure to Close Under the Acquisition Agreement. If the acquisition fails to
close other than because the senior debt financing is not available, Universal
American and Capital Z have agreed that:
- Capital Z will indemnify Universal American 100% if Universal American
cannot close under the acquisition agreement because Universal American
is unable to take action because of the failure or refusal by Capital Z
to give consent as described above under the heading "-- Universal
American Actions Relating to the Acquisition Agreement."
- Capital Z will be responsible for 60% and Universal American will be
responsible for 40% of any liabilities under the acquisition agreement
resulting from action as described above under the heading "-- Universal
American Actions Relating to the Acquisition Agreement" taken or not
taken by Universal American upon mutual agreement with Capital Z.
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- Universal American will indemnify Capital Z 100% for liabilities arising
from action taken by Universal American in violation of the provisions
described above under the heading "-- Universal American Actions Relating
to the Acquisition Agreement," including Universal American's failure to
close the acquisition after Capital Z has demanded in writing that
Universal American close the transaction.
If the acquisition fails to close because the senior debt financing is not
available, Universal American and Capital Z have agreed as follows:
- Universal American will indemnify Capital Z 100% for liabilities to PFG
if the senior debt financing is unavailable solely because of (i)
Universal American's failure to satisfy specified fundamental
representations, warranties or covenants, (ii) a breach or violation of a
representation or warranty under the share purchase agreement that
involves or results from intentional false statements or omissions by
Universal American or (iii) a willful breach by Universal American of any
covenant under the share purchase agreement.
- Universal American will be responsible for 6% of its liabilities to PFG
and Capital Z will be responsible for 94% of Universal American's
liabilities to PFG if the senior debt financing is unavailable because of
breaches or violations of any representation, warranty, covenant or
agreement of Universal American under the share purchase agreement other
than those discussed in the previous bullet point or because of breaches
of representations or warranties that did not exist as of the date of the
share purchase agreement but arise before the closing because of events
outside of Universal American's control.
- Capital Z will indemnify Universal American for 100% of the liability if
the senior debt financing is unavailable for any other reason not
specified in the two immediately preceding bullet points.
Required Additional Investment. If Chase Bank and/or the lenders under the
senior debt financing have notified Universal American that the senior debt
financing will not be available to Universal American unless an additional
amount of equity is invested in Universal American, then Capital Z will have the
right, but not the obligation, together with certain other shareholders of
Universal American, to purchase additional shares of common stock in order to
fund the additional equity. If Capital Z and any shareholder of Universal
American, as of the date of the share purchase agreement, opt to purchase
additional shares, the purchase price per share will be (x) if Capital Z and
Universal American prior to the closing agree on the price to be paid for the
additional shares of common stock, the agreed price, and (y) if Capital Z and
Universal American cannot agree on the price to be paid for the additional
shares of common stock, a price per share equal to 60% of the per share purchase
price determined according to the per share purchase price adjustment mechanism
described above under the heading "-- Per Share Purchase Price Adjustment."
Exclusivity. Universal American has agreed that it will not, directly or
indirectly, at any time prior to the closing, solicit, entertain or accept
offers from persons (other than Capital Z) for the investment contemplated by
the share purchase agreement. Universal American has further agreed that during
the term of the share purchase agreement and for two additional years, it will
not consummate any other purchase of the Penn Union Companies or any other
purchase of any of PFG's assets without first consummating the acquisition
contemplated by the acquisition agreement unless (i) the share purchase
agreement is terminated due to a breach by Capital Z, (ii) Universal American
and Capital Z mutually agree not to complete the acquisition, or (iii) Universal
American is unable to complete the
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acquisition because of Capital Z's failure to give its consent to Universal
American to waive or acknowledge the satisfaction of conditions to the closing
of the acquisition agreement.
Conditions to Closing
The share purchase agreement contains the following material conditions:
Conditions to Each Party's Obligations. The parties do not have to
complete the Capital Z Issuance unless the following conditions are met or
waived by Universal American or Capital Z on or before the Closing:
- no United States or state authority or other agency or commission or
federal or state court of competent jurisdiction shall have enacted,
issued, promulgated, enforced or entered any statute, rule, regulation,
injunction or other order, whether temporary, preliminary, or permanent,
which is in effect and has the effect of prohibiting the consummation of
the transactions contemplated by the share purchase agreement or
restricting the operation of the business of Universal American and the
subsidiaries in a manner that would have a material adverse effect on
Universal American;
- any waiting period applicable to the transactions contemplated by the
share purchase agreement, including, without limitation, those applicable
to any HSR filing, any Form A required to be filed, or any further
approval required by any department of insurance of any state or any
other regulatory filing, or any filing in connection with or in
compliance with the provisions of each of the Securities Act of 1933, the
Exchange Act of 1934, and any applicable state securities laws shall have
expired or been terminated;
- the closing provided for in the share purchase agreement shall occur
simultaneously with the closing of the transactions contemplated by the
acquisition agreement; and
- the shareholders of Universal American shall have duly approved at the
special meeting Proposal No. 1 and item (a) of Proposal No. 2 contained
in this proxy statement.
Conditions to Universal American's Obligation. Universal American does not
have to complete the Capital Z Issuance unless the following conditions are met
or waived on by it on or before the closing:
- the accuracy of specified representations and warranties of Capital Z
when given and at the closing and material performance of its obligations
required to be performed under the share purchase agreement;
- the execution of the documents containing the terms of the senior debt
financing; and
- the receipt of all necessary waivers, consents or approvals.
Conditions to Capital Z's Obligation. Capital Z does not have to complete
the Capital Z Issuance unless the following conditions are met or waived by it
on or before the closing:
- Universal American will not have violated specified covenants including
those relating to incurrence of debt, repurchase of stock, payment of
dividends, amendment to its certificate of incorporation or by-laws,
stock issuance or sale of equity securities, Capital Z's exclusivity,
amendment or termination of the share purchase agreement, or other
actions relating to the acquisition agreement;
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- Universal American's representations and warranties, relating to
corporate organization, its subsidiaries, capital stock, newly issued
shares, and authority shall be true and correct as of the closing;
- Universal American will have obtained all necessary waivers or consents
to, approvals of, and notices or filings have been made with respect to
the transactions contemplated by the share purchase agreement;
- neither Universal American nor its designated principal executive
officers shall have committed criminal fraud or otherwise engaged in
felonious, criminal conduct with respect to, or in the operation of, the
business or the affairs of Universal American or any of its subsidiaries;
and
- all of the closing conditions for Universal American and PFG under the
acquisition agreement shall have been satisfied or waived.
Termination/Amendment
The share purchase agreement may be terminated:
- by either party simultaneously with, or at any time following, the
termination of the acquisition agreement;
- by Universal American, on the one hand, or Capital Z, on the other hand,
upon notice to the other, five business days after the failure of the
shareholders of Universal American to approve Proposal No. 1 or item (a)
of Proposal No. 2;
- by either party if the transactions contemplated in the acquisition
agreement fail to close by March 31, 1999, subject to four 30-day
extensions under some circumstances;
- by either party at any time on or after July 31, 1999; or
- upon substitution of a new buyer in place of Universal American as
described above under the heading "-- Per Share Purchase Price
Adjustment."
Survival
The representations and warranties set forth in the share purchase
agreement will survive the closing for 18 months. However, (i) the
representations and warranties relating to corporate organization, subsidiaries,
capital stock, newly issued shares, and authority will survive without
limitation and (ii) the representations and warranties relating to taxes and
employee benefit plans will survive until 30 days after the date upon which all
relevant claims are barred by all applicable statutes of limitation.
Costs/Expenses/Transaction Fee
If the transactions contemplated by the share purchase agreement are
consummated, Universal American will pay all costs and expenses incurred by
Capital Z, including any sales or transfer taxes. If the transactions
contemplated in the share purchase agreement are not consummated because the
senior debt financing is unavailable under circumstances that obligate Universal
American to indemnify Capital Z 100% for amounts owed to PFG, then Universal
American will pay all of the costs and expenses of Capital Z.
Upon consummation of the purchase of the shares, Universal American will
pay a transaction fee of $5 million to Capital Z Management, Inc., an affiliate
of Capital Z. Of the $5 million fee $1.375 million will be in the form of shares
of Universal American common
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stock valued at the same price per share as the price paid by Capital Z in the
Capital Z Issuance.
Registration Rights Agreement
Universal American, Capital Z, AAM, Richard Barasch and WAND/Universal
Investments I, L.P. and WAND/Universal Investments II, L.P. (collectively,
"WAND") and several other shareholders of Universal American (collectively,
"Selling Shareholders") will enter into a registration rights agreement as a
condition to the Capital Z Issuance. The registration rights agreement provides
that each of WAND, AAM and Capital Z (including some of its affiliates) may, at
any time after the closing, require Universal American to prepare and file with
the Securities and Exchange Commission (the "SEC") a registration statement
under the Securities Act of 1933 covering the public offer and sale of shares of
common stock they hold, including shares issued in the Capital Z Issuance.
Universal American must use its reasonable best efforts to cause the
registration statement to be declared effective and remain effective for up to
the lesser of 180 days or the period during which all of the shares requested to
be so registered have been sold (a "Demand Registration"). WAND may require two
Demand Registrations, both at Universal American's expense. AAM may require one
Demand Registration at Universal American's expense. Capital Z and any affiliate
to whom shares of common stock have been transferred by Capital Z may request
unlimited Demand Registrations, but no more than four registrations will be paid
by Universal American.
Notwithstanding the terms described above, Universal American is not
required to file a registration statement in response to a Demand Registration
if specified conditions are not met, including the anticipated failure of a
Demand Registration to have an aggregate net market value of at least $15
million.
The parties to the registration rights agreement have customary "piggyback"
registration rights allowing them to register shares in the event Universal
American proposes to sell any of its common stock to the public in a transaction
registered under the Securities Act of 1933. In addition, the parties may
include shares held by them in any Demand Registration of another party.
Shareholders' Agreement
Universal American, AAM, Richard Barasch and several other shareholders of
Universal American will enter into a shareholders' agreement as a condition to
the Capital Z Issuance. The shareholders' agreement requires that all proposed
sales/transfers by the other shareholders who are party to the shareholders'
agreement must first be offered to Richard A. Barasch and Capital Z, including
its affiliates. However, pledges and some other transfers by any party to the
shareholders' agreement of less than 1% of Universal American's outstanding
common stock at any one time, or 2.5% when aggregated with other transfers by
the shareholder and his, her or its permitted transferees of Universal
American's outstanding common stock, are permitted. In addition, the
shareholders' agreement subjects the parties to tag-along and drag-along rights
under some circumstances. "Tag-along rights" allow the holder of stock to
include his, her or its stock in a sale of common stock initiated by another
party to the shareholders' agreement. "Drag-along rights" permit a selling party
to the shareholders' agreement to force the other parties to the shareholders
agreement to sell a proportion of the other holder's shares in a sale arranged
by the selling shareholder.
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Under the terms of the shareholders' agreement, of the nine members of
Universal American's board, the shareholders are permitted to nominate directors
as follows: Capital Z -- four, Richard Barasch -- two, AAM -- one and Universal
American -- two. Because of Capital Z's majority stock ownership, Capital Z also
effectively controls the election of the two directors that Universal American
is entitled to nominate. Capital Z, Richard Barasch and AAM are each required to
vote for the director(s) nominated by the others. The ability to nominate
directors may be adjusted based upon the amount of common stock owned by each
such shareholder. The ability of Richard Barasch to nominate directors is also
affected by his continued employment with Universal American. In addition, the
ability to nominate directors is not transferable, except that Capital Z may
transfer its right to a third-party buyer who acquires 10% or more of the
outstanding common stock of Universal American from Capital Z.
Pursuant to the terms of the shareholders' agreement, Capital Z is entitled
to representation on each of the audit committee and the compensation committee
of the board of directors provided that it continues to hold at least 10% of the
outstanding common stock of Universal American.
Each party to the shareholders' agreement has agreed for two years
following the closing not to vote his or its shares in favor of a merger where
Universal American's shareholders would receive consideration other than in the
form of shares of the surviving entity.
MATERIAL TERMS OF THE ACQUISITION AGREEMENT AND RELATED TRANSACTIONS
The acquisition agreement among Universal American, American Exchange, PFG
and several of PFG's subsidiaries provides that Universal American and American
Exchange, under conditions described more fully below, will purchase the Penn
Union Companies for an aggregate purchase price of $130.5 million of which will
be in cash. In addition, immediately prior to the closing an affiliate of PFG
that is not being purchased by Universal American or American Exchange will
receive $6.5 million in the form of a cash dividend paid by Union Bankers.
Richard A. Barasch and representatives of Capital Z principally negotiated the
terms of the acquisition, the Capital Z Issuance and the senior debt financing.
The statements made in this proxy statement with respect to the terms of
the acquisition and related transactions are qualified in their entirety by
reference to the amended and restated acquisition agreement, a copy of which
accompanies this proxy statement as Annex B.
Purchase Price Adjustment
Universal American and PFG have agreed to a purchase price adjustment based
upon the capital and surplus amounts of the PennLife Companies and the ConLife
Companies derived by Universal American and set forth in a closing statement to
be prepared by Universal American after the closing. If PFG and Universal
American cannot agree on the capital and surplus amounts listed in the closing
statement, an independent accounting firm of national reputation will resolve
the dispute. The closing statement will be adjusted to reflect the independent
accounting firm's resolution of the dispute. For each of the PennLife Companies
and the ConLife Companies, PFG has agreed to pay Universal American the amount
by which the capital and surplus or, in the case of Penncorp Life, total
shareholders' equity, listed on the final closing statement is less than target
capital and surplus amounts specified in the acquisition agreement. In addition,
PFG has agreed to pay Universal American an amount by which the aggregate
capital and surplus for all of the PennLife
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Companies and the ConLife Companies set forth on the final closing statement is
less than the aggregate target capital and surplus amount specified in the
acquisition agreement. The accounting for any purchase price adjustment will be
in accordance with APB 16, which will either increase or decrease the cost of
the acquired assets and be amortized over the remaining life of the assets.
Closing of the Acquisition
Unless Universal American and PFG otherwise agree, the closing will occur
as soon as possible following the satisfaction or waiver of all of the
conditions specified in the acquisition agreement. Universal American
anticipates that, if the Capital Z Issuance is approved by Universal American's
shareholders, and the other closing conditions to the Capital Z issuance and the
acquisition are satisfied or waived, the acquisition will occur in July 1999.
Conditions to the Acquisition
The obligations of Universal American and American Exchange to complete the
acquisition are subject to, among other conditions:
- receipt of necessary consents, authorizations and approvals by the
appropriate regulatory authorities, including: (i) approvals to
restructure the capital of, and to reset to not less than zero, the
unassigned surplus of the PennLife Companies and the ConLife Companies
and (ii) the approval of Proposal No. 1 and item (a) of Proposal No. 2 of
this proxy statement;
- the companies comprising the PennLife Companies and the ConLife Companies
must each meet specified minimum capital and surplus requirements and all
of those companies as a whole must meet an aggregate capital and surplus
requirement equal to the sum of $65.8 million plus the earnings of the
PennLife Companies and the ConLife Companies from January 1, 1999 to the
closing of the acquisition;
- completion of the reserve consultants' review of the amount and
composition of certain statutory reserves of Pennsylvania Life which must
be reasonably satisfactory to Universal American;
- completion, to the reasonable satisfaction of Universal American, of
specified restructuring transactions; and
- each of the companies constituting the Penn Union Companies has received
either (i) a rating of B+ or better from A.M. Best or (ii) assurances
from A.M. Best satisfactory to Universal American that, on or immediately
after the closing, each of the companies constituting the Penn Union
Companies will be assigned at least a B+ rating.
The obligations of PFG to complete the acquisition are subject to, among
other conditions:
- receipt of necessary consents, authorizations and approvals by Universal
American and American Exchange, including shareholder approval of
Proposal No. 1 and item (a) of Proposal No. 2; and
- Universal American shall have entered into services agreements with
Security Life and Trust Insurance Company, Occidental Life Insurance
Company of North Carolina and Professional Insurance Company, all
subsidiaries of PFG, to provide data processing services to them.
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Representations and Warranties
The acquisition agreement contains representations and warranties by PFG,
the Penn Union Companies, Universal American and American Exchange, where
indicated, to the effect that, except as specified or disclosed and, in some
cases, subject to some materiality exceptions, including the following material
representations and warranties: (a) all parties are duly organized and in good
standing, and have the requisite corporate power to own their properties and
carry on their business as it is now being conducted; (b) all parties, including
American Exchange, have all requisite corporate power and authority to enter
into the acquisition agreement and all agreements contemplated by the
acquisition agreement and to consummate the acquisition, and the acquisition
agreement has been duly authorized by and constitutes the valid and binding
obligation of each party; and (c) the execution, delivery and performance of the
acquisition agreement by all parties, including American Exchange, will not
conflict with any party's articles or certificates of incorporation or by-laws,
violate any agreement or law to which such party or its assets are bound, or
violate any order, writ, judgment, injunction, decree, statute, rule or
regulation of any court, regulatory or governmental agency.
Material Covenants
The acquisition agreement contains covenants, including but not limited to
the following:
Conduct of Business Prior to the Closing. Prior to the closing, PFG must
conduct the business and operations of the Penn Union Companies in the ordinary
and usual course. PFG will not permit any of the companies constituting the Penn
Union Companies to:
- amend its certificate of incorporation or by-laws;
- incur any indebtedness except in the ordinary course of business;
- adopt any new benefit plan or materially change any existing benefit
plans;
- sell any asset or assets worth more than $500,000 other than in the usual
course, or encumber any of its assets;
- sell any securities except consistent with past practice;
- enter into or terminate any material contracts except in the ordinary
course;
- split its shares, pay a dividend, other than as specifically permitted in
the acquisition agreement, issue any additional shares, or purchase any
of its capital stock;
- enter into a capital expenditure or expenditures that exceed $100,000
except in the ordinary course;
- intentionally breach any of its representations and warranties in the
acquisition agreement;
- restructure or reorganize;
- materially change its accounting practices;
- settle any claim or claims in excess of $250,000; or
- make any loan to or engage in any transaction with any affiliated
company.
Transaction Bonuses; Payments to Field Force Managers. Except for
obligations reserved for on the unaudited financial statements and the audited
financial statements and except for obligations otherwise scheduled, PFG will
pay, prior to or at the closing, all bonuses payable to certain specified
officers, directors, employees and agents in connection with the proposed
transaction. Prior to or at the closing, PFG will pay to all field force
managers amounts agreed to under compensation arrangements made in connection
with or
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relating to the sale of the Penn Union Companies and Universal American will
adopt commission schedules and stock-based and other compensation plans.
Nonsolicitation. PFG and its signatory affiliates agree not to solicit or
hire any current officers, general sales agents, or sales agents (to the level
of district manager) of the Penn Union Companies for a period of two years after
the closing other than as specifically permitted in the acquisition agreement.
PFG and its affiliates, however, may make general solicitations or hire
terminated employees under conditions specifically described in the acquisition
agreement.
Acquisition Proposals. PFG may not make, entertain, solicit, encourage,
accept, negotiate or hold substantive discussions regarding any competing offer.
Financial Matters. As of the date the acquisition agreement was amended
and restated, PFG has recorded additional reserves of at least $25 million in
accordance with SAP relating to the disability income claim reserves of
Pennsylvania Life for 1998 and prior years.
Survival/Indemnification
Survival. All representations and warranties of PFG survive the closing,
except the representation as to the adequacy of reserves which will not survive
the closing. All of the representations and warranties of Universal American
survive the closing, except those representations and warranties regarding SEC
reports; the absence of undisclosed liabilities; the absence of certain changes;
and compliance with applicable law, permits, and licenses, all of which do not
survive the closing.
With the exceptions listed in this paragraph, the representations and
warranties that survive the closing expire 18 months after the closing. Any
claim based on a tax representation or warranty will terminate 30 days after the
expiration of the applicable statute of limitations. Any claim based on an
environmental representation or warranty will terminate three years after the
closing. Any claim based on a representation or warranty related to the employee
benefit plans will terminate on the expiration of the applicable statute of
limitations. Any claim based on specific fundamental representations and
warranties will survive indefinitely.
Indemnification by PFG. PFG agrees to indemnify Universal American and its
affiliates for, among other things:
- any breach of any representation or warranty that survives the closing
and any covenant or agreement;
- any derivative lawsuits or lawsuits based on violations by PFG of federal
or state securities laws;
- any liability for taxes of any affiliates of the Penn Union Companies;
- any Phase III Taxes up to the closing date and 75% of certain Phase III
taxes for five years after the closing. Phase III Taxes relate to
insurance income that has been earned but, under prior tax law, was not
subject to tax at such time. Instead, a tax liability is incurred if, and
when, such income is distributed to Universal American's shareholders;
- any reductions in or limitations on the net operating losses including
any increased liability or taxes with respect to periods after the
closing, and a portion of Universal American's tax liability if the net
operating losses available for carryover are less than $20 million;
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- any liabilities of PennCorp Financial Services, Inc. that Universal
American has not expressly assumed;
- any taxes relating to the transactions contemplated by the acquisition
agreement; and
- any transaction bonuses and pre-sale obligations to any field force
managers.
PFG, however, is not required to indemnify Universal American for losses arising
out of any breach of representation or warranty relating to or arising from the
inadequacy of the reserves of any of the Penn Union Companies.
Indemnification by Universal American. Universal American has agreed to
indemnify PFG for any breach of any representation, warranty, covenant or
agreement by Universal American or American Exchange. Universal American will
also indemnify PFG for Universal American's failure to enter into investment
agreements with some agents of Pennsylvania Life, to adopt certain commission
schedules and stock-based compensation plans, and to carry out certain other
post-closing compensation obligations to certain agents and persons of
Pennsylvania Life. In each case, Universal American's indemnification
obligations are limited to the extent described in the next paragraph.
Limitations on Indemnification. PFG will not be obligated to indemnify
Universal American and its affiliates for losses arising from any inaccuracy in
or any breach of any representation or warranty, until the aggregate amounts for
indemnification equal $2.5 million, at which time PFG must pay only the amount
of losses in excess of $2.5 million. The limitation in the previous sentence
does not apply to losses based on several fundamental representations, nor does
it apply to the representations and warranties that relate to employee benefit
plans or taxes. Except for some fundamental representations, PFG is not
obligated to indemnify Universal American and its affiliates for breaches of any
representations or warranties in excess of the purchase price. In any event,
Universal American is not obligated to make any payment to PFG for
indemnification in excess of $50 million.
Termination. The acquisition agreement may be terminated (i) by the mutual
consent of Universal American and PFG, (ii) by either Universal American or PFG
(a) if a governmental authority enters an order restraining, enjoining or
prohibiting any of the transactions contemplated by the acquisition agreement;
(b) if the closing does not occur by March 31, 1999, subject to four 30-day
extensions under some circumstances; or (c) upon a material default or breach by
the other, that is not remedied or waived within 30 days, of the performance of
any obligations, covenants, and agreements or in their representations and
warranties under the acquisition agreement, or (iii) by PFG, upon a material
default or breach by American Exchange, that is not remedied or waived within 30
days, of the performance of any obligations, covenants and agreements or in its
representations and warranties under the acquisition agreement.
THE VOTING AGREEMENT
In connection with the acquisition of the Penn Union Companies, Richard
Barasch, AAM, certain limited partners of Barasch Associates Limited Partnership
(the "Shareholders") and Universal American, PFG and Capital Z have executed a
voting agreement. The Shareholders together control more than 50% of Universal
American's outstanding voting stock.
Under the voting agreement, the Shareholders have agreed to vote in favor
of the Capital Z Issuance and the amendment to Universal American's certificate
of incorporation to increase the number of authorized shares of common stock
from 20 million to 80 million (Item (a) of Proposal No. 2).
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In addition, the Shareholders agreed that until the voting agreement
terminates, they will vote against (i) any proposal opposed to or in competition
with the acquisition of the Penn Union Companies, (ii) any change in Universal
American's capital structure other than under the share purchase agreement and
the conversion of the Convertible Preferred Stock, and (iii) any action or
agreement that could impede, interfere with, delay, postpone or attempt to
discourage the Capital Z Issuance or the acquisition of the Penn Union Companies
or result in a breach by Universal American which is likely to result in the
failure of a condition to the share purchase agreement or the acquisition
agreement.
The Shareholders have also agreed that for two years after the share
purchase agreement is terminated, they will not vote in favor of any transaction
contemplating or proposing the acquisition by Universal American of any business
or assets of PFG. This obligation does not apply if (i) the share purchase
agreement is terminated due to a breach by Capital Z of that agreement, (ii)
Universal American and Capital Z mutually agree not to complete the acquisition,
or (iii) Universal American is unable to complete the acquisition as a result of
Capital Z's failure to give its consent to Universal American to waive or
acknowledge the satisfaction of conditions to the closing of the acquisition
agreement.
Except for the two-year agreement described in the preceding paragraph, the
voting agreement will terminate upon the earlier of (i) the consummation of the
Capital Z Issuance and the acquisition, (ii) the termination of the share
purchase agreement, or (iii) the termination of the acquisition agreement. If
the voting agreement is terminated under clause (ii) or (iii) of this paragraph
because of the failure to vote in favor of Proposal No. 1 and item (a) of
Proposal No. 2, Universal American will be solely responsible for, and will
indemnify Capital Z for all liabilities arising under the acquisition agreement.
Even though there is a voting agreement, you have been asked to vote on
Proposal No. 1 and item (a) of Proposal No. 2 because Universal American's
certificate of incorporation does not permit shareholders to vote by written
consent; all shareholder actions must be taken by a vote of shareholders at a
duly held meeting of shareholders. In addition, the voting agreement does not
cover the other items of Proposal No. 2 or Proposal No. 3. You are not entitled
to rights of appraisal or similar rights for any matter to be acted on at the
meeting.
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OPINION OF ADVEST
On December 8, 1998, Universal American hired Advest to render its opinion
to the board of directors as to whether (i) the controlling-interest investment
in Universal American by Capital Z, together with the additional investment by
AAM and certain members of management and agents of the Penn Union Companies
(the "Investment") and (ii) the acquisition of the Penn Union Companies by
Universal American, are fair, from a financial point of view, to Universal
American and its shareholders. On December 31, 1998, Advest delivered its
opinion to a designated committee of the board, to the effect that, in reliance
upon and subject to the assumptions and considerations set forth in the opinion,
as of the date of the opinion, the financial terms and effects of the Investment
and the acquisition, both individually and in the aggregate, are fair, from a
financial point of view, to Universal American and its shareholders. On May 24,
1999, Advest subsequently delivered a revised opinion that, as of the date of
that opinion, the terms and effects of the Investment and the acquisition, as
reflected in the amended and restated acquisition agreement and the amended
share purchase agreement, both individually and in the aggregate, are fair, from
a financial point of view, to Universal American and its shareholders. Advest
subsequently revised its opinion to provide that as of the date of the mailing
of this proxy statement, the Investment and the acquisition, both individually
and in the aggregate, are fair, from a financial point of view, to Universal
American and its shareholders. Advest is a nationally recognized investment
banking firm and, as part of its investment banking activities, regularly
engages in the evaluation of businesses and their securities in connection with
mergers and acquisitions, private placements of securities and valuations for
other corporate purposes. Universal American's board of directors selected
Advest because of its expertise and reputation and because its investment
banking professionals have experience in transactions similar to the Capital Z
Issuance and the merger. Universal American paid Advest a fee of $250,000 for
delivery of its opinion and any updated opinions. Universal American and its
affiliates have not in the past two years had, do not currently have and do not
currently contemplate any material relationships with Advest or its affiliates,
other than the relationship described in this proxy statement.
THE FULL TEXT OF ADVEST'S OPINION, DATED MAY 24, 1999, WHICH SETS FORTH THE
ASSUMPTIONS MADE, MATTERS CONSIDERED, AND LIMITS ON THE REVIEWS UNDERTAKEN IN
CONNECTION WITH THE OPINION IS ATTACHED TO THIS PROXY STATEMENT AS ANNEX C AND
IS INCORPORATED BY REFERENCE INTO THIS PROXY STATEMENT. SHAREHOLDERS OF
UNIVERSAL AMERICAN ARE URGED TO, AND SHOULD, READ THE OPINION CAREFULLY IN ITS
ENTIRETY.
No limitations were imposed by Universal American on the scope of Advest's
investigation or the procedures to be followed by Advest in rendering its
opinion. Advest was not requested to and did not make any recommendation as to
the form or amount of consideration to be received by Universal American, which
was determined through arm's length negotiations between Universal American,
Capital Z and PFG. The summary set forth below does not purport to be a complete
description of the analyses performed by Advest underlying the opinion. The
preparation of a fairness opinion is a complex process that is not susceptible
to partial analysis or summary description. Accordingly, notwithstanding the
factors summarized below, Advest believes that its analyses must be considered
as a whole and that selecting portions of its analyses and factors considered,
without considering all analyses and factors, or attempting to ascribe relative
weights to some or all of such analyses and factors, could create an incomplete
view of the processes underlying the opinion. Accordingly, the following summary
is qualified by reference to the written opinion of Advest, which is attached to
this proxy statement as Annex C.
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FAIR VALUATION PRICES. In arriving at its opinion, Advest advised us that,
among other things, it performed the following analyses and investigations:
In the case of the Investment, Advest attempted to determine whether the
price to be paid for the common stock of Universal American issued in connection
with the Investment is fair, from a financial point of view, to Universal
American's current shareholders. In this regard, Advest (a) compared the price
paid to Universal American's common stock price trading range and record; (b)
compared the price paid on a price/earnings and price/book value basis to recent
market valuations of similar publicly traded life/health insurers; (c) evaluated
the share price/earnings and price/book valuations paid for the new Universal
American shares against valuations paid for life/health insurers in similar
acquisition transactions; (d) reviewed the price paid for Universal American
shares relative to liquidation values derived in an actuarial valuation of
Universal American, for its business in-force and other assets, and (e) compared
the price being paid by the investors with a valuation derived from a discounted
cash flow analysis. The actuarial valuation was prepared by Universal American's
Chief Financial Officer and his staff and was reviewed by an internationally
recognized independent actuarial consulting firm hired by Capital Z in
connection with this transaction. In the process, Advest reviewed Universal
American's Forms 10-K and 10-Q for the years 1995 through 1998, its Annual
Reports to shareholders from 1995 through 1998, statutory statements for each of
Universal American's subsidiaries, American Pioneer, American Progressive, and
American Exchange, and the GAAP basis statements of WorldNet, comparative
financial and operating data for companies selected for each of the peer groups,
plus operating projections for Universal American prepared by Universal American
and its advisors. In addition, they conducted discussions with members of
management concerning various aspects of Universal American's operations,
financial prospects, and projections.
In the case of the acquisition, Advest examined statutory financial results
for the companies constituting the Penn Union Companies for the years 1995
through 1998. Advest also compared the pricing of the acquisition on a
price/earnings and price/book value basis relative to market and transaction
peer groups and, in doing so, utilized several different valuation
methodologies, and did so on both a current and pro forma basis. They also
examined audited statutory financials for the companies constituting the Penn
Union Companies for 1997. Future period financial projections, on which much of
Advest's evaluation analyses are based, were provided by Universal American and
its other financial advisor.
Advest independently performed sensitivity analyses to determine the
effects of leverage and earnings volatility on dividend capacity for debt
service coverage, in order to quantify the level of financial risk in the
transaction on a pro forma basis, and reviewed such other financial information,
studies and analyses and performed such other investigations and took into
account such other matters as Advest deemed necessary.
The following is a summary of the material financial analyses performed by
Advest in arriving at its opinion, but does not purport to be a complete
description of the analyses performed by Advest for such purposes. The
preparation of a fairness opinion involves various determinations as to the most
appropriate and relevant methods of financial analysis and the application of
these methods to the particular circumstances and, therefore, such an opinion is
not readily susceptible to a partial analysis or summary description.
Accordingly, notwithstanding the separate factors summarized below, Advest
believes that its analyses must be considered as a whole and that selecting
portions of its analyses and factors considered by it, without considering all
analyses and factors, or attempting to ascribe
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relative weights to some or all of such analyses and factors, could create an
incomplete view of the evaluation process underlying the Advest opinion.
In addition to the analyses and investigations discussed above, in arriving
at its opinion of the fairness from a financial point of view to Universal
American and its shareholders of the per share price to be paid by Capital Z,
AAM and certain agents and members of management of Universal American for the
shares issued in connection with the Investment, Advest (i) analyzed the per
share price for the investment and compared it to historical stock market value
prices of Universal American's publicly traded common stock; (ii) determined the
estimated value of Universal American before the Investment and (iii) analyzed
the estimated expected value of Universal American, pro forma, for the
Investment and the acquisition. Next, Advest compared the aforementioned
estimated values and considered the results of that comparison, as well as such
other factors deemed necessary in arriving at its opinion on the fairness, from
a financial point of view, of the price paid for the Investment.
Advest compared the Investment price of $3.15 per share with the historical
market prices over a three year period and found that this price was higher than
the peak market price by a range of 17.2% to 5.0% for one month, three month,
one year, three year and year to date periods (to December 18, 1998), and 110.2%
to 48.2% above the low prices recorded on each of these measurement dates.
The following is a summary of the valuation techniques used by Advest,
along with Universal American's historical market values, to determine an
estimated value range for Universal American prior to the Investment.
Appraisal Value Analysis. Advest reviewed an actuarial appraisal value of
Universal American prepared by Universal American's Chief Financial Officer and
his staff, which was reviewed by an internationally recognized independent
actuarial consulting firm hired by Capital Z, in order to determine an estimate
of Universal American's value assuming it allows its business in force to
"run-off." The appraisal value was $2.55 per share assuming a 35% federal tax
rate and $2.78 per share assuming a 15% federal tax rate. The per share values
also assume that all securities of Universal American that would be converted
into common stock were converted and that there was no growth in Universal
American's business.
Comparable Public Companies Analysis. Advest performed a valuation of
Universal American before giving effect to the Investment and the acquisition by
comparing it to eight small publicly held life/health insurance companies:
Cotton States Life Insurance Company, Intercontinental Life Corporation,
Independent Holding Company, Bancinsurance Corporation, Standard Management
Corporation, Investors Heritage Life Insurance Company, Inc., Erie Family Life
Insurance Company, and Security National Financial. As of May 14, 1999 these
companies were valued in a range of 6.0 times to 9.8 times analysts' consensus
estimated 1999 earnings. In addition, the companies were valued in a range of
0.5 times to 1.6 times their latest reported GAAP book values. Based on
Universal American's financial information made available to Advest, the
analysis indicated a range of values for Universal American's common stock of
$1.85 per share to $2.80 per share, after application of a discount factor of
25% to projected earnings.
Precedent Transactions Analysis. Advest selected seven precedent
life/health insurance companies acquisition transactions, which indicated a
median price of 14.4 times earnings and 2.2 times book value. The precedent
acquisition transactions, along with their announced or effective dates are as
follows: American Income Holdings (October 31, 1994),
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American Travellers Corp. (December 17, 1996), Capitol American Financial (March
4, 1997), Transport Holdings (December 23, 1996), John Alden Financial Corp.
(August 31, 1998), Family Service Life Insurance (June 1, 1998), and
NationalCare Insurance Co. (September 30, 1998) and Provident Companies
(November 23, 1998). Based on Universal American's financial information and
projections made available to Advest, the analysis indicated a range of values
for Universal American's common stock of $3.25 per share to $5.75 per share,
after application of a discount factor of 25% of projected earnings.
Present Value of GAAP Earnings Analysis. Advest valued Universal American
using the present value of Universal American's projected GAAP earnings. Based
on Universal American's financial information and projections made available to
Advest, the analysis indicated a range of values for Universal American's common
stock of $4.70 per share to $5.40 per share, after application of a discount
factor of 25% to projected earnings.
UNIVERSAL AMERICAN AND THE PENN UNION COMPANIES COMBINED. Following is a
summary of the valuation techniques used by Advest, to determine an estimated
value range for Universal American on a pro forma basis, as if the Investment
and the acquisition had in fact taken place. Advest considered that after the
acquisition, Universal American will be significantly larger than the eight
small publicly held companies referred to above in "-- Comparable Public
Companies Analysis." In completing its analyses described above under
"-- Comparable Public Companies Analysis", "-- Precedent Transaction Analysis"
and "Present Value of GAAP Earnings Analysis" using the pro forma projections
provided to it, Advest determined that it would be appropriate to compare
Universal American to larger publicly held companies referenced in the
discussion below.
Comparable Public Companies Analysis. Advest performed a valuation of
Universal American after giving effect to the Investment and the acquisition by
comparing it with seven larger publicly held life/health insurance companies:
American Heritage Life Investment Corporation, Ceres Group, Inc., Delphi
Financial Group, Inc., The Guarantee Life Companies, Inc., Penn Treaty American
Corporation, Protective Life Corporation, and UICI. As of May 14, 1999 these
companies were valued in a range of 10.0 times to 16.1 times analysts' consensus
estimated 1998 earnings, and 8.0 times to 22.4 times analysts' consensus
estimated 1999 earnings. In addition, the companies were valued in a range of
0.8 times to 3.4 times their latest reported GAAP book values. Based on
Universal American's financial information and pro forma projections made
available to Advest, the analysis indicated a range of values for the common
stock of Universal American, after giving effect to the Investment and the
acquisition, of $5.60 per share to $5.65 per share, after application of a
discount factor of 25% to projected earnings.
Precedent Transactions Analysis. Using the valuation multiples indicated
above under "-- Precedent Transaction Analysis", and Universal American's
financial information and pro forma projections made available to Advest, the
analysis indicated a range of values for the common stock of Universal American,
after giving effect to the Investment and the acquisition, of $6.40 per share to
$6.80 per share, after application of a discount factor of 25% to projected
earnings.
Present Value of GAAP Earnings Analysis. Advest valued Universal American,
after giving effect to the Investment and the acquisition, using the present
value of Universal American's projected pro forma GAAP earnings. Based on
Universal American's financial information and projections made available to
Advest, the analysis indicated a range of values for the common stock of
Universal American, after giving effect to the Investment and the acquisition,
of $4.95 per share to $5.80 per share, after application of a discount factor of
25% to projected earnings.
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PENN UNION COMPANIES PURCHASE PRICE. In arriving at its opinion on the
fairness, from a financial point of view, to Universal American and its
shareholders, of the purchase price paid for the Penn Union Companies, Advest
analyzed the value of the Penn Union Companies using a (i) Comparable Public
Company Analysis, (ii) a Precedent Transactions Analysis, and (iii) an analysis
of the Present Value of GAAP Earnings.
Comparable Public Company Analysis. Using the valuation multiples
indicated above under "-- Comparable Public Companies Analysis" and the Penn
Union Companies' financial information and pro forma projections made available
to Advest, the analysis indicated a range of values for the Penn Union Companies
of $250 million to $234 million, after application of a discount factor of 25%
to projected earnings.
Precedent Transactions Analysis. Using the valuation multiples indicated
above under "-- Precedent Transaction Analysis" and the Penn Union Companies'
financial information and pro forma projections, made available to Advest, the
analysis indicated a range of values for the Penn Union Companies of $292
million to $338 million, after application of a discount factor of 25% to
projected earnings.
Present Value of GAAP Earnings Analysis. Advest valued the Penn Union
Companies using the present value of the Penn Union Companies' projected GAAP
earnings. Based on the Penn Union Companies' financial information and
projections, made available to Advest, the analysis indicated a range of values
for the Penn Union Companies of $191 million to $230 million, after application
of a discount factor of 25% to projected earnings.
61
68
UNAUDITED PRO FORMA FINANCIAL INFORMATION
We are providing the pro forma financial information reflecting Universal
American after the Capital Z Issuance and the acquisition of the Penn Union
Companies (which we refer to as "pro forma" information) to give you a better
picture of what the results of operations and the financial position of the
consolidated businesses of Universal American and the Penn Union Companies might
have looked like had the Capital Z Issuance and the acquisition of the Penn
Union Companies occurred on an earlier date. As noted previously, the purchase
price is subject to adjustment. However, it is Universal American's management's
opinion that the purchase price adjustments reflected in the Proxy Statement are
not expected to materially differ from the final amounts agreed upon.
The Universal American Financial Corp. Unaudited Pro Forma Condensed
Consolidated Statement of Operations for the three months ended March 31, 1999
and the year ended December 31, 1998 present results for Universal American as
if the acquisition and the financing of the acquisition had been consummated
January 1, 1998. The Universal American Financial Corp. Unaudited Pro Forma
Condensed Consolidated Balance Sheet as of March 31, 1999 gives effect to the
acquisition of the Penn Union Companies by Universal American as if it had
occurred on the balance sheet date, March 31, 1999. The unaudited pro forma
financial information has been derived from and should be read in conjunction
with the Notes to Unaudited Pro Forma Financial Information that follow on page
59, as well as historical Consolidated Financial Statements and Notes of
Universal American for the three months ended March 31, 1999 and for the year
ended December 31, 1998 and the historical Combined Financial Statements and
Notes of the Penn Union Companies of PFG for the three months ended March 31,
1999 and for the year ended December 31, 1998 set forth in Annex E to this proxy
statement. See "Universal American Financial Corp. Management's Discussion and
Analysis of Financial Condition and Results of Operations" on page 104 and "Penn
Union Companies Management's Discussion and Analysis of Financial Conditions and
Results of Operations" on page 122.
The unaudited pro forma combined financial information reflects
management's best estimate based upon currently available information. The pro
forma adjustments and combined amounts are provided for informational purposes
only, and if the acquisition of the Penn Union Companies is consummated,
Universal American's consolidated financial statements will reflect the effects
of the acquisition only from the date such transaction occurs. The pro forma
adjustments are applied to the historical financial statements of Universal
American and the Penn Union Companies to account for the acquisition of the Penn
Union Companies by Universal American under the purchase method of accounting in
accordance with APB Opinion No. 16. Under this method of accounting, the total
purchase cost will be allocated to the Penn Union Companies' assets and
liabilities based on their relative fair values. These allocations are subject
to valuations as of the date of the acquisition based upon appraisals and other
information at that time. For example, it is not possible to fully estimate the
reserves for future policy benefits and certain components of claims reserves as
the assumptions have not been unlocked and analyzed for current circumstances
(e.g., current interest rates) and experience (e.g., current morbidity and
termination experience). Such assumptions cannot be determined with certainty
until the acquisition of the Penn Union Companies has been consummated. SFAS No.
38 "Accounting for Preacquisition Contingencies of Purchased Entities" allows a
period of one year to complete the purchase accounting allocations for business
combinations. Management believes it will complete this recalculation of
reserves within that period of time, management has provided its best estimate
of what the likely fair values of assets and liabilities for the purpose of
these pro forma financial statements; management cannot
62
69
predict the potential adjustments resulting from actual final purchase
assumptions which could result in differences from these pro forma estimates. It
is reasonably likely that the reserve amounts will increase, which difference
could be material and impact future results of operations. For example, an
increase in the final fair value reserve amount would decrease negative goodwill
and the positive effects of its amortization on future results of operations.
Accordingly, the final purchase price adjustments will be different from the
amounts reflected herein. However, it is management's opinion that the
allocation of the purchase price reflected in the unaudited pro forma financial
information is not expected to be materially different from the final amounts.
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the results of operations or financial
position that would have occurred had the acquisition been consummated on the
dates assumed, nor is the pro forma information intended to be indicative of
Universal American's future results of operations.
63
70
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
---------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
--------- ---------- ---------------- ------------------ ------------
REVENUES:
Net premium and policyholder fees
earned............................... $10,424 $45,720 $ (842) $ -- $55,302
Net investment income.................. 2,799 11,868 (636) -- 14,031
Realized gains on investments.......... 47 92 -- -- 139
Other income........................... 579 3,371 (120) -- 3,830
------- ------- ------- ------- -------
Total revenues......................... 13,849 61,051 (1,598) -- 73,302
------- ------- ------- ------- -------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.................. 9,172 32,944 (1,267) -- 40,849
Change in deferred acquisition costs... (856) (1,437) (33) (3,168)(2) (5,494)
Amortization of present value of future
profits.............................. 44 2,829 (121) (2,708)(3) 44
Amortization of goodwill............... 39 1,383 -- (1,383)(3) 39
Amortization of negative goodwill...... -- -- -- (1,353)(4) (1,353)
Interest expense on the senior secured
note................................. -- -- -- 1,641(5) 1,641
Interest expense on affiliated surplus
notes................................ -- 2,530 -- (2,530)(6) --
Other operating costs and expenses..... 4,383 23,109 (925) -- 26,567
------- ------- ------- ------- -------
Total benefits, claims and other
deductions........................... 12,782 61,358 (2,346) (9,501) 62,293
------- ------- ------- ------- -------
Operating income before taxes.......... 1,067 (307) 748 9,501 11,009
Federal income tax expense............. 356 360 257 2,492(7) 3,465
------- ------- ------- ------- -------
Net income............................. 711 (667) 491 7,009 7,544
Redemption accrual on Series C
preferred stock...................... 180 -- -- (180)(8) --
------- ------- ------- ------- -------
Net income applicable to common
shareholders......................... $ 531 $ (667) $ 491 $ 7,189 $ 7,544
======= ======= ======= ======= =======
EARNINGS PER COMMON SHARE:
Basic.............................. $ 0.07 $ 0.19
======= =======
Diluted............................ $ 0.05 $ 0.17
======= =======
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic.............................. 7,706 32,890(9) 40,596
Diluted............................ 14,854 30,714(9) 45,568
64
71
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
PRO FORMA
ADJUSTMENTS
RELATING TO THE
HISTORICAL FINANCIAL PRO FORMA ACQUISITION OF THE
STATEMENTS ADJUSTMENTS PENN UNION
---------------------- RELATING TO COMPANIES
UNIVERSAL PENN UNION TRANSFER OF AND THE PRO FORMA
AMERICAN COMPANIES CERTAIN LINES(1) RELATED FINANCING CONSOLIDATED
--------- ---------- ---------------- ------------------ ------------
REVENUES:
Net premium and policyholder fees
earned............................... $42,496 $ 199,556 $(13,968) $ -- $228,084
Net investment income.................. 10,721 47,938 (6,255) -- 52,404
Realized gains on investments.......... 256 6,207 (43) -- 6,420
Other income........................... 2,616 11,408 (120) -- 13,904
------- --------- -------- --------- --------
Total revenues......................... 56,089 265,109 (20,386) -- 300,812
------- --------- -------- --------- --------
BENEFITS, CLAIMS AND EXPENSES:
Policyholder benefits.................. 38,235 174,646 (11,122) -- 201,758
Change in deferred acquisition costs... (3,530) 53,030 (245) (87,001)(2) (37,746)
Amortization of present value of future
profits.............................. 174 10,842 (1,194) (9,648)(3) 174
Amortization of goodwill............... 171 5,547 -- (5,547)(3) 171
Amortization of negative goodwill...... -- -- -- (4,749)(4) (4,749)
Interest expense on the senior secured
note................................. -- -- -- 6,630(5) 6,630
Interest expense on affiliated surplus
notes................................ -- 10,948 -- (10,948)(6) --
Other operating costs and expenses..... 17,107 119,211 (5,984) -- 130,335
------- --------- -------- --------- --------
Total benefits, claims and other
deductions........................... 52,157 374,224 (18,545) (111,263) 296,573
------- --------- -------- --------- --------
Operating income (loss) before taxes... 3,932 (109,115) (1,841) 111,263 4,239
Federal income tax expense (benefit)... 1,325 (35,257) (361) 35,863(7) 1,570
------- --------- -------- --------- --------
Net income (loss)...................... 2,607 (73,858) (1,480) 75,400 2,669
Redemption accrual on Series C
preferred stock...................... 433 -- -- (433)(8) --
------- --------- -------- --------- --------
Net income (loss) applicable to common
shareholders......................... $ 2,174 $ (73,858) $ (1,480) $ 75,833 $ 2,669
======= ========= ======== ========= ========
EARNINGS PER COMMON SHARE:
Basic.............................. $ 0.29 $ 0.07
======= ========
Diluted............................ $ 0.20 $ 0.06
======= ========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:
Basic.............................. 7,533 32,890(9) 40,423
Diluted............................ 13,155 30,714(9) 43,869
65
72
UNIVERSAL AMERICAN FINANCIAL CORP.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF MARCH 31, 1999
(IN THOUSANDS)
PRO FORMA
ADJUSTMENTS
FINANCING RELATING TO PURCHASE
UNIVERSAL ACCOUNTING PENN UNION TRANSFER OF ACCOUNTING PRO FORMA
AMERICAN ADJUSTMENTS(10) COMPANIES CERTAIN LINES ADJUSTMENTS(11) CONSOLIDATED
--------- --------------- ---------- ------------- --------------- ------------
ASSETS:
Total investments........... $149,456 $ -- $ 669,150 $(65,581) $ -- $ 753,025
Cash........................ 8,926 15,000 15,720 -- (6,500) 33,146
Deferred policy acquisition
costs..................... 26,368 -- 117,105 (485) (116,620) 26,368
Goodwill.................... 4,316 -- 95,697 -- (95,697) 4,316
Present value of future
profits................... 1,526 -- 85,823 (5,094) (80,729) 1,526
Other assets................ 93,623 6,250 133,361 -- -- 233,234
-------- -------- ---------- -------- --------- ----------
Total assets.............. 284,215 21,250 1,116,856 (71,160) (299,546) 1,051,615
======== ======== ========== ======== ========= ==========
LIABILITIES, SERIES C AND D
PREFERRED STOCK AND
STOCKHOLDERS' EQUITY:
Reserves for future policy
benefits.................. 230,080 -- 631,485 (61,387) -- 800,178
Loan payable................ 4,500 (4,500) -- -- -- --
Affiliated surplus notes.... -- -- 98,500 -- (98,500) --
Senior secured note
payable................... -- 70,000 -- -- -- 70,000
Deferred income tax (asset)
liability................. 1,127 -- (410) (3,421) (61,129) (71,833)
Negative goodwill........... -- -- -- -- 74,111 74,111
Other liabilities........... 10,074 -- 50,901 -- -- 60,975
-------- -------- ---------- -------- --------- ----------
Total liabilities......... 245,781 72,000 780,476 (64,808) (93,518) 933,431
-------- -------- ---------- -------- --------- ----------
Series C and D preferred
stock (including
redemption accrual
thereon).................. 10,031 (10,031) -- -- -- --
-------- -------- ---------- -------- --------- ----------
Total stockholders'
equity.................... 28,403 96,281 336,380 (6,352) (336,528) 118,184
-------- -------- ---------- -------- --------- ----------
Total liabilities, Series C
and D preferred stock and
stockholders' equity...... $284,215 $158,250 $1,116,856 $(71,160) $(430,046) $1,051,615
======== ======== ========== ======== ========= ==========
66
73
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION
(IN THOUSANDS)
Universal American and American Exchange have entered into an amended and
restated acquisition agreement with PFG and some of PFG's subsidiaries to
purchase the Penn Union Companies for an aggregate price of $130.5 million in
cash. In addition, immediately prior to the closing an affiliate of PFG that is
not being purchased by Universal American or American Exchange will receive $6.5
million of which will be in the form of a cash dividend payable by Union
Bankers. For a description of the transaction and the companies to be acquired,
see "The Capital Z Issuance and the Acquisition of the Penn Union Companies" on
page 31 of this proxy statement. The purchase price may be adjusted to reflect
differences between the capital and surplus set forth in the closing statement
and the amounts required by the purchase agreement. This adjustment must be made
within 90 days of the closing date of the acquisition. For a further discussion
of the purchase price adjustment, see "Material Terms of the Acquisition
Agreement and Related Transactions -- Purchase Price Adjustment" on page 51 of
this proxy statement. The purchase price was determined based upon many factors,
including:
- the statutory capital base of the Penn Union Companies;
- the historical statutory earnings of the Penn Union Companies;
- the adequacy of the statutory reserves held by the Penn Union Companies;
- the status of the sales force at the time of negotiating the transaction;
and
- the anticipated rate of return on the investment.
For a discussion of the reasons why the terms of the acquisition agreement
were renegotiated to provide for a reduction in the purchase price, the
elimination of PFG's representation as to the adequacy of reserves and the
elimination of the purchase price adjustment based on adequacy of reserves see
"The Capital Z Issuance and the Acquisition of the Penn Union
Companies -- Background" beginning on page 31.
Adjustments to the unaudited pro forma condensed consolidated statements of
operations to give effect to the acquisition of the Penn Union Companies as of
January 1, 1998 are summarized below:
(1) The share purchase agreement contains certain pre-closing restructuring
provisions, of which material provisions include the termination of the
reinsurance agreements between Peninsular and Occidental (both are
subsidiaries of PFG), reinsurance of 100% of the Peninsular direct business
and the reinsurance of 100% of the comprehensive major medical and
unreinsured Medicare supplement business of Union Bankers. The termination
of the existing reinsurance between Peninsular and Occidental and the
reinsurance of 100% of the Peninsular direct business are currently
contemplated to be effected through a single reinsurance treaty. The pro
forma income statement effects of the reinsurance transactions for the
three months ended
67
74
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
March 31, 1999 and the year ended December 31, 1998, by line item of each
of the above-mentioned reinsurance transactions are as follows:
MARCH 31, 1999
--------------------------------------------------
REINSURANCE
OF THE REINSURANCE
UNREINSURED PRO FORMA
MEDICARE ADJUSTMENTS
SUPPLEMENT RELATING TO
PENINSULAR BUSINESS OF TRANSFER OF
REINSURANCE(A) UNION BANKERS(B) CERTAIN LINES
-------------- ----------------- -------------
Revenues:
Net premium and policyholder fees earned.... $ (842) -- (842)
Net investment income....................... (636) -- (636)
Realized gains on investments............... -- -- --
Other income................................ (120) -- (120)
------- ------ ------
Total revenues.............................. (1,598) -- (1,598)
------- ------ ------
Benefits, claims and expenses:
Policyholder benefits incurred.............. (1,267) -- (1,267)
Change in deferred acquisition costs........ (33) -- (33)
Amortization of present value of future
profits.................................. (121) -- (121)
Amortization of goodwill.................... -- -- --
Amortization of negative goodwill........... -- -- --
Interest expense on the senior secured
note..................................... -- -- --
Other operating costs and expenses.......... (925) -- (925)
------- ------ ------
Total benefits, claims and other
deductions............................... (2,346) -- (2,346)
------- ------ ------
Operating income (loss) before taxes.......... 748 -- 748
Federal income tax expense (benefit).......... 257 -- 257
------- ------ ------
Net income (loss)............................. $ 491 -- 491
======= ====== ======
68
75
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
DECEMBER 31, 1998
---------------------------------------------------
REINSURANCE
OF THE REINSURANCE
UNREINSURED PRO FORMA
MEDICARE ADJUSTMENTS
SUPPLEMENT RELATING TO
PENINSULAR BUSINESS OF TRANSFER OF
REINSURANCE(1A) UNION BANKERS(1B) CERTAIN LINES
--------------- ----------------- -------------
Revenues:
Net premium and policyholder fees earned... $(3,105) (10,863) (13,968)
Net investment income...................... (5,117) (1,138) (6,255)
Realized gains on investments.............. (43) -- (43)
Other income............................... (120) -- (120)
------- ------- -------
Total revenues............................. (8,385) (12,001) (20,386)
------- ------- -------
Benefits, claims and expenses:
Policyholder benefits incurred............. (5,807) (5,315) (11,122)
Change in deferred acquisition costs....... (113) (132) (245)
Amortization of present value of future
profits................................. (523) (671) (1,194)
Amortization of goodwill................... -- -- --
Amortization of negative goodwill.......... -- -- --
Interest expense on the senior secured
note.................................... -- -- --
Other operating costs and expenses......... (1,831) (4,153) (5,984)
------- ------- -------
Total benefits, claims and other
deductions.............................. (8,274) (10,271) (18,545)
------- ------- -------
Operating income (loss) before taxes......... (111) (1,730) (1,841)
Federal income tax expense (benefit)......... 245 (605) (360)
------- ------- -------
Net income (loss)............................ $ (356) (1,125) (1,481)
======= ======= =======
(a) Termination of the reinsurance agreements between Peninsular and
Occidental: This business is separately tracked for reinsurance
disclosure purposes, including premiums earned, policyholder benefits
incurred, change in deferred acquisition costs, amortization of
present value of future profits and the related taxes on these items.
Net investment income earned on the reserves held and expenses are
allocated to lines of business based on the pro-rata share of the mean
reserves and premiums, respectively. All of these impacts have been
removed. No new third party reinsurance agreements will be consummated
to replace the reinsurance between Peninsular and Occidental. However,
a related party reinsurance agreement between Peninsular and
Constitution is currently being drafted but would not impact the
combined results.
Reinsurance of 100% of the Peninsular direct business: This business
is separately tracked for disclosure purposes, including premiums
earned, policyholder benefits incurred, change in deferred
acquisition costs, amortization of present value of future profits
and the related taxes on these items. Net investment income earned on
the reserves held and expenses are allocated to lines of business
based on the pro-rata share of the mean reserves and premiums,
respectively. This activity as recorded by the Penn Union Companies
prior to the acquisition has been eliminated. After the cancellation
of the
69
76
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
agreements as described above, all direct business is identified and
removed on a historical basis, totally eliminating all business of
Peninsular which is tracked as a separate company for reporting
purposes.
All adjustments to realized gains (losses) and other income are
related to the removal of the actual direct and assumed Peninsular
business. Assets are transferred backing the reserves for the
business reinsured and thus the related realized gains and losses and
the investment income are adjusted in the pro forma information.
For all direct business of Peninsular, this reinsurance is on a full
assumption basis, which results in the legal replacement of the
insurance carrier, Peninsular, with Occidental Life Insurance Company
upon completion of the transaction. This line of business is to be
fully transferred to Occidental Life via this legal replacement prior
to close and thus the business will not be acquired in this
transaction. Therefore, it has been removed in the pro forma
presentation.
Both the termination of the reinsurance agreements between Peninsular
and Occidental Life and the reinsurance of 100% of the direct
business of Peninsular will be settled at amounts equal to the
statutory reserves at the date the new agreements become effective.
Net GAAP reserves, net of deferred policy acquisition costs and
present value of insurance in force of approximately $55,808 (as of
March 31, 1999) will be transferred to Occidental Life along with
cash and investments totaling approximately $65,581. Accordingly, it
is anticipated that Peninsular will recognize a pre-tax loss of
approximately $9,773, as a result of the above transaction.
Additionally, this transaction will result in a reduction in future
total revenues, net income and total assets of approximately $8,000,
$300 and $71,000, respectively.
(b) Reinsurance of the unreinsured Medicare supplement business of Union
Bankers: During the fourth quarter of 1998, Union Bankers and
Constitution ceded the remaining 20% of the Medicare supplement
business to Cologne Life Reinsurance Company. This business is
separately tracked for disclosure purposes, including premiums earned,
policyholder benefits incurred, change in deferred acquisition costs,
amortization of present value of future profits and the related taxes
on these items. Net investment income earned on the reserves held is
allocated to this line of business based on the pro-rata share of the
mean reserves. Certain identifiable expenses (i.e., fees paid to third
parties for the administration of the block of business) are directly
assigned to this line. Other expenses are allocated based on premium.
However, these expenses are offset in part by expense allowances,
based on specified percentages of premiums, which are recovered from
Cologne. This activity, as recorded by the Penn Union Companies prior
to the coinsurance of the remaining 20%, has been eliminated on a pro
forma basis.
Both the initial cession of 80% of the Medicare supplement business,
as well as the subsequent cession of the remaining 20%, resulted in
gains to Union Bankers which were deferred and are amortized into
income over the life of the business. The combined amortization of
these gains amounted to $9.6 million during 1998 and has not been
eliminated on a pro-forma basis, as it relates to the Penn Union
70
77
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
Companies' profit on the sales transactions and is not part of the
operating results for the Medicare supplement line of business.
The removal of the remaining 20% or unreinsured Medicare supplement
business of Union Bankers and Constitution relates to the coinsurance
transaction with Cologne Re. Upon completion of this transaction
during the fourth quarter of 1998, the entire block of business is
coinsured with Cologne. This transaction does not result in the legal
replacement of Union Bankers and Constitution, however, the block of
business is transferred to Cologne under coinsurance and is presented
accordingly in the pro forma financial information. The income
statement effects of this line of business were removed for the
portion of 1998 prior to the execution of the remaining 20%. Under
coinsurance, the liabilities are transferred to Cologne. Cologne is
contractually responsible for the liabilities of this block. If,
however, they fail to meet their contractual obligation, Union Bankers
and Constitution would be obligated under the insurance contracts with
the policyholders.
Other than the Medicare supplement business of Union Bankers as noted
above, these planned reinsurance transactions to transfer lines of
business not acquired have not been consummated as of December 31,
1998.
(2) The components of the Penn Union historical amounts for the change in
deferred acquisition costs for the three months ended March 31, 1999 and
the year ended December 31, 1998 consisted of the following:
MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
Capitalized acquisition costs................ $ 7,887 $ 40,337
Amortization of amounts capitalized in 1998
and later.................................. (3,249) (6,121)
Amortization of DAC balances prior to 1998... (3,168) (87,001)
Amortization of DAC balance on lines of
business transferred....................... (33) (245)
------- --------
Total increase in deferred acquisition
costs................................. 1,437 (53,030)
======= ========
The amortization of deferred acquisition costs recorded by the Penn Union
Companies prior to 1998 was eliminated. However, the capitalization of
acquisition costs and the related amortization which occurred during 1998
were recorded.
(3) The amortization of the present value of future profits and goodwill
recorded by the Penn Union Companies prior to the acquisition was
eliminated.
(4) Amortization of the excess of estimated fair values of net assets acquired
over the purchase price (negative goodwill) is recognized over a ten-year
period on a straight-line basis. See Note 11 in "Notes to Unaudited Pro
Forma Financial Information" on page 73.
(5) Interest expense was recorded to reflect the issuance of $70,000 of senior
bank debt with an annual interest rate of 8.69%.
(6) The interest expense recorded by the Penn Union Company's relating to the
affiliated surplus notes, which will be settled at the date of acquisition,
has been eliminated.
71
78
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(7) Income taxes were adjusted at a rate of 35% to reflect the effect on taxes
of notes (2) through (6).
(8) The redemption accrual on the Series C preferred stock of Universal
American accumulated prior to the acquisition was eliminated since these
securities were converted into common stock of Universal American in April
1999.
(9) Basic and diluted weighted average number of common shares outstanding at
March 31, 1999 were adjusted to reflect the issuance of 27.857 million
shares of Universal American's common stock as if they were issued on
January 1, 1998 and outstanding for the entire year. These shares would be
issued pursuant to the proposed transaction as follows:
DESCRIPTION SHARES $ AMOUNT
----------- --------- --------
Capital Z Issuance................................... 28,888 $91,000
Transaction fees..................................... 437 1,375
Series D-1 preferred stock........................... 833 2,250
Series D-2 preferred stock........................... 556 1,750
--------- -------
Total........................................... 30,714 $96,375
========= =======
As of March 31, 1999, the Series C preferred stock was outstanding.
Therefore, the shares that are issuable upon conversion of the Series C
preferred stock were not included in determining the basic weighted average
number of common shares outstanding but were included in the determination
of the diluted weighted average number of common shares outstanding for the
historical Universal American financial statements for the three months
ended March 31, 1999. Thus, to arrive at the amount of basic weighted
average number of common shares outstanding after the transaction, the
2,176 shares issuable upon conversion of the Series C preferred stock need
to be added to the 30,714 shares issuable pursuant to the proposed
transaction resulting in the adjustment of 32,890.
Adjustments to the unaudited pro forma condensed consolidated balance sheet
to give effect to the purchase of the Penn Union Companies as of March 31, 1999
are summarized as follows:
(10) The financing of this acquisition consists of the following:
Issuance of common stock............................... $ 96,375
Senior secured term note............................... 70,000
--------
Total sources of financing........................ $166,375
========
The uses of the financing consists of the following:
Acquisition of the Penn Union Companies (see Note
12)................................................... $130,500
Refinancing of Universal American's outstanding loan... 4,500
Capital infusion to Pennsylvania Life.................. 15,000
Cash to be held at Universal American's parent company
for corporate purposes from the sale of Series D
Preferred Stock....................................... 4,000
Expenses incurred in issuance of equity................ 6,125
Expenses incurred on the senior debt financing......... 6,250
--------
Total uses of the financing....................... $166,375
========
72
79
UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
In addition to the financing described above, the Series C preferred stock
was converted into the common stock of Universal American in April 1999.
As of March 31, 1999, Universal American had $5,168 of Series C preferred
stock outstanding and $800 of redemption accruals on the Series C
preferred stock. The Series C preferred stock was converted into common
stock at a price of $2.375 per common share (2,176 shares) and the
elimination of the redemption accrual will be reflected in the retained
earnings account of Universal American.
As of March 31, 1999, Universal American had $4,000 of Series D Preferred
Stock outstanding, and $63 of redemption accruals as the Series D
Preferred Stock. The Series D Preferred Stock will be converted to 1,399
shares of common stock at the closing of the transaction. The $4,000 of
proceeds from the issuance of Series D Preferred Stock will be held at the
holding company for corporate purposes.
The components of the pro forma adjustment to total stockholders' equity
are as follows:
Capital Z Issuance of common stock..................... $ 91,000
Transaction fees taken as common stock................. 1,375
--------
Total common stock issued.............................. 92,375
Expenses incurred in issuance of equity................ (6,125)
--------
Net proceeds from issuance of common stock............. 86,250
Conversion of Series C and D preferred stock........... 10,031
--------
Total adjustment to stockholders' equity............... $ 96,281
========
(11) The purchase price for the Penn Union Companies is $130,500 in cash. In
addition, an affiliate of PFG that is not being purchased by Universal
American or American Exchange will receive a $6,500 dividend from Union
Bankers immediately prior to the closing. Cash is reduced by $6,500 in the
purchase accounting adjustments in the pro forma balance sheet to reflect
the payment of this dividend immediately prior to the closing. The
following table reflects the adjustments made to the acquired business
equity of the Penn Union Companies:
Net asset value acquired.................................... $ 336,380
---------
Increase (decrease) in the Penn Union net asset value to
reflect estimated fair value:
Elimination of affiliated surplus notes (Note 11a)........ 98,500
Elimination of the historical deferred policy acquisition
costs.................................................. (116,620)
Elimination of the historical present value of future
profits................................................ (80,729)
Elimination of the historical goodwill.................... (95,697)
Elimination of the deferred tax liability related to the
historical adjustments................................. 69,129
Elimination of effect of the Peninsular reinsurance
transactions
described in note 1a (Note 11b)........................ (6,352)
---------
Total estimated fair value adjustments................. (131,769)
---------
Estimated fair value of net assets acquired................. 204,611
Purchase price.............................................. 130,500
---------
Excess of estimated fair value of net assets acquired over
purchase price (negative goodwill) (see Note 12).......... $ 74,111
=========
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UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(a) The surplus notes at Constitution principally supported the acquisition
of Southwestern Life, an insurer not acquired in this transaction. The
business of Southwestern Life provided Constitution with the primary
means of servicing these obligations. The principal balance of the
surplus notes must be re-paid in connection with the sale of
Southwestern Life to Constitution's parent, Southwestern Financial
Corporation as a condition precedent to the closing of the Penn Union
Companies acquisition.
This surplus component will no longer be needed to support the
ownership of Southwestern Life by Constitution. The statutory capital
restructuring and related capital infusions that will occur prior or
simultaneous to closing are designed to place each of the companies at
or above 300% of the authorized control level risk based capital. This
planned level of capital is sufficient to support the intended
operations of each of the insurers as presented in requisite financial
plans delivered to each regulatory required to approve all facets of
the purchase of the Penn Union Companies.
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UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
(b) The following table highlights the effect of the Peninsular
reinsurance transaction described in Note 1.
MARCH 31, 1999
-------------------------------------------------
REINSURANCE
OF THE REINSURANCE
UNREINSURED PRO FORMA
MEDICARE ADJUSTMENTS
SUPPLEMENT RELATING TO
PENINSULAR BUSINESS OF TRANSFER OF
REINSURANCE UNION BANKERS CERTAIN LINES
-------------- ---------------- -------------
ASSETS:
Total Investments.............................. $(65,581) -- (65,581)
Cash........................................... -- -- --
Deferred policy acquisition costs.............. (485) -- (485)
Goodwill....................................... -- -- --
Present value of future profits................ (5,094) -- (5,094)
Other assets................................... -- -- --
-------- ------- --------
Total assets................................... $(71,160) -- (71,160)
======== ======= ========
LIABILITIES, SERIES C AND D PREFERRED STOCK AND
STOCKHOLDER'S EQUITY:
Reserve for future policy benefits............. $(61,387) -- (61,387)
Loan payable................................... -- -- --
Senior secured note payable.................... -- -- --
Dividend from Union Bankers.................... -- -- --
Deferred income tax (asset) liability.......... (3,421) -- (3,421)
Negative goodwill.............................. -- -- --
Other liabilities.............................. -- -- --
-------- ------- --------
Total liabilities.............................. (64,808) -- (64,808)
======== ======= ========
Series C and D preferred stock (including
redemption accrual thereon).................... -- -- --
-------- ------- --------
Total stockholders' equity....................... (6,352) -- (6,352)
-------- ------- --------
Total liabilities, Series C and D preferred stock
and stockholders' equity....................... $(71,160) -- (71,160)
======== ======= ========
(12) The pro forma information presents a preliminary allocation of the purchase
price that will be finalized when the purchase accounting work is
completed. It is not possible to fully estimate the reserves for future
policy benefits and certain components of claims reserves as the
assumptions have not been unlocked and analyzed for current circumstances
(e.g., current interest rates) and experience (e.g., current morbidity and
termination experience). Such assumptions cannot be determined with
certainty until the acquisition of the Penn Union Companies has been
consummated. SFAS No. 38 "Accounting for Preacquisition Contingencies of
Purchased Entities" allows a period of one year to complete the purchase
accounting allocations for business combinations. Management believes it
will complete this recalculation of reserves
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UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION -- (CONTINUED)
within the period of time. Management has provided its best estimate of
what the likely fair values of assets and liabilities for the purpose of
these pro forma financial statements; management cannot predict the
potential adjustments resulting from actual final purchase assumptions
which could result in differences from these pro forma estimates. It is
reasonably likely that the reserve amounts will increase, which difference
could be material and impact future results of operations. For example, an
increase in the final reserve amount would decrease negative goodwill and
the positive effects of its amortization on future results of operations.
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SPECIAL MEETING OF SHAREHOLDERS OF UNIVERSAL AMERICAN
TIME, DATE, PLACE AND PURPOSE
The special meeting of shareholders of Universal American will be held on
July 27, 1999 at 9:00 a.m., local time, at The Penn Club, 30 West 44th Street,
New York, New York 10036.
At the special meeting, Universal American's shareholders will be asked to
consider and vote upon the three proposals described in this proxy statement and
to conduct other business that properly comes before the special meeting or any
adjournment or postponement of the special meeting. This proxy statement and the
proxy card used at the special meeting were mailed or delivered to the
shareholders of Universal American on or about July 12, 1999.
RECORD DATE, SHAREHOLDERS ENTITLED TO VOTE AND QUORUM REQUIREMENTS
The record date for determining the shareholders of Universal American
entitled to vote upon the matters set forth in this proxy statement is the close
of business on June 23, 1999.
As of June 23, 1999, Universal American had two classes of voting
securities outstanding, namely 9,993,924 shares of common stock and 400 shares
of Series B preferred stock. Holders of the common stock are entitled to one
vote for each share registered in their names at the close of business on the
record date. As to all matters, each shareholder is entitled to one vote for
each share of common stock held or each share of common stock into which voting
preferred stock is convertible. Holders of the Series B preferred stock are each
entitled to vote together with the holders of the common stock on all matters,
other than the election of directors, as if the 400 shares of the Series B
preferred stock had been converted into 1,777,777 shares of common stock. The
holders of record of a majority of the combined voting power of the outstanding
shares of capital stock will constitute a quorum for the transaction of business
at the special meeting requiring a vote of all the outstanding voting stock of
Universal American.
All proxies that are properly completed, signed, and returned before the
special meeting will be voted. If a shareholder specifies how the proxy is to be
voted with respect to any of the proposals for which a choice is provided, the
proxy will be voted in accordance with such specifications. For Proposal No. 1,
each item of Proposal No. 2 and for Proposal No. 3, if a shareholder fails to
specify or fails to clearly indicate how the proxy is to be voted, the signed
proxy will be treated as a vote in favor. Any proxy given by a shareholder may
be revoked at any time before it is exercised by filing with the Secretary of
Universal American an instrument revoking it, by a duly executed proxy bearing a
later date, or by the shareholder attending the special meeting and expressing a
desire to vote his or her shares in person.
EFFECT OF BROKER NON-VOTES
"Broker Non-Votes" occur when a broker holding shares of common stock in
street name withholds its vote on some "non-routine" matters because the broker
has not received instructions from the beneficial owner of those shares and does
not have discretionary authority to vote on non-routine matters without specific
instructions. Brokers holding shares in street name must receive specific
instructions from the beneficial owners in order to have the authority to vote,
in person or by proxy, on non-routine matters. When a beneficial owner does not
give specific instructions to the broker, the broker, as the holder
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of record, is entitled to vote only on "routine" matters and must withhold its
votes as to all non-routine matters. Where a proxy solicitation includes a
non-routine proposal and the broker does not receive specific instructions from
the beneficial owner, the resulting proxy is considered a "limited proxy."
Shares represented by limited proxies are considered present for quorum
purposes, but are not considered present for purposes of determining the total
number of shares with voting power present with regard to a non-routine
proposal. The resulting Broker Non-Vote of a limited proxy will be treated as an
abstention on each non-routine proposal.
All of the proposals are non-routine. For Proposal No. 1, a limited proxy
will have no effect. For each item of Proposal No. 2 and for Proposal No. 3, the
effect of a limited proxy will be that Broker Non-Votes will be treated as votes
against any item of such Proposal.
NASDAQ LISTING AND ACCOUNTANTS
The common stock is listed for trading under the symbol "UHCO" on The
Nasdaq National Market, which is operated by The Nasdaq Stock Market, Inc.
A member of Ernst & Young LLP, Universal American's independent auditor, is
expected to be present at the special meeting, will have an opportunity to make
a statement, and will be available to respond to appropriate questions.
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PROPOSAL NO. 1 --THE CAPITAL Z ISSUANCE
INTRODUCTION
The board of directors believes that the best interests of Universal
American and its shareholders will be served by the issuance and sale of up to
28,888,888 shares of common stock to Capital Z, some agents and members of
management of the Penn Union Companies and some holders of preemptive rights to
purchase common stock for $3.15 per share, for a total purchase price of
approximately $91 million. If an adjustment is required under the share purchase
agreement, the number of shares of common stock to be purchased by Capital Z,
those agents and members of management and those holders of preemptive rights
may exceed 28,888,888. In that case, the shares would be sold at a price less
than $3.15 per share. Capital Z actively participated in negotiating the
acquisition agreement with PFG, completing detailed due diligence of the Penn
Union Companies, determining the appropriate capital structure for Universal
American following the acquisition, and assisting in obtaining bank financing
for the transaction. As compensation for its participation, as well as for
committing to purchase up to $91 million of common stock, Universal American
will pay $5 million to Capital Z Management, Inc., the management company of
Capital Z, of which $1.375 million will be paid in Universal American common
stock.
The amount invested by the agents and members of management of the Penn
Union Companies and the holders of preemptive rights to purchase common stock is
expected to be approximately $5.5 million. In any case, the total purchase price
to be paid by Capital Z is expected to be approximately $85.5 million.
Notwithstanding any purchase price adjustment or investment by other parties,
the aggregate proceeds from the issuance of the common stock to Capital Z, the
agents and members of management and the holders of preemptive rights will be
approximately $91 million.
Following the Capital Z Issuance and the conversion of the Convertible
Preferred Stock in conjunction with the transaction, Capital Z and its
affiliates will own a total of approximately 27,579,365 shares or approximately
65.0% of Universal American's then-outstanding common stock, which includes the
$1.375 million in common stock that may be issued to Capital Z's management
company. If all of the securities of Universal American that could be converted
or exchanged into common stock were converted or exchanged, Capital Z and its
affiliates would own 59.5% of the outstanding common stock, which would include
the $1.375 million in common stock that will be issued to Capital Z's management
company.
The board of directors has agreed to the Capital Z Issuance for the reasons
set forth in this proxy statement, and its consummation is subject to some
conditions. See "The Capital Z Issuance and the Acquisition of the Penn Union
Companies --Reasons for the Acquisition and the Capital Z Issuance" and "The
Capital Z Issuance and the Acquisition of the Penn Union Companies --Material
Terms of the Share Purchase Agreement." The simultaneous closing of the
acquisition and the senior debt financing are conditions to the closing of the
Capital Z Issuance. Shareholders are urged to read carefully all sections of
this proxy statement, including the related annexes, before voting on this
proposal.
The affirmative vote of the holders of a majority of the outstanding voting
shares of common stock on the record date voting at a meeting at which a quorum
is present must approve the Capital Z Issuance. The board of directors has
unanimously approved the Capital Z Issuance and has determined that it is fair
and in the best interests of Universal American and its shareholders.
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CONSEQUENCES IF PROPOSAL NO. 1 IS NOT APPROVED
IF THE SHAREHOLDERS DO NOT APPROVE THE CAPITAL Z ISSUANCE, THEN UNIVERSAL
AMERICAN AND AMERICAN EXCHANGE CANNOT COMPLETE THE ACQUISITION OF THE PENN UNION
COMPANIES and Universal American cannot otherwise purchase or acquire, by merger
or otherwise, any of the businesses or assets of PFG for a period of two years
after the termination of the share purchase agreement. However, you should note
that Universal American has entered into a voting agreement which provides the
holders of more than 50% of Universal American's voting stock have agreed to
vote in favor of this Proposal No. 1. IF PROPOSAL NO. 1 IS NOT APPROVED, NONE OF
THE ITEMS OF PROPOSAL NO. 2 WILL BE IMPLEMENTED EVEN IF THEY ARE APPROVED.
VOTE REQUIRED TO APPROVE PROPOSAL NO. 1
Approval of "Proposal No. 1 --The Capital Z Issuance" requires the
affirmative vote of the holders of a majority of the issued and outstanding
voting shares of common stock represented and voting at a meeting at which a
quorum is present. Abstentions will have no effect.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE
FOR THIS PROPOSAL NO. 1.
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PROPOSAL NO. 2 -- AMENDMENTS TO THE CERTIFICATE OF INCORPORATION
THE AMENDMENTS
EACH OF ITEMS (A) THROUGH (F) MUST BE VOTED ON SEPARATELY AND INDEPENDENTLY
OF THE OTHERS, BUT YOU DO NOT HAVE TO VOTE THE SAME WAY ON EACH ITEM. THE
FAILURE TO RETURN YOUR PROXY CARD WILL BE COUNTED AS A VOTE AGAINST EACH ITEM OF
PROPOSAL NO. 2.
The board of directors has approved and adopted, subject to shareholder
approval, a resolution providing for amendments to Universal American's
certificate of incorporation to:
Increase in Authorized Shares (Item (a))
(a) Increase the authorized number of shares of common stock from 20 million to
80 million shares.
Shareholder Matters (Items (b)-(e))
(b) Permit shareholders to act by written consent instead of a meeting. Written
consent would only need to be given by the number of shareholders required
to approve the action being taken by written consent.
(c) Revise Article Fourteen of Universal American's current certificate of
incorporation, the result of which is to no longer require approval by
holders of 66 2/3% of the outstanding voting stock of Universal American to
amend certain provisions of the certificate of incorporation, which means
only majority approval will be necessary for those amendments.
(d) Remove the provision in the certificate of incorporation which requires the
vote of holders of 66 2/3% of the outstanding voting capital stock to call
a special meeting of the shareholders. The board will amend the by-laws to
allow special meetings of the shareholders to be called at the request of
holders of 50% of the outstanding voting capital stock.
(e) Replace the way in which directors are elected and the length of their
terms with a system in which all directors are elected at one time each for
a term expiring at the next annual meeting. Directors are currently elected
to three-year staggered terms.
Board Matters (Item (f))
(f) Require 66 2/3% of the total number of the board of directors to approve
(i) (x) entering into any merger or consolidation in which either Universal
American or a material subsidiary is a constituent corporation or its
securities are being issued and the shareholders following such transaction
do not own, directly or indirectly, in the aggregate a majority of the
shares or equity securities of the surviving corporation of any such merger
or consolidation entitled to elect members of the board of directors, (y)
the sale of all or substantially all of the corporation's assets or
properties in a single transaction or in a series of related transactions,
or (z) the sale, lease, exchange or other disposition of any shares of a
material subsidiary or all or substantially all assets of any material
subsidiary; (ii) changing the authorized number of directors; (iii)
amending or modifying the certificate of incorporation or by-laws; (iv)
electing or removing any of the President, Chief Financial Officer or other
executive officers and amending or modifying the employment agreement to be
entered
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into with the Chief Executive Officer on the closing of the acquisition;
(v) voluntarily dissolving or winding-up the corporation or any material
subsidiary or filing with respect to the corporation or any material
subsidiary a voluntary petition in bankruptcy or for reorganization or for
the adoption of any plan or arrangement with creditors or an admission
seeking the relief therein provided under any existing or future law of any
jurisdiction relating to bankruptcy, insolvency, reorganization or relief
of debtors; and (vi) approving any dividend or other distribution in
respect of the common stock.
The proposed amended and restated certificate of incorporation, which
incorporates the amendments set forth in this Proposal No. 2, is attached as
Annex D to this proxy statement.
REASONS FOR THE AMENDMENTS AND THE PRINCIPAL EFFECTS
Item (a) is a condition to the closing of the Capital Z Issuance. In
addition, Capital Z insisted that the proposals set forth in items (b) through
(f) be presented to the shareholders.
Increase in Authorized Shares (Item (a))
At the close of business on the record date, there were 20 million shares
of common stock authorized and 9,993,924 shares of common stock outstanding and
entitled to vote. There are currently not enough authorized and unissued shares
of common stock to complete the Capital Z Issuance. In order to consummate the
Capital Z Issuance, Universal American needs to authorize at least 27.5 million
additional shares of common stock and to issue at least 34.0 million additional
shares of common stock.
This amount includes sufficient additional shares in case an event occurs
that gives rise to a per share purchase price adjustment that requires the
issuance of additional shares in excess of the 28,888,888 shares contemplated
for the Capital Z Issuance. The proposed amount also includes shares that need
to be issued upon conversion of the Series D Preferred Stock preferred stock,
the exercise of any options or warrants issued or permitted to be issued under
current compensation plans and the payment of a transaction fee to an affiliate
of Capital Z in shares of common stock. Any shares authorized but not issued in
connection with the Capital Z Issuance and the conversion of the Series D
Preferred Stock would be available for issuance in the future for purposes that
the board of directors may determine to be in the best interests of Universal
American and its shareholders. These purposes could include the issuance of
shares for cash, for acquisitions, through employee benefit programs, and for
other general corporate purposes. In many situations, prompt action may be
required that would not permit seeking shareholder approval to authorize
additional shares for a specific transaction on a timely basis. The board of
directors believes it is important that it maintain the flexibility to act
promptly in the best interests of shareholders. The terms of any future issuance
of shares of stock will depend largely on market and financial conditions and
other factors existing at the time of issuance.
Shareholder Matters (Items (b)-(e))
In negotiating the share purchase agreement and the other documents related
to the Capital Z Issuance and the acquisition of the Penn Union Companies with
Capital Z, Universal American agreed, at Capital Z's insistence, to seek
shareholder approval of the amendments to its certificate of incorporation
described in items (b) through (e).
Generally, these amendments will make it easier for Universal American's
shareholders, including Capital Z, to govern the company. By allowing
shareholders to take action by written consent, the amendment contemplated by
item (b) would give shareholders the
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ability to act without the necessity of holding a meeting of shareholders. Until
recently, New York State did not allow corporate action by the written consent
of shareholders. Now that this restriction no longer applies, Universal American
believes that it would be advantageous to amend its charter to facilitate
shareholder governance of the corporation while simultaneously making such
governance more efficient and less expensive. Shareholder action by written
consent will allow, in most cases, the majority shareholder to effect corporate
action, without having a meeting at which the other shareholders could be
present to express their views.
Item (c) would substitute a simple majority (50%) for the existing
requirement that holders of 66 2/3% of Universal American's outstanding voting
stock approve certain amendments to the certificate of incorporation. Lowering
the number of votes required to approve such amendments provides more
flexibility to Universal American and its shareholders, including Capital Z, to
change the certificate of incorporation. The amendment contemplated by item (c)
would maintain the requirement that holders of 66 2/3% of the outstanding voting
stock approve any amendment of the provision of the certificate of incorporation
which relates to transactions with interested parties.
Item (d) permits holders of 50% of the outstanding voting stock of
Universal American, instead of the current 66 2/3%, to call a special meeting.
The ability of a lower percentage of shareholders to call a special meeting may
facilitate and accelerate the shareholder approval process. Universal American's
current certificate of incorporation and by-laws both require the vote by
holders of 66 2/3% of the outstanding voting stock to call a special meeting of
the shareholders. If item (b) is approved and the 66 2/3% requirement is removed
from the certificate of incorporation, the board of directors will amend the
by-laws to allow shareholder meetings to be called by a vote of 50% of the
outstanding voting stock.
Item (e) would eliminate Universal American's staggered board of directors.
A staggered board is a common way to resist undesirable takeovers. Under the
terms of the shareholders' agreement, Universal American plans to restructure
the board to accurately represent the principal investing parties who are
involved in the Capital Z Issuance.
Board Matters (Item (f))
In its negotiations with Capital Z about the terms of the share purchase
agreement and the related documents, Universal American also agreed, at Capital
Z's insistence, to seek shareholder approval of the amendment to its certificate
of incorporation described in item (f). This amendment would make those
corporate actions identified in clauses (i) through (vi) of item (f) more
difficult to effect because such action will require 66 2/3% of the total number
of the directors instead of a simple majority of directors. As a result, two
directors that are not nominees of Capital Z would have to approve the actions
set forth in clauses (i) through (vi). However, because Capital Z will
effectively be able to select Universal American's two nominees, Capital Z will
effectively control 66 2/3% of the board. For the actions specified in clauses
(i) through (vi), a quorum of the board shall be 7 of the 9 directors on the
board.
CONSEQUENCES IF THE ITEMS OF PROPOSAL NO. 2 ARE NOT APPROVED
The additional shares of common stock authorized by the approval of item
(a) would have rights identical to those of the currently outstanding common
stock. Adoption of item (a) would not affect the rights of the holders of
currently outstanding stock, except for effects that are incidental to
increasing the number of shares of stock outstanding upon any future issuance of
newly authorized shares of stock. If Universal American's shareholders
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approve item (a), then it will become effective upon the filing of the amended
and restated certificate of incorporation of Universal American with the
Secretary of State of the State of New York. The amended and restated
certificate of incorporation will be filed immediately prior to completion of
the acquisition.
IF ITEM (A) IS NOT APPROVED, THEN THE CAPITAL Z ISSUANCE WILL NOT OCCUR AND
THE ACQUISITION OF THE PENN UNION COMPANIES WILL NOT BE CONSUMMATED. You should
note that Universal American has entered into a voting agreement under which the
holders of more than 50% of Universal American's voting stock have agreed to
vote in favor of item (a). EVEN THOUGH SHAREHOLDERS OWNING OVER 50% OF THE
OUTSTANDING VOTING STOCK OF UNIVERSAL AMERICAN HAVE AGREED TO VOTE IN FAVOR OF
ITEM (A), THE VOTING AGREEMENT DOES NOT COVER THE APPROVAL OF ITEMS (B) THROUGH
(F) WHICH ALSO RELATE TO THE CAPITAL Z ISSUANCE AND THE ACQUISITION OF THE PENN
UNION COMPANIES. IN ADDITION, ITEMS (B) THROUGH (E) REQUIRE APPROVAL BY HOLDERS
OF 66 2/3% OF THE TOTAL OUTSTANDING VOTING SHARES ENTITLED TO VOTE ON THOSE
ITEMS. ACCORDINGLY, YOUR VOTE IS PARTICULARLY IMPORTANT TO THE APPROVAL OF ITEMS
(B) THROUGH (F) AND YOU ARE REQUESTED TO VOTE ON ALL PROPOSALS IN THIS PROXY
STATEMENT, INCLUDING EACH ITEM OF PROPOSAL NO. 2, BY COMPLETING AND RETURNING
YOUR PROXY CARD.
If any of items (b) through (f) are not approved, then Universal American
will still amend the certificate of incorporation to give effect to Proposal No.
1 and those items of Proposal No. 2 that are approved. HOWEVER, IF THE
ACQUISITION OR THE CAPITAL Z ISSUANCE DO NOT CLOSE, THEN NONE OF THE AMENDMENTS
TO THE CERTIFICATE OF INCORPORATION DESCRIBED IN ITEMS (B) THROUGH (F) WILL BE
MADE, EVEN IF THEY ARE APPROVED BY THE SHAREHOLDERS.
VOTE REQUIRED TO APPROVE THE AMENDMENTS
Increase in Authorized Shares (Item (a))
Approval of Item (a) of Proposal No. 2 -- Increase in Authorized
Shares -- requires the affirmative vote of holders of 50% of the outstanding
voting shares of Universal American entitled to vote thereon. Abstentions will
have the effect of a negative vote.
Shareholder Matters (Items (b)-(e))
Approval of items (b), (c), (d) and (e) of Proposal No. 2 -- Governance
Matters -- requires the affirmative vote of holders of 66 2/3% of the total
outstanding shares entitled to vote thereon. Abstentions will have the effect of
a negative vote.
Board Matters (Item (f))
Approval of item (f) of Proposal No. 2 -- Supermajority Board
Approvals -- requires the affirmative vote of holders of 50% of the outstanding
voting shares of Universal American entitled to vote thereon. Abstentions will
have the effect of a negative vote.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE
FOR EACH ITEM OF THIS PROPOSAL NO. 2.
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PROPOSAL NO. 3 -- AMENDMENT TO
THE 1998 INCENTIVE COMPENSATION PLAN
INTRODUCTION
In 1998, Universal American's board adopted, and the shareholders approved,
the 1998 Incentive Compensation Plan. The 1998 plan superseded the Universal
Holding Corp. Incentive Stock Option Plan, the Universal American Financial
Corp. Stock Option Plan For Directors, and the Non-Qualified Stock Option Plan
for Agents and Others. Under the 1998 plan, the exercise price of the option is
determined by the board's compensation committee. However, under the terms of
the 1998 plan, the exercise price cannot be lower than fair market value on the
date of the grant (with certain exceptions).
Following the acquisition of the Penn Union Companies, a limited number of
members of management of the Penn Union Companies and Universal American will be
granted, subject to shareholder approval, options under the 1998 plan to
purchase Universal American common stock at the same price per share paid by
Capital Z in the Capital Z Issuance. At the time the acquisition agreement and
the share purchase agreement were signed on December 31, 1998, the $3.15 per
share purchase price to be paid by Capital Z in connection with the Capital Z
Issuance was greater than the per share fair market value of Universal American
common stock. However, since that date, there has been an increase in the value
of Universal American's common stock. As of the date this proxy statement is
being mailed, the per share fair market value is greater than the proposed $3.15
per share price. As a result, on the date of the option grants, the exercise
price may be lower than the fair market value of the common stock, which is
currently prohibited by the 1998 plan. In the event that stock options are
granted to employees at prices below the fair market value on the date of the
grant, an expense will be recorded for the difference between the exercise price
of the stock option and the fair market price of the stock on the date of the
grant.
The board of directors has determined that it is in the best interests of
Universal American to approve and adopt an amendment to the 1998 Incentive
Compensation Plan to allow the grant of options to purchase Universal American
common stock which may be exercised at a per share price less than the stock's
current fair market value. The options would only be granted to members of
management of the Penn Union Companies and Universal American following the
acquisition of the Penn Union Companies.
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The relevant provision of the 1998 plan is Section 6(b)(i) which governs
the price at which options granted under the plan may be exercised. The
following table compares the language of the existing Section 6(b)(i) and the
language of the proposed amended Section 6(b)(1) as it would read if Proposal
No. 3 is approved:
CURRENT SECTION 6(B)(I):
Exercise Price. The exercise price per share of Stock purchasable under an
Option shall be determined by the Committee, provided that such exercise price
shall be not less than the Fair Market Value of a share of Stock on the date of
the grant of such Option except as provided under Section 7(a) hereof.
SECTION 6(B)(I) AS AMENDED:
(i) Exercise Price. The exercise price per share of Stock purchasable
under an Option shall be determined by the Committee, provided that such
exercise price shall not be less than the Fair Market Value of a share of Stock
on the date of grant of such Option except (A) for Options granted in connection
with the consummation of the transaction contemplated by the Share Purchase
Agreement between Universal American Financial Corp. and Capital Z Financial
Services Fund II, L.P. and (B) as provided under Section 7(a) hereof.
The board recommends approval of the proposed amendment to the 1998 plan
because it believes that attracting and retaining key employees is essential to
its growth and success. In addition, the board has determined that awards of
stock options align the interests of key employees with Universal American's
interests. The acquisition of the Penn Union Companies will merge new businesses
and employees into Universal American, and the grant of options to employees in
connection with this acquisition is an important way to ensure that this
integration is successfully managed.
Therefore, we are asking you to vote to amend the 1998 plan to allow
Universal American to create a narrow exception allowing the grant options in
connection with the acquisition of the Penn Union companies at a price less than
fair market value.
CONSEQUENCES IF PROPOSAL NO. 3 IS NOT APPROVED
If the shareholders do not approve the amendment to the 1998 plan, the
board will consider the implementation of alternative incentive compensation
arrangements to attract and retain the employees to successfully manage the
integration of the Penn Union Companies.
VOTE REQUIRED TO APPROVE PROPOSAL NO. 3
Approval of the amendment to the 1998 plan requires the affirmative vote of
holders of a majority of the votes cast at the special meeting of Universal
American shareholders by the holders of the shares entitled to vote on the
proposal. Abstentions will have no effect.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE
FOR THIS PROPOSAL NO. 3.
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INTERESTS OF PERSONS INVOLVED IN THE CAPITAL Z ISSUANCE AND
THE ACQUISITION THAT MAY BE DIFFERENT FROM YOURS
General. In connection with its approval of the acquisition agreement and
the share purchase agreement and the transactions contemplated thereby, the
board concluded that it was in the best interests of Universal American's
shareholders to ensure that Universal American continues to have the dedication
of its Chief Executive Officer, Richard A. Barasch, following the Capital Z
Issuance. The board of directors also considered the interests of its officers
and directors who have existing employment agreements and severance and benefit
plans. In addition, the acquisition agreement and the share purchase agreement
contain provisions relating to the indemnification of Universal American's
directors and officers and directors' and officers' liability insurance.
Employment Agreement with Richard A. Barasch. In connection with the
acquisition, Universal American agreed in the share purchase agreement that, as
a condition to closing, an employment agreement will be entered into with
Richard A. Barasch (the "Employment Agreement"). The Employment Agreement
provides that Mr. Barasch will continue to serve as the Chairman of the Board
and Chief Executive Officer of Universal American starting after the closing of
the Capital Z Issuance for a period of three years. The Employment Agreement
also provides for an automatic one-year extension unless Universal American or
Mr. Barasch provides the other party six months' prior written notice before the
expiration of the original three-year term.
Under the Employment Agreement, Mr. Barasch is entitled to receive an
annual base salary of $475,000 and any annual increases that may be determined
in the sole discretion of the board (the "Salary"). In 1999, Mr. Barasch is
entitled to receive an annual bonus equal to: (i) for the period prior to the
closing of the Capital Z Issuance, a pro rated bonus based on Universal
American's existing executive bonus plan plus (ii) the product of the Salary
times a fraction, the numerator of which is the number of days from the closing
of the Capital Z Issuance through the end of the fiscal year and the denominator
of which is 365 and shall be based upon the achievement of goals established by
the board in good faith consultation with Mr. Barasch. If goals are not
established, the amount will be determined by reference to Universal American's
existing executive bonus plan. Commencing in the year 2000, and for each fiscal
year during the remaining employment term under the Employment Agreement, Mr.
Barasch will be eligible to earn a bonus based on criteria set by the
compensation committee of the board giving him an opportunity to earn a maximum
bonus of up to 200% of his Salary.
Mr. Barasch is entitled to an initial grant of stock options to purchase
600,000 shares under Universal American Financial Corp.'s 1998 Incentive
Compensation Plan (the "1998 Incentive Plan") on the date of the closing of the
Capital Z Issuance. The options will be granted to Mr. Barasch at the same price
per share at which Capital Z purchases shares of common stock in the Capital Z
Issuance and shall have a ten-year term. Options representing the right to
purchase 400,000 shares vest ratably over a five-year period and the remainder
will vest on the seventh anniversary of the grant date. The remainder, however,
will become immediately exercisable if Capital Z has achieved a compounded
annual internal rate of return on its equity interest in Universal American of
30% by dates set forth in the Employment Agreement. In the event that stock
options are granted to Mr. Barasch at prices below the fair market value on the
date of the grant, an expense will be recorded for the difference between the
exercise price of the stock option and the fair market price of the stock on the
date of the grant.
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Mr. Barasch does not have a formal employment contract with Universal
American that fixes his compensation or provides for a term of employment.
Instead, the board of directors of Universal American, based on the
recommendation of its compensation committee, determines all compensation paid
to Mr. Barasch, including bonuses, stock grants and options. The guidelines for
the compensation committee were established in the 1998 Incentive Compensation
Plan approved by the shareholders of Universal American in June 1998. The
primary differences between the prior arrangement and the proposed agreement are
the base salary increase from $390,000 to $475,000 and the bonus opportunity
increased from 70% of base to 200% of base. Mr. Barasch's employment contract
will have a three-year term and will include customary severance provisions.
Other Employment Agreements and Arrangements. It is anticipated that
Universal American will enter into employment agreements with some of its other
executive officers simultaneously with the consummation of the acquisition and
the Capital Z Issuance. The terms of those agreements have not been determined
as of the date of the mailing of this proxy statement. Universal American
expects that on or after the closing certain other senior members of management
of Universal American and the Penn Union Companies will be granted options to
purchase Universal American's common stock at the same purchase price per share
paid by Capital Z in the Capital Z Issuance.
Holders of Preemptive Rights. Some former holders of the Series C-1
preferred stock, which was automatically converted as described under
"-- Investment by AAM" below, have preemptive rights to purchase shares of
Universal American common stock. As a result, holders of these preemptive rights
have the right to purchase shares simultaneously with, and at the same price
offered to, Capital Z in the Capital Z Issuance. Some of these holders are
directors, affiliates and executive officers of Universal American.
Loans to Executive Officers. Executive officers of Universal American,
including former officers of the Penn Union Companies who will become officers
of Universal American at the closing, who purchase at least $20,000 of common
stock at $3.15 per share will be offered a loan by Universal American to
purchase those shares. Under the terms of the loan, Universal American will lend
these officers up to 50% of the total purchase price, the principal of which
will be due four years from the date of the closing, subject to acceleration or
cancellation under specified circumstances. Interest on the loans will be
payable annually, in arrears, at the Chase Manhattan Bank prime rate. The loan
to each officer will be secured by a pledge of the stock purchased. The loan
will be accelerated if the executive officer voluntarily terminates employment
with Universal American or its subsidiaries prior to the loan's due date. All
amounts owing under the loan, including accrued interest since the last
anniversary of the closing, will be canceled if the closing price of Universal
American's common stock for any 60-day trading period is at least twice the
closing price reported for the common stock on the day before the closing.
1998 Stock Incentive Plan. Certain officers, directors and employees were
granted options under the 1998 Incentive Compensation Plan. The Capital Z
Issuance will constitute a change of control under the 1998 Incentive
Compensation Plan and any option outstanding, except for the options granted on
or after December 8, 1998 through the closing, will vest upon the change of
control. Therefore, approximately 583,750 options will vest upon the Capital Z
Issuance. Universal American has no other material agreements which contain a
change of control provision.
Registration Rights Agreement. Under the registration rights agreement to
be executed in connection with closing of the Capital Z Issuance, WAND, AAM and
some other shareholders of Universal American will have registration rights not
held by all shareholders
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of Universal American. Some parties are entitled to a number of Demand
Registrations, at the expense of Universal American, as follows: WAND -- two,
AAM -- one and Capital Z and its affiliates -- four. In addition, Capital Z and
some of its affiliates may make an unlimited number of Demand Registrations if
the related expenses are paid by Capital Z or its affiliates. Each of WAND and
AAM and the other parties to the registration rights agreement will be allowed
to register securities when either Universal American registers securities for
its own account or when it registers securities in connection with a Demand
Registration. See "The Capital Z Issuance and the Acquisition of the Penn Union
Companies -- Material Terms of the Share Purchase Agreement -- Registration
Rights Agreement."
Shareholders' Agreement. Under the shareholders' agreement to be executed
in connection with the closing of the Capital Z Issuance, Richard A. Barasch,
Capital Z, AAM and several other parties to the shareholders' agreement will be
subject to limitations on the transfer of their shares. Those parties may be
forced to sell a portion of their shares to a third-party buyer under some
circumstances. In addition, the parties to the shareholders' agreement are
permitted to include a proportion of the shares they own in a sale to a third
party by another party to the shareholders' agreement. See "The Capital Z
Issuance and the Acquisition of the Penn Union Companies -- Material Terms of
the Share Purchase Agreement -- Shareholders' Agreement."
Investment by AAM in Universal American. On December 31, 1998, AAM
executed an agreement pursuant to which it invested (i) $2.25 million in
Universal American on that date in exchange for 22,500 shares of preferred stock
designated "Series D-1 preferred stock" and (ii) an additional $1.75 million in
Universal American as of February 2, 1999 in exchange for 17,500 shares of
preferred stock designated "Series D-2 preferred stock." The Series D-1
preferred stock and the Series D-2 preferred stock are referred to as the
"Series D Preferred Stock" in this proxy statement. Each share of Series D
Preferred Stock was sold at a price of $100 per share.
While the negotiations for the Penn Union acquisition were progressing,
management and the board of directors of Universal American decided that
additional capital was needed to support the current growth of Universal
American, especially if the acquisition of the Penn Union Companies was delayed
or ultimately abandoned.
The funds will be used to support the operations of the current Universal
American companies until the closing of the transactions described in this proxy
statement, after which the funds from the investment will be part of the working
capital of Universal American, to support the operations of all of its
subsidiaries. One million dollars of the investment has already been contributed
as capital to American Pioneer.
The terms of the Series D Preferred Stock are identical to the terms of the
Series C-1 preferred stock, except that: (a) the Series D Preferred Stock does
not have any voting rights, except to the extent required by law, (b) Universal
American's obligation to issue common stock upon the conversion of the Series D
Preferred Stock is subject to compliance with any applicable requirements of the
insurance laws relating to the acquisition of voting securities of an insurance
company of each state in which a subsidiary of Universal American is domiciled,
and (c) the conversion price of the Series D-1 preferred stock and the Series
D-2 preferred stock is $2.70 rather than $2.375 per share. If the Capital Z
Issuance is consummated, or if the conversion takes place in connection with
another sale contracted in 1999 by Universal American of common stock or
securities convertible into common stock having at least 30% of the voting power
after the sale, the Series D-2
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preferred stock will be mandatorily converted into common stock at a conversion
price equal to the price per share at which such stock or securities are sold by
Universal American.
At the time the sale of Series D-1 and D-2 preferred stock to AAM was
negotiated and signed in December of 1998, the price of Universal American
common stock ranged between $2.0625 and $2.875 per share, and there was no
certainty that the Penn Union acquisition agreement would be signed or
consummated. The price and other terms of the AAM investment were negotiated on
an arms length basis, taking into account all relevant factors at that time,
including the then-current price of the Universal American common stock, the
operating condition of Universal American, and the possibility that the
acquisition of the Penn Union Companies would be consummated. Universal American
paid AAM Capital Partners, Inc., an affiliate of AAM, a fee of $50,000 to
structure the Series D Preferred Stock offering.
The AAM investment was made in two tranches. The first tranche consisted of
the Series D-1 preferred stock, and the second consisted of the Series D-2
preferred stock. The Series D-1 investment was in the amount of $2.25 million
and closed on December 31, 1998. The Series D-1 preferred stock has a conversion
price of $2.70 per share, subject to anti-dilution adjustments. The Series D-2
investment was in the amount of $1.75 million and closed on February 2, 1999.
The Series D-2 preferred stock will convert at $3.15 per share (Capital Z's
price) if the Capital Z Issuance closes. If the Capital Z Issuance is abandoned,
the conversion price will revert to $2.70.
As of the date of this proxy statement, all of the Series C-1 preferred
stock and Series C-2 preferred stock has been automatically converted into
common stock. Since the conversion of the Series D Preferred Stock would result
in the holder of these shares owning more than 10% of Universal American's
outstanding voting stock, which would require regulatory approval, under the
terms of the Series D Preferred Stock, the conversion will not be effective
until the required regulatory approval is obtained or becomes unnecessary. The
Series D Preferred Stock will be converted as a result of the same conversion
right as the Series C-1 and Series C-2 preferred stock. The closing of the
Capital Z Issuance will satisfy the latter condition, so that if the Capital Z
Issuance is consummated, the conversion of the Series D Preferred Stock will
take place concurrently with the closing of the Capital Z Issuance.
Other Arrangements with Interested Parties. The current consulting
arrangement between Universal American and Barco Associates, Inc. under which
Barco Associates was paid $100,000 in 1998 will be extended to December 31,
2000. Barco Associates is a company wholly-owned by Marvin Barasch who is a
director of Universal American. In addition, upon the consummation of the
Capital Z Issuance, Marvin Barasch will step down as a director and become a
non-voting observer of the board of directors. The Employment Agreement, dated
December 9, 1997 between American Progressive Life and Health Insurance Company
of New York and Marvin Barasch will be extended through December 31, 2000.
The current consulting arrangement with Robert F. Wright Associates, Inc.,
a company wholly-owned by Robert F. Wright, a director of Universal American,
will continue. Under the arrangement with Robert F. Wright Associates, Robert F.
Wright receives payments and will continue to receive payments for services
performed by him in his capacity as chairman of the audit committee of Universal
American. Those payments totalled $50,486 in 1998.
The financial advisory contract between Universal American and WAND
Partners, Inc., an affiliate of WAND, will be terminated. Pursuant to such
agreement, WAND Partners, Inc.
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will continue to receive its agreed-upon annual fee of $100,000, reduced by any
directors' fees paid to the director designated by WAND, through December 31,
1999.
Universal American has a variety of relationships with Chase which are
described in this proxy statement. See "The Capital Z Issuance and the
Acquisition of the Penn Union Companies -- Reasons for the Acquisition and the
Capital Z Issuance."
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SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of June 23, 1999 as
to the number of shares of common stock beneficially owned by (i) each person
known by Universal American to own beneficially more than 5% of Universal
American's common stock ("5% Holder"), (ii) each person who is a director of
Universal American or a nominee for election as a director, and (iii) all
persons as a group who are directors and officers of Universal American, and as
to the percentage of outstanding shares held by them on that date. Unless
otherwise indicated, each such beneficial owner holds the sole voting and
investment power with respect to shares of common stock outstanding. Universal
American's common stock and Series B preferred stock are the only classes of
voting securities outstanding. WAND owns all of the issued and outstanding
Series B preferred stock. Universal American's outstanding Series D Preferred
Stock will be converted into common stock at the closing of the transactions.
BENEFICIAL OWNERSHIP(A)
-------------------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER STATUS SHARES OF CLASS
- ------------------------------------ --------- ------------------ ---------
Barasch Associates Limited
Partnership (BALP).............................. 5% Holder 3,476,828 (b)(c) 28.9%
c/o Richard Barasch
Six International Drive
Rye Brook, NY 10573
Wand/Universal American Investments I L.P. and
Wand/Universal American
Investments II L.P.............................. 5% Holder 1,777,777 (c)(d) 15.2%
630 Fifth Avenue
New York, NY 10111
UAFC, L.P....................................... 5% Holder 2,399,414 (e) 24.1%
30 North LaSalle Street
Chicago, IL 60602
Midland National Life Insurance Company......... 5% Holder 671,807 6.8%
One Midland Plaza
Sioux Falls, SD 57193
Marvin Barasch.................................. Director 218,432 (f) 2.2%
Six International Drive
Rye Brook, NY 10573
Michael Barasch................................. Director 73,553 (g) *
11 Park Place
New York, NY 10007
Richard A. Barasch.............................. Executive 6,559,642 (h) 54.6%
Six International Drive Officer/
Rye Brook, NY 10573 Director/
5% Holder
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BENEFICIAL OWNERSHIP(A)
-------------------------------
NUMBER OF PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER STATUS SHARES OF CLASS
- ------------------------------------ --------- ------------------ ---------
David F. Bolger................................. Director/ 508,500 (i) 5.1%
79 Chestnut Street 5% Holder
Ridgewood, NJ 07450
Gary W. Bryant.................................. Executive 374,572 (j) 3.7%
600 Courtland Street Officer
Orlando, FL 32084
Bertram Harnett................................. Director/ 6,679,091 (k) 55.2%
150 East Palmetto Park Road 5% Holder
Boca Raton, FL 33432
Mark M. Harmeling............................... Director 16,500 (i) *
108 Chestnut Street
North Reading, MA 01864
Walter L. Harris................................ Director 18,500 (l) *
320 West 57th Street
New York, NY 10019
Harry B. Henshel................................ Director 102,000 (i) 1.0%
One Bulova Avenue
Woodside, NY 11377
Patrick J. McLaughlin........................... Director 40,500 (m) *
100 Chetwynd Drive
Rosemont, PA 19010
Richard Veed.................................... Director 4,500 (n) *
30 North LaSalle Street
Chicago, IL 60602
Robert A. Waegelein............................. Executive 261,030 (o) 2.6%
Six International Drive Officer
Rye Brook, NY 10573
William E. Wehner............................... Executive 573,030 (p) 5.6%
600 Courtland Street Officer/
Orlando, FL 32804 5% Holder
Robert F. Wright................................ Director 206,946 (q) 2.1%
57 West 57th Street
New York, NY 10019
Directors and Officers as a Group (17
persons)........................................ 8,773,673 (r) 61.8%
- -------------------------
* Percent of class is less than 1%.
(a) The SEC has defined "beneficial owner" of a security to include any person
who has or shares voting power or investment power with respect to any such
security or who has the right to acquire beneficial ownership of any
security within 60 days. The percentages shown for each person or persons
are therefore based on the 9,993,924 shares of common stock outstanding as
of June 23, 1999 plus common stock issuable with respect to options and
warrants presently exercisable and convertible preferred stock presently
convertible held by such person or persons.
(b) Includes 2,065,419 shares that would be received upon the exercise of
340,036 warrants registered under the Exchange Act of 1934 and 1,725,383
warrants not registered under the Exchange Act of 1934. Richard
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Barasch serves as trustee of the Barasch Universal Trust which holds shares
of the general partner of BALP. Richard Barasch, through his direct
ownership in the general partner of BALP, together with his control of the
Barasch Universal Trust, which also has an ownership interest in BALP's
general partner, has the voting power with respect to the shares of
Universal American held by BALP.
(c) BALP and Wand have entered into an agreement, which provides that as long as
Wand holds common stock issued from conversion of its Series B preferred
stock, BALP will vote its shares for the election of one director nominated
by Wand and Wand will vote its shares for BALP's nominees for the balance of
the board positions.
(d) Represents the amount of common stock issuable upon conversion of the Series
B preferred stock held by Wand.
(e) Included 1,388,889 shares of common stock issuable upon conversion of the
Series D-1 and D-2 preferred stock held by UAFC, L.P.
(f) Includes 25,600 shares of common stock that would be received upon the
exercise of 20,000 stock options and 5,600 warrants held by Marvin Barasch.
Excludes any indirect ownership through BALP of which Marvin Barasch is a
limited partner.
(g) Includes 8,500 shares of common stock that would be received upon the
exercise of 8,500 stock options held by Michael Barasch. Excludes any
indirect ownership through BALP of which Michael Barasch is a limited
partner.
(h) Includes 276,100 shares of common stock that would be received upon the
exercise of 273,000 stock options and 3,100 warrants held by Richard
Barasch. Includes 5,741,666 shares of voting stock beneficially owned
pursuant to an irrevocable limited proxy given by some shareholders of
Universal American to Richard Barasch and Bertram Harnett to vote in favor
of some matters set forth in this proxy statement. Richard Barasch and
Bertram Harnett share voting power with each shareholder who granted the
irrevocable proxy. Excludes any indirect ownership through BALP. Richard
Barasch serves as trustee of the Harnett Family Trust which holds shares of
the general partner of BALP. Richard Barasch, through his direct ownership
in the general partner of BALP, together with his control of the Barasch
Universal Trust, which also has an ownership interest in BALP's general
partner, has the voting power with respect to the shares of Universal
American held by BALP. Richard Barasch disclaims beneficial ownership of
77,800 shares of common stock held directly by, or in trust for, members of
his immediate family.
(i) Includes 8,500 shares of common stock that would be received upon the
exercise of 8,500 stock options.
(j) Includes 190,000 shares of common stock that would be received upon the
exercise of 190,000 stock options.
(k) Includes 32,595 shares of common stock that would be received upon the
exercise of 12,095 warrants and 20,500 stock options held by Bertram
Harnett. Includes 6,222,291 shares of voting stock beneficially owned
pursuant to an irrevocable limited proxy given by some shareholders of
Universal American to Richard Barasch and Bertram Harnett to vote in favor
of some matters set forth in this proxy statement. Richard Barasch and
Bertram Harnett share voting power with each shareholder who granted the
irrevocable proxy. Includes 339,901 shares of common stock that would be
received upon the exercise of 339,901 warrants and 50,000 shares of common
stock. The 339,901 warrants and the 50,000 shares are held in an irrevocable
trust for the benefit of the Harnett family (the "Barasch Universal Trust")
of which Richard Barasch is trustee. Bertram Harnett disclaims beneficial
ownership of such warrants and shares.
(l) Excludes any indirect ownership through BALP of which Mr. Harris is a
limited partner.
(m) Includes 6,500 shares of common stock that would be received upon the
exercise of 6,500 stock options.
(n) Includes 4,500 shares of common stock that would be received upon the
exercise of 4,500 warrants. Does not include any indirect ownership through
UAFC, L.P. by Mr. Veed who is a partner of AAM Capital Partners, L.P., in a
partnership that owns an interest in UAFC, L.P.
(o) Includes 140,000 shares of common stock that would be received upon the
exercise of 140,000 stock options.
(p) Includes 234,000 shares of common stock that would be received upon the
exercise of 140,000 stock options and 94,000 warrants held by Mr. Wehner.
(q) Includes 15,000 shares of common stock that would be received upon the
exercise of 15,000 stock options held by Mr. Wright. Excludes any indirect
ownership through BALP of which Mr. Wright is a limited partner.
(r) Includes the 3,476,828 shares of common stock beneficially owned by BALP
and the shares of common stock beneficially owned by Richard Barasch and
Bertram Harnett pursuant to the irrevocable limited proxy.
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EXECUTIVE COMPENSATION
In connection with the Amendment to Universal American's 1998 Incentive
Compensation Plan, we are providing you with the following information about
Universal American's compensation of directors and executive officers.
REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION
The compensation committee of the board of directors reviews and approves
the compensation of Universal American's executive officers. The committee is
made up of four independent, non-employee members of the board. The objective of
Universal American's compensation program is to provide a total compensation
package that will enable Universal American to:
- attract, motivate and retain outstanding individuals;
- align the financial interests of those individuals with the interests of
Universal American's shareholders;
- reward those individuals for increasing levels of profit and shareholder
value; and
- encourage management's stake in the long-term performance and success of
Universal American.
In order to achieve these goals, the committee establishes a competitive
and appropriate total compensation package for each executive officer,
consisting primarily of four components -- base salary, annual bonus, stock
options and restricted stock awards. The committee conducts an annual review of
compensation relative to other life insurance companies and companies of similar
size in the financial industry.
Base Salaries
The committee establishes base salaries each year at a level intended to be
within the competitive market range of similar companies. Other factors
considered in determining base salary include the responsibilities of the
executive officer, experience, length of service and individual performance.
During fiscal year 1998, base salaries of the executive officer group increased
an average of 9.8%. The committee believes that the base salaries of the current
executive officers are within or below the competitive market range of similar
companies.
Cash Bonuses
The committee awards cash bonuses to the executive officers. The criteria
used to determine cash bonus levels include operating profits, new business
production and expenses relative to pre-determined budgets. The executive
officer group's fiscal year 1998 cash bonus was 13.9% of the group's annual base
salary.
Stock Options and Restricted Stock
An important component of Universal American's executive compensation
program is the award of stock options and restricted stock. Restricted stock is
stock in Universal American which the executive officer must hold for a period
of time before it can be sold. The committee believes that stock options and
restricted stock motivate the executive officers to remain focused on the
overall long-term performance of Universal American. Generally, the award of a
stock option creates no financial benefit to the executive unless there is
appreciation in the price of Universal American's stock after the award date.
The
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financial benefit of an award of restricted stock can not be realized by the
executive officer until the restriction is lifted from the stock, generally a
minimum of two years. The total number of restricted stock and stock options
awarded to the executive officer group during fiscal year 1998 amounted to
51,000 and 423,000, or 0.7% and 5.7% of the average outstanding shares of
Universal American during 1998.
The Compensation Committee
Mark Harmeling, Chairman
Walter Harris
Richard Veed
Robert Wright
PERFORMANCE GRAPH
The performance graph below compares Universal American's cumulative total
shareholder return on its common stock for the five year period between December
31, 1993 to December 31, 1998, with the cumulative total returns of The Nasdaq
Stock Market as measured by the Nasdaq Stock Market Total Return Index ("NSM")
and the Nasdaq Insurance Stocks as measured by the Nasdaq Insurance Stocks Total
Return Index ("NIS"). The comparison for each period assumes that $100 was
invested on December 31, 1993 in each of Universal American's common stock, the
stocks included in the NSM and the stocks included in the NIS.
PERFORMANCE GRAPH
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MANAGEMENT
The following table shows the total compensation paid by Universal American
and its subsidiaries to Universal American's Chief Executive Officer and the
three most highly compensated executive officers of Universal American and its
subsidiaries for services rendered in all capacities to Universal American and
its subsidiaries for the fiscal years ended December 31, 1998, 1997 and 1996:
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
ANNUAL COMPENSATION -----------------------------------------
--------------------------------- SECURITIES
OTHER RESTRICTED UNDERLYING
ANNUAL STOCK STOCK ALL OTHER
SALARY BONUS COMPENSATION AWARDS(1) OPTIONS COMPENSATION(2)
NAME, AGE AND PRINCIPAL POSITION YEAR ($) ($) ($) ($) (#) ($)
- -------------------------------- ---- -------- ------- ------------ ---------- ---------- ---------------
Richard A. Barasch (45)................. 1998 $375,000 $60,000 -- $60,000 168,000 $3,200
President and Chief Executive Officer 1997 325,000 30,000 -- 27,500 25,000 2,375
1996 312,000 5,000 -- 14,000 40,000 2,350
Gary W. Bryant (49)..................... 1998 225,000 27,000 -- 27,500 115,000 3,200
Senior Vice President of Universal
American and 1997 212,000 25,000 -- 22,000 20,000 2,120
President of American Pioneer 1996 203,000 3,000 -- 7,000 30,000 2,030
William E. Wehner (55).................. 1998 165,000 20,000 -- 20,000 70,000 3,200
Exec. Vice President & Chief Operating
officer, 1997 155,000 15,000 -- 13,750 15,000 1,550
of American Progressive 1996 140,000 3,000 -- 7,000 30,000 1,400
Robert A. Waegelein(38)................. 1998 150,000 20,000 -- 20,000 70,000 3,000
Sr. Vice President & Chief 1997 141,000 15,000 -- 13,750 15,000 1,410
Financial Officer 1996 135,500 3,000 -- 7,000 30,000 1,355
- -------------------------
(1) The executive officers were awarded shares of restricted stock of Universal
American on various dates. These shares are shown at the fair market value
of Universal American's common stock on the date of the award.
(2) The amounts in this column represent the value of common stock of Universal
American contributed by Universal American under the 401(k) plan to match
contributions to the plan on behalf of the executive officer.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information about options to purchase
Universal American common stock granted to the executive officers named in the
summary compensation table during 1998:
NUMBER OF PERCENT OF
SECURITIES TOTAL
UNDERLYING OPTIONS EXERCISE OF
OPTIONS GRANTED TO BASE
GRANTED EMPLOYEES PRICE
NAME (#) IN 1998 ($/SHARE) EXPIRATION DATE
---- ---------- ---------- ----------- -------------------
Richard A. Barasch.................. 168,000 18.36% 2.25-2.625 5/28/08;12/8/08
Gary W. Bryant...................... 115,000 12.57% 2.25-2.625 5/28/08;12/8/08
William E. Wehner................... 70,000 7.65% 2.25-2.625 5/28/08;12/8/08
Robert A. Waegelein................. 70,000 7.65% 2.25-2.625 5/28/08;12/8/08
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AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth information about options to purchase
Universal American common stock exercised by the executive officers named in the
summary compensation table and the number and value of options each of those
officers held on December 31, 1998:
NUMBER OF SECURITIES VALUE OF UNEXERCISE
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END(2)
ACQUIRED ON VALUE (#) ($)
EXERCISE REALIZED --------------------------- ---------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ---------- ----------- ------------- ----------- -------------
Richard A. Barasch....... 50,000 $39,750(1) 92,500 180,500 $ 19,900 $ 10,090
Gary W. Bryant........... 50,000 46,750(1) 65,000 125,000 22,500 13,365
William E. Wehner........ 20,000 18,700(1) 62,500 77,500 22,500 7,650
Robert A. Waegelein...... 20,000 18,700(1) 62,500 77,500 22,500 7,650
- ---------------
(1) Based on a closing price of $2.375 for Universal American's common stock on
the exercise date, July 16, 1998.
(2) Calculated using the market price on December 31, 1998 of $2.625 per share
and exercise prices ranging between $2.00 and $3.33 for exercisable options
and ranging between $2.25 and $3.03 for unexercisable options.
DIRECTOR COMPENSATION
Directors who are not employees of Universal American receive a fee of $500
for each meeting of the board of directors or committee meeting attended, unless
the committee meeting is held immediately before or after the board meeting. In
that case, a non-employee director will receive a $250 fee for the committee
meeting. In addition, directors are reimbursed for their travel and related
expenses in connection with serving as board members.
In 1998, each director was eligible to be granted options under the 1998
plan. On May 28, 1998, each eligible director was granted options to purchase
4,500 shares of Universal American common stock at an exercise price of $2.62
for a total of 40,500 options granted. In addition, although the 1998 plan
superceded all other incentive compensation plans, options previously granted
under the Stock Option Plan for Directors, adopted in 1992, will remain
outstanding in accordance with their terms. Under the directors' plan, options
were granted on June 30th of each year to each eligible director in office at
that time at the rate of 1,000 options for each year of service on the board
since the last grant. Options under this plan are exercisable one year after
grant.
The following is a list of other arrangements under which directors were
compensated during 1998 for any services provided as a director:
- Universal American and Wand Partners, Inc. entered into a financial
advisory agreement, under which the Wand affiliate is to render advisory
services to Universal American. Wand Partners will be paid a fee of
$100,000 per year for its services as long as Wand owns 500,000 shares of
common stock, or common stock equivalent. The fee will be reduced by any
directors' fees paid to the director designated by Wand.
- Universal American paid $50,000 in fees to AAM Capital Partners, Inc., an
affiliate of AAM, for its structuring of the Series D Preferred Stock
offering.
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105
- Bertram Harnett, a director of Universal American, is a shareholder in
Harnett, Lesnick & Ripps P.A., which was paid $317,864 in 1998 for its
legal services to, as well as reimbursement for disbursements made on
behalf of Universal American.
- Robert F. Wright, a director of Universal American, is the sole
shareholder and president of Robert F. Wright Associates, Inc., which has
a consulting arrangement with Universal American. Through this consulting
arrangement, Mr. Wright was paid $50,486 in connection with his services
as Chairman of the Audit Committee, as well as reimbursement for
disbursements made on behalf of Universal American.
- Marvin Barasch, Chairman Emeritus and a director of Universal American,
is the sole shareholder of Barco Associates Inc. of New York City, which
was paid $100,000 pursuant to a consulting agreement that expires on
December 31, 1999.
For additional information about these and other transactions involving
related parties, see "Interests of Persons Involved in the Capital Z Issuance
and the Acquisition that may be Different From Yours."
99
106
MARKET FOR UNIVERSAL AMERICAN'S COMMON EQUITY AND
RELATED MATTERS
PRICE RANGE OF COMMON STOCK
Universal American's common stock has been traded in the over-the-counter
market and quoted on Nasdaq under the symbol UHCO since May 12, 1983. The
following table sets forth the high and low sales prices per share of common
stock reported on the Nasdaq National Market for the periods indicated:
COMMON STOCK
-----------------
HIGH LOW
---- ---
1996
First Quarter............................................... $ 3 1/8 $ 2 1/4
Second Quarter.............................................. 3 1/8 2
Third Quarter............................................... 3 1/8 2 31/32
Fourth Quarter.............................................. 2 11/16 1 1/2
1997
First Quarter............................................... 2 31/64 1 3/4
Second Quarter.............................................. 2 5/8 1 3/4
Third Quarter............................................... 2 5/8 1 7/8
Fourth Quarter.............................................. 3 1/4 2
1998
First Quarter............................................... 3 2 3/8
Second Quarter.............................................. 2 15/16 2 5/16
Third Quarter............................................... 2 7/8 2 1/8
Fourth Quarter.............................................. 2 7/8 2
1999
First Quarter............................................... 4 1/4 2 13/16
Second Quarter.............................................. 4 1/4 3
Third Quarter (through July 8th)............................ 4 1/2 4
As of June 23, 1999, there were approximately 2,000 holders of the common
stock. On July 8, 1999, the last reported bid and ask sales prices for the
common stock were $4 1/8 and $4 1/4.
DIVIDENDS
Universal American has neither declared nor paid dividends on its common
stock and no dividends are likely to be paid in the foreseeable future. Any
future decision to pay dividends will be made by the board of directors in light
of conditions then existing, including Universal American's results of
operations, financial condition and requirements, loan covenants, insurance
regulatory restrictions, business conditions and other factors. In addition, the
ability of Universal American to pay cash dividends, if and when it should wish
to do so, may depend on the ability of its subsidiaries to pay dividends to
Universal American.
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107
UNIVERSAL AMERICAN FINANCIAL CORP.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following selected consolidated financial information is derived from
consolidated financial statements of Universal American. The financial
statements as of December 31, 1996, 1997, and 1998 and for each of the three
years in the period ended December 31, 1998 have been audited by Ernst & Young
LLP, independent auditors. The selected financial information as of March 31,
1999 and for the three months ended March 31, 1998 and March 31, 1999 has been
derived from unaudited consolidated financial statements of Universal American,
but includes all adjustments, including normal recurring accruals, that
Universal American considers necessary for fair presentation of the results of
operations for the periods presented. The results for the three months ended
March 31, 1999 are not necessarily indicative of the results that may be
expected for Universal American's fiscal year ended December 31, 1999. The
financial statements as of December 31, 1994 and 1995 and for each of the two
years in the period ended December 31, 1995 have been audited by KPMG LLP,
independent auditors. The information should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included in the most recent annual and quarterly reports filed with
the SEC, and the more comprehensive historical financial information included as
Annex E to this proxy statement. See "Universal American Financial Corp.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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108
UNIVERSAL AMERICAN FINANCIAL CORP.
INCOME STATEMENT INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1999
----------- -----------
(UNAUDITED) (UNAUDITED)
Direct premium and policyholder fees........................ $31,405 $32,066
Reinsurance premium assumed................................. 203 249
Reinsurance premium ceded................................... (21,124) (21,891)
------- -------
Net premium and other policyholder fees................... 10,484 10,424
Net investment income....................................... 2,708 2,799
Realized gains on investments............................... (26) 47
Fee income.................................................. 633 569
Other income................................................ 16 11
------- -------
Total revenues.......................................... 13,815 13,850
------- -------
Total benefits, claims and other deductions................. 13,040 12,783
------- -------
Operating income before taxes............................... 775 1,067
Net income after taxes...................................... 533 711
Net income applicable to common shareholders(1)............. $ 425 $ 531
======= =======
Earnings per share:
Basic..................................................... $ 0.06 $ 0.07
======= =======
Diluted................................................... $ 0.04 $ 0.05
======= =======
YEAR ENDED DECEMBER 31,
------------------------------------------------
1994 1995 1996(2) 1997(3) 1998
------- ------- ------- ------- --------
Direct premium and policyholder fees................ $40,652 $46,145 $55,287 $99,339 $131,044
Reinsurance premium assumed......................... 13,564 8,866 10,522 998 998
Reinsurance premium ceded........................... (13,892) (18,200) (25,664) (62,623) (89,546)
------- ------- ------- ------- --------
Net premium and other policyholder fees........... 40,324 36,811 40,145 37,714 42,496
Net investment income............................... 9,239 8,945 9,850 10,023 10,721
Realized gains on investments....................... 42 674 240 1,133 256
Fee income.......................................... 4,126 3,137 2,872 2,368 2,553
Other income........................................ 219 244 280 93 63
------- ------- ------- ------- --------
Total revenues.................................. 53,950 49,811 53,387 51,331 56,089
------- ------- ------- ------- --------
Total benefits, claims and other deductions......... 51,712 47,161 53,014 48,119 52,157
------- ------- ------- ------- --------
Operating income before taxes....................... 2,238 2,650 373 3,212 3,932
Net income after taxes.............................. 2,228 2,642 104 2,119 2,607
Net income applicable to common shareholders(1)..... $ 3,173 $ 2,642 $ 104 $ 1,870 $ 2,174
======= ======= ======= ======= ========
Earnings per share:
Basic............................................. $ 0.59 $ 0.42 $ 0.01 $ 0.26 $ 0.29
======= ======= ======= ======= ========
Diluted........................................... $ 0.37 $ 0.25 $ 0.01 $ 0.18 $ 0.20
======= ======= ======= ======= ========
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BALANCE SHEET INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
AS OF DECEMBER 31, AS OF
---------------------------------------------------- MARCH 31,
1994 1995 1996 1997 1999 1999
-------- -------- -------- -------- -------- ---------
Total cash and investments... $125,487 $135,603 $144,681 $159,429 $164,674 $158,382
Total assets................. 164,862 182,994 242,237 272,575 283,302 284,215
Policyholder account
balances................... 108,777 118,609 134,539 145,085 154,886 156,196
Series C preferred stock..... -- -- -- 5,168 5,168 5,168
Series D preferred stock..... -- -- -- -- 2,250 4,000
Series B preferred stock..... 4,000 4,000 4,000 4,000 4,000 4,000
Stockholders' equity......... 15,321 24,114 22,079 25,706 28,318 28,403
Stockholders' equity per
share of common stock
Basic(4)................ $ 1.83 $ 2.89 $ 2.53 $ 2.96 $ 3.18 $ 3.14
Diluted(5).............. $ 1.66 $ 2.30 $ 2.12 $ 2.39 $ 2.59 $ 2.55
- -------------------------
(1) After provision for Series A preferred stock dividends of $576,000 for the
year ended December 31, 1994, Series C preferred stock dividends of $250,000
and $433,000 for the years ended December 31, 1997 and 1998, respectively,
and Series C preferred stock and Series D Preferred Stock dividends of
$180,000 for the three months ended March 31, 1999.
(2) Includes the results of the First National Life Insurance Company block of
business since its acquisition on October 1, 1996. See "Universal American
Financial Corp. Management's Discussion and Analysis of Financial Condition
and Results of Operations".
(3) Includes the results of American Exchange Life Insurance Company since its
acquisition on December 1, 1997. See "Universal American Financial Corp.
Management's Discussion and Analysis of Financial Condition and Results of
Operations".
(4) Basic stockholders' equity per share of common stock represents
stockholders' equity less the financial statement value of Series B
preferred stock divided by outstanding shares of common stock.
(5) Diluted stockholders' equity per share of common stock represents
stockholders' equity plus the financial statement value of the Series C
preferred stock, redemption accrual on the Series C preferred stock, the
Series D Preferred Stock, the proceeds from the exercise of outstanding
options and warrants divided by outstanding shares of common stock plus the
stock issued pursuant to the conversion of the Series B preferred stock,
Series C preferred stock and Series D Preferred Stock and the exercise of
the options and warrants outstanding.
103
110
UNIVERSAL AMERICAN FINANCIAL CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Universal American is an insurance holding company representing the
strategic combination of three life insurance companies, American Progressive,
American Pioneer and American Exchange, and WorldNet. Management is focused on
growth, both internal, through aggressive marketing and product development
programs directed at specialty life and accident and health insurance products,
and by seeking further acquisitions of insurance companies or blocks of
business. It also has embarked on a program to streamline operations through
consolidation of administrative and processing facilities.
Universal American cautions readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this report
and in any other oral or written statements, either made by, or on behalf of
Universal American, whether or not in future filings with the 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
Universal American's products, investment spreads or yields, or the earnings or
profitability of Universal American's activities.
Forward-looking statements are based upon estimates and assumptions that
are subject to significant business, economic and competitive uncertainties,
many of which are beyond Universal American's control and are subject to change.
These uncertainties can affect actual results and could cause actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, Universal American. Whether or not actual results differ
materially from forward-looking statements may depend on numerous foreseeable
and unforeseeable events or developments, some of which may be national in
scope, such as general economic conditions and interest rates. Some of these
events may be related to the insurance industry generally, such as pricing
competition, regulatory developments and industry consolidation. Others may
relate to Universal American specifically, such as credit, volatility and other
risks associated with Universal American's investment portfolio, and other
factors. Universal American disclaims any obligation to update forward-looking
information.
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111
RESULTS OF OPERATIONS
Three Months Ended March 31, 1999
For the three months ended March 31, 1999, Universal American earned net
income after federal income taxes of $0.5 million or $0.05 per share compared to
$0.4 million or $0.04 per share in the prior year. Operating income before
federal income taxes amounted to $1.1 million for the three months ended March
31, 1999 compared to $0.8 million in the prior year.
REVENUES. Total revenues increased approximately $35,000 to approximately
$13.8 million for the three months ended March 31, 1999, compared to total
revenues of approximately $13.8 million in the prior year.
Gross premium and policyholder fees earned and reinsurance assumed
In the three months ended March 31, 1999, Universal American's gross
premium and policyholder fees earned, including reinsurance assumed, amounted to
$32.3 million, a $0.7 million increase over the $31.6 million amount in 1998.
This gross premium increase is primarily related to Universal American's
currently marketed programs which increased as follows:
1999 TOTAL
PREMIUM INCREASE PREMIUM EARNED
PRODUCT ---------------- --------------
- ------- (IN MILLIONS) (IN MILLIONS)
Senior market accident & health.................... $3.90 $ 7.61
Senior market life insurance....................... 0.12 0.86
Specialty life insurance........................... 0.24 0.55
Specialty medical.................................. 0.71 1.73
Major medical...................................... 0.09 1.55
----- ------
Totals............................................. 5.09 12.30
===== ======
These increases totaling $5.1 million were offset by the decrease of $1.1
million in premiums related to American Exchange. Total premiums of American
Exchange were $3.8 million for the three months ended March 31, 1999. In
addition, gross earned premiums decreased on the following products which have
been terminated and are not currently marketed by Universal American as follows:
1999 TOTAL
PREMIUM DECREASE PREMIUM EARNED
PRODUCT ---------------- --------------
- ------- (IN MILLIONS) (IN MILLIONS)
First National assumed business.................... $ 1.75 $10.57
Dallas General assumed business.................... 1.06 2.18
Non-marketed life insurance........................ 0.47 1.36
Non-marketed accident & health..................... 0.01 1.22
Group life insurance............................... 0.01 0.85
------ ------
Totals............................................. $ 3.30 $16.18
====== ======
Reinsurance premiums ceded
While Universal American was able to increase its gross premium revenue
from its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the three months ended
March 31, 1999 amounted to
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112
$21.9 million, a $0.8 million increase from the 1998 amount of $21.1 million.
Details of the changes in reinsurance premiums ceded are as follows:
CEDED PREMIUM 1999 TOTAL
INCREASE (DECREASE) PREMIUM CEDED
PRODUCT ------------------- -------------
- ------- (IN MILLIONS) (IN MILLIONS)
American Exchange products....................... $(1.08) $ 2.82
Dallas General assumed business.................. (0.24) 2.18
Senior market accident & health.................. 2.58 4.28
Senior market life insurance..................... 0.24 0.59
Specialty life insurance......................... 0.27 0.49
Specialty medical................................ 0.66 2.35
First National assumed business.................. (1.80) 8.12
Other lines...................................... 0.14 1.06
------ ------
Totals........................................... $ 0.77 $21.89
====== ======
Investment related revenue
Net investment income of Universal American increased $91,000 to $2.8
million for the three months ended March 31, 1999, compared to $2.7 million in
1998. This increase is attributable to the increase in invested assets
outstanding during 1999 compared to 1998. Realized gains on investments amounted
to $47,000 for the three months ended March 31, 1999 compared to a loss of
$27,000 in 1998. Included in the 1999 amount is the $60,000 write down of
certain securities determined by management to be permanently impaired.
Other revenue
Fee income showed a slight decrease of $65,000 to $0.6 million for the
three months ended March 31, 1999.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions decreased approximately $0.2 million to $12.8 million for the three
months ended March 31, 1999, compared to $13.0 million for the three months
ended March 31, 1998.
Claims and other benefits increased $49,000 to $6.9 million for the three
months ended March 31, 1999 compared to $6.9 million in 1998. The change in
reserves for the three months ended March 31, 1999 amounted to an increase of
$0.3 million consistent with the increase of $0.3 million in 1998. These
increases in claims and change in reserves are the result of the $60,000
increase in net premiums earned for the three months ended March 31, 1999
discussed above.
Interest credited to policyholders increased $0.2 million to $1.9 million,
which increase is the result of an increase in account values related to
interest sensitive policies in force.
The change in deferred acquisition costs increased by $0.4 million for the
three months ended March 31, 1999 compared to 1998. The overall increase in
deferred acquisition costs is the result of the increase in new premium
production in the three months ended March 31, 1999 compared to 1998 noted
above. In the three months ended March 31, 1999, Universal American amortized
$39,000 of goodwill generated in the acquisitions of First National ($28,000)
and American Exchange ($11,000) and $44 thousand of present value of future
profits generated in the acquisitions of American Exchange ($32,000) and Dallas
General ($12,000).
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Commissions increased $1.1 million in the three months ended March 31, 1999
to $6.3 million, compared to $5.2 million in 1998. This increase is the result
of the $5.1 million increase in new premium discussed above. Commissions and
expense allowances on reinsurance ceded increased $1.5 million in the three
months ended March 31, 1999 to $7.4 million, compared to $5.9 million in 1998.
This increase is the direct result of the increase in direct commission and
reinsurance premium ceded discussed above.
Other operating costs and expenses increased $0.3 million in the three
months ended March 31, 1999 to $5.5 million, compared to $5.2 million in 1998.
The insurance companies' expenses amounted to $5.1 million for the three months
ended March 31, 1999 compared to $4.8 million in 1998, an increase of $0.3
million. This increase is the result of an increase in general overhead incurred
at the insurance companies.
FEDERAL INCOME TAX EXPENSE. Federal income tax expense increased
approximately $0.1 million to $0.4 million for the three months ended March 31,
1999, compared to $0.3 million for the three months ended March 31, 1998. This
increase is the result of the increase in operating income before taxes to $1.1
million in 1999 from $0.8 million in 1998. The effective tax rate in 1999 was
33.4% compared to 31.2% in 1998.
Years Ended December 31, 1997 and 1998
The results of operations for the years ended December 31, 1997 and 1998
include the operations of American Progressive, American Pioneer and WorldNet
for the year ended December 31, 1997 and other operations of American Exchange
for the period December 4, 1997, the date of its acquisition, to December 31,
1997. All references to per share amounts are on a diluted basis.
For the year ended December 31, 1998, Universal American earned net income
after Federal income taxes of $2.6 million ($0.20 per share) compared to $2.1
million ($0.18 per share) in the prior year. Operating income before Federal
income taxes amounted to $3.9 million for the year ended December 31, 1998
compared to $3.2 million in the prior year. During 1997, Universal American sold
AmeriFirst Insurance Company, an inactive insurance company, for $3.4 million
and realized a pretax gain of $0.6 million ($0.4 million after tax or $0.03 per
share.)
REVENUES. Total revenues increased approximately $4.8 million to
approximately $56.1 million for the year ended December 31, 1998, compared to
total revenues of approximately $51.3 million in the prior year.
Gross premium and policyholder fees earned and reinsurance assumed
In the year ended December 31, 1998, Universal American's gross premium and
policyholder fees earned (including reinsurance assumed) amounted to $132.0
million, a $31.7 million increase over the $100.3 million amount in 1997. This
gross premium increase is primarily related to Universal American's acquisitions
of the stock of American Exchange in December 1997 ($19.5 million) and a
Medicare Supplement block of business from Dallas
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General effective January 1, 1998 ($10.5 million). In addition, the gross earned
premiums on Universal American's currently marketed programs are as follows:
1998 TOTAL
PREMIUM INCREASE PREMIUM EARNED
PRODUCT ---------------- --------------
- ------- (IN MILLIONS) (IN MILLIONS)
Senior market accident & health.................... $ 9.79 $21.16
Senior market life insurance....................... 0.91 3.30
Specialty life insurance........................... 1.51 2.60
Specialty medical.................................. 3.25 6.35
Group life insurance............................... -- 3.39
------ ------
Totals........................................ $15.46 $36.80
====== ======
These increases totaled $45.5 million and were offset by the decrease in
premiums on the products terminated and not currently marketed by Universal
American as follows:
1998 TOTAL
PREMIUM DECREASE PREMIUM EARNED
PRODUCT ---------------- --------------
- ------- (IN MILLIONS) (IN MILLIONS)
First National assumed business.................... $ 3.95 $47.32
Non-marketed life insurance........................ 0.53 6.74
Non-marketed accident & health..................... 2.42 11.20
Group dental insurance............................. 6.86 --
------ ------
Totals........................................ $13.76 $65.26
====== ======
In continuation of its restructuring activity, Universal American executed
an agreement, with an unaffiliated insurer, to reinsure 100% of its group dental
block of business effective September 1, 1997. Universal American will continue
to perform the administration on the business for a fee.
Reinsurance premiums ceded
While Universal American was able to increase its gross premium revenue
from its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December
31, 1998 amounted to $89.5 million, a $26.9 million increase from the 1997
amount of $62.6 million. Details of the changes in reinsurance premiums ceded
are as follows:
CEDED PREMIUM 1998 TOTAL
INCREASE (DECREASE) PREMIUM CEDED
PRODUCT ------------------- -------------
- ------- (IN MILLIONS) (IN MILLIONS)
Business acquired
American Exchange.............................. $15.36 $15.36
Dallas General................................. 8.41 8.41
Senior market accident & health.................. 5.74 10.62
Senior market life insurance..................... 0.51 1.67
Specialty life insurance......................... 0.68 1.43
Specialty medical................................ 2.90 5.71
First National assumed business.................. (3.37) 38.38
Other lines...................................... (3.29) 7.96
------ ------
Totals...................................... $26.94 $89.54
====== ======
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Investment related revenue
Net investment income of Universal American increased $0.7 million to $10.7
million for the year ended December 31, 1998, compared to $10.0 million in 1997.
This increase is attributable to the increase in invested assets outstanding
during 1998 compared to 1997. Realized gains on investments amounted to $0.3
million for the year ended December 31, 1998 compared to $1.1 million in 1997.
Included in the 1998 amount is the $0.5 million write down of certain securities
determined by management to be permanently impaired. Included in the 1997 amount
is the $0.6 million realized gain on the sale of the AmeriFirst Insurance
Company to an unaffiliated third party.
Other revenue
Fee income amounted to $2.6 million for the year ended December 31, 1998,
an increase of $0.2 million from the $2.4 million amount from 1997.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions increased approximately $4.0 million to $52.2 million for the year
ended December 31, 1998, compared to $48.1 million for the year ended December
31, 1997.
Claims and other benefits increased $1.9 million to $25.6 million for the
year ended December 31, 1998 compared to $23.7 million in 1997. The change in
reserves for the year ended December 31, 1998 amounted to an increase of $5.4
million compared to an increase of $0.4 million in 1997 generating a variance of
$4.9 million. These increases in claims and change in reserves are the result of
the $4.8 million increase in net premiums earned for the year ended December 31,
1998 discussed above.
Interest credited to policyholders increased $0.6 million to $7.2 million,
which increase is the result of more interest sensitive account values in force,
primarily from the sale of the Asset Enhancer product.
The change in deferred acquisition costs increased by $0.6 million for the
year ended December 31, 1998 compared to 1997. The amount of acquisition costs
capitalized increased $2.1 million from $6.7 million in 1997 to $8.8 million in
1998. The overall increase in capitalized costs is the result of the increase in
new premium production in the year ended December 31, 1998 compared to 1997. The
amortization of deferred acquisition costs increased $1.5 million from $3.8
million in 1997 to $5.3 million in 1998. This increase is the result of the
increase in the asset balance. In the year ended December 31, 1998, Universal
American amortized $0.2 million of goodwill generated in the acquisitions of
First National ($111,000) and American Exchange ($60,000) and $0.2 million of
present value of future profits generated in the acquisitions of American
Exchange ($128,000) and Dallas General ($46,000).
Commissions increased $6.0 million in the year ended December 31, 1998 to
$27.1 million compared to $21.1 million in 1997. This increase is the direct
result of the $31.7 million increase in total premium discussed above.
Commissions and expense allowances on reinsurance ceded increased $10.9 million
in the year ended December 31, 1998 to $31.2 million, compared to $20.3 million
in 1997. This increase is the direct result of the $26.9 million increase in
reinsurance premium ceded discussed above.
Other operating costs and expenses increased $1.8 million in the year ended
December 31, 1998 to $21.2 million, compared to $19.4 million in 1997. The
insurance companies' expenses amounted to $19.8 million for the year ended
December 31, 1998 compared to $16.7 million in 1997, an increase of $3.1
million. This increase is the result of an increase of expenses incurred in
generating new business ($1.5 million) and the result of
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expenses incurred at American Exchange ($.5 million), which was not owned by
Universal American in the 1997 period as well as an increase in fees paid to
third party administrators ($2.1 million). These increases were offset by
decreases in the general overhead incurred at the insurance companies ($1.1
million). The non-insurance companies' expenses decreased $0.3 million to $1.3
million for the year December 31, 1998. This decrease in non-insurance
companies' expenses incurred by WorldNet ($1.1 million) was offset by an
increase in expenses incurred at the Parent Company ($.6 million), which is
primarily the interest expense on the new loan outstanding and increased
activity of the public company operations in 1998 relative to 1997.
FEDERAL INCOME TAX EXPENSE. Federal income tax expense increased
approximately $0.2 million to $1.3 million for the year ended December 31, 1998,
compared to $1.1 million for the year ended December 31, 1997. This increase is
the result of the increase in operating income before taxes to $3.9 million in
1998 from $3.2 million in 1997. The effective tax rate in 1998 was 33.7%
compared to 34.0% in 1997.
Years Ended December 31, 1996 and 1997
The results of operations for the years ended December 31, 1996 and 1997
include the operations of American Progressive, American Pioneer and WorldNet
for the year ended December 31, 1997 and the operations of American Exchange for
the period December 4, 1997, the date of its acquisition, to December 31, 1997.
All references to per share amounts are on a diluted basis.
For the year ended December 31, 1997, Universal American earned net income
after federal income taxes of $2.1 million ($0.18 per share) compared to $0.1
million ($0.01 per share) in the prior year. Operating income before federal
income taxes amounted to $3.2 million for the year ended December 31, 1997
compared to $0.4 million in the prior year. In September, 1997, Universal
American sold AmeriFirst Insurance Company, an inactive insurance company, to an
unaffiliated third party, for $3.4 million and realized a pretax gain of $0.6
million ($0.4 million after tax or $0.03 per share).
REVENUES. Total revenues decreased approximately $2.1 million to
approximately $51.3 million for the year ended December 31, 1997, compared to
total revenues of approximately $53.4 million in the prior year, which decrease
is primarily attributable to Universal American's decision to restructure its
operations and exit certain product lines.
Gross Premium and Policyholder Fees Earned and Reinsurance Assumed
In the year ended December 31, 1997, Universal American's gross premium and
policyholder fees earned, including reinsurance assumed, amounted to $100.3
million, a $34.5 million increase over the $65.8 million amount in 1996. This
gross premium increase is significantly attributable to the increase of $37.1
million of premiums received on the policies assumed in the fourth quarter of
1996 from First National, which premiums amounted to
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$51.3 million in 1997 compared to $14.2 million in 1996. In addition, the gross
premiums on Universal American's currently marketed programs increased as
follows:
PREMIUM PREMIUM
PRODUCT INCOME EARNED
- ------- ------- -------
Senior market supplemental health.......................... $4.39 $11.37
Senior market life insurance............................... 0.77 2.37
Group life insurance....................................... 0.12 3.41
----- ------
Totals................................................... $5.28 $17.15
===== ======
In addition, other life insurance premiums increased $2.1 million to $8.4
million in 1997.
These increases totaled $44.5 million and were offset by the net decrease
in premiums on the products terminated and not currently marketed by Universal
American. Effective December 1, 1996, Universal American withdrew its
participation in the National Association of Insurance Underwriters ("NAIU")
specialty accident and health insurance pool and also sold its New York State
Disability Insurance business ("New York State DBL") in force. The decrease in
premium from the exit from these lines amounted to $11.2 million for the year
ended December 31, 1997. Effective September 1, 1997, Universal American decided
to exit the group dental business and executed an agreement with an unaffiliated
reinsurer to cede 100% of all business earned after September 1, 1997. The
premium will continue to be received by American Pioneer and will be ceded to
the reinsurer on a 100% quota share basis. Gross premiums for the group dental
business increased $1.1 million in 1997.
Other accident and health insurance premiums increased $0.1 million for the
year ended December 31, 1997. Premiums on the international medical insurance
product (which was 90% and 95% reinsured to unaffiliated reinsurers in 1997 and
1996, respectively) increased $1.3 million in 1997, while the premiums on the
non-marketed accident and health products decreased $1.1 million in 1997.
Reinsurance Premiums Ceded
While Universal American was able to increase its gross premium revenue
from its core products, it continues to reinsure a portion of these risks to
unaffiliated reinsurers. Reinsurance premiums ceded for the year ended December
31, 1997 amounted to $62.6 million, a $37.0 million increase from the 1996
amount of $25.7 million. Of this increase, $31.0 million relates to the business
acquired from First National, while $1.9 million relates to senior market
accident and health and $0.2 million relates to senior market life insurance. In
addition to these increases, the reinsurance on the international medical
insurance discussed above increased $1.1 million in 1997, while premiums ceded
on life insurance increased $2.2 million.
Effective January 1, 1997, Universal American entered into a new
reinsurance agreement on American Pioneer's major medical/major hospital
business. Under the new treaty, Universal American retains 50% of the first
$60,000 in claims risk compared to 25% under the prior agreement. As a result,
premiums ceded on this product decreased $1.7 million in 1997. Accident and
health premiums ceded on the policies not currently marketed also decreased $1.0
million.
In connection with the restructuring activity previously discussed,
reinsurance on the NAIU pool business amounted to $1.1 million and reinsurance
on the group dental business amounted to $2.2 million.
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Net investment income of Universal American increased $0.2 million to $10.0
million for the year ended December 31, 1997, compared to $9.9 million in the
prior year. Realized gains on investments amounted to $1.1 million for the year
ended December 31, 1997 compared to $0.2 million in the prior year. Included in
the 1997 amount is the $0.6 million gain realized on the sale of Amerifirst
Insurance Company to an unaffiliated third party.
Other Revenue
Fee income amounted to $2.4 million for the year ended December 31, 1997, a
decrease of $0.5 million from the $2.9 million amount for the prior year. This
decrease is the result of the cancellation of WorldNet's Ontario Blue Cross
contract in 1996. The amortization of deferred revenue amounted to $0.3 million
for the year ended December 31, 1997, compared to $0.3 million in the prior
year. This $0.2 million decrease is the result of the full amortization of the
deferred revenue generated by the reinsurance of the major medical business on
June 30, 1995, which agreement was terminated by the reinsurer on December 31,
1996.
BENEFITS, CLAIMS AND OTHER DEDUCTIONS. Total benefits, claims and other
deductions decreased approximately $4.9 million to $48.1 million for the year
ended December 31, 1997, compared to $53.0 million in the prior year.
Claims and other benefits decreased $0.3 million to $23.7 million for the
year ended December 31, 1997 compared to $24.0 million in the prior year. The
increase in net claims on the business assumed from First National amounted to
$6.5 million, while net claims on the senior market accident and health business
increased $0.8 million. As discussed above, Universal American is retaining a
higher amount of major medical/major hospital business under a new reinsurance
agreement and, as a result, Universal American's claims on this product
increased $1.1 million to $2.1 million. (This increase corresponds to the $1.1
million increase in retained premiums.) In addition, claims on the non-marketed
accident and health products increased $0.4 million in 1997.
These increases of $8.7 million were offset by decreases in the claims
incurred on the terminated businesses (NAIU -- $4.2 million, New York State
DBL -- $3.7 million; group dental -- $0.9 million). The remaining decrease of
$0.2 million represents a decrease in life insurance claims.
The change in reserves for the year ended December 31, 1997 amounted to an
increase of $0.4 million compared to an increase of $1.9 million in the prior
year generating a decrease of $1.4 million. Included in the 1996 change in
reserves is $0.3 million generated by the NAIU accident pool business that
Universal American has exited. Interest credited to policyholders increased
$32,000 to $6.6 million.
The change in deferred acquisition costs increased $0.7 million for the
year ended December 31, 1997 compared to 1996. The amount of acquisition costs
capitalized increased $1.7 million from $5.0 million in 1996 to $6.7 million in
1997. This increase is the result of the increase in new premium production in
the year ended December 31, 1997 compared to the prior year. The amortization of
deferred acquisition costs increased $1.0 million from $2.8 million in 1996 to
$3.8 million in 1997. This increase is the result of the increase in the asset
balance. In the year ended December 31, 1997, Universal American amortized $0.1
million of the goodwill generated in the First National acquisition.
Commissions increased $5.0 million in the year ended December 31, 1997 to
$21.1 million, compared to $16.1 million in the prior year. This increase is the
direct result of the $34.5 million increase in gross premium earned discussed
above. Commissions and expense
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allowances on reinsurance ceded increased $9.3 million for the year ended
December 31, 1997 to $20.3 million, compared to $11.4 million in the prior year.
This increase is the direct result of the $37.0 million increase in reinsurance
premium ceded discussed above and reduces the amounts of commissions and
expenses capitalized for deferred acquisition costs.
Other operating costs and expenses increased $1.7 million in the year ended
December 31, 1997 to $19.4 million, compared to $17.7 million in the prior year.
The non-Insurance Subsidiaries' expenses decreased $0.3 million to $2.6 million
for the year ended December 31, 1997 as a result of the decrease in expenses
incurred at WorldNet -- Miami.
The Insurance Subsidiaries' expenses amounted to $16.8 million for the year
ended December 31, 1997 compared to $14.8 million in the prior year, an increase
of $2.0 million. Expenses incurred administrating the recently acquired business
from First National amounted to $4.3 million, while premium taxes increased $0.8
million. These increases totaled $5.0 million and were offset by the decrease in
new business expenses of $0.3 million, general overhead of the insurance
companies of $1.1 million and expenses incurred by the NAIU pool in 1996 of $1.6
million.
FEDERAL INCOME TAX EXPENSE. Federal Income tax expense increased
approximately $0.8 million to $1.1 million for the year ended December 31, 1997,
compared to $0.3 million for the year ended December 31, 1996. This increase is
the result of the increase in operating income before taxes to $3.2 million in
1997 from $0.4 million in 1996. The operating loss of the non-insurance
companies amounted to $0.6 million in 1996 and a valuation allowance was
recorded for this net operating loss. The effective tax rate in 1997 was 34.0%
compared to 72.3% in 1996 (29.1% after backing out the non-insurance companies
operating loss) .
LIQUIDITY AND CAPITAL RESOURCES
Universal American's need for capital has historically been to maintain or
increase the surplus of its Insurance Subsidiaries and to support Universal
American as an insurance holding company, including the maintenance of its
status as a public company. In addition, Universal American requires capital to
fund its anticipated growth through acquisitions of other companies and blocks
of insurance business.
Universal American
Universal American requires cash to pay the operating expenses necessary to
support its status as an insurance holding company, which under applicable
insurance department regulations must bear its own expenses, and to meet the
cost involved in being a publicly-owned company. In addition, it requires cash
to meet Universal American's obligations under the debentures outstanding with
American Progressive and to meet the quarterly amortization of its bank loan.
As of March 31, 1999 Universal American had outstanding $4.5 million
pursuant to a credit agreement with Chase Manhattan Bank. During the three
months ended March 31, 1999, Universal American repaid $0.3 million in principal
and $92.9 thousand in interest.
In connection with an agreement whereby American Pioneer will become a
direct subsidiary of Universal American, rather than an indirect subsidiary
owned through American Progressive, Universal American has $7.9 million in
debentures outstanding to its subsidiary, American Progressive. The debentures
pay interest quarterly at 8.50% and are due between September 2002 and May 2003.
During the three months ended March 31, 1999 Universal
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American paid $0.2 million in interest on these debentures to American
Progressive which was eliminated in consolidation.
Management believes that the current cash position and expected cash flows
of the non-insurance companies and the availability of dividends from American
Pioneer can support the obligations of Universal noted above for the foreseeable
future. However, there can be no assurance as to the expected future cash flows
or to the availability of dividends from American Pioneer.
Insurance Subsidiaries
American Progressive, American Pioneer and American Exchange (collectively,
the "Insurance Subsidiaries") are required to maintain minimum amounts of
capital and surplus as determined by statutory accounting. The minimum statutory
capital and surplus requirements of American Progressive, American Pioneer and
American Exchange as of March 31, 1999 for the maintenance of authority to do
business were $2.5 million, $2.7 million and $0.8 million, respectively.
However, substantially more than such minimum amounts are needed to meet
statutory and administrative requirements of adequate capital and surplus to
support the current level of the Insurance Subsidiaries' operations. At March
31, 1999 the adjusted statutory capital and surplus, including asset valuation
reserve, of American Progressive, American Pioneer and American Exchange was
$9.8 million, $12.4 million and $3.5 million, respectively.
During 1998, Universal American made capital contributions totaling $2
million to American Pioneer. These amounts were generated by the proceeds of the
First Amendment to Universal American's credit agreement and from the proceeds
of the Series D Preferred Stock issuance. The capital contributions were made to
support the growth in new business production at American Pioneer.
Liquidity for the life insurance subsidiaries is measured by their ability
to pay scheduled contractual benefits, pay operating expenses, and fund
investment commitments. Sources of liquidity include scheduled and unscheduled
principal and interest payments on investments, premium payments and deposits
and the sale of liquid investments. These sources of liquidity for the Insurance
Subsidiaries significantly exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments including death
benefits, benefits under accident & health policies and interest-sensitive
policy surrenders and withdrawals. The amount of surrenders and withdrawals is
affected by a variety of factors such as credited interest rates for similar
products, general economic conditions and events in the industry that affect
policyholders' confidence. Although the contractual terms of substantially all
of Universal American's in force life insurance policies and annuities give the
holders the right to surrender the policies and annuities, Universal American
imposes penalties for early surrenders. At March 31, 1999 Universal American
held reserves that exceeded the underlying cash surrender values of its in force
life insurance and annuities by more than $18.0 million. The Insurance
Subsidiaries, in management's view, have not experienced any material changes in
surrender and withdrawal activity in recent years.
Investments
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 Universal American were required to sell
investments at reduced values in order to meet liquidity demands. Universal
American manages the asset and liability portfolios in order to minimize the
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adverse earnings impact of changing market rates. Universal American seeks to
invest in assets that have duration and interest rate characteristics similar to
the liabilities that they support.
The net yield on Universal American's cash and invested assets increased
slightly from 6.67% at December 31, 1998 to 6.93% at March 31, 1999. 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 management
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.
Universal American's investment policy is to balance the portfolio between
long-term and short-term investments to continue to achieve investment returns
consistent with the preservation of capital and maintenance of liquidity
adequate to meet payment of policy benefits and claims. Universal American
invests in assets permitted under the insurance laws of the various states in
which it operates. Such laws generally prescribe the nature, quality of and
limitations on various types of investments that may be made. Universal American
currently engages the services of an investment advisor, Asset Allocation and
Management Company, an affiliate of AAM, to manage Universal American's fixed
maturity portfolio, under the direction of the management of the Insurance
Subsidiaries and in accordance with guidelines adopted by their respective
Boards of Directors. Universal American does not invest in derivative programs
or other hybrid securities, except for GNMA's, FNMA's and investment grade
corporate collateralized mortgage obligations. It invests primarily in fixed
maturity securities of the U.S. Government and its agencies and in corporate
fixed maturity securities with investment grade ratings of "Baa3" (Moody's),
"BBB-" (Standard & Poor's) or higher. However, Universal American does own some
investments that are rated "BB" or below (together 2.3% and 2.4% of total fixed
maturities as of December 31, 1998 and March 31, 1999, respectively). As of
March 31, 1999 all securities were current in the payment of principal and
interest.
At March 31, 1999, the Insurance Subsidiaries held cash and cash
equivalents totaling $5.5 million, as well as fixed maturity and equity
securities that could readily be converted to cash with carrying values (and
fair values) of $137.7 million.
FEDERAL INCOME TAXATION OF UNIVERSAL AMERICAN
At March 31, 1999 Universal American had established a valuation allowance
of $1.3 million with respect to certain of its net operating loss carryforwards
(deferred tax assets). Universal American determined the valuation allowance
based upon an analysis of projected taxable income and through its ability to
implement prudent and feasible tax planning strategies. The tax planning
strategies include Universal American's recent reorganization and use of its
administration company WorldNet to generate taxable income. Management believes
it is more likely than not that Universal American will realize the recorded net
deferred tax assets.
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. As a result, those
computer programs have time-sensitive software that recognize a date using "00"
as the year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of
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operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
Universal American's plan to resolve the Year 2000 issue involves the
following phases: (1) the assessment phase, which determines the impact of the
Year 2000 issue, (2) the remediation phase, which is the updating or modifying
of affected systems, (3) the testing phase, which determines the effectiveness
of the remediation phase, (4) the implementation phase, which applies all proven
systems to the operating environment and (5) the contingency planning phase,
which develops plans in the event that the Year 2000 issue was not appropriately
addressed.
Universal American has completed its assessment of the systems that could
be significantly affected by the Year 2000 issue. The completed assessment
indicated that Universal American's main policy administration system utilizes
programs that were written using four digit codes to define the applicable year.
This main policy administration system was tested to determine the system's
ability to operate after January 1, 2000. Test results indicated that the system
should continue to process transactions without disruption. Some of Universal
American's computer programs used to process portions of Universal American's
business outside of the main policy administration system were written using two
digits rather than four to define the applicable year and therefore have to be
modified or replaced. As a result, Universal American began a conversion process
to bring all of Universal American's products onto its main policy
administration system. All of Universal American's products were placed on this
system by January 1, 1999.
In addition to its policy administration system, Universal American
performed assessments of other processing systems and determined that a claims
paying system for a small block of business was not Year 2000 compliant.
Universal American obtained the vendor upgrade for this system. The
installation, testing and implementation of this upgrade was completed in April
1999.
Universal American recently acquired blocks of business (the First National
and Dallas General blocks) and American Exchange. In connection with those
acquisitions, Universal American has converted all of the acquired businesses
into the Year 2000 compliant systems currently in place.
In addition to resolving the internal Year 2000 issue, Universal American
is working with all external organizations, business partners and vendors to
assess Year 2000 issues associated with the exchange of electronic data.
Universal American is in the process of testing the interfaces with these
business partners. Universal American has also begun the process of obtaining
Year 2000 readiness statements from all its external business partners to
determine the extent to which Universal American might be vulnerable to those
third parties' failure to remediate their own Year 2000 issues. There is no
guarantee that the systems of other companies on which Universal American's
systems rely will be timely converted and will not have an adverse effect on
Universal American's systems.
Universal American estimates that its plan to resolve the Year 2000 issue
will be completed by June 30, 1999, which is prior to any anticipated impact on
its operating systems, and that the Year 2000 issue should not pose significant
operational problems for its computer systems. However, if Universal American's
plan is not successfully implemented, the Year 2000 issue could have a material
impact on the operations of Universal American.
Universal American's plan includes the development of contingency plans for
any significant risks that might result from the Year 2000 issue. As discussed
above, Universal
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American is not presently aware of any specific significant business risk that
it believes it is exposed to regarding the Year 2000 issue. Therefore, Universal
American has not developed a contingency plan for the Year 2000 issue. Universal
American will continue to monitor and assess risks for which contingency plans
will be required.
A possible worst case scenario, although this is not considered likely,
would occur if the Federal government and its vendors were unable to continue to
process Medicare supplement claims electronically. In the event that this would
occur, Universal American's current procedure of obtaining Medicare claim data
through an electronic interface would not occur and Universal American would
have to revert to manually entering this data into the claims paying system.
This would result in Universal American hiring approximately 20 additional
employees to handle the increase in this data entry function. Universal American
considers the clerical marketplace in each of its primary office locations
(Pensacola, Orlando, Miami and Rye Brooke) capable of handling this situation in
a satisfactory manner.
Currently, Universal American expects the Year 2000 project costs to be
limited to the allocation of its data processing department resources, and
significant external expenses are not expected. Accordingly, no specific budget
for such costs has been allocated. The costs of the project and the date on
which Universal American believes it will complete the Year 2000 modifications
are based on management's best estimates, which were derived utilizing numerous
assumptions of future events, including the continued availability of certain
resources and other factors. There can be no guarantee that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relates, broadly, to changes in the value of financial
instruments that arise from adverse movements in interest rates, equity prices
and foreign exchange rates. Universal American is exposed principally to changes
in interest rates that affect the market prices of its fixed income securities.
Interest Rate Risk
Universal American could experience economic losses if it was required to
liquidate fixed income securities during periods of rising and/or volatile
interest rates. However, Universal American attempts to mitigate its exposure to
adverse interest rate movements through a combination of active portfolio
management and by staggering the maturities of its fixed income investments to
assure sufficient liquidity to meet its obligations and to address reinvestment
risk considerations. Universal American's insurance liabilities are generally
long tailed in nature, which generally permits ample time to prepare for their
settlement. To date, Universal American has not utilized various financial risk
management tools on its investment securities, such as interest rate swaps,
forwards, futures and options to modify it exposure to changes in interest
rates. However, Universal American may consider them in the future.
Universal American is aware that certain classes of mortgage backed
securities are subject to significant prepayment risk due to the fact that in
periods of declining interest rates, individuals may refinance higher rate
mortgages to take advantage of the lower rates then available. Universal
American monitors investment portfolio mix to mitigate this risk.
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Sensitivity Analysis
Universal American regularly conducts various analyses to gauge the
financial impact of changes in interest rate on it financial condition. The
ranges selected in these analyses reflect management's assessment as being
reasonably possible over the succeeding twelve-month period. The magnitude of
changes modeled in the accompanying analyses should, in no manner, be construed
as a prediction of future economic events, but rather, be treated as a simple
illustration of the potential impact of such events on Universal American's
financial results.
The sensitivity analysis of interest rate risk assumes an instantaneous
shift in a parallel fashion across the yield curve, with scenarios of interest
rates increasing and decreasing 100 and 200 basis points from their levels at
March 31, 1999, and with all other variables held constant. A 100 and 200 basis
point increase in market interest rates would result in a pre-tax decrease in
the market value of Universal American's fixed income investments of $6.1
million and $11.7 million, respectively. Similarly, a 100 and 200 basis point
decrease in market interest rates would result in a pre-tax increase in the
market value of Universal American's fixed income investments of $5.3 million
and $11.5 million, respectively.
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UNIVERSAL AMERICAN FINANCIAL CORP.
SUPPLEMENTARY UNAUDITED FINANCIAL INFORMATION
(IN THOUSANDS EXCEPT FOR PER SHARE DATA)
Summarized unaudited quarterly financial information for the first quarter
of 1999 and 1998, 1997, 1996 is as follows:
THREE MONTHS ENDED
------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- -------
1999
Total revenue............................... $13,850
Operating income before income taxes........ 1,067
Net income applicable to common
shareholders.............................. 531
Basic earnings per share.................... .07
Diluted earnings per share.................. .05
1998
Total revenue............................... $13,815 $14,331 $14,068 $13,875
Operating income before income taxes........ 774 1,260 1,018 879
Net income applicable to common
shareholders.............................. 425 701 564 485
Basic earnings per share.................... .06 .09 .07 .07
Diluted earnings per share.................. .04 .06 .05 .05
1997
Total revenue............................... $12,885 $13,275 $14,030 $11,141
Operating income before income taxes........ 560 709 1,238 705
Net income applicable to common
shareholders.............................. 370 413 726 362
Basic earnings per share.................... .05 .06 .10 .05
Diluted earnings per share.................. .03 .04 .07 .04
1996
Total revenue............................... $12,258 $11,737 $14,200 $15,192
Operating income (loss) before income
taxes..................................... 328 187 150 (292)
Net income (loss) applicable to common
shareholders.............................. 282 123 101 (402)
Basic earnings (loss) per share............. .04 .02 .01 (.06)
Diluted earnings (loss) per share........... .03 .01 .01 (.04)
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PENN UNION COMPANIES
SELECTED COMBINED FINANCIAL INFORMATION
The following selected combined financial information is derived from
combined financial statements of the Penn Union Companies. The financial
statements as of December 31, 1998 and for each of the four years in the period
ended December 31, 1998 have been audited by KPMG LLP, independent auditors. The
selected financial information as of December 31, 1994, March 31, 1999 and for
the year ended December 31, 1994 and the three months ended March 31, 1998 and
March 31, 1999 has been derived from unaudited consolidated financial statements
of the Penn Union Companies, but includes all adjustments, including normal
recurring accruals, that the Penn Union Companies considers necessary for fair
presentation of the results of operations for the periods presented. The results
for the three months ended March 31, 1999 are not necessarily indicative of the
results that may be expected for the Penn Union Companies' fiscal year ended
December 31, 1999. The information should be read in conjunction with the
combined financial statements, related notes, and the more comprehensive
historical financial information included as Annex E to this proxy statement.
See "Penn Union Companies Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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THE PENN UNION COMPANIES
SELECTED COMBINED FINANCIAL INFORMATION
INCOME STATEMENT INFORMATION
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
--------------------- -------------------------------------------------------
1998 1999 1994(1)
UNAUDITED UNAUDITED UNAUDITED 1995(2) 1996 1997 1998
--------- --------- --------- -------- -------- --------- ---------
Direct premium and policyholder
fees.......................... 78,008 67,828 $158,385 $161,188 $329,871 $ 326,096 $ 299,846
Reinsurance premiums assumed.... 2,637 595 6,266 9,156 22,514 5,029 2,495
Reinsurance premiums
ceded......................... (24,452) (22,703) (1,677) (4,058) (56,123) (106,121) (102,785)
------- ------- -------- -------- -------- --------- ---------
Net premium and policyholder
fees earned................... $56,193 $45,720 162,974 166,286 296,262 225,004 199,556
Net investment income........... 12,332 11,868 28,971 30,572 48,113 47,405 47,938
Realized gains (losses) on sale
of investments................ (606) 92 (3,018) (278) (616) 4,795 6,207
Other income.................... 3,193 3,371 908 3,717 9,252 17,550 11,408
------- ------- -------- -------- -------- --------- ---------
Total revenues................ 71,112 61,051 189,835 200,297 353,011 294,754 265,109
------- ------- -------- -------- -------- --------- ---------
Total benefits, claims and other
deductions.................... 73,317 61,358 37,675 153,792 310,970 276,370 374,224
------- ------- -------- -------- -------- --------- ---------
Operating income (loss) before
taxes......................... (2,205) (307) 52,160 46,505 42,041 18,384 (109,115)
Net income (loss) after
taxes......................... $(2,495) $ (667) $ 32,569 $ 27,037 $ 24,435 $ 10,795 $ (73,858)
BALANCE SHEET INFORMATION
(IN THOUSANDS)
AS OF DECEMBER 31, AS OF
---------------------------------------------------------------- MARCH 31,
1994 1999
UNAUDITED(1) 1995 1996 1997 1998 UNAUDITED
------------ ---------- ---------- ---------- ---------- ----------
Total cash and investments........ $ 368,391 $ 760,690 $ 651,061 $ 674,749 $ 706,278 $ 684,870
Total assets...................... 653,502 1,226,883 1,226,372 1,266,182 1,144,026 1,119,057
Policy liabilities and accruals... 362,585 734,748 638,991 666,598 635,302 631,485
Business equity................... 263,291 371,841 364,179 385,840 336,881 336,380
- -------------------------
(1) Does not include results of Constitution, Union Bankers and Marquette which
were not acquired until December 14, 1995.
(2) Includes results of Constitution, Union Bankers and Marquette since their
acquisition on December 14, 1995. See "Note 3 -- Acquisitions" to the
financial statements of the Penn Union Companies.
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PENN UNION COMPANIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This management's discussion and analysis of financial condition and
results of operations should be read together with the unaudited combined
financial statements for the Penn Union Companies as of March 31, 1999 and
December 31, 1998 which are also included in this proxy statement. For purposes
of this management's discussion and analysis, the Penn Union Companies include
the insurance operations of Pennsylvania Life, Penncorp Life, Constitution,
Union Bankers, Marquette, Peninsular and PennCorp Financial, Inc. The Penn Union
Companies market and underwrite limited fixed-benefit accident and sickness
products and, to a lesser extent, life and accumulation products through a sales
force exclusive to the Penn Union Companies throughout the United States and
Canada. All dollar amounts presented below are in thousands unless otherwise
stated.
CAUTIONARY STATEMENTS
The Penn Union Companies caution readers regarding certain forward-looking
statements contained in the following discussion and elsewhere in this proxy
statement and in any other oral or written statements, either made by, or on
behalf of the Penn Union Companies, whether or not in future filings with the
SEC. Forward-looking statements are statements not based on historical
information. They relate to future operations, strategies, financial results or
other developments. In particular, statements using verbs such as "expect,"
"anticipate," "believe," or similar words generally involve forward-looking
statements. Forward-looking statements include statements that represent the
Penn Union Companies' products, investment spreads or yields, or the earnings or
profitability of the Penn Union Companies' activities.
These forward-looking statements are subject to known and unknown risks,
uncertainties and other factors which may cause actual results to be materially
different from those contemplated by the forward looking statements. Such
factors include, among other things: (1) general economic conditions and other
factors, including prevailing interest rate levels and stock market performance,
which may affect the ability of the Penn Union Companies to sell their products,
the market value of the Penn Union Companies' investments and the lapse rate and
profitability of policies; (2) the Penn Union Companies' ability to achieve
anticipated levels of operational efficiencies and cost-saving initiatives and
to meet cash requirements based upon projected liquidity sources; (3) customer
response to new products, distribution channels and marketing initiatives; (4)
mortality, morbidity, and other factors which may affect the profitability of
the Penn Union Companies' insurance products; (5) changes in the federal income
tax laws and regulations which may affect the relative tax advantages of some of
the Penn Union Companies' products; (6) increasing competition in the sale of
insurance and annuities; (7) regulatory changes or actions, including those
relating to regulation of insurance products and of insurance companies; (8)
ratings assigned to the Penn Union Companies' insurance companies by independent
rating organizations such as A.M. Best; (9) the Penn Union Companies' ability to
successfully complete their Year 2000 remediation efforts; (10) the completion,
including obtaining required regulatory approvals, of the sale of the Penn Union
Companies to Universal American; and (11) unanticipated litigation. There can be
no assurance that other factors not currently anticipated by management will not
also materially and adversely affect the Penn Union Companies' results of
operations.
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RECENT DEVELOPMENTS
On December 31, 1998, PFG, the ultimate parent of the Penn Union Companies,
and several of PFG's subsidiaries entered into an acquisition agreement to sell
the Penn Union Companies to Universal American, in conjunction with Capital Z's
simultaneous equity investment in Universal American.
The purchase price was originally $175,000, consisting of $136,000 of cash
and $39,000 original principal amount of subordinated notes. Subsequent to the
execution of the acquisition agreement on December 31, 1998, the parties agreed
to amend the acquisition agreement to reflect, among other things, a reduction
in the purchase price to $130,500 in cash. In addition, immediately prior to the
closing an affiliate of PFG that is not being purchased by Universal American or
American Exchange will receive $6,500 in the form of a cash dividend payable by
Union Bankers. The purchase price may be increased or decreased under the terms
of the acquisition agreement. PFG's board of directors and a majority of the
banks comprising the participating institutions in PFG's amended Bank Credit
Facility have approved the amendments to the acquisition agreement.
To finance part of the transaction, Universal American will issue
approximately $91,000 of new equity in the form of common stock to Capital Z and
some agents and members of management of the Penn Union Companies at a price of
$3.15 per share. In addition, Universal American may pay a portion of a
transaction fee in its common stock to an affiliate of Capital Z.
Universal American also intends to fund the transaction by borrowing
$70,000, which has been committed by a syndicate of lenders arranged by CSI. The
lenders will make an additional $10,000 available to Universal American on a
revolving credit basis.
The closing of the acquisition and the Capital Z Issuance is subject to
certain closing conditions, including receipt of all required regulatory
approvals and the completion of actuarial reviews of the statutory reserves of
Pennsylvania Life. The Capital Z Issuance and the increase in the authorized
shares of Universal American, which are conditions to closing the acquisition,
require the approval of Universal American's shareholders.
The acquisition agreement contains other pre-closing restructuring
provisions, including the termination of the current reinsurance agreements
between Peninsular and Occidental Life Insurance Company of North Carolina
("Occidental"), an affiliate not acquired, relating to the assumption by
Peninsular of a portion of Occidental's life and annuity block and the
establishment of a new reinsurance agreement, whereby Peninsular will cede 100%
of its existing direct business to Occidental. These transactions will be
settled at amounts equal to the statutory reserves at the date the new agreement
becomes effective. Net GAAP reserves of approximately $55,808 will be
transferred to Occidental along with cash and investments totalling
approximately $65,581. Accordingly, it is anticipated that Peninsular will
recognize a pre-tax loss of approximately $9,773, as a result of the above
transaction. Additionally, this transaction will result in a reduction in future
total revenues, net income and total assets of approximately $8,000, $300 and
$71,000, respectively.
For an understanding of the impact on the results of operations of the Penn
Union Companies due to this pending acquisition, see the pro forma financial
statements on pages 62 to 76.
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RESULTS OF OPERATIONS
Three Months Ended March 31, 1999 and 1998
For the three months ended March 31, 1999, the Penn Union Companies
generated an operating loss after income taxes of $(667), compared to $(1,906)
for the same period of the prior year. Operating loss before income taxes
amounted to $(307) for the three months ended March 31, 1999 compared to
$(2,205) in the same period of the prior year.
REVENUES. Total revenues decreased by $10,061, or 14.1%, to $61,051 for
the three months ended March 31,1999, compared to $71,112 for the same period of
the prior year.
PREMIUMS AND POLICY AND PRODUCT CHARGES. Net premiums decreased by
$10,439, or 18.8%, to $45,116 for the three months ended March 31, 1999,
compared to $55,555 for the same period of the prior year. Premiums at Union
Bankers decreased by $8,334. This decrease reflects the amendment to cede the
remaining 20% of the Medicare business effective July 1998 that resulted in a
decrease of $5,598 for the three month period ended March 31, 1999 compared to
the same period of the prior year. The remaining decrease at Union Bankers
relates primarily to the runoff of the Major Medical business. Premiums at
Peninsular and Pennsylvania Life decreased by $1,005 and $881, respectively. The
Peninsular decrease relates to a reduction in premiums assumed from Occidental,
an affiliate. The Pennsylvania Life decrease is principally due to lower first
year sales. Interest sensitive policy product charges decreased by $34 to $604
for the three months ended March 31, 1999 compared to the same period for the
prior year.
INVESTMENT INCOME AND NET REALIZED GAINS. Net investment income decreased
by $464, or 3.8%, to $11,868 for the three months ended March 31, 1999 compared
to $12,332 for the same period of the prior year. The decrease relates primarily
to a decrease in net investment income at Marquette of $572. In 1998, Marquette
had assumed a block of annuity business from Southwestern Life Insurance Company
("Southwestern Life"), an affiliate. Marquette's results for the three months
ended March 31, 1998 included the earnings on the approximately $57,000 of
assets supporting this block of business. This reinsurance was cancelled as of
September 30, 1998.
Realized gains on investments amounted to $92 for the three months ended
March 31, 1999 compared to realized losses of $606 for the same period of the
prior year.
OTHER INCOME. Other income increased by $178, or 5.6%, to $3,371 for the
three months ended March 31, 1999 compared to $3,193 for the same period of the
prior year. This decrease is not considered significant.
BENEFITS AND EXPENSES. Total benefits and expenses decreased by $11,959,
or 16.3%, to $61,358 for the three months ended March 31, 1999, compared to
$73,317 for the same period of the prior year.
Policyholder benefits incurred decreased by $8,526, or 23.9%, to $27,211
for the three months ended March 31, 1999 compared to $35,737 in the same period
of the prior year. Policyholder benefits for accident and health products for
Union Bankers decreased by $6,597. The cession of the remaining 20% of the
Medicare supplement line of business as of July 1, 1998 resulted in a decrease
of $3,962. The remaining decrease for Union Bankers relates primarily to the
runoff of the Major Medical business. At Pennsylvania Life, policyholder
benefits for accident and health products decreased by $1,396 due primarily to a
change in the mix of business, including less disability income written with
lifetime benefits as well as the discontinuation of the instant issue line and
its replacement with a home office underwritten product, resulting in reduced
loss ratios.
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The change in liability for future policy benefits and other policy
benefits for the three months ended March 31, 1999 amounted to an increase of
$5,733 compared to $3,274 for the same period of the prior year, generating an
overall increase of $2,459.
The increase in the change in reserves was due primarily to several factors
for Union Bankers. In 1998, Medicare supplement reserves decreased by $1,028.
Subsequent to the cession of the remaining 20% of this block of business
effective July 1998, changes in reserves for this line of business no longer
effect the results of Union Bankers. Additionally, reserves for Life products
decreased $839 during the first three months of 1998 due primarily to the
termination of a reinsurance contract whereby Union Bankers assumed a block of
Life business from an unaffiliated entity. For 1999, reserves for Life products
did not change significantly from the prior year-end as business in force
remained constant between periods. During 1999, reserves for long term care
products reflected an increase of $974. Also, the run-off of the major medical
business slowed during 1998 resulting in a $286 smaller decrease in reserves
compared to the same period in the prior year.
The amortization of present value of insurance in force and deferred policy
acquisition costs decreased by $1,202, or 11.5%, to $9,279 for the three months
ended March 31, 1999 compared to $10,481 for the same period of the prior year.
During the third quarter of 1998, the Penn Union Companies recorded an
impairment loss related to the deferred policy acquisition costs for
Pennsylvania Life (refer below for additional information regarding the
impairment). As a result of this reduction in the deferred policy acquisition
cost asset, the amortization for the three months ended March 31, 1999 was
approximately $1,500 lower than the same period for the prior year. However, the
amortization for the current year deferrals increased over the prior year period
by $2,185, resulting in a net increase in the amortization of deferred policy
acquisition costs for Pennsylvania Life of $685. The increase in the
amortization for current year deferrals results from the acceleration of the
amortization over prior years due to reduced projected profitability of new
business primarily related to a decrease in production volumes.
At Union Bankers the amortization decreased by $1,858. As a result of the
cession of the remaining 20% of the Medicare supplement block of business, the
related deferred policy acquisition cost and present value of insurance in force
assets were eliminated, comprising $518 of the decrease. The remaining
difference is due to reduced deferrals as a result of the run off of the major
medical business.
The amortization of costs in excess of net assets acquired was $1,383 for
the three months ended March 31, 1999 compared to $1,394 for the same period of
the prior year, representing a decrease of 0.8%.
Interest expense was $2,556 for the three months ended March 31, 1999
compared to $3,470 for the same period of the prior year, representing a
decrease of 26.3%. The interest expense relates to the affiliated surplus notes
issued by Constitution to Southwestern Financial Corporation as well as the
imputed interest on a capitalized lease obligation relating to certain office
furniture. The decrease is due to the reduction in the surplus notes as a result
of scheduled principal repayments.
Underwriting and other administrative expenses decreased by $3,765, or
19.9%, to $15,196 for the three months ended March 31, 1999 compared to $18,961
for the same period of the prior year. As a result of the Penn Union Companies
initiative to transfer administration of its comprehensive and Medicare
supplement blocks of business to third party administrators, the Penn Union
Companies recorded a pre-tax restructuring charge of $1,834 during 1998. This
charge was completely related to termination benefits for 145
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employees of the health operation in the Dallas, Texas office that were moved to
third party administrators ("TPAs"). The move to TPAs was made in order to
affect the consolidation of the Penn Union Companies held for sale by PennCorp
to Raleigh, North Carolina and to place the business with experts in the related
product lines. Total payments made under the restructuring plan through March
31, 1999 amounted to $1,364. As a result of the voluntary termination of certain
employees prior to meeting eligibility criteria, the restructure charge was
reduced by $396 during 1998. However, during 1999, the estimate of remaining
costs was revised and the liability was increased by $44. The restructure plan
was substantially completed as of March 31, 1999. Aside from the one time
restructuring and conversion costs, the transfer of the administration of these
lines of business is not anticipated to have a material effect on the future
operations of the Acquired Companies.
Additionally at Pennsylvania Life, expenses decreased by $2,239, compared
to the same period of the prior year. Non-deferrable commissions decreased by
$1,129 due to reductions in production. General expenses decreased by $1,110 due
primarily to reductions in data processing fees.
Years Ended December 31, 1998 and 1997
For the year ended December 31, 1998, the Penn Union Companies incurred an
operating loss after income taxes of $73,858, compared to operating income of
$10,795 for the prior year. The operating loss before income taxes amounted to
$109,115 for the year ended December 31, 1998 compared to operating income
before income taxes of $18,384 in the prior year.
REVENUES. Total revenues decreased by $29,645, or 10.1%, to $265,109 for
the year ended December 31, 1998, compared to total revenues of $294,754 for the
prior year.
PREMIUMS AND POLICY AND PRODUCT CHARGES. Net premiums decreased by
approximately $27,295, or 12.2%, to $195,988 for the year ended December 31,
1998, compared to $223,283 for the prior year. Premiums at Union Bankers
decreased by $21,433. This decrease reflects the continued run-off of the
Medicare supplement and comprehensive blocks of business, due to the decision to
not actively market these blocks of business at Union Bankers, as well as the
amendment to the existing reinsurance agreement to cede the remaining 20% of the
Medicare business, effective July 1998. At Pennsylvania Life, premiums decreased
by $3,747 principally as a result of lower first year sales.
Interest sensitive policy product charges increased by $1,847 to $3,568 for
the year ended December 31, 1998. This increase reflects an increase in the
policy fees assumed by Peninsular from Occidental, an affiliate, offset in part
by the continued decline of policy fees on direct interest sensitive business.
INVESTMENT INCOME AND NET REALIZED GAINS. Net investment income increased
by $533, or 1.1%, to $47,938 for the year ended December 31, 1998 compared to
$47,405 for the prior year.
Realized gains on investments amounted to $6,207 for the year ended
December 31, 1998 compared to realized gains of $4,795 for the prior year.
Included in the 1998 gains is $3,362 of gains resulting from the sale of various
mortgage backed securities classified as other invested assets and $1,809
relating to the sale of a limited partnership interest. The remaining gains were
individually insignificant. The gains realized in 1997 relate primarily to
equity securities. The Penn Union Companies maintain an investment portfolio
that focuses on maximizing investment income, without exposure to unwarranted
interest rate and credit risk. The Penn Union Companies actively manage asset
duration and liquidity risks. As a
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result of this strategy, the Penn Union Companies routinely sell positions in
securities no longer meeting its criteria, and during 1997, Pennsylvania Life
liquidated the vast majority of its equity holdings.
OTHER INCOME. Other income decreased by $6,142, or 35.0%, to $11,408 for
the year ended December 31, 1998 compared to $17,550 for the prior year. The
amortization of the deferred ceding allowance associated with the reinsurance of
the Medicare supplement line of business amounted to $9,631 for the year ended
December 31, 1998 compared to $15,370 for the prior year. The amortization is
anticipated to continue to decrease as this block of business runs off.
BENEFITS AND EXPENSES. Total benefits and expenses increased by $97,854,
or 35.4%, to $374,224 for the year ended December 31, 1998, compared to $276,370
for the prior year.
Policyholder benefits incurred decreased by $20,739, or 14.1%, to $126,316
for the year ended December 31, 1998, compared to $147,055 in the prior year.
The run-off of the Medicare supplement block of business combined with the
cession of the remaining 20% of that line of business resulted in a decrease in
policyholder benefits at Union Bankers of $11,088. At Pennsylvania Life,
policyholder benefits decreased by $7,829 due to a change in the mix of
business, including less disability income written with lifetime benefits, as
well as the discontinuation of the instant issue line and its replacement with a
home office underwritten product, resulting in reduced loss ratios.
The change in liability for future policy benefits and other policy
benefits for the year ended December 31, 1998 amounted to an increase of $48,330
compared to a decrease of $2,604 for the prior year.
The increase was primarily the result of specific increases in reserve
estimates associated with long term care products and the present value of
amounts payable on certain claims reserves held by Pennsylvania Life. The
increase in the liability for future policy benefits at Pennsylvania Life for
1998 was $39,786. The Penn Union Companies have been closely monitoring the
development of its claims reserve experience. The historical method utilized
primarily claim lag factors in the establishment of the claim reserves. Based on
recent results of independent calculations of the claim lag factors, performed
annually, the Penn Union Companies believe this methodology indicated a
deterioration in the adequacy of its claim reserves associated with its
disability income products underwritten prior to PFG's ownership of Pennsylvania
Life. The estimated amounts included in the financial statements for policy
liabilities are based upon management's best estimate in each year for which the
financial statements are presented.
Disability claim adequacy analysis included statutory claim information,
independent third-party review of claim lag factors and method and other claim
tests. Previous results indicated no reason to consider a new methodology as
results appeared consistent between periods and claim reserves appeared
adequate. Once results of such analysis began to vary outside an acceptable
tolerance, the Penn Union Companies reviewed their methods to determine the
reasons for the variances.
Pennsylvania Life sells disability income products in the low to moderate
income market. The lag factor method is one method which utilized Pennsylvania
Life's experience considering its products and market. The Penn Union Companies
believe that available industry data for establishing claim reserves was not
appropriate for Pennsylvania Life's products and market. The utilization of a
case reserve method for Pennsylvania Life required experience, in addition to
that utilized by the lag factor method, to create case reserves based on
Pennsylvania Life's experience. This experience was not sufficient until
recently.
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With recent system upgrades, Pennsylvania Life was able to obtain better benefit
data distinguishing disability benefits from other benefits which may be payable
under the same policy form. With the systems upgrades and more robust experience
the company was able to consider a more refined claims methodology such as
seriatim case reserves.
During 1998, Pennsylvania Life implemented a method which substituted case
reserves for most disability claims. The new method utilizes more detailed
information by policy and by line of business resulting in a more refined
estimate. As a result, the accident and health claim reserve for Pennsylvania
Life increased by $25,691 during 1998.
During 1998 the Penn Union Companies also refined their calculation of
policy benefit reserves for long term care products which resulted in an
increase of approximately $15,750. The PennUnion Companies allocated $9,950 of
previously identified redundant reserves and additionally increased policy
reserves by $5,800. The refinement recognized that the long term care reserve
factors, which originally were patterned after hospital income policy factors,
should be higher at later durations than the hospital income factors produced.
Additionally, it was determined that an optional inflation rider to certain long
term care policies required its unique benefit factors. The additions to
benefits from the inflation coverage have a benefit pattern, in addition to that
caused by aging of the insured, which increases by policy duration. It is
anticipated that future reserves will be calculated on a basis consistent with
1998 and that this basis will generate slightly larger increases in reserves in
the near term.
However, establishment of appropriate reserves is an inherently uncertain
process due to the variability of the in force of the block of business and
management cannot reasonably estimate the effect of these refinements on the
calculation of future reserves, nor can there be certainty that current
established reserves will prove adequate in light of subsequent experience.
Other policy benefits, which include surrenders and interest credited of
$8,706 comprise the remaining expense for this line and were consistent with the
prior year.
The amortization of present value of insurance in force and deferred policy
acquisition costs increased by $65,380, or 164.8%, to $105,046 for the year
ended December 31, 1998 compared to $39,666 for the prior year. The year ended
December 31, 1998 includes an impairment provision related to deferred policy
acquisition costs.
During 1998, the Penn Union Companies' assumptions as to future morbidity
have increased primarily as a result of adverse trends identified by the Penn
Union Companies with respect to disability income claim reserves. See the
previous discussion regarding the change in liability for future policy benefits
on page 127.
Additionally, effective in 1998, Pennsylvania Life modified the commission
structure and related participation in agency profitability. During 1997,
Pennsylvania Life worked closely with the U.S. based career sales force to
develop and implement a new compensation structure which resulted in
Pennsylvania Life giving up its rights to a portion of the profit participation
associated with the branch compensation structures. As a result, career sales
force agents receive a lower base commission structure on new business and fully
absorb all field office costs. However, the elimination of the profit
participation in the existing business reduced the margin for recoverability of
the unamortized deferred policy acquisition cost. Pennsylvania Life retained
approximately $1,500, $2,600 and $2,300 during 1998, 1997 and 1996,
respectively, in profit sharing income, which is recorded as an offset to
commissions. Based on a recoverability analysis, comparing future discounted
cash flows from these blocks of business to unamortized deferred policy
acquisition costs, it was
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determined that the unamortized deferred policy acquisition costs for these
blocks of business were not fully recoverable from future profits. This resulted
in a charge to income and a reduction of unamortized deferred policy acquisition
costs of $65,216. The present value of insurance in force asset was also tested
for recoverability, and, based on the tests performed, the present value of
insurance in force asset was recoverable.
Management believes that the benefits of the new compensation structure
will outweigh the decreased profit participation noted above. Under the new
structure, the sales force will absorb all costs of the field offices (focusing
sales force management on controlling costs), resulting in expense savings. The
expense savings also include the reduced costs associated with sales promotion
and agent conventions and are anticipated to amount to approximately $974 in
1999. First year commissions under the new structure were reduced from 80% to
65% and renewal commissions were reduced from 20% to 15%, grading down to 3%
over the life of the related policy. The commission savings will be present with
all future sales thereby lowering the overall commission rate. The savings from
the reduction in the commission rates is expected to grade in over time as the
new policies comprise a greater portion of Penn Union Companies' business.
Reductions in commissions related to the new commission rate are anticipated to
amount to approximately $1,071 for 1999.
The savings from the new compensation structure, resulting from the expense
savings and reduced commission rates, net of the forgone profit participation is
estimated to be approximately $500 for 1999. This savings is anticipated to
potentially increase in future years. In addition, the new compensation
structure allows for bonuses to be paid to agents based upon improving
persistency and new sales growth. These bonuses are accrued when earned and paid
annually following year-end. This new structure is expected to better align the
objectives of the field force with Pennsylvania Life's goal of persistency and
growth and to result in potentially enhanced profitability in the future for
Pennsylvania Life.
The amortization of costs in excess of net assets acquired was $5,547 for
the year ended December 31, 1998 compared to $5,594 for the prior year,
representing a decrease of 0.8%.
Interest expense was $11,100 for the year ended December 31, 1998 compared
to $13,711 for the prior year, representing a decrease of 19.0%. The interest
expense relates to the affiliated surplus notes issued by Constitution to
Southwestern Financial Corporation, as well as the imputed interest on a
capitalized lease obligation. The decrease is due to the reduction in the
surplus notes as a result of scheduled principal repayments.
Underwriting and other administrative expenses increased by $4,937, or
6.8%, to $77,885 for the year ended December 31, 1998 compared to $72,948 for
the prior year. As a result of the Penn Union Companies' initiative to transfer
administration of its comprehensive and Medicare supplement blocks of business
to third party administrators, the Penn Union Companies recorded a pre-tax
restructuring charge of $1,834 during 1998. This charge was completely related
to termination benefits for 145 employees of the health operation in the Dallas,
Texas office that were moved to third party administrators ("TPAs"). The move to
TPAs was made in order to effect the consolidation of the Penn Union Companies
held for sale by PFG to Raleigh, North Carolina, to place the business with
experts in the related product lines and to remediate Year 2000 issues for the
systems previously utilized in Dallas for these blocks of business. Total
payments made under the restructuring plan through December 31, 1998 amounted to
$1,214. As a result of the voluntary termination of certain employees prior to
meeting eligibility criteria, the restructuring charge was reduced by $397. The
restructuring plan was substantially completed as of December 31, 1998. The Penn
Union Companies also incurred additional period costs related to the transition
to TPAs and
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as the move of the financial operations of Constitution, Union Bankers and
Marquette from Dallas to Raleigh aggregating $1,086. Aside from the one time
restructuring and conversion costs, the transfer of the administration of these
lines of business is not anticipated to have a material effect on the future
operations of the Acquired Companies.
Years Ended December 31, 1997 and 1996
For the year ended December 31, 1997, the Penn Union Companies earned
operating income after income taxes of $10,795 compared to $24,434 in the prior
year. Operating income before income taxes amounted to $18,384 for the year
ended December 31, 1997 compared to $42,040 in the prior year.
REVENUES. Total revenues decreased by $58,257, or 16.5%, to $294,754 for
the year ended December 31, 1997, compared to total revenues of $353,011 in the
prior year.
PREMIUMS AND POLICY AND PRODUCT CHARGES. Net premiums decreased by
$70,226, or 23.9%, to $223,283 for the year ended December 31, 1997 compared to
$293,509 in the prior year. Gross premiums of $324,375 for the year ended
December 31, 1997 were consistent with the prior year. Assumed premiums
decreased by $17,485 to $5,029 in 1997. This decrease relates primarily to a
decrease in a block of life business assumed by Peninsular from an affiliate,
Occidental. Ceded premiums increased $49,998 to $106,121 in 1997. This increase
is primarily attributable to the Penn Union Companies' decision to reinsure 80%
of their Medicare supplement line of business at Union Bankers with an
unaffiliated reinsurer, effective July 1996. Premiums ceded under this treaty
were $97,851 in 1997 compared to $49,726 in 1996.
Interest sensitive policy product charges decreased by $1,032, or 37.5%,
primarily due to the run-off of this block of business. During 1997, the Penn
Union Companies (primarily Constitution) significantly reduced emphasis on the
marketing and writing of interest sensitive life and annuity business. The Penn
Union Companies reduced their emphasis on these products to focus on the health
business while other divisions of PFG focused on the interest sensitive
business. Although emphasis on new sales of these products has been reduced, the
Penn Union Companies continue to offer these products and continue to administer
the existing blocks of business.
INVESTMENT INCOME AND NET REALIZED GAINS. Net investment income decreased
by $708, or 1.5%, to $47,405 for the year ended December 31, 1997 compared to
$48,113 in the prior year. Realized gains on investments amounted to $4,795 for
the year ended December 31, 1997 compared to a realized loss of $616 in the
prior year. Included in the gain realized in 1997 is $4,400 of gains relating to
the liquidation of the vast majority of the equity holdings at Pennsylvania
Life. The Penn Union Companies maintain an investment portfolio that focuses on
maximizing investment income, without exposure to unwarranted interest rate and
credit risk. The Penn Union Companies actively manage asset duration and
liquidity risks. As a result of this strategy, the Penn Union Companies
routinely sell positions in securities no longer meeting its criteria and during
1997, the Penn Union Companies liquidated the vast majority of its equity
holdings at Pennsylvania Life.
OTHER INCOME. Other income increased by $8,298, or 89.7%, to $17,550 for
the year ended December 31, 1997 compared to $9,252 in the prior year. The
amortization of the deferred ceding allowance associated with the reinsurance of
the Medicare supplement line of business amounted to $15,370 for the year ended
December 31, 1997, compared to $6,880 in the prior year. This increase is the
result of a full year of amortization of the
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deferred gain in 1997 compared to a half year of amortization in 1996, as the
reinsurance was effective on July 1, 1996.
BENEFITS AND EXPENSES. Total benefits and expenses decreased by $34,601,
or 11.1%, to $276,370 for the year ended December 31, 1997, compared to $310,971
in the prior year.
Policyholder benefits incurred decreased by $28,118, or 16.1%, to $147,055
for the year ended December 31, 1997, compared to $175,173 in the prior year.
The increase in net Medicare supplement claims ceded at Union Bankers was
approximately $32,766. This is the result of a full year of claims ceded under
the treaty in 1997 compared to six months in the prior year. In addition, due to
the run-off of this block of business, there was a decrease in the net claims
and benefits retained of approximately $1,900. These decreases were offset by an
increase of approximately $5,500 at Pennsylvania Life as a result of adverse
experience on its accident and health line of business.
The change in liability for future policy benefits and other policy
benefits for the year ended December 31, 1997 amounted to a decrease of $2,604
compared to a decrease of $15,137 in the prior year generating an increase of
$12,533. At Union Bankers, the change in reserves increased by $20,336. This is
due to a reduced decrease in reserves for 1997 for the Medicare block of
business of approximately $15,500, compared to 1996. The decrease in Medicare
reserves was $10,500 less in 1997 than in 1996 due to the run-off of this block
of business. Additionally, the ceded Medicare reserves increased by $5,000 in
1997 because the reinsurance treaty was in effect for a full year in 1997
compared to six months in 1996. Similarly, smaller decreases in reserves for
life and other accident and health reserves comprise the remaining difference.
In addition, the decrease of $14,424 from the prior year at Peninsular is due
primarily to the 1996 assumption of a block of life business by Peninsular from
Occidental, which increased reserves for that period. Lastly, at Pennsylvania
Life, the change in the liability increased by $7,375. In 1997, the conversion
to the new valuation system negatively impacted reserves by $3,596 compared to
the historical system results in 1996. The remaining increase is due primarily
to a reduction in the run-off of accident and health claims reserves during
1997.
The amortization of present value of insurance in force and deferred policy
acquisition costs increased by $1,169, or 3.0%, to $39,666 for the year ended
December 31, 1997 compared to $39,487 in the prior year. In 1997, the
amortization of deferred acquisition costs increased by $7,784 over 1996. The
amortization in 1996 reflects the effects of purchase accounting in the prior
year, which reduced the deferred policy acquisition cost asset for both Union
Bankers and Constitution to zero. Continued growth in the deferred policy
acquisition cost asset through current year capitalization accounts for the
remaining increase. Offsetting the increase in deferred policy acquisition cost
amortization was a decrease in the amortization of the present value of
insurance in force of $6,615. This decrease was due primarily to the reduction
in the present value of insurance in force in 1996 related to the 80%
coinsurance of the Medicare supplement block of business at Union Bankers.
The amortization of costs in excess of net assets acquired was $5,594 for
the year ended December 31,1997 compared to $5,613 in the prior year,
representing a decrease of 0.3%.
Interest expense was $13,711 for the year ended December 31, 1997 compared
to $12,213 in the prior year, representing an increase of 12.3%. The interest
expense relates to the affiliated surplus notes issued by Constitution to
Southwestern Financial Corporation, as well as the imputed interest on a
capitalized lease obligation. The lease agreement pertains
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to certain office furniture. The increase is due primarily to an increase in the
rate of interest on the surplus notes consistent with their terms.
Underwriting and other administrative expenses decreased by $21,664, or
22.9%, to $72,948 for the year ended December 31, 1997 compared to $94,612 in
the prior year. Commissions decreased by $13,683 related primarily to the
cession of premium on the medicare block of business. In addition, expenses
recovered under this reinsurance contract in 1997 were $4,600 greater than in
the prior year. General expenses at Pennsylvania Life also declined by
approximately $4,600 in 1997. This is due primarily to the non-recurring expense
relating to the write-down of unrecoverable agent balances of approximately
$3,300 in 1996.
INCOME TAXES
The Penn Union Companies are parties to tax sharing agreements.
Constitution is the parent of the group that includes Union Bankers and
Marquette as well as Southwestern Life, an entity not combined in the acquired
Penn Union Companies. Pennsylvania Life and Peninsular and other life insurance
subsidiaries of PFG not included in the Penn Union Companies are included in a
different consolidated return with Pacific Life & Accident Insurance Company as
the parent. PennCorp Life files a separate return in Canada. PennCorp Financial,
Inc. is a member of a consolidated return separate from any life insurance
companies. Under each of the appropriate tax sharing agreements, each company
pays the tax parent of its federal consolidated return group an amount equal to
the tax due on a separate company basis. Losses and credits, if any, are
reimbursed when the company that generates the loss or credit uses the loss or
credit on its return calculated on a separate return basis.
After the acquisition of the Penn Union Companies by Universal American,
the Penn Union Companies, except for PennCorp Financial, Inc. and Penncorp Life,
will join a federal life consolidated return with American Exchange as the
parent. Penncorp Life will continue to file separately and PennCorp Financial,
Inc. will join the Universal American consolidated federal return. Under these
agreements, each company will pay the parent of its federal consolidated return
group an amount equal to the tax due on a separate company basis. Losses and
credits, if any, are reimbursed when the company that generates the loss or
credit uses the loss or credit on its return calculated on a separate return
basis.
THREE MONTHS ENDED MARCH 31, 1999 AND 1998. The effective tax rates for
the three months ended March 31, 1999 and 1998 were (117.3)% and 13.6%,
respectively. The permanent differences relate primarily to the amortization of
costs in excess of net assets acquired. The increase in the effective tax rate
from a benefit in 1998 to an expense in 1999 on the respective net losses
relates primarily to disproportionate impact of the permanent differences and
foreign taxes relative to the small size of the losses. Because the Penn Union
Companies that generate the foreign taxes are in a net operating loss position
for federal income tax purposes, no benefit is recognized for the potential
foreign tax credit. The foreign taxes are deducted rather than credited for
financial statement purposes.
The effective tax rates for the years ended December 31, 1998, 1997 and
1996 were 32.3%, 41.3% and 41.9%, respectively. The permanent differences relate
primarily to the change in the valuation allowance on the deferred tax assets
and amortization of costs in excess of net assets acquired and gains on sales of
affiliates that are treated as deemed capital contributions.
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YEARS ENDED DECEMBER 31, 1998 AND 1997. The increase in the effective tax
rate to 32.3% for the year ended December 31, 1998 from 41.3% for the same
period in the prior year is due primarily to the effect of the reduction of the
deferred policy acquisition cost asset at December 31, 1998 as well as the
reserve adjustments. Those items significantly increased the operating loss
before income taxes in relation to the permanent differences, therefore
minimizing the effects of the permanent differences. However, the valuation
allowance was decreased during the year ended December 31, 1998 by $4,468
compared to a reduction of $525 in the prior year. This was due primarily to an
increase in foreign tax credits utilized relating to the foreign operations of
Pennsylvania Life that in 1997, management believed would not be utilized in
future periods.
The Penn Union Companies have historically established a valuation
allowance for foreign tax credits, tax proxy deferred policy acquisition costs
and certain capital losses, due to the conclusion that a tax benefit equal to
the foreign taxes paid was, more likely than not, not realizable. The Penn Union
Companies based this determination, principally, on two factors: (1) the tax
rate in the foreign jurisdiction exceeded the U.S. tax rate and (2) the
consolidated group of which the Penn Union Companies are members is in a net
operating loss carryforward position such that no current benefit is derived by
using the foreign taxes paid as a credit.
The Penn Union Companies calculate their separate tax provision under the
provisions of the tax sharing agreement. Under this agreement, a company may not
receive a benefit for its separate company credits and deductions until they are
used by the company that generated the credit or deduction. While the Penn Union
Companies' projections contain ample income to recognize the deferred tax assets
within the carryforward period, there is no guarantee that the projections will
be met. Consequently, conservatism requires that some amount of a valuation
allowance be established.
YEARS ENDED DECEMBER 31, 1997 AND 1996. During 1997, net income before
taxes decreased by $22,180, amplifying the effects of the permanent differences.
In addition, the valuation allowance was decreased by $525 during the year ended
December 31, 1997 compared to an increase of $1,052 in the prior year. The
decrease in the valuation allowance was based on management's belief that a
greater portion of net operating losses and other credits would be utilized in
future periods.
INFLATION
The Penn Union Companies sell fixed benefit insurance products, and to a
lesser extent life and accumulation products. The fixed benefit products
typically provide a predetermined fixed payment that will be paid under
specified conditions. Fixed benefit products are not designed to provide
reimbursement for medical and related costs incurred as a result of accident and
sickness. Accordingly, payment amounts are not affected by the insured's actual
cost of health care services. Because of the characteristics of their fixed
benefit products, the Penn Union Companies believe that inflation does not have
a material effect on their operations.
LIQUIDITY AND CAPITAL RESOURCES
Statutory Requirements
The Penn Union Companies that are insurance subsidiaries prepare their
statutory financial statements in accordance with accounting practices
prescribed or permitted by their respective state insurance departments.
Prescribed SAP includes state laws, regulations, and general administrative
rules, as well as a variety of publications of the National
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Association of Insurance Commissioners ("NAIC"). Permitted SAP encompass all
accounting practices that are approved by insurance regulatory authorities; such
practices differ from state to state, and may differ from company to company
within a state, and may change in the future. The NAIC has a project to codify
SAP, the result of which is expected to constitute the only source of prescribed
SAP. Accordingly, that project will likely change to some extent prescribed SAP
and may result in changes to the accounting practices that insurance enterprises
use to prepare their statutory financial statements.
Pennsylvania Life, Peninsular, Constitution, Union Bankers and Marquette
are required to maintain minimum amounts of capital and surplus as determined by
state regulatory authorities.
Statutory capital and surplus of the insurance companies as reported to
regulatory authorities March 31, 1999 and 1998 totaled $171,639 and $205,837,
respectively. Statutory net income (loss) of the insurance companies as reported
to regulatory authorities totaled $2,386 and $(1,977) for the three months ended
March 31, 1999, and 1998, respectively.
Statutory capital and surplus of the insurance companies as reported to
regulatory authorities at December 31, 1998 and 1997 totaled $175,466 and
$226,312, respectively. Statutory net (loss) income of the insurance companies
as reported to regulatory authorities totaled $(29,626), $9,469 and $21,473 for
the years ended December 31, 1998, 1997 and 1996, respectively.
For the year ended December 31, 1998 Pennsylvania Life requested and
received permission from the Pennsylvania Department of Insurance for the use of
Pennsylvania Life's own termination rate experience and other assumptions,
providing for a grade in period to full statutory tables, as required by the
Pennsylvania Department of Insurance, over a three year period. Use of the full
statutory tables would further increase the claim liabilities over the amounts
reported in the Annual Statement at December 31, 1998, by $16,200, and reduce
statutory surplus in a like amount.
During 1998, Constitution requested and received permission from the Texas
Department of Insurance to recognize the loss on the sale of its investment in
Fund America Investors in the amount of $6,900 through earnings rather than
defer the recognition through the Interest Maintenance Reserve. This permitted
practice does not have an effect on Constitution's statutory surplus.
Pennsylvania Life's Canadian branch and Canadian subsidiary report to
Canadian regulatory authorities based upon Canadian SAP that vary in some
respects from U.S. SAP. Canadian net assets based upon Canadian SAP were
$60,698, and $50,390 as of March 31, 1999 and 1998, respectively. Canadian net
assets based upon Canadian SAP were $56,191 and $51,428 as of December 31, 1998
and 1997, respectively.
Liquidity
Cash generated by the insurance companies included in the Penn Union
Companies is made available to PFG, the ultimate parent, principally through
periodic payments of principal and interest on surplus debentures, funded
primarily by dividends from the insurance companies included in or owned by the
Penn Union Companies.
Dividend payments by insurance companies are limited by, or subject to the
approval of the insurance regulatory authority of each insurance company's state
of domicile. Such dividend requirements and approval processes vary
significantly from state to state. Currently, the insurance companies included
in the Penn Union Companies are not able to pay dividends without prior approval
from their respective insurance regulatory authorities.
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The surplus debentures in the amount of $98,500 and $109,375, at March 31,
1999 and 1998, respectively, are included in net assets in the combined
statements (see Note 1 on the basis of presentation). Pursuant to the terms of
the surplus debenture issued by Constitution to the benefit of Southwestern Life
Companies, Inc., Constitution may make principal and interest payments to the
extent that Constitution's statutory surplus, plus liabilities relating to the
surplus debentures, less the statutory carrying value of Southwestern Life and
Union Bankers, exceeds $1,200. Constitution's statutory surplus at March 31,
1999 was $147,047, of which $144,175 was attributable to its ownership of
Southwestern Life and Union Bankers. Liabilities relating to the surplus
debentures at December 31, 1998 were $7,297, representing accrued principal and
interest. At March 31, 1999 were $6,630, representing accrued principal and
interest. At March 31, 1998, Constitution's statutory surplus was $165,468 of
which $161,221 was attributable to its ownership of Southwestern Life and Union
Bankers.
The surplus debentures amounted to $102,125 and $113,000 at December 31,
1998 and 1997, respectively. Constitution's statutory surplus at December 31,
1998 was $152,385, of which $143,914 was attributable to its ownership of
Southwestern Life and Union Bankers. Liabilities relating to the surplus
debentures at December 31, 1998 were $7,297, representing accrued principal and
interest. At December 31, 1997, Constitution's statutory surplus was $174,715 of
which $161,098 was attributable to its ownership of Southwestern Life and Union
Bankers.
Risk Based Capital Requirements
Beginning in 1993, the NAIC imposed regulatory risk-based capital ("RBC")
requirements on life insurance enterprises, including the insurance companies.
The RBC model serves as a benchmark for the regulation of life insurance
companies by state insurance regulators. RBC provides for targeted surplus
levels based on formulas which specify various weighting factors that are
applied to financial balances or various levels of activity based on the
perceived degree of risk, and are set forth in the RBC requirements. Such
formulas focus on four general types of risk: (a) the risk with respect to a
company's assets (asset or default risk); (b) the risk of adverse insurance
experience with respect to a company's liabilities and obligations (insurance or
underwriting risk); (c) the interest rate risk with respect to a company's
business (asset/liability matching); and, (d) all other business risk
(management, regulatory action, and contingencies). The amount determined under
such formulas is called the authorized control level RBC ("ACLC").
The RBC guidelines define specific capital levels based on a company's ACLC
that are determined by the ratio of a company's total adjusted capital ("TAC")
to its ACLC. TAC is equal to statutory capital, plus AVR and certain other
specified adjustments. The specified capital levels, in declining order, and
applicable ratios are generally as follows: "Company Action Level" where TAC is
less than or equal to 2.0 times ACLC or the TAC is less than or equal to 2.5
times ACLC with a negative trend; "Regulatory Action Level" where TAC is less
than or equal to 1.5 times ACLC; "Authorized Control Level" where TAC is less
than or equal to 1.0 times ACLC; and, "Mandatory Control Level" where TAC is
less than or equal to 0.7 times ACLC. Companies at the Company Action Level are
required to submit a comprehensive financial plan to the insurance commissioner
of the state of domicile. Companies at the Regulatory Action Level are subject
to mandatory examination or analysis by the commissioner and possible required
corrective actions. At the Authorized Control Level, companies are subject to,
among other things, the commissioner placing it under regulatory control. At the
Mandatory Control Level, the insurance commissioner is required to place a
company under regulatory control.
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At December 31, 1998 Pennsylvania Life's TAC was $27,735, or 1.73 times
ACLC, placing it within the Company Action Level. Should Pennsylvania Life need
to substantially increase its claims reserves further, it is likely that
Pennsylvania Life's RBC ratio would materially decline, without further
management action, to a level which could require certain actions be taken by
the Commonwealth of Pennsylvania Insurance Department. See "Regulatory Matters"
on page 138.
Pennsylvania Life has enacted a plan to improve the RBC ratio which
includes several different actions. These actions include the sale of Penncorp
Life to PFG for fair value; the replacement, by PFG of certain nonperforming
assets held by Pennsylvania Life with investment grade bonds assigned an NAIC
rating of 1 or 2; and the reallocation of capital in conjunction with the
proposed sale of the Penn Union Companies to Universal American. These actions
are designed to place Pennsylvania Life at a target surplus of $36,000 and bring
its TAC in compliance with RBC requirements.
Attaining and maintaining the required RBC levels depends on future events
and circumstances, the outcome of which cannot be assured and the ultimate
outcome cannot be presently determined. Accordingly, no adjustments that may
result from the ultimate resolution of this uncertainty have been made in the
accompanying financial statements. Management presently believes that it will
implement its plan and meet and maintain RBC requirements.
At December 31, 1998, Union Bankers, Constitution, Peninsular, and
Marquette's TAC place them above the Company Action Level.
INVESTMENTS
The Penn Union Companies' investment policy is to balance the portfolio
between long-term and short-term investments so as to achieve investment returns
consistent with the preservation of capital and maintenance of liquidity
adequate to meet the payment of policy benefits and claims. The Penn Union
Companies invest in assets permitted under the insurance laws of the various
states in which they operate; such laws generally prescribe the nature, quality
of and limitations on various types of investments that may be made. The Penn
Union Companies currently engage the services of an investment advisor to manage
their investment portfolio, under the direction and management of the Penn Union
Companies and in accordance with guidelines adopted by their respective boards
of directors. The Penn Union Companies have no investments in any derivative
instruments or other hybrid securities that contain any off balance sheet risk.
The Penn Union Companies have invested in a limited number of
non-investment grade securities that provide higher yields than investment grade
securities. As of December 31, 1998 and 1997, the Penn Union Companies held
unrated or less-than investment grade securities with fair values of $24,997 and
$25,668, respectively. These holdings amounted to 3.6% of total investments and
2.2% of total assets at December 31, 1998 compared to 3.9% of total investments
and 2.0% of total assets at December 31, 1997. The Penn Union Companies had
non-income producing securities with fair values of $2,252 and $1,948 at
December 31, 1998 and December 31, 1997, respectively.
IMPACT OF YEAR 2000
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g., "98" represents 1998). It is
highly likely that such systems will not be able to accurately process data
containing date information for the year 2000 and beyond. The Penn Union
Companies are highly reliant upon computer systems and
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software as are many of the businesses with which the Penn Union Companies
interact. The Penn Union Companies' ability to service their policyholders and
agents is dependent upon accurate and timely transaction reporting. Transaction
reporting in turn is dependent upon the Penn Union Companies' highly complex
interdependent computer hardware, software, telecommunications and desktop
applications. The inability of the Penn Union Companies or any of their integral
business partners to complete Year 2000 remediation efforts associated with
these highly complex and interdependent systems could lead to a significant
business interruption. Such an interruption could result in a decline in current
and long-term profitability and business franchise value.
The Penn Union Companies' plan to resolve the Year 2000 issue involves the
following phases: (1) the assessment phase, (2) the remediation phase which is
the upgrading or modifying of affected systems, (3) the testing phase which
determines effectiveness of the remediation phase, (4) the implementation phase
which applies all proven systems to the operating environment and (5) the
contingency planning phase which develops plans in the event that the Year 2000
issue was not appropriately addressed.
The Penn Union Companies believe that they have substantially completed
their Year 2000 assessment and remediation efforts, which will be subject to
ongoing tests for the remainder of 1999.
In addition to addressing the internal Year 2000 issue, the Penn Union
Companies are working with critical external organizations, business partners
and vendors to assess Year 2000 issues associated with the exchange of
electronic data. The Penn Union Companies are in the process of testing the
interfaces with these business partners. The Penn Union Companies have obtained
Year 2000 readiness statements from their critical external business partners to
determine the extent to which the Penn Union Companies might be vulnerable to
those third parties' failure to remediate their own Year 2000 issues. There is
no guarantee that the systems of other companies on which the Penn Union
Companies' systems rely will be timely converted and will not have an adverse
effect on the Penn Union Companies' systems.
The Penn Union Companies, based upon internal assessment metrics, believed
that they were complete with respect to their Year 2000 remediation efforts of
critical business systems as of December 31, 1998. However, if the Penn Union
Companies' plan is not successfully implemented, the Year 2000 issue could have
a material impact on the operations of the Penn Union Companies.
The Penn Union Companies' plan includes the development of contingency
plans for any significant risks that might result from the Year 2000 issue. As
discussed above, the Penn Union Companies are not presently aware of any
specific significant business risk that they believe they are exposed to
regarding the Year 2000 issue. Although the Penn Union Companies believe that
the Year 2000 issues should not cause a material disruption to their business,
they have developed various contingency plans and proposed action steps
associated with remediation tasks which the Penn Union Companies believe are at
a higher risk for potential failure. However, the Penn Union Companies will
continue to monitor and assess risks, which may require modification to the
current contingency plans. Penn Union currently believes that the most
reasonably likely worst case scenario is that there will be some Year 2000
disruptions for a critical external organization, business partner, vendor or
third party administrator that will affect individual business processes and
cause a minor but noticeable delay in customer service. Penn Union does not
expect such disruptions to be long-term, or for the disruptions to affect the
operation of the company as a whole. Because of the uncertainty as to the exact
nature of a potential Year 2000 related issue, the above
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mentioned contingency plans include emergency response teams and developing
manual workarounds. Penn Union expects to have personnel and resources available
to deal with any Year 2000 problems that might occur.
The Penn Union Companies have engaged certain outside vendors and focused
certain employees' full time efforts to help in their Year 2000 initiative. This
includes systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Penn Union Companies are projecting to
incur costs associated with such expertise of approximately $2,060, to be
incurred primarily during 1998 and early 1999. The Penn Union Companies estimate
that they have incurred costs aggregating $1,796 through March 31, 1999.
Although the Penn Union Companies believe that their operating companies,
outside vendors and most critical business partners will be sufficiently
compliant that the Year 2000 issue should not cause a material disruption in the
Penn Union Companies' business, there can be no assurance that there will not be
material disruptions to the Penn Union Companies' business or an increase in the
cost of doing business.
OTHER COMMITMENTS AND CONTINGENCIES
Certain lawsuits have been brought against the Penn Union Companies in the
normal course of the insurance business involving the settlement of various
matters and seeking compensatory and in some cases punitive damages. Management
of the Penn Union Companies believes that the ultimate settlement of all such
litigations will not have a materially adverse effect on the Penn Union
Companies' combined financial position or results of operations.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered through a reduction in future premium taxes.
REGULATORY MATTERS
The Texas Department of Insurance is in the process of completing its
regularly scheduled triennial examinations of Constitution, Union Bankers, and
Marquette. Management believes that no material adjustments will be recorded as
a result of this examination.
The Commonwealth of Pennsylvania Insurance Department is in the process of
completing its statutory examination of Pennsylvania Life as of December 31,
1996. As a result of proposed examination adjustments, Pennsylvania Life has
increased its statutory reserves for long term care policies and has also
increased certain statutory claims reserves using Pennsylvania Life's own
experience, a practice permitted by the Pennsylvania Department of Insurance.
This permitted practice provides for a grade in period to full statutory tables,
as required by the Pennsylvania Department, over a three year period. Without
this permitted practice, statutory claim liabilities as of December 31, 1998
would be further increased by $16,200. To offset the impact of such reserve
increases on Pennsylvania Life's statutory capital and surplus, Pennsylvania
Life entered into a reinsurance agreement with an unaffiliated reinsurer which
allows Pennsylvania Life to maintain sufficient statutory capital and surplus.
Should Pennsylvania Life need to substantially increase its claims reserves
estimates further, it is likely that Pennsylvania
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Life's RBC ratios would decline, without further management action, to a level
which could require certain actions be taken by the Commonwealth of Pennsylvania
Insurance Department. The Penn Union Companies continue to closely monitor
Pennsylvania Life's RBC ratios.
ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 defines derivative instruments and provides comprehensive accounting and
reporting standards for the recognition and measurement of derivative and
hedging activities (including certain instruments embedded in other contracts).
It requires derivatives to be recorded in the balance sheet at fair value and
establishes criteria for hedges of changes in the fair value of assets,
liabilities or firm commitments, hedges of variable cash flows of forecasted
transactions, and hedges of foreign currency exposures of net investments in
foreign operations. Changes in the fair value of derivatives not meeting
specific hedge accounting criteria would be recognized in the Combined Statement
of Income. SFAS No. 133 is effective for all fiscal quarters of all years
beginning after June 15, 1999. The Penn Union Companies are evaluating SFAS No.
133 and have not determined its effect on the combined financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Penn Union Companies analyze and review the risks arising from market
exposures of financial instruments. During the three months ended March 31,
1999, there have been no material changes to such risks. Market risk relates,
broadly, to changes in the value of financial instruments that arise from
adverse movements in interest rates, equity prices and foreign exchange rates.
The Penn Union Companies are exposed principally to changes in interest rates
that affect the market prices of its fixed income securities and rate sensitive
investment contract type liabilities. To a lesser extent, the Penn Union
Companies are also exposed to changes in the exchange rate between the U.S.
dollar and the Canadian dollar due to its foreign operations in Canada.
Interest Rate Sensitivity
The operations of the Penn Union Companies are subject to risk resulting
from interest rate fluctuations to the extent that there is a difference between
the amount of the Penn Union Companies interest earnings assets and the amount
of its interest bearing liabilities that are prepaid, withdrawn, mature or
re-price in specified periods.
The Penn Union Companies analyze and review the risks arising from market
exposures of financial instruments. From an overall perspective, the Penn Union
Companies attempt to mitigate their exposure to adverse interest rate movements
through a combination of active portfolio management and by staggering the
maturities of their fixed income investments to assure sufficient liquidity to
meet their obligations and to address reinvestment risk considerations. To date,
Penn Union Companies have not utilized various financial risk management tools
on their investment securities, such as interest rate swap, forwards futures or
options to modify their exposure to changes in interest rates. However, the Penn
Union Companies may consider them in the future.
The Penn Union Companies are aware that certain classes of mortgage backed
securities are subject to significant prepayment risk due to the fact that in
periods of declining interest rates, individuals may refinance higher rate
mortgages to take advantage
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ANNEX A
SHARE PURCHASE AGREEMENT
BETWEEN
UNIVERSAL AMERICAN FINANCIAL CORP.
AND
CAPITAL Z FINANCIAL SERVICES FUND II, L.P.
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DATED AS OF DECEMBER 31, 1998
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TABLE OF CONTENTS
PAGE
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ARTICLE I
THE TRANSACTIONS.................................................. A-1
1.1 Purchase and Sale........................................... A-1
1.2 Closing Matters............................................. A-2
1.3 The Closing................................................. A-2
1.4 Fee......................................................... A-2
1.5 PennCorp Purchase Agreement................................. A-2
1.6 Per Share Purchase Price Adjustment......................... A-3
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF THE PURCHASER................... A-5
2.1 Organization................................................ A-5
2.2 Authority................................................... A-5
2.3 No Violation................................................ A-5
2.4 Brokers..................................................... A-6
2.5 Funds Available............................................. A-6
2.6 Securities Act Representation............................... A-6
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF THE COMPANY..................... A-6
3.1 Corporate Organization...................................... A-6
3.2 Subsidiaries................................................ A-6
3.3 Capital Stock............................................... A-7
3.4 Books and Records........................................... A-7
3.5 Newly Issued Shares......................................... A-7
3.6 Authority for and Title to Properties....................... A-8
3.7 Authority................................................... A-8
3.8 No Violation................................................ A-8
3.9 SEC Filings................................................. A-9
3.10 SAP Financial Statements; Reserves.......................... A-10
3.11 Litigation.................................................. A-11
3.12 Compliance with Laws........................................ A-11
3.13 No Material Adverse Change.................................. A-11
3.14 Private Offering............................................ A-11
3.15 Taxes....................................................... A-12
3.16 Brokers..................................................... A-12
3.17 Certain Agreements.......................................... A-12
3.18 Year 2000 Compliance........................................ A-13
3.19 Insurance and Reinsurance................................... A-13
3.20 Employee Benefit Plans...................................... A-13
3.21 Labor Relations............................................. A-14
3.22 Potential Conflicts of Interest............................. A-15
3.23 Representations and Warranties on Closing Date.............. A-15
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PAGE
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ARTICLE IV
COVENANTS AND AGREEMENTS.......................................... A-15
4.1 Conduct of Business Prior to the Closing; Management of the
Company..................................................... A-15
4.2 Proxy Statement and Meeting of Company's Shareholders....... A-16
4.3 Further Assurances.......................................... A-17
4.4 Indemnification by the Company.............................. A-17
4.5 Indemnification by the Purchaser............................ A-18
4.6 Limitations on Indemnification.............................. A-18
4.7 Disclosure Supplements...................................... A-19
4.8 Additional Indemnification Obligation....................... A-19
4.9 Consents.................................................... A-20
4.10 Use of Proceeds............................................. A-20
4.11 HSR Reports................................................. A-21
4.12 Exclusivity................................................. A-21
4.13 SEC Filings and Annual Statements........................... A-21
4.14 Amendment or Termination of Purchase Agreement.............. A-21
4.15 Actions Relating to the PennCorp Purchase Agreement......... A-21
4.16 Registration Rights Agreement............................... A-21
4.17 Shareholders Agreement...................................... A-21
4.18 Employment Agreement........................................ A-22
ARTICLE V
CONDITIONS PRECEDENT.............................................. A-22
5.1 Conditions to Each Party's Obligations...................... A-22
5.2 Conditions to the Obligations of the Company................ A-22
5.3 Conditions to the Obligations of the Purchaser.............. A-23
ARTICLE VI
MISCELLANEOUS..................................................... A-24
6.1 Termination................................................. A-24
6.2 Amendment................................................... A-24
6.3 Waiver...................................................... A-24
6.4 Survival.................................................... A-24
6.5 Notices..................................................... A-24
6.6 Headings; Agreement......................................... A-25
6.7 Publicity................................................... A-25
6.8 Entire Agreement............................................ A-26
6.9 Assignment.................................................. A-26
6.10 Counterparts................................................ A-26
6.11 Governing Law............................................... A-26
6.12 Third Party Beneficiaries................................... A-26
6.13 Costs and Expenses.......................................... A-26
6.14 Specific Performance........................................ A-26
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EXHIBITS
Exhibit A PennCorp Purchase Agreement
Exhibit B Chase Commitment Letter
Exhibit C Form of Registration Rights Agreement
Exhibit D Form of Shareholders Agreement
Exhibit E Form of Opinion of Simpson Thatcher & Bartlett
[Exhibits have been intentionally omitted for purposes of this proxy
statement]
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SHARE PURCHASE AGREEMENT
SHARE PURCHASE AGREEMENT ("Agreement"), dated as of December 31, 1998,
between Universal American Financial Corp., a New York corporation (the
"Company"), and Capital Z Financial Services Fund II, L.P., a Bermuda limited
partnership (the "Purchaser").
R E C I T A L S:
WHEREAS, the Purchaser wishes to purchase from the Company, and the Company
wishes to issue and sell to the Purchaser, the number of shares of common stock,
par value $.01 per share (the "Common Stock"), of the Company set forth in
Section 1.1 below, on the terms and subject to the conditions set forth herein;
WHEREAS, the Purchaser, together with the Company, has participated in the
negotiation of a Stock Purchase Agreement (the "PennCorp Purchase Agreement") to
be entered into between the Company and PennCorp Financial Group, Inc.
("PennCorp"), pursuant to which the Company will acquire (the "Acquisition")
certain subsidiaries and assets of PennCorp (the "PennCorp Subsidiaries");
WHEREAS, concurrently with the execution of this Agreement, the Company and
PennCorp are entering into the PennCorp Purchase Agreement, a copy of which is
attached hereto as Exhibit A;
WHEREAS, concurrently with the execution of this Agreement, the Company,
Chase Manhattan Bank, N.A. ("Chase") and Chase Securities Inc. ("CSI") are
entering into a Commitment Letter (the "Chase Commitment Letter"), a copy of
which is attached hereto as Exhibit B, for a term loan facility and a revolving
credit facility (the "Chase Facility");
WHEREAS, the proceeds of the Chase Facility, together with the proceeds of
the issuance and sale of the Shares to the Purchaser are intended to be used to
consummate the Acquisition;
WHEREAS, the Board of Directors of the Company (the "Board of Directors")
has approved this Agreement and the transactions contemplated hereby, upon the
terms and subject to the conditions set forth herein.
A G R E E M E N T:
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants, agreements and conditions contained
herein, the sufficiency of which is hereby acknowledged, and in order to set
forth the terms and conditions of the transactions described herein and the mode
of carrying the same into effect, the parties hereby agree as follows:
ARTICLE I
THE TRANSACTIONS
1.1 Purchase and Sale. Subject to the terms and conditions of this
Agreement, the Purchaser agrees to purchase from the Company and the Company
agrees to issue and sell to the Purchaser (the "Purchase") at the Closing (as
defined below) an aggregate of Twenty Six Million Thirty One Thousand Seven
Hundred Forty Six (26,031,746) shares of Common Stock at a purchase price per
share equal to Three Dollars and Fifteen Cents ($3.15), for an aggregate
purchase price equal to Eighty Two Million Dollars ($82,000,000), in each case
subject to adjustment as provided in Section 1.6 below. The number of shares of
Common Stock to be purchased at $3.15 per share by the Purchaser and the
aggregate purchase price to be paid by the Purchaser will be reduced by the
aggregate number of shares of Common Stock purchased
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at or prior to the Closing (defined below) by certain members of management of
the Company and certain agents of the Company (the "Management Investors") and
the aggregate purchase price paid for such shares by such Management Investors
pursuant to subscription agreements entered into between the Company and such
Management Investors (which will be in form and substance reasonably
satisfactory to the Purchaser). Notwithstanding the foregoing, the aggregate
purchase price paid by the Purchaser will be at least Sixty Two Million Five
Hundred Thousand Dollars ($62,500,000) for which the Purchaser will receive
Nineteen Million Eight Hundred Forty One Thousand Two Hundred Seventy
(19,841,270) shares of Common Stock at a purchase price per share equal to
$3.15, subject to adjustment as provided in Section 1.6. The shares of Common
Stock to be purchased by the Purchaser under this Agreement, after the
adjustments, if any, made as described above and in Section 1.6, are referred to
as the "Shares," and the aggregate purchase price actually paid by the Purchaser
as reduced by the purchase price paid by the Management Investors as
contemplated above is referred to as the "Purchase Price."
1.2 Closing Matters. At the Closing, the Purchaser shall wire transfer or
otherwise make available in same day funds to the Company the Purchase Price and
the Company shall deliver to the Purchaser certificates representing the Shares.
1.3 The Closing. Subject to the fulfillment of the conditions precedent
specified in Article V hereof (any or all of which may be waived in writing by
the respective parties whose performance is conditioned upon satisfaction of
such conditions precedent), the purchase and sale of the Shares shall be
consummated (the "Closing") simultaneously with the closing of the Acquisition
in accordance with Section 7.1 of the PennCorp Purchase Agreement (the "Closing
Date").
1.4 Fee. If the transactions contemplated by this Agreement are
consummated and the Purchase occurs, the Company shall pay to Capital Z
Management, Inc. at the Closing by wire transfer of immediately available funds
to an account or accounts designated by Capital Z Management, Inc. a transaction
fee (the "Fee") equal to Five Million Dollars ($5,000,000); provided, that the
Purchaser may elect to receive up to One Million Three Hundred Seventy Five
Thousand Dollars ($1,375,000) of such Fee in a number of shares of Common Stock
equal to the amount elected by the Purchaser divided by the per Share purchase
price (as adjusted pursuant to Section 1.6); provided, further, however, that no
Fee is payable if the transactions contemplated by this Agreement are not
consummated.
1.5 PennCorp Purchase Agreement.
(a) The parties hereto understand that the purpose of this Agreement is to
enable the Company to have funds necessary for the Acquisition.
(b) Notwithstanding anything in this Agreement to the contrary, neither
party hereto makes any representation or warranty of any type with respect to
PennCorp or any PennCorp Subsidiary. Neither party hereto has made any
inducements to the other with respect to the PennCorp Purchase Agreement or to
the status, prospects or profitability of the PennCorp Subsidiaries.
(c) The Purchaser and the Company agree that, in the event that (i) the
PennCorp Purchase Agreement is terminated under Section 9.1 thereof and (ii) the
Purchaser and the Company supply to PennCorp an invoice or invoices identifying
their costs and expenses pursuant to Section 9.2 thereof, the Purchaser and the
Company will cooperate with each other to prepare such invoice or invoices (and
collect all supporting information), which invoice or invoices will clearly (i)
distinguish between amounts owed by PennCorp to the Purchaser and amounts owed
by PennCorp to the Company and (ii) identify the account or accounts of the
Purchaser into which payment by PennCorp should be made to the Purchaser and the
account or accounts of the Company into which payment by PennCorp should be made
to the Company.
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The Purchaser and the Company agree to work together to ensure that payment by
PennCorp is made in accordance with the invoice or invoices provided to it by
the Purchaser and the Company, including, to the extent necessary, transferring
money to each other in the amount of any overpayment by PennCorp to one party
and underpayment by PennCorp to the other so as either (i) to cause each of the
Purchaser and the Company to be reimbursed for all of such party's reimbursable
costs and expenses or (ii) if the amount paid or payable by PennCorp is
insufficient fully to reimburse all of the Purchaser's and the Company's
reimbursable costs and expenses, ratably in proportion to each party's total
expenses.
1.6 Per Share Purchase Price Adjustment.
(a) If between the date hereof and the Closing the Purchaser believes that
an MAE Event (defined below) has occurred, the Purchaser shall promptly deliver
to the Company, before the Closing, a written notice (the "MAE Notice") setting
forth in reasonable detail the grounds for its belief that an MAE Event has
occurred and the diminution in the value of the Company the Purchaser believes
has or will occur as a result of such MAE Event. "MAE Event" means any one (or a
series of related) event(s), condition(s) or circumstance(s) occurring after the
date hereof and before the Closing Date that has had, or is reasonably likely to
have, an adverse impact on the business, results of operations or financial
condition of the Company and its Subsidiaries (taken as a whole) that would
reduce the value of the Company and its Subsidiaries (taken as a whole) by an
amount in excess of $3 million (assuming the Benchmark Value set forth on
Schedule 1.6).
(b) Promptly following the delivery of the MAE Notice (if any) by the
Purchaser, the Purchaser and the Company will begin good faith negotiations to
agree on a mutually acceptable adjustment to the per share purchase price to be
paid by Purchaser (it being understood by both parties that any such adjustment
will be determined in accordance with paragraph (d) below). If within 10
business days following the inception of negotiations the parties have not
agreed on a mutually acceptable adjustment to the per share purchase price, such
disagreement will be submitted for resolution to, and the amount of the
adjustment, if any, will be determined by PricewaterhouseCoopers (the
"Settlement Valuator") (or if PricewaterhouseCoopers is not available, such
other independent accounting firm of national reputation selected by the mutual
agreement of the Purchaser and the Company or, if the Purchaser and the Company
cannot agree, a nationally recognized accounting firm or investment bank
selected by PricewaterhouseCoopers. The Purchaser and the Company will cooperate
with the Settlement Valuator and will proceed in good faith to cooperate with
the Settlement Valuator to resolve any such disagreement within 45 days after
such disagreement is submitted to the Settlement Valuator (the "Settlement
Date"). The Purchaser and the Company will each pay one-half of the fees and
expenses of the Settlement Valuator.
(c) Promptly (but in any event within 10 business days) following the
submission of any dispute to the Settlement Valuator, the Purchaser and the
Company shall each deliver to the Settlement Valuator and the other party a
statement setting forth in reasonable detail (with such supporting data as such
party deems appropriate), its determination of the adjustment to the per share
purchase price to be paid by Purchaser (the "Per Share Purchase Price
Adjustment"). The Settlement Valuator, in its reasonable discretion, will
determine (i) the nature and extent of the participation by the Purchaser and
the Company and their respective agents in connection with any disagreement
submitted to the Settlement Valuator for resolution and (ii) the nature and
extent of information, whether documentary or by live witness, that the
Purchaser and the Company may submit to the Settlement Valuator for
consideration in connection with such resolution. The Settlement Valuator's
resolution of any such disagreement, with respect to dollar amounts, must fall
within the range of the disputed amounts stated by the Purchaser and the Company
in the statements supplied by them to the Settlement Valuator pursuant to this
Section 1.6(c) and will be reflected in a written report which will be delivered
on or before the Settlement Date to, and will be final and binding upon, the
Purchaser and the Company. The
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report of the Settlement Valuator will contain the Settlement Valuator's
determination of the Per Share Purchase Price Adjustment in accordance with
paragraph (d) below.
(d) The parties agree that the diminution of value that has resulted or is
reasonably likely to result from a MAE Event will be determined in accordance
with the principles set forth on Schedule 1.6, and without regard to the trading
price of the Common Stock as listed on Nasdaq (or such other stock exchange on
which the Common Stock is then listed). The Per Share Purchase Price Adjustment
will be determined in accordance with the following formula:
Per Share Purchase
Price Adjustment = the after-tax amount of the diminution in value resulting
from the MAE Event minus the product of (x) all
out-of-the-money options, warrants or other securities
convertible into or exchangeable or exercisable for shares
of Common Stock existing on the date of this Agreement times
(y) $3.15 less the applicable conversion, exchange or
exercise price of each such option
divided by
the aggregate number of shares of Common Stock outstanding
on the date of this Agreement plus all in-the-money
options, warrants or other securities convertible into or
exchangeable or exercisable for shares of Common Stock
existing on the date of this Agreement.
For purposes of determining whether options, warrants or other securities
convertible into or exchangeable or exercisable for shares of Common Stock are
"in-the-money" or "out-of-the-money," the applicable conversion, exchange or
exercise price will be compared to the post-adjustment per Share purchase price.
In addition, all shares of Series D-1 and Series D-2 Preferred Stock, par value
$1.00 per share, of the Company outstanding on the date hereof (and all shares
of Common Stock issuable upon conversion or exchange thereof) are expressly
excluded from the foregoing formula.
(e) If there is to be an adjustment pursuant to the foregoing provisions,
upon the earlier to occur of (i) the parties' agreement with respect to the
amount of the Per Share Purchase Price Adjustment or (ii) the delivery of the
report of the Settlement Valuator as provided in Section 1.6(c) hereof with
respect to a dispute submitted to the Settlement Valuator pursuant to Section
1.6(b), either:
(i) if the Closing has not yet occurred, then, at the Closing, the
Company shall issue to the Purchaser, and the Purchaser will acquire from
the Company, instead of the number of Shares described in Section 1.1, that
number of Shares determined by dividing the Purchaser's money commitment
under Section 1.1 by the adjusted purchase price per Share which shall be
$3.15 less the Per Share Purchase Price Adjustment; or
(ii) if the Closing has already occurred, the Company promptly (but in
any event no later than 10 days thereafter) will issue to the Purchaser,
for no additional consideration, certificates representing such number of
additional Shares necessary to cause the Purchaser's purchase price per
share to equal $3.15 less the Per Share Purchase Price Adjustment.
(f) The parties hereby agree that, so long as all conditions precedent set
forth in Article V have been satisfied or waived, neither the delivery of an MAE
Notice nor the pendency of proceedings before the Settlement Valuator will in
any way prevent or delay the Closing, regardless of whether an adjustment is
requested or may be made pursuant to the foregoing provisions.
(g) Notwithstanding the foregoing or any other provision of this Agreement,
if an MAE Event causes (or would be reasonably likely to cause) the purchase
price per share payable by the
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Purchaser (determined in accordance with the formula set forth in paragraph (d)
above) to be $2.25 per share or less (i.e., if the Per Share Purchase Price
Adjustment would be $0.90 or more), the Purchaser shall have the absolute right
(i) to cause the Company to assign to another person (the "Substituted Buyer")
all of the Company's rights and obligations under the PennCorp Purchase
Agreement pursuant to Section 10.12 of the PennCorp Purchase Agreement and (ii)
upon such assignment to and assumption by the Substituted Buyer, the parties'
obligations under this Agreement, except for the indemnification obligations set
forth in Section 4.8(b) and 6.13 (to the extent set forth therein), shall
terminate; provided, however, that if the PennCorp Purchase Agreement is
assigned to a Substituted Buyer and the Acquisition is consummated by such
Substituted Buyer, the Company shall not be liable for, and the Purchaser shall
indemnify and hold harmless the Company from, any and all liabilities, including
without limitation, defense costs, relating to PennCorp or the PennCorp Purchase
Agreement. It is further understood that the right of substitution hereunder
will terminate and have no further force or effect upon the consummation of the
Acquisition.
ARTICLE II
REPRESENTATIONS AND WARRANTIES
OF THE PURCHASER
The Purchaser represents and warrants to the Company as follows:
2.1 Organization. The Purchaser is a limited partnership duly organized,
validly existing and in good standing under the laws of its jurisdiction of
formation.
2.2 Authority. (i) The Purchaser has full partnership power and authority
to execute and deliver this Agreement and each other agreement contemplated
hereby to which it is a party, to carry out its obligations hereunder and
thereunder and to consummate the transactions contemplated on its part hereby
and thereby, (ii) the execution, delivery and performance by the Purchaser of
this Agreement and each other agreement contemplated hereby to which it is a
party have been duly authorized by all necessary partnership action on the part
of the Purchaser, (iii) no other action on the part of the Purchaser is
necessary to authorize the execution and delivery of this Agreement and each
other agreement contemplated hereby by the Purchaser or the performance by the
Purchaser of its obligations hereunder and (iv) this Agreement has been duly
executed and delivered by the Purchaser and (assuming due execution and delivery
by the other parties hereto) constitutes a legal, valid and binding agreement of
the Purchaser, enforceable against it in accordance with its terms, subject to
applicable bankruptcy, insolvency, moratorium, reorganization or similar laws
affecting creditors' rights generally and subject to general equitable
principles (regardless of whether such enforceability is considered in a
proceeding in equity or at law). Each other agreement to be executed by the
Purchaser in connection with this Agreement on or prior to the Closing Date will
be duly executed and delivered by the Purchaser, and (assuming due execution and
delivery by the other party or parties thereto) will constitute a legal, valid
and binding obligation of the Purchaser, enforceable against it in accordance
with its terms, subject to applicable bankruptcy, insolvency, moratorium,
reorganization or similar laws affecting creditors' rights generally and subject
to general equitable principles (regardless of whether such enforceability is
considered in a proceeding in equity or at law).
2.3 No Violation. The execution and delivery by the Purchaser of this
Agreement and each other agreement contemplated hereby to which it is a party,
the performance by the Purchaser of its obligations hereunder and thereunder and
the consummation by it of the transactions contemplated hereby and thereby will
not (a) violate any provision of law, rule or regulation or final order,
judgment, injunction, decree, determination or award found against it
(collectively, "Requirements of Law") applicable to the Purchaser, (b) require
the Purchaser to obtain the consent, waiver, approval, license or authorization
of or make any filing with any person or
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governmental authority except for (i) filings to be made in connection with or
in compliance with the provisions of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), Regulation D as promulgated under the Securities
Act of 1933, as amended (the "Securities Act"), and applicable state securities
laws, (ii) if required, the filing by the Company or the Purchaser of a
pre-merger notification report under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (an "HSR Report"), and (iii) the filing of
a Form A Information Statement ("Form A") by the Purchaser with the insurance
departments of such states as may be required in connection with the
transactions contemplated by this Agreement or (c) violate, result (with or
without notice or the passage of time, or both) in a breach of or give rise to
the right to accelerate, terminate or cancel any obligation under or constitute
(with or without notice or the passage of time, or both) a default under, any of
the terms or provisions of any charter or bylaw, partnership agreement,
indenture, mortgage, agreement, contract, order, judgment, ordinance, regulation
or decree to which the Purchaser is subject or by which the Purchaser is bound,
except for any of the foregoing matters which would not reasonably be expected
to have, individually or in the aggregate, a materially adverse impact upon the
ability of the Purchaser to consummate the transactions contemplated hereby or
to perform its obligations hereunder.
2.4 Brokers. Neither the Purchaser nor any of its affiliates has
committed on behalf of itself or a third party to pay any fee or commission to
any broker, finder, investment banker or other intermediary in connection with
this Agreement.
2.5 Funds Available. The Purchaser has funds available, or firm
commitments from third parties to provide funds, sufficient to pay the Purchase
Price as evidenced by Schedule 2.5.
2.6 Securities Act Representation. As of the Closing hereunder, the
Purchaser will be an "accredited investor" as defined in Rule 501 promulgated as
part of Regulation D under the Securities Act. The Purchaser is not purchasing
the Shares with a view to a distribution or resale of any of such securities in
violation of any applicable securities laws.
ARTICLE III
REPRESENTATIONS AND WARRANTIES
OF THE COMPANY
The Company represents and warrants to the Purchaser as follows:
3.1 Corporate Organization. Each of the Company and its Subsidiaries (as
defined below) is a corporation duly organized, validly existing and in good
standing under the laws of the jurisdiction of its incorporation, with all
requisite corporate power and authority to carry on its business as it is now
being conducted in any such jurisdiction as described in the SEC Filings (as
defined herein), and is duly qualified or licensed to do business and is in good
standing in each jurisdiction in which it currently carries on its business,
except where the failure to be so qualified or licensed or be in good standing
would not reasonably be expected to have, individually or in the aggregate, a
materially adverse impact on the business, results of operations or financial
condition (a "Material Adverse Effect") of the Company. With respect to the
Company, a "Material Adverse Effect" as that term is used throughout this
Agreement, shall mean and refer to the Company and its Subsidiaries on a
consolidated basis. True and complete copies of the Certificate of Incorporation
and the Bylaws of the Company and respective charter documents of the
Subsidiaries, each as amended to date, heretofore have been delivered to the
Purchaser. "Subsidiaries" means, with respect to the Company, a corporation or
other entity of which 50% or more of the voting power of the outstanding voting
securities or 50% or more of the outstanding equity interests is held, directly
or indirectly, by the Company.
3.2 Subsidiaries. Schedule 3.2 sets forth a complete and accurate list of
all of the Subsidiaries of the Company, together with their respective
jurisdictions of incorporation or organization. Unless otherwise indicated on
Schedule 3.2, each such Subsidiary is directly wholly
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owned by the Company. All of the outstanding shares of capital stock of the
Subsidiaries are validly issued, fully paid and, except as provided under
Section 630 of the Business Corporation Law of New York (relating to employee
wages), non-assessable. Except as indicated on Schedule 3.2, all of the
outstanding shares of capital stock of, or other ownership interests in, each of
the Subsidiaries are owned by the Company or by a wholly owned Subsidiary free
and clear of any and all liens, encumbrances, security interests, preemptive
rights, adverse claims or rights in favor of another ("Liens"). Except as
indicated on Schedule 3.2, no Subsidiary has outstanding options, warrants,
subscriptions, calls, rights convertible securities or other agreements or
commitments obligating the Subsidiary to issue, transfer or sell any securities
of the Subsidiary.
3.3 Capital Stock. The authorized capital stock of the Company consists
of: (a) 20,000,000 shares of Common Stock, of which, as of the date hereof,
7,638,057 shares are issued and outstanding; (b) 500 shares of Series B
Convertible Preferred Stock, par value $1.00 per share (the "Series B Preferred
Stock"), of which, as of the date hereof, 400 are issued and outstanding; (c)
100,000 shares of Series C Convertible Preferred Stock, par value $1.00 per
share (the "Series C Preferred Stock"), of which, as of the date hereof, 45,680
shares designated as Series C-1 (the "Series C-1 Shares") are issued and
outstanding and 6,000 shares designated as Series C-2 are issued and
outstanding; (d) 22,500 shares of Series D-1 Convertible Preferred Stock, par
value $1.00 per share (the "Series D-1 Preferred Stock"), of which, as of the
date hereof, 22,500 shares are issued and outstanding; and (e) 17,500 shares of
Series D-2 Convertible Preferred Stock, par value $1.00 per share (collectively
with the Series B Preferred Stock, the Series C Preferred Stock and the Series
D-1 Preferred Stock, the "Preferred Stock"), of which, as of the date hereof, no
shares are issued and outstanding. In addition, as of the date hereof, there are
2,673,991 warrants to purchase shares of Common Stock (the "Common Stock
Warrants") issued and outstanding. All of the outstanding shares of Common Stock
and Preferred Stock have been duly and validly authorized and issued, are fully
paid and, except as provided under Section 630 of the Business Corporation Law
of New York (relating to employee wages), nonassessable, and were issued in
compliance with all applicable federal and state securities laws. Upon exercise
of the Common Stock Warrants, the shares of Common Stock issued pursuant to such
warrants will be validly issued, fully paid and, except as provided under
Section 630 of the Business Corporation Law of New York (relating to employee
wages) nonassessable, and issued in compliance with all applicable federal and
state securities laws. Except for the Common Stock Warrants, for options and
other stock rights authorized for issuance pursuant to the Company's stock plans
and director, employee and agent stock option and purchase plans described in
the SEC Filings and except as set forth on Schedule 3.3, there are no preemptive
rights, options, warrants, conversion privileges or other rights presently
outstanding to purchase or otherwise acquire any authorized but unissued shares
of capital stock or other securities of the Company or any of the Subsidiaries.
3.4 Books and Records. Copies of all the minute books and stock record
books of the Company and the Subsidiaries have been delivered to the Purchaser
for inspection and contain records of all meetings of, and written consents by,
the boards of directors (and any committees thereof) and shareholders of the
Company and each Subsidiary since, in the case of the Company, the date of its
incorporation and, in the case of the Subsidiaries, the date on which the
Company acquired such Subsidiary, in each case through the date hereof.
3.5 Newly Issued Shares. The Shares to be issued and sold by the Company
to the Purchaser in accordance with the terms of this Agreement have been or
will be, when approved by the shareholders of the Company as provided in Section
4.2, duly authorized and, when issued as contemplated hereby, will be validly
issued, fully paid and, except as provided under Section 630 of the Business
Corporation Law of New York (relating to employee wages) non-assessable and the
issuance of the Shares by the Company will not be subject to preemptive or other
similar rights. At the Closing, the Purchaser will acquire good and marketable
title to the
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Shares free and clear of any and all Liens, except for such Liens as may be
created pursuant to this Agreement or imposed by applicable federal and state
securities laws.
3.6 Authority for and Title to Properties. The Company and each
Subsidiary have all requisite corporate power and authority to lease the
properties it operates as lessee. The Company and each Subsidiary have good
record and marketable title in fee simple to, or hold interests as lessee under
leases in full force and effect in, all of their respective real properties,
except for such defects in title as would not be reasonably expected to have,
individually or in the aggregate, a Material Adverse Effect on the Company.
3.7 Authority. The Company has full corporate power and authority to
execute and deliver this Agreement and each other agreement contemplated hereby
to which it is a party, to carry out its obligations hereunder and thereunder
and to consummate the transactions contemplated on its part hereby and thereby.
The execution, delivery and performance by the Company of this Agreement and
each other agreement contemplated hereby to which it is a party and the
consummation of the transactions contemplated on its part hereby have been duly
authorized by the Board of Directors, and no other corporate proceedings on the
part of the Company, except for the shareholder approval specified in Section
4.2 hereof, are necessary to authorize the execution and delivery of this
Agreement and each other agreement contemplated hereby by the Company or the
performance by the Company of its obligations hereunder or thereunder. This
Agreement has been duly executed and delivered by the Company and (assuming due
execution and delivery by the other parties hereto) constitutes the legal, valid
and binding obligation of the Company, enforceable against the Company in
accordance with its terms, subject to applicable bankruptcy, insolvency,
moratorium, reorganization or similar laws affecting creditors' rights generally
and subject to general equitable principles (regardless of whether such
enforceability is considered in a proceeding in equity or at law). Each other
agreement to be executed by the Company in connection with this Agreement on or
prior to the Closing Date will be duly executed and delivered by the Company,
and (assuming due execution and delivery by the other party or parties thereto)
will constitute a legal, valid and binding obligation of the Company,
enforceable against the Company in accordance with their respective terms,
subject to applicable bankruptcy, insolvency, moratorium, reorganization, or
similar laws affecting creditors' rights generally and subject to general
equitable principles (regardless of whether such enforceability is considered in
a proceeding in equity or at law).
3.8 No Violation. The execution, delivery and performance of this
Agreement and each other agreement contemplated hereby by the Company and the
consummation by it of the transactions contemplated hereby and thereby do not
(a) violate any Requirements of Law applicable to the Company or any of the
Subsidiaries, (b) require the consent, waiver, approval, license or
authorization of or any notice or filing by the Company or any of the
Subsidiaries with any person or governmental authority except for (i) filings to
be made in connection with or in compliance with the provisions of the
Securities Act, the Exchange Act and applicable state securities laws and
Canadian federal and provisional laws, (ii) the filing of (A) HSR Reports by the
Company or the Purchaser, if required, in connection with this Agreement and (B)
the filing and approval of Forms A by the Purchaser and, where required, the
Company, with the insurance departments as may be required by the insurance
departments in order for the Company to implement this Agreement and (iii) the
shareholder approval specified in Article V or (c) violate, result (with or
without notice or the passage of time, or both) in a breach of or give rise to
the right to accelerate, terminate or cancel any obligation under, constitute
(with or without notice or the passage of time, or both) a default under, any of
the terms or provisions of any charter or bylaw, indenture, mortgage, agreement,
contract, order, judgment, ordinance, regulation or decree to which the Company
or any of its Subsidiaries is subject or by which the Company or any of its
Subsidiaries is bound, except for any of the foregoing which would not be
reasonably expected to have, individually or in the aggregate, a Material
Adverse Effect on the Company. Except as set forth on Schedule 3.8, neither the
Company nor any of the Subsidiaries is party to
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any agreement which is currently in effect, or by which the Company or any of
the Subsidiaries is currently bound, granting any rights to any person which
conflict with the rights to be granted by the Company in this Agreement
(including the registration rights granted to the Purchaser pursuant to Section
4.16) and each other agreement contemplated hereby. Except as set forth on
Schedule 3.8, the execution, delivery and performance of this Agreement and each
other agreement contemplated hereby by the Company and the consummation by it of
the transactions contemplated hereby and thereby will not result in a "change of
control" or similar event occurring under any agreement, indenture, mortgage,
contract or plan to which the Company or any of its Subsidiaries is subject or
by which the Company or any of its Subsidiaries is bound or give rise to a
payment by the Company or any of its Subsidiaries under a change of control or
similar provision in any agreement, indenture, mortgage or contract to which the
Company or any of its Subsidiaries is subject or by which the Company or any of
its Subsidiaries is bound.
3.9 SEC Filings. Except as set forth on Schedule 3.9, the Company has
filed all SEC Filings required to be filed by it since December 31, 1997 under
the Securities Act or the Exchange Act, and all amendments thereto. The Company
heretofore has delivered to the Purchaser true and complete copies of (a) its
audited consolidated financial statements of the Company and the Subsidiaries
(balance sheet and statements of operations, cash flows and stockholders' equity
and cash flows, together with the notes thereto) for the fiscal years ended and
as at December 31, 1996 and December 31, 1997 (as such financial statements
appear in the Company's Form 10-K for each of the fiscal years ended December
31, 1996 and December 31, 1997, which were filed with the Securities and
Exchange Commission (the "Commission") on April 1, 1997 and March 30, 1998,
respectively, and the Company's Amendment No. 1 to Form 10-K for the fiscal year
ended December 31, 1997, which was filed with the Commission on April 29, 1998
("Amendment No. 1") (collectively, the "Financial Statements")), (b) its
Quarterly Reports on Form 10-Q for the quarters ended September 30, 1997, March
1, 1998, June 30, 1998 and September 30, 1998, (c) its Annual Report on Form
10-K for the fiscal year ended December 31, 1997, as amended by Amendment No. 1,
(d) each of its Proxy Statements on Schedule 14A under the Exchange Act, dated
May 7, 1997 and April 27, 1998, respectively, and (e) all other reports,
statements, registration statements and other documents (including Current
Reports on Form 8-K) filed by it with the Commission under the Securities Act or
the Exchange Act, and all amendments and supplements thereto, since December 31,
1997 (the foregoing subsections (a) through (e), including all exhibits and
Schedules thereto and documents incorporated by reference therein, are
collectively referred to in this Agreement as the "SEC Filings"). As of the
respective date that it was filed with the Commission, each of the SEC Filings
complied as to form and content, in all material respects, with the requirements
of the Securities Act or the Exchange Act, as the case may be, and the rules and
regulations promulgated thereunder, and did not contain any untrue statement of
a material fact or omit to state any material fact required to be stated therein
or necessary to make the statements therein, in light of the circumstances under
which they were made, not misleading. Except as set forth on Schedule 3.9, the
Financial Statements included in the SEC Filings were prepared in accordance
with generally accepted accounting principles ("GAAP"), consistently applied,
and (except as may be indicated therein or in the notes thereto) present fairly
the consolidated financial position, results of operations and cash flows of
Company as of the dates and for the respective periods indicated (subject, in
the case of unaudited financial statements, to normal recurring year-end
adjustments and any other adjustments described therein). The Company has (i)
delivered to the Purchaser true and complete copies of (x) all correspondence
relating to the Company between the Commission, on the one hand, and the Company
or its legal counsel or, to the Knowledge of the Company, after inquiry, its
accountants, on the other hand, since January 1, 1996 (other than routine filing
package cover letters) and (y) all audit letters delivered to the Company by its
counsel and all correspondence relating thereto, and all letters to or from the
Company relating to any dispute or disagreement between the Company and the
Company's auditors with respect to any audit or financial review or with
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respect to the Company's accounting policies, in each case since January 1,
1996, and (ii) disclosed to the Purchaser the content of all material
discussions between the Commission, on the one hand, and the Company or its
legal counsel and, to the Knowledge of the Company, after inquiry, its
accountants, on the other hand, concerning the adequacy or form of any SEC
Filings filed with the Commission since January 1, 1996, except for routine
discussions with respect to filings now effective. The Company is not aware of
any issues raised by the Commission with respect to any of the SEC Filings,
other than those disclosed to the Purchaser pursuant to this paragraph. For
purposes of this Agreement, "Knowledge of the Company" means the actual
knowledge of Richard A. Barasch ("Barasch"), Robert Waegelein ("Waegelein"),
Gary Bryant ("Bryant"), Bradley Leonard and Bertram Harnett, Esq.
3.10 SAP Financial Statements; Reserves.
(a) The Company heretofore has delivered to the Purchaser true and complete
copies of the following (the "SAP Financial Statements"):
(i) the annual statements required by applicable state statutes
("Annual Statements") for American Exchange Life Insurance Company, a Texas
corporation, (ii) American Pioneer Life Insurance Company, a Florida
corporation, and (iii) American Progressive Life & Health Insurance Company
of New York, a New York corporation ((i), (ii) and (iii) being collectively
referred to herein as the "Insurance Company Subsidiaries") for each of the
years ended December 31, 1996 and 1997, in each case as filed with the
departments of insurance in the respective states of domicile of the
Insurance Company Subsidiaries including all exhibits, interrogatories,
notes and schedules thereto and any actuarial opinions, affirmation or
certification filed in connection therewith;
(ii) the Quarterly Statements for the Insurance Company Subsidiaries
for the quarters ended March 31, June 30 and September 30, 1998, including
all exhibits, interrogatories, notes and schedules thereto; and
(iii) the statutory annual statements and quarterly statements of the
Insurance Company Subsidiaries which were filed for 1996, 1997 or 1998
(with respect to the quarters ended March 31 and June 30) in any
jurisdiction (other than such Subsidiary's jurisdiction of domicile) and
that differ from the corresponding Annual Statements and Quarterly
Statements for such periods.
Each such statement was prepared in accordance with SAP and, except as set forth
in Schedule 3.10, presents fairly in all material respects the statutory
financial position of the Insurance Company Subsidiaries as of the respective
dates thereof and the related summary of operations and changes in capital and
surplus and in cash flows of the Insurance Company Subsidiaries for and during
the respective periods covered thereby.
(b) Except as set forth on Schedule 3.10, all statutory reserves and other
similar amounts with respect to insurance as established or reflected in the
December 31, 1997 Annual Statement and September 30, 1998 Quarterly Statement of
the Insurance Company Subsidiaries were determined in accordance with SAP and
were based on actuarial assumptions that were in material compliance with the
then-applicable requirements of the insurance laws of the respective states of
domicile of the Insurance Company Subsidiaries. Except as set forth on Schedule
3.10, all such reserves and other similar amounts were adequate in all material
respects as of the respective dates of such statements, based upon then-current
information and assumptions concerning investment income, mortality and
morbidity experience, persistency and expenses, to cover the total amount of all
reasonably anticipated matured and unmatured benefits, dividends, claims and
other liabilities of the Insurance Company Subsidiaries under all insurance
contracts under which the Insurance Company Subsidiaries had any liability
(including without limitation any liability arising under or as a result of any
reinsurance, coinsurance or other similar contract) on the respective dates of
such financial statements. Except as set forth above, nothing in this
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Section 3.10(b) shall be deemed a guaranty or warranty by the Company that
claims actually paid and other liabilities actually incurred by the Insurance
Company Subsidiaries will not exceed the reserves established as set forth
hereinabove in this Section 3.10(b) by the Insurance Company Subsidiaries.
Except as set forth on Schedule 3.10, the Insurance Company Subsidiaries own
assets that qualify as admitted assets under applicable insurance laws in an
amount at least equal to all such required reserves of such Subsidiaries.
3.11 Litigation. Except as set forth in the SEC Filings or otherwise
disclosed to the Purchaser in writing, there are no actions, suits, proceedings,
claims, complaints, disputes or investigations pending of which the Company has
received notice or, to the Knowledge of the Company, threatened, at law, in
equity, in arbitration or before any governmental authority against the Company
or any of its Subsidiaries and with respect to which the Company or any of its
Subsidiaries is responsible by way of indemnity or otherwise, that would, if
adversely determined, (a) have a Material Adverse Effect on the Company or (b)
materially impede or impair the ability of the Company to perform its
obligations under this Agreement and each other agreement contemplated hereby to
which it is a party. No injunction, writ, temporary restraining order, decree or
order of any nature has been issued by any court or other governmental authority
against the Company or any of its Subsidiaries purporting to enjoin or restrain
the execution, delivery or performance of this Agreement or any other agreement
contemplated hereby.
3.12 Compliance with Laws. Except as set forth on Schedule 3.12:
(a) each of the Company and the Subsidiaries (including the forms of
insurance policies and riders issued by the Company and the Subsidiaries) is in
compliance with all Requirements of Law in all respects, except to the extent
that the failure to comply with such Requirements of Law would not have a
Material Adverse Effect on the Company;
(b) (i) each of the Company and the Subsidiaries has all licenses, permits,
orders or approvals of any governmental authority (collectively, "Permits") that
are material to or necessary for the conduct of the business of the Company in
the manner described in the SEC Filings filed with the Commission prior to the
date hereof, except to the extent that the failure to have such Permits would
not have a Material Adverse Effect on the Company, (ii) such Permits are in full
force and effect, and (iii) no material violations are recorded in respect to
any Permit;
(c) the Company and the Subsidiaries (exclusive of their independent
agents) and, to the Knowledge of the Company, their independent agents, have
marketed, sold and issued products of the Company and the Subsidiaries in
material compliance with all laws applicable to the business of the Company and
the Subsidiaries in the respective jurisdictions in which such products have
been sold; and
(d) the Company has previously delivered or made available to the Purchaser
true and complete copies of the reports (or the most recent draft thereof, to
the extent any final report is not available) reflecting the results of the two
most recent financial examinations and market conduct examinations of the
Company and any Subsidiary issued by any insurance regulator.
3.13 No Material Adverse Change. Except (a) as set forth in the SEC
Filings, (b) as contemplated by this Agreement, the Shareholders' Agreement, the
Registration Rights Agreement and the Employment Agreements and (c) as set forth
on Schedule 3.13, since December 31, 1997, neither the Company nor any of the
Subsidiaries, taken as a whole, has (a) experienced any material adverse change
in their business, financial condition or results of operations, (b) conducted
its business in any material respect other than in the ordinary course or (c)
suffered any material casualty losses not covered by insurance.
3.14 Private Offering. No form of general solicitation or general
advertising was used by the Company or any of the Subsidiaries or their
respective representatives in connection with the offer or sale of the Shares.
Assuming the accuracy of the Purchaser's representations in
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Section 2.6, no registration of the Shares, pursuant to the provisions of the
Securities Act or any state securities or "blue sky" laws, will be required by
the offer, sale or issuance of the Shares.
3.15 Taxes. Except as provided in Schedule 3.15, (a) (i) all income tax
returns required to be filed by or with respect to each of the Company and its
Subsidiaries have been timely filed, (ii) all such income tax returns are
correct and complete in all material respects, (iii) all income taxes owed and
due by the Company or its Subsidiaries (whether or not shown on any income tax
return) have been paid, (iv) the Company has given or otherwise made available
to the Purchaser correct and complete copies of all income tax returns,
examination reports and statements of deficiencies for all periods for which the
statute of limitations has not expired, (v) there are no outstanding agreements
to extend or waive the statutory period of limitations with respect to income
taxes due from the Company or its Subsidiaries for any taxable period and (vi)
the Company has delivered to the Purchaser true and complete copies of any Tax
sharing agreements to which it or any of its Subsidiaries is party and such
agreements have not been amended in any manner.
(b) No audit or other proceeding by any taxing authority, court or similar
person is pending or, to the Knowledge of the Company, threatened with respect
to any Taxes due from or with respect to the operations of the Company or any of
its Subsidiaries or any Tax return filed by or with respect to the operations of
the Company or any of its Subsidiaries. To the Knowledge of the Company, no
assessment of Taxes is proposed against the Company, any of its Subsidiaries or
any of their assets.
(c) the Tax treatment under the Code of each insurance, annuity, contract,
agreement or product, or any similar or related policy, contract, agreement or
product, issued or sold by the Company or the Subsidiaries (collectively,
"Products") is and at all times has been the same as or not less favorable to
any purchaser, policyholder, or beneficiaries thereof that is subject to U.S.
Tax than the Tax treatment under the Code which the Company or any Subsidiary
represented could be obtained at the time of its issuance, purchase,
modification or exchange. The Company promptly investigates complaints made by
customers to the Company regarding conduct of its independent agents, including
conduct regarding representations made regarding the Tax treatment of any of the
Products. For purposes of this Section 3.15(c), the provisions of the Code
relating to the Tax treatment of such contracts shall include, but shall not be
limited to, Sections 72, 79, 101, 104, 105, 106, 125, 130, 401, 402, 403, 404,
408, 412, 415, 419, 419A, 457, 501, 505, 817, 817A, 818, 1035, 7702, and 7702A
of the Code.
(d) each Insurance Company Subsidiary is taxable as a life insurance
company within the meaning of Section 816 of the Code.
(e) For purposes of this Agreement, "Tax" or "Taxes" (or any derivation
thereof) means any and all federal, state, local, foreign and other taxes,
levies, fees, imposts duties and similar governmental charges (including any
interest, fines, assessments, penalties or additions to tax imposed in
connection therewith or with respect thereto) including, without limitation,
taxes imposed on, or measured by, income, franchise, profits or gross receipts,
ad valorem, value added, sales, use, service, real or personal property, capital
stock, license, payroll, estimated, withholding, employment, social security (or
similar), unemployment, compensation, utility, severance, production, excise,
stamp, occupation, premium, windfall profits, transfer and gains taxes and
customs duties.
3.16 Brokers. Except with respect to fees payable to Chase, CSI and to
Advest, Inc., the Company has not paid or become obligated to pay any fee or
commission to any broker, finder, investment banker or other intermediary in
connection with this Agreement.
3.17 Certain Agreements. (a) Except as disclosed on Schedule 3.17 or in
the SEC Filings, neither the Company nor any of the Subsidiaries is a party to
any written (i) agreement, contract, indenture or other instrument relating to
the borrowing of money or the guarantee of
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any obligation for the borrowing of money, (ii) employment, consulting,
compensation or severance agreement with any of its directors, employees or
consultants, (iii) agreement, contract or commitment limiting or restraining it
from engaging or competing in any business, (iv) distribution, dealer,
representation or agency agreement, other than agency agreements, brokerage
agreements or other distribution agreements with insurance agents in the
ordinary course of business, or (v) contract, agreement, obligation or
commitment with any affiliates (each of the foregoing a "Listed Contract"). Each
Listed Contract is in full force and effect and has been complied with by the
Company and the Subsidiaries and, to the Knowledge of the Company, has been
complied with by all other parties thereto.
(b) All transactions between the Company and its affiliates which were
required to have been identified or reported to and/or approved by the
applicable departments of insurance have been identified, reported and/or
approved in all material respects. For purposes of this Agreement, "affiliates"
means, as to a specified person, any other person that directly or indirectly,
through one or more intermediaries, controls, is controlled by, or is under
common control with, the specified person.
3.18 Year 2000 Compliance. The information included under the heading
"Impact of Year 2000" in the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, filed with the Commission on November 16,
1998, accurately reflects the status of the Company's program to address, on a
timely basis, the risk that its computer systems are not Year 2000 compliant.
There have been no circumstances or events since September 30, 1998 that would
adversely effect or change, in any material respect, the Company's expectations
to resolve its Year 2000 issues on a timely basis.
3.19 Insurance and Reinsurance.
(a) Schedule 3.19 is a true and complete list of each material contract
providing for reinsurance, coinsurance, excess insurance, ceding of insurance,
assumption of insurance or indemnification of insurance liabilities to which the
Company or any Subsidiary is a party which is currently in effect (the
"Reinsurance Agreements").
(b) Except as disclosed on Schedule 3.19, neither the Company nor any
Subsidiary is in material default under any Reinsurance Agreement and, to the
Knowledge of the Company, there is no reasonable basis for a reinsurer to
terminate or refuse to pay under any Reinsurance Agreement. Except as disclosed
in Schedule 3.19, to the Knowledge of the Company, no reinsurer that is a party
to any of the Reinsurance Agreements has a valid defense to payment of its
material obligations under such Reinsurance Agreements or is in default in any
material respect under any Reinsurance Agreement. Each Reinsurance Agreement is
in compliance with applicable insurance laws and regulations regarding life and
health reinsurance agreements. Schedule 3.19 sets forth a list of all surplus
relief reinsurance treaties of the Company. The Company is appropriately
recording all reinsurance in accordance with SAP.
(c) The A.M. Best rating presently held by the Insurance Company
Subsidiaries has not been reduced, and none of the Insurance Company
Subsidiaries have been given any notice of any intended or potential downgrading
by A.M. Best.
3.20 Employee Benefit Plans.
(a) Schedule 3.20 lists all employee benefit plans, arrangements, policies
or commitments (whether or not an employee benefit plan within the meaning of
Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended
("ERISA")), including any employment (other than the Employment Agreements),
consulting or deferred compensation agreement, executive compensation, bonus,
incentive, pension, profit-sharing, savings, retirement, stock option, stock
purchase or severance pay plan, any life, health, disability, or accident
insurance plan or any holiday or vacation practice, as to which the Company or
the Subsidiaries has or in the future would have any direct or indirect, actual
or contingent liability ("Benefit Plans"). With
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respect to each such Benefit Plan, the Company heretofore has delivered to the
Purchaser true, correct and complete copies of (i) all plan texts and agreements
and related trust agreements or annuity contracts, (ii) all summary plan
descriptions and material employee communications, (iii) the most recent annual
report (including all schedules thereto); (iv) if the plan is intended to
qualify under Section 401(a) or 403(a) of the Code, the most recent
determination letter received from the Internal Revenue Service (the "IRS"), and
(v) all material communications with any governmental authority with respect to
Benefit Plans.
(b) Each Benefit Plan conforms in all material respects to, and its
administration is in substantial compliance with, its terms and all Requirements
of Law and regulations. Each Benefit Plan intended to be qualified under Code
section 401(a) has been determined to be so qualified by the IRS and each trust
established in connection with any Benefit Plan that is intended to be exempt
from federal income taxation under Code section 501(a) has been determined to be
so exempt by the IRS and, since the date of each most recent determination, no
event has occurred and no condition or circumstance has existed to adversely
affect the qualified status of any Benefit Plan.
(c) Except as set forth on Schedule 3.20 or as contemplated by this
Agreement, the consummation of the transactions contemplated by this Agreement
will not (i) entitle any current or former employee to severance pay or
unemployment compensation, (ii) accelerate the time of payment or vesting, or
increase the amount of any compensation due to, any current or former employee
or (iii) result in a payment that would constitute a parachute payment within
the meaning of Section 280G of the Code.
(d) No Benefit Plan is a "multiple employer plan" or a "multiemployer plan"
within the meaning of the Code or ERISA and neither the Company nor the
Subsidiaries, or any member of their controlled group (as defined in Section 414
of the Code) has had any liability to contribute to a multiemployer plan in the
previous six years.
(e) No Benefit Plan that is a welfare plan (as defined in Section 3611 of
ERISA) provides for payments of medical or death benefits with respect to
current or former employees of the Company or the Subsidiaries beyond their
termination of employment (other than as mandated by law).
(f) No "reportable event" as defined in Section 4043 of ERISA has occurred
with respect to any Benefit Plan and no accumulated funding deficiency, whether
or not waived, exists with respect to any Benefit Plan; and, to the Knowledge of
the Company, there is no risk of termination of any Benefit Plan by the Pension
Benefit Guaranty Corporation under Section 4042 of ERISA and no event has
occurred which has or is likely to subject the Company or any of the
Subsidiaries to liability under Section 4062 of ERISA.
(g) None of the Company or the Subsidiaries, or any organization with
respect to which the Company is a successor or parent corporation, within the
meaning of Section 4069(b) of ERISA, has engaged in any transaction described in
Section 4069 of ERISA.
3.21 Labor Relations. Neither the Company nor any of the Subsidiaries is
engaged in any unfair labor practice. There is (a) no unfair labor practice
complaint pending or, to the Knowledge of the Company, threatened in writing
against the Company or any of the Subsidiaries before the National Labor
Relations Board and no grievance or arbitration proceeding arising out of or
under any collective bargaining agreement is so pending or, to the Knowledge of
the Company, threatened, (b) no strike, labor dispute, slowdown or stoppage
pending or threatened against the Company, (c) no union representation question
existing with respect to the employees of the Company or any of the Subsidiaries
and, to the Knowledge of the Company, no union organizing activities are taking
place and (d) there is and has not been a "mass layoff" or "plant closing," as
such terms are defined by the Worker Adjustment and
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Retraining Notification Act, with respect to the employees of the Company or any
of the Subsidiaries.
3.22 Potential Conflicts of Interest. To the Knowledge of the Company,
except as set forth on Schedule 3.22, no officer, director or affiliate of the
Company or any of the Subsidiaries: (a) owns, directly or indirectly, any
interest in a company (excepting less than 1% stock holdings for investment
purposes in securities of publicly held and traded companies), or is an officer,
director, employee or consultant of, any such company that is engaged in
business as, a competitor, lessor, lessee, supplier, distributor, sales agent or
customer of, or lender to or borrower from, the Company or any of its
Subsidiaries; (b) owns, directly or indirectly, in whole or in part, any
tangible or intangible property that the Company or any of the Subsidiaries uses
in the conduct of its business; or (c) has any cause of action or other claim
whatsoever against, or owes any amount to, the Company or any of the
Subsidiaries, except for claims in the ordinary course of business such as for
accrued vacation pay, accrued benefits under the Benefit Plans, and similar
matters and agreements arising in the ordinary course of business.
3.23 Representations and Warranties on Closing Date. The representations
and warranties contained in this Article III shall be true and correct in all
material respects on and as of the Closing Date with the same force and effect
as though such representations had been made on and as of the Closing Date
(except as to those representations or warranties which specifically relate to
an earlier date, which are or will be true and correct in all material respects
as of such specified date).
ARTICLE IV
COVENANTS AND AGREEMENTS
4.1 Conduct of Business Prior to the Closing; Management of the
Company. During the period from the date hereof to the Closing Date, except as
otherwise contemplated by this Agreement, the PennCorp Purchase Agreement or as
the Purchaser shall otherwise agree in writing in advance (which agreement shall
not be unreasonably withheld), or except as set forth on Schedule 4.1, the
Company shall not:
(a) except in the ordinary course of business, incur any indebtedness
for borrowed money or issue any debt securities or assume, guarantee or
endorse the obligations of any other person;
(b) except in the ordinary course of business (including the managing
by the Company of its investment assets), (i) sell, transfer or otherwise
dispose of any of its property or assets, (ii) mortgage or encumber any of
its property or assets or (iii) enter into any material contracts;
(c) repurchase any of its capital stock or any capital stock of any of
the Subsidiaries;
(d) declare, set aside or pay any dividend or other distribution in
respect of its capital stock;
(e) amend its Certificate of Incorporation or Bylaws or merge with or
into or be consolidated with any other person;
(f) split, combine or reclassify its capital stock;
(g) other than in connection with ordinary course exercises of
outstanding options or grants under existing stock option plans of the
Company described in the SEC Filings, issue or sell (or agree to issue or
sell) any of its equity securities or any options, warrants, conversion or
other rights to purchase any such securities or any securities convertible
into or exchangeable for such securities, or grant, or agree to grant any
such rights;
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(h) increase the rates of compensation (including bonuses) payable or
to become payable to any of its officers, employees, agents, independent
contractors or consultants other than increases made in the ordinary course
of business consistent with past practice;
(i) enter into any new or amend any existing employment contracts,
severance agreements or consulting contracts, other than the Employment
Agreements; or other than in the ordinary course of business, institute or
agree to institute any increase in benefits or alter its employment
practices or the terms and conditions of employment;
(j) except as may be required by applicable law, change in any
material respect its underwriting, actuarial or tax or financial accounting
methods, principles or practices;
(k) enter into or amend or terminate any transaction or contract the
result of which is reasonably likely to have a Material Adverse Effect on
the Company;
(l) enter into any joint ventures or partnerships of any kind; or
(m) enter into any contract or other agreements to do any of the
foregoing.
During the period from the date hereof to the Closing Date or this
Agreement is terminated in accordance with its terms, at the request of the
Purchaser, the Company will discuss in good faith with the Purchaser significant
policies, decisions and practices of the Company and the Subsidiaries.
4.2 Proxy Statement and Meeting of Company's Shareholders.
(a) As soon as reasonably practicable following the date hereof, the
Company shall (i) prepare and file with the Commission, (ii) use its reasonable
efforts to cause to be cleared by the Commission and (iii) within 5 business
days following clearance with the Commission, mail to its shareholders the Proxy
Statement (as defined below) with respect to a special meeting of shareholders
of the Company (the "Special Meeting") to consider and vote, among other things,
(A) to amend the Certificate of Incorporation to authorize for issuance
additional shares of Common Stock and, with respect to the holders of the Series
C-1 Shares, to obtain approval for the issuance of debt to finance the
Acquisition (the "Amendment and Approval"), (B) to issue the Shares as
contemplated hereby and (C) such other related matters as the Company deems
appropriate. The Board of Directors of the Company has authorized and approved
the Amendment and Approval and the issuance of the Shares to the Purchaser and
shall submit to its shareholders for approval the Amendment and Approval and the
issuance of the Shares to the Purchaser. The Purchaser agrees to assist and
cooperate with the Company in the preparation of the Proxy Statement with
respect to the information therein concerning the Purchaser.
(b) The Company, on the one hand, and the Purchaser, on the other hand,
hereby represents, warrants and agrees with the other that the Proxy Statement
will not, at the time the Proxy Statement is mailed, and at the date of the
Special Meeting, contain any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they are made, not
misleading, or to correct any statement made in any earlier communication with
respect to the solicitation of any proxy or approval of the transactions
contemplated by this Agreement in connection with which the Proxy Statement
shall be mailed, except that no representation or warranty is being made by any
party hereto with respect to information supplied in writing by any other party
hereto for inclusion in the Proxy Statement. The Company further represents,
warrants and agrees that the Proxy Statement will comply as to form in all
material respects with the provisions of the Exchange Act. The letter to
shareholders, notice of meeting, proxy statement and form of proxy, or any
information statement filed under the Exchange Act, as the case may be, that may
be provided to shareholders of the Company in connection with the transactions
contemplated by this Agreement (including any supplements), and any schedules
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required to be filed with the Commission in connection therewith, as from time
to time amended or supplemented, are collectively referred to as the "Proxy
Statement."
(c) The Company shall take all actions necessary in accordance with the
Business Corporation Law of New York and the Certificate of Incorporation and
Bylaws of the Company to duly call, give notice of, convene and hold the Special
Meeting within 45 calendar days after the mailing of the Proxy Statement to
approve the matters set forth therein.
4.3 Further Assurances. Upon the terms and subject to the conditions
herein provided, the Purchaser and the Company agree to use their reasonable
best efforts to take, or cause to be taken, all action, and to do, or cause to
be done, all things necessary, proper or advisable to consummate the
transactions contemplated by this Agreement and each other agreement
contemplated hereby including (a) to lift or rescind any injunction or
restraining order or other order adversely affecting the ability of the parties
to consummate the transactions contemplated hereby and (b) to fulfill all
conditions on its part to be fulfilled under this Agreement and each other
agreement contemplated hereby. In case at any time after the Closing Date any
further action is reasonably necessary or desirable to carry out the purposes of
this Agreement and each other agreement contemplated hereby, the proper
partners, officers or directors of all parties to this Agreement shall take all
such reasonably necessary action. No party hereto will take any action for the
purpose of delaying, impairing or impeding the receipt of any required consent,
authorization, order or approval or the making of any required filing. Each
party hereto shall give prompt notice to all other parties of (i) the
occurrence, or failure to occur, of any event which occurrence or failure would
be likely to cause any representation or warranty of such party contained in
this Agreement to be untrue or inaccurate in any material respect any time from
the date hereof to the Closing Date and (ii) any material failure of such party,
as the case may be, to comply with or satisfy any covenant, condition or
agreement to be complied with or satisfied by it hereunder, and such party shall
use all reasonable efforts to remedy such failure.
4.4 Indemnification by the Company.
(a) If the Closing occurs, the Company will indemnify the Purchaser and its
affiliates and their respective directors, officers, partners, members,
employees, agents and representatives (the "Purchaser Indemnified Parties"),
against and hold the Purchaser Indemnified Parties harmless from all claims,
obligations, costs and expenses (including, without limitation, reasonable
attorneys' fees and expenses of one counsel for all Purchaser Indemnified
Parties in any action between such Purchaser Indemnified Party and the Company
or between any Purchaser Indemnified Party and any third party or otherwise) and
liabilities of and damages to such Purchaser Indemnified Party arising out of
the breach of any representation, warranty, covenant or agreement of the Company
in this Agreement.
(b) Such Purchaser Indemnified Party agrees to give the Company prompt
written notice of any claim, assertion, event or proceeding by or in respect of
a third party of which it has knowledge concerning any liability or damage as to
which such Purchaser Indemnified Party is entitled to indemnification hereunder.
The Company shall have the right to direct, through counsel of its own choosing,
the defense or settlement of any such claim, assertion, event or proceeding
(provided that the Company shall have acknowledged its indemnification
obligations hereunder specifically in respect of such claim, assertion, event or
proceeding) at its own expense, which counsel shall be reasonably satisfactory
to such Purchaser Indemnified Party. If the Company elects to assume the defense
of any such claim, assertion, event or proceeding, such Purchaser Indemnified
Party may participate in such defense, but in such case the expenses of such
Purchaser Indemnified Party incurred in connection with such participation shall
be paid by such Purchaser Indemnified Party. Such Purchaser Indemnified Party
shall cooperate with the Company in the defense or settlement of any such claim,
assertion, event or proceeding. If the Company elects to direct the defense of
any such claim or proceeding, such Purchaser Indemnified Party shall not pay, or
permit to be paid, any part of any claim or demand arising
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from such asserted liability, unless the Company consents in writing (which
consent shall not unreasonably be withheld) to such payment or unless the
Company withdraws from the defense of such asserted liability, or unless a final
judgment from which no appeal may be taken by or on behalf of the Company is
entered against such Purchaser Indemnified Party for such liability. If the
Company shall elect not to defend any such claim, assertion, event or
proceeding, such Purchaser Indemnified Party shall have the right to undertake
the defense or settlement thereof at the Company's expense, but such matter
shall not be settled without the Company's consent, which consent shall not be
unreasonably withheld. If the Company shall, after commencing or undertaking a
defense, fail to prosecute or withdraws from such defense, such Purchaser
Indemnified Party shall have the right to undertake the defense or settlement
thereof at the Company's expense.
4.5 Indemnification by the Purchaser.
(a) If the Closing occurs, the Purchaser will indemnify the Company and its
affiliates, and their respective officers, directors, employees, agents and
representatives (the "Company Indemnified Parties"), against and hold the
Company Indemnified Parties harmless from all claims, obligations, costs and
expenses (including, without limitation, reasonable attorneys' fees and expenses
of one counsel for all Company Indemnified Parties in any action between any
Company Indemnified Party and the Purchaser or between such Company Indemnified
Party and any third party or otherwise) and liabilities of and damages to such
Company Indemnified Party arising out of the breach of any representation,
warranty, covenant or agreement of the Purchaser in this Agreement.
(b) Such Company Indemnified Party agrees to give the Purchaser prompt
written notice of any claim, assertion, event or proceeding by or in respect of
a third party of which it has knowledge concerning any liability or damage as to
which such Company Indemnified Party is entitled to indemnification hereunder.
The Purchaser shall have the right to direct, through counsel of their own
choosing, the defense or settlement of any such claim, assertion, event or
proceeding (provided that the Purchaser shall have first acknowledged its
indemnification obligations hereunder specifically in respect of such claim,
assertion, event or proceeding) at its own expense, which counsel shall be
reasonably satisfactory to such Company Indemnified Party. If the Purchaser
elects to assume the defense of any such claim, assertion, event or proceeding,
such Company Indemnified Party may participate in such defense, but in such case
the expenses of such Company Indemnified Party incurred in connection with such
participation shall be paid by such Company Indemnified Party. Such Company
Indemnified Party shall cooperate with the Purchaser in the defense or
settlement of any such claim, assertion, event or proceeding. If the Purchaser
elects to direct the defense of any such claim, assertion, event or proceeding,
such Company Indemnified Party shall not pay, or permit to be paid, any part of
any claim or demand arising from such asserted liability, unless the Purchaser
consents in writing (which consent shall not unreasonably be withheld) to such
payment or unless the Purchaser withdraws from the defense of such asserted
liability, or unless a final judgment from which no appeal may be taken by or on
behalf of the Purchaser is entered against such Company Indemnified Party for
such liability. If the Purchaser shall elect not to defend any such claim,
assertion, event or proceeding, such Company Indemnified Party shall have the
right to undertake the defense or settlement thereof at the Purchaser's expense,
but such matter shall not be settled without the Purchaser's consent, which
consent shall not be unreasonably withheld. If the Purchaser shall, after
commencing or undertaking a defense, fail to prosecute or withdraws from such
defense, such Company Indemnified Party shall have the right to undertake the
defense or settlement thereof at such Purchaser's expense.
4.6 Limitations on Indemnification.
(a) Neither the Company nor the Purchaser shall be obligated to pay any
amounts for indemnification under Section 4.4 or Section 4.5 for any breaches of
any representations and
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warranties in Article II or Article III until the aggregate amount for
indemnification equals Five Hundred Thousand Dollars ($500,000), whereupon the
Company and the Purchaser shall be obligated to pay only amounts in excess
thereof.
(b) Neither the Company nor the Purchaser shall be obligated to pay any
amounts for indemnification under Section 4.4 or Section 4.5 for breaches of any
representations and warranties in Article II or Article III in excess of the
Purchase Price.
(c) The Company shall not be liable in any event to pay any amounts for
indemnification under Section 4.4 in respect of any events, conditions or
circumstances for which an adjustment was made pursuant to Section 1.6.
4.7 Disclosure Supplements. From time to time prior to the Closing, the
Company may supplement the Schedules delivered in connection with this Agreement
with respect to any matter which, if existing or occurring at or prior to the
date of this Agreement, would have been required to be set forth or described in
such Schedule or which is necessary to correct any information in such Schedule
which has been rendered inaccurate thereby. Such supplements shall not be given
effect for purposes of Section 5.3(b); however, if the Closing occurs, the
Purchaser shall be deemed to have waived any right or claim it may otherwise
have or have had on account of any matter so disclosed in such supplement.
4.8 Additional Indemnification Obligation.
(a) Indemnification Relating to Section 4.15 of this Agreement.
(i) The Purchaser agrees to indemnify and hold harmless, without
offset, the Company Indemnified Parties from any liability under the
PennCorp Purchase Agreement resulting from the Company's inability to take
action under the PennCorp Purchase Agreement as a result of the failure of
or refusal by the Purchaser to give any consent required pursuant to
Section 4.15 of this Agreement.
(ii) Responsibility for any liability under the PennCorp Purchase
Agreement resulting from actions of the character described in Section 4.15
that are taken (or not taken) by the Company upon mutual agreement with the
Purchaser will be allocated as follows: the Purchaser will be responsible
for, and will indemnify and hold harmless, without offset, the Company
Indemnified Parties from and against, 60% and the Company will be
responsible for, and indemnify and hold harmless, without offset, the
Purchaser Indemnified Parties from and against, 40%.
(iii) The Company will be responsible for, and will indemnify and hold
harmless, without offset, the Purchaser Indemnified Parties from and
against, any liability resulting from any actions taken by the Company in
violation of Section 4.15 (including the failure of the Company to close
the transactions contemplated by the PennCorp Purchase Agreement, if the
Purchaser has notified the Company in writing that all conditions to
closing thereunder have been satisfied and that the Purchaser demands that
the Company close such transaction).
(b) Indemnification Relating to the Unavailability of the Chase
Facility. The Purchaser will indemnify and hold harmless, without offset, the
Company Indemnified Parties, and/or the Company will indemnify and hold
harmless, without offset, the Purchaser Indemnified Parties, in each case from
and against any and all liabilities arising under the PennCorp Purchase
Agreement as a result of the Company's failure to proceed with the Acquisition
(the "Acquisition Liabilities"), as follows:
(i) If the conditions to the Chase Facility have not been satisfied as
a result solely of (A) conditions, events or circumstances which cause any
of the conditions contained in Section 5.3(a), (b) or (e) of this Agreement
not to be satisfied or (B) conditions, events or circumstances which
constitute (x) a breach or violation of any representation or warranty
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under this Agreement that involves or results from false statements or
omissions made intentionally (in the sense of intending to mislead) or (y)
a willful breach (in the sense that such breach is not inadvertent) by the
Company of any covenant or agreement under this Agreement, then, in either
such case, the Company, without offset, shall be solely responsible for,
and shall indemnify and hold harmless, without offset, the Purchaser
Indemnified Parties from and against, all Acquisition Liabilities.
(ii) If the conditions to the Chase Facility have not been satisfied
as a result of conditions, events or circumstances which constitute a
breach or violation of any representation, warranty, covenant or agreement
of the Company under this Agreement (other than (x) those set forth in
clause (i) above or (y) breaches of representations or warranties that did
not exist as of the date hereof but arise after such date and prior to the
Closing Date because of conditions, events or circumstances outside the
reasonable control of the Company), then the Company, without offset, shall
be responsible for, and shall indemnify and hold harmless Purchaser
Indemnified Parties from and against, 6% of the Acquisition Liabilities,
and the Purchaser, without offset, shall be responsible for, and shall
indemnify and hold harmless the Company Indemnified Parties from and
against, 94% of the Acquisition Liabilities.
(iii) If the conditions to the Chase Facility have not been met for
any other reason whatsoever (including as a result of the failure of the
Purchaser to proceed with the Purchase in violation of the terms of this
Agreement), then the Purchaser, without offset, shall be solely responsible
for, and shall indemnify and hold harmless the Company Indemnified Parties
from and against all fees and expenses due to Chase under the Chase
Commitment Letter and all Acquisition Liabilities.
(c) Required Additional Investment. If Chase and/or the lenders under the
Chase Facility has notified the Company that the Chase Facility will not be
available to the Company unless a specified amount of additional equity is
invested in the Company (the "Required Equity"), then the Purchaser, together
with the other shareholders of the Company, shall have the right (but no
obligation) to purchase additional shares of Common Stock in order to fund such
Required Equity. If the Purchaser and any shareholder of the Company as of the
date hereof (any such shareholders, the "Opting Shareholders") opt to purchase
such shares, the Purchase Price Per Share shall be (x) if the Purchaser and the
Company prior to the Closing agree on the price to be paid by the Purchaser and
the Opting Shareholders for such additional shares of Common Stock, such agreed
price, and (y) if the Purchaser and the Company cannot agree on the price to be
paid for such additional shares of Common Stock by the Purchaser and the Opting
Shareholders, a price per share equal to 60% of the per share Purchase Price
determined under Article I. The Purchaser and the Opting Shareholders will be
entitled to purchase such additional shares of Common Stock in proportion to
their respective percentage shareholdings of the Company (after giving effect to
the Closing but without giving effect to the infusion of the Required Equity).
Nothing in this subsection (c), or any failure to invest under this subsection,
shall impair any indemnity obligation under Sections 4.8(a) and (b).
4.9 Consents. The Company and the Purchaser will use their reasonable
best efforts to obtain all necessary waivers, consents and approvals of all
third parties and governmental authorities necessary to the consummation of the
transactions contemplated by this Agreement and each agreement contemplated
hereby, including, but not limited to, those required in connection with the
filing of any required HSR Reports and Forms A to the Departments of Insurance
of the applicable states and any filings to be made in connection with or in
compliance with the provisions of each of the Securities Act, the Exchange Act
and any applicable state securities laws.
4.10 Use of Proceeds. The Company covenants and agrees that it will use
the proceeds from the sale of the Shares hereunder solely to consummate the
Acquisition.
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4.11 HSR Reports. If the Purchaser is required to file an HSR Report in
connection with the Purchase, then the Purchaser shall so notify the Company in
writing and, within 15 business days from the receipt by the Company of such
notice, the Purchaser and the Company shall file with the Federal Trade
Commission and the Antitrust Division of the Department of Justice, an HSR
Report and any supplemental information which may be requested in connection
with such HSR Reports. The Purchaser and the Company shall cooperate fully in
the preparation of such filings.
4.12 Exclusivity. The Company hereby agrees that prior to the Closing
Date, the Company shall not, directly or indirectly, solicit, entertain or
accept offers from persons (other than the Purchaser) for the investment
contemplated by this Agreement. The Company hereby agrees that it will not,
during the term of this Agreement and for a period of two years thereafter,
consummate the Acquisition (or any other purchase or acquisition (by merger or
otherwise) of any of the businesses or assets of PennCorp) without first
consummating the Purchase, unless (i) this Agreement is terminated due to a
breach by Purchaser of its obligations hereunder (ii) the Company and the
Purchaser mutually agree not to consummate the transactions contemplated by the
PennCorp Purchase Agreement or (iii) the Company is unable to consummate the
transactions contemplated by the PennCorp Purchase Agreement as a result of the
failure of or refusal by the Purchaser to give consent pursuant to Section 4.15
of this Agreement. If the Company enters into a transaction with PennCorp after
the occurrence of any of the events described in (i), (ii) or (iii) above, the
Company will either (x) obtain from PennCorp a complete release of the Purchaser
from any liability or claims relating to the PennCorp Purchase Agreement (and
the transactions contemplated thereby) or (y) indemnify the Purchaser for all
such liabilities and claims.
4.13 SEC Filings and Annual Statements. From and after the date hereof to
the Closing the Company shall make all SEC Filings required to be filed under
the Securities Act or the Exchange Act, and all amendments thereto. The Company
shall deliver to the Purchaser a copy of each such SEC Filing and any Annual
Statements of the Insurance Company Subsidiaries filed with any departments of
insurance from and after the date hereof to the Closing (including all exhibits,
interrogatories, notes and schedules thereto and any actuarial opinions,
affirmations or certifications filed in connection therewith).
4.14 Amendment or Termination of Purchase Agreement. The Company shall
not amend or terminate the PennCorp Purchase Agreement without the prior written
consent of the Purchaser (which consent may be given or withheld in the
Purchaser's sole discretion).
4.15 Actions Relating to the PennCorp Purchase Agreement. The Company
shall not, without the Purchaser's prior consent (which consent may be given or
withheld in the Purchaser's sole discretion), (i) indicate or acknowledge
fulfillment of or waive any of the conditions to Closing set forth in Article VI
of the PennCorp Purchase Agreement or (ii) with respect to any such conditions
in the PennCorp Purchase Agreement that by their terms require that a specified
event, action or circumstance occur or be performed to the satisfaction of the
Company, indicate or acknowledge the Company's satisfaction as to such
occurrence or performance. The Company shall perform all of its obligations
under the PennCorp Purchase Agreement required to be performed by it prior to
the closing of the Acquisition.
4.16 Registration Rights Agreement. In connection with the transactions
contemplated by this Agreement, the Company and the Purchaser will enter into
the Registration Rights Agreement, a form of which is attached hereto as Exhibit
C (the "Registration Rights Agreement").
4.17 Shareholders Agreement. In connection with the transactions
contemplated by this Agreement, the Company, the Purchaser and certain other
shareholders of the Company will enter into a shareholders agreement, a form of
which is attached hereto as Exhibit D (the "Shareholders Agreement").
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4.18 Employment Agreement. In connection with the transactions
contemplated by this Agreement, the Company and Richard Barasch, President and
Chief Executive Officer of the Company, will enter into an employment agreement,
in the form of the draft dated December 30, 1998 (10:12 p.m. version) (the
"Employment Agreement").
ARTICLE V
CONDITIONS PRECEDENT
5.1 Conditions to Each Party's Obligations. The respective obligations of
each party to effect the transactions contemplated by this Agreement shall be
subject to the fulfillment (or waiver by the Purchaser and the Company) on or
prior to the Closing Date of the following conditions:
(a) no United States or state authority or other agency or commission
or United States or state court of competent jurisdiction shall have
enacted, issued, promulgated, enforced or entered any statute, rule,
regulation, injunction or other order (whether temporary, preliminary, or
permanent) which is in effect and has the effect of prohibiting
consummation of the transactions contemplated by this Agreement or
restricting the operation of the business of the Company and the
Subsidiaries as conducted on the date hereof in a manner that would have a
Material Adverse Effect on the Company;
(b) any waiting period applicable to the transactions contemplated by
this Agreement and each agreement contemplated hereby, including, without
limitation, those applicable to any HSR Report, any Form A required to be
filed by, or any further approval required by, any Department of Insurance
of any State or any other regulatory filing or any filing in connection
with or in compliance with the provisions of each of the Securities Act,
the Exchange Act and any applicable state securities laws shall have
expired or been terminated;
(c) the Closing provided for in Section 1.3 hereof shall occur
simultaneously with the closing of the transactions contemplated by the
PennCorp Purchase Agreement;
(d) the shareholders of the Company shall have duly approved at the
Special Meeting the Amendment, the issuance of the Shares to Capital Z and
the other matters set forth in Section 4.2 of this Agreement; and
(e) each of the Purchaser and the Company shall have received fully
executed copies of the Registration Rights Agreement, the Shareholders'
Agreement, the Employment Agreement and any and all other agreements,
documents, certificates or instruments contemplated by this Agreement and
any of the foregoing.
5.2 Conditions to the Obligations of the Company. The obligation of the
Company to effect the transactions contemplated by this Agreement shall be
subject to the fulfillment (or waiver by the Company) on or prior to the Closing
Date of the following additional conditions:
(a) the Purchaser shall have performed in all material respects its
obligations under this Agreement required to be performed by it on or prior
to the Closing Date pursuant to the terms hereof, including without
limitation payment of the Purchase Price pursuant to Section 1.1;
(b) the representations and warranties of the Purchaser contained in
this Agreement shall be true and correct in all material respects at and as
of the Closing Date as if made at and as of such date, except to the extent
that any such representation or warranty is made as of a specified date in
which case such representation or warranty shall have been true and correct
as of such date. The Purchaser shall have delivered a certificate to the
effect set forth in Sections 5.2(a) and (b);
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(c) the Company shall have received fully executed copies of the Chase
Facility set forth in the Chase Commitment Letter or similar arrangement;
(d) all of the conditions to Closing set forth in Article VI of the
PennCorp Purchase Agreement shall have been satisfied or waived;
(e) the Company shall have received, in a form reasonably satisfactory
to the Company, a favorable fairness opinion of its financial advisor in
connection with the transactions contemplated hereunder and under the
PennCorp Purchase Agreement, as of the date of the mailing of the Proxy
Statement, as to the fairness on a financial basis of the terms of the
Purchase and the transactions contemplated by this Agreement; and
(f) all necessary waivers or consents to, approvals of and notices or
filings with respect to the transactions contemplated by Sections 2.3, 3.8
and 3.17 of this Agreement shall have been obtained.
5.3 Conditions to the Obligations of the Purchaser. The obligations of
the Purchaser to effect the transactions contemplated by this Agreement shall be
subject to the fulfillment (or waiver by the Purchaser) on or prior to the
Closing Date of the following additional conditions (and the Purchaser agrees
that if the conditions set forth below and in Section 5.1 above have been
satisfied (or waived by the Purchaser), the Purchaser shall consummate the
Purchase):
(a) the Company shall not have violated its obligations under Sections
4.1(a), (c), (d), (e), (f) and (g), or Section 4.14 or 4.15 of this
Agreement;
(b) the representations and warranties of the Company contained in
Sections 3.1, 3.2, 3.3, 3.5 and 3.7 of this Agreement shall be true and
correct in all material respects at and as of the Closing Date as if made
at and as of such date, except to the extent that any such representation
or warranty is made as of a specified date in which case such
representation or warranty shall have been true and correct in all material
respects as of such date. The Company shall have delivered to the Purchaser
a certificate to the effect set forth in Sections 5.3(a) and (b);
(c) the Purchaser shall have received the opinion of Simpson Thacher &
Bartlett, special counsel to the Company in the form attached hereto as
Exhibit E;
(d) all necessary waivers or consents to, approvals of and notices or
filings with respect to the transactions contemplated by Sections 2.3 and
3.8 of this Agreement shall have been obtained;
(e) neither the Company nor any of Barasch, Waegelein and Bryant shall
have committed criminal fraud or otherwise engaged in felonious criminal
conduct with respect to, or in the operation of, the business or affairs of
the Company or any of its Subsidiaries;
(f) all of the conditions to Closing set forth in Article VI of the
PennCorp Purchase Agreement shall have been satisfied or waived; and
(g) the Purchaser shall not have exercised its option, pursuant to
Section 4.19 of this Agreement and Section 10.12 of the PennCorp Purchase
Agreement, to cause an affiliate to assume the rights and obligations of
the Company under the PennCorp Purchase Agreement and to terminate the
Purchaser's obligation to Purchase the Shares pursuant to this Agreement.
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ARTICLE VI
MISCELLANEOUS
6.1 Termination. This Agreement may be terminated and the transactions
contemplated hereby abandoned:
(a) by either the Company or the Purchaser, simultaneously with or at
any time following the termination of the PennCorp Purchase Agreement;
(b) by the Company, on the one hand, or the Purchaser, on the other
hand, upon notice to the other, five Business Days after the failure by the
shareholders of the Company to approve at the Special Meeting the Amendment
and the issuance of the Shares pursuant to this Agreement;
(c) if the transactions contemplated by the PennCorp Purchase
Agreement fail to close by the date set forth in Section 9.1(b)(ii) of the
PennCorp Purchase Agreement;
(d) by either the Company or the Purchaser at any time after May 30,
1999; or
(e) pursuant to the terms of Section 1.6(g).
6.2 Amendment. This Agreement may be amended only by written agreement
between the parties hereto.
6.3 Waiver. At any time prior to the Closing Date, either party may (a)
extend the time for the performance of any of the obligations or other acts of
the other party, (b) waive any inaccuracies in the representations and
warranties of the other party contained herein or in any document delivered
pursuant hereto, and (c) waive compliance by the other party with any of the
agreements or conditions herein; provided, that any such waiver of or failure to
insist on strict compliance with any such representation, warranty, agreement or
condition shall not operate as a waiver of, or estoppel with respect to, any
subsequent or other failure. Any agreement on the part of one party to any such
extension or waiver shall be valid only if set forth in an instrument in writing
signed on behalf of such party.
6.4 Survival. The representations and warranties set forth in this
Agreement shall survive the Closing for a period of 18 months thereafter.
Notwithstanding the foregoing, (i) the representations and warranties contained
in Sections 3.1, 3.2, 3.3, 3.5 and 3.7 shall survive without limitation and (ii)
the representations and warranties contained in Sections 3.15 and 3.20 shall
survive until the date which is 30 days after the date upon which the liability
to which any claim may relate is barred by all applicable statutes of
limitations (including all periods of extension, whether automatic or
permissive). Claims based on the covenants and agreements set forth in Sections
1.4 and Articles II, III and IV which, by their terms are to be performed at or
prior to the Closing may be made during the 18 month period following the
Closing. All other covenants (including without limitation those contained in
Section 1.6(g)) shall survive the Closing without limitation.
6.5 Notices. All notices and other communications given or made pursuant
hereto shall be in writing and shall be deemed to have been given or made if in
writing and delivered personally, sent by commercial carrier or registered or
certified mail (postage prepaid, return receipt
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requested) or transmuted by facsimile with automated receipt confirmation to the
parties at the following addresses and numbers:
If to the Company, to:
Universal American Financial Corp.
Six International Drive, Suite 190
Rye Brook, NY 10573-1068
Fax: (914) 934-9123
Attention: Richard A. Barasch
with copies to:
Harnett Lesnick & Ripps, P.A.
NationsBank Tower
150 E. Palmetto Park Road
Suite 500
Boca Raton, FL 33432-4832
Fax: (561) 368-4315
Attention: Judge Bertram Harnett
and
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, NY 10017-3954
Fax: (212) 455-2502
Attention: Gary I. Horowitz, Esq.
If to the Purchaser, to:
Capital Z Partners, Ltd.
One Chase Manhattan Plaza
44th Floor
New York, NY 10005
Fax: (212) 898-8720
Attention: Bradley E. Cooper
with copies to:
Paul, Weiss, Rifkind, Wharton & Garrison
1285 Avenue of the Americas
New York, NY 10019-6064
Fax: (212) 757-3990
Attention: David K. Lakhdhir, Esq.
6.6 Headings; Agreement. The headings contained in this Agreement are
inserted for convenience only and do not constitute a part of this Agreement.
The term "Agreement" for purposes of representations and warranties hereunder
shall be deemed to include the Exhibits hereto to be executed and delivered by
parties relevant thereto.
6.7 Publicity. So long as this Agreement is in effect, except as required
by law, regulation or stock exchange requirements, the parties hereto shall not,
and shall cause their affiliates not to, issue or cause the publication of any
press release or other announcement with respect to the transactions
contemplated by this Agreement or the other agreements contemplated hereby
without the consent of the other party, which consent shall not be unreasonably
withheld or delayed or without consulting with the other parties as to the
content of such press release or other announcement.
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175
6.8 Entire Agreement. This Agreement (including all Exhibits hereto)
constitutes the entire agreement among the parties with respect to the subject
matter hereof and supersedes all other prior agreements and understandings, both
written and oral, among the parties, or any of them.
6.9 Assignment. This Agreement and all of the provisions hereof shall be
binding upon and inure to the benefit of the parties hereto and their respective
successors and permitted assigns. The Purchaser may transfer or assign this
Agreement and all of its rights, interests and obligations hereunder to one or
more of the following entities: any partnership of which the Purchaser is,
directly or indirectly, the general partner, any limited liability company of
which the Purchaser is, directly or indirectly, the managing member or any
Associate of the Purchaser (provided that the Purchaser remains fully liable
under this Agreement) or any other fund of which the general partner of the
Purchaser is the general partner, and such assignee shall be a "Purchaser" for
all purposes under this Agreement. Except as provided in the immediately
preceding sentence, neither this Agreement nor any of the rights, interests or
obligations shall be assigned by any of the parties hereto without the prior
written consent of the other party.
6.10 Counterparts. This Agreement may be executed in one or more
counterparts, all of which shall be considered one and the same agreement and
each of which shall be deemed an original.
6.11 Governing Law. The validity and interpretation of this Agreement
shall be governed by the laws of the State of New York, without reference to the
conflict of laws principles thereof which might indicate the applicability of
the laws of any other jurisdiction.
6.12 Third Party Beneficiaries. This Agreement is not intended to confer
upon any other person any rights or remedies hereunder.
6.13 Costs and Expenses. Upon the consummation of the transactions
contemplated hereby, the Company will pay all costs and expenses (including
sales or transfer taxes, if any) incurred by the Purchaser in connection with
the transactions contemplated hereby, including without limitation the
reasonable legal fees and expenses of Paul, Weiss, Rifkind, Wharton & Garrison
and any filing fees paid in connection with the filing of HSR Reports and Forms
A by the Purchaser; provided, that if the transactions contemplated hereby are
not consummated and the Company would be required to indemnify the Purchaser
pursuant to Section 4.8(b)(i), the Company will pay all costs and expenses of
the Purchaser referred to above.
6.14 Specific Performance. The parties hereto agree that irreparable
damage would occur in the event any provision of this Agreement is not performed
in accordance with the terms hereof, and that the parties shall be entitled to
specific performance of the terms hereof, in addition to any other remedy at law
or in equity.
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IN WITNESS WHEREOF, the Purchaser and the Company have caused this
Agreement to be duly signed as of the date first written above.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /s/ RICHARD BARASCH
------------------------------------
Name: Richard Barasch
Title: Chief Executive Officer
CAPITAL Z FINANCIAL SERVICES FUND II,
L.P.
By: Capital Z Partners, L.P., general
partner
By: Capital Z Partners Ltd., its
General
Partner
By: /s/ BRADLEY COOPER
------------------------------------
Name: Bradley Cooper
Title: Partner
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AMENDMENT
AMENDMENT (this "Amendment") to the Share Purchase Agreement (the "Share
Purchase Agreement"), dated as of December 31, 1998, between Universal American
Financial Corp., a New York corporation (the "Company"), and Capital Z Financial
Services Fund II, L.P., a Bermuda limited partnership (the "Purchaser"). This
Amendment is being entered into this 2nd day of July, 1999. Capitalized terms
used but not defined herein have the meanings assigned to them in the Share
Purchase Agreement.
WHEREAS, the Company is party to that certain Purchase Agreement (the
"Purchase Agreement"), dated December 31, 1998, among the Company, PennCorp
Financial Group, Inc., Pacific Life and Accident Insurance Company, Pennsylvania
Life Insurance Company, Southwestern Financial Corporation, Constitution Life
Insurance Company and PennCorp Financial Services, Inc. (collectively the
"PennCorp Parties");
WHEREAS, concurrently with the execution of this Amendment, the Company and
the PennCorp Parties are amending and restating the Purchase Agreement in its
entirety; and
WHEREAS, the parties wish to amend the Share Purchase Agreement with
respect to certain matters as set forth herein.
NOW, THEREFORE, for good and valuable consideration, and subject to and on
the terms and conditions herein set forth, the parties agree to amend the Share
Purchase Agreement as follows:
1. The first sentence of Section 1.1 of the Share Purchase Agreement
is hereby amended by deleting reference to "Twenty Six Million Thirty One
Thousand Seven Hundred Forty Six (26,031,746)" and replacing it with
"Twenty Eight Million Eight Hundred Eighty Eight Thousand Eight Hundred
Eighty Eight (28,888,888)."
2. The first sentence of Section 1.1 of the Share Purchase Agreement
is hereby amended by deleting the reference to "Eighty Two Million Dollars
($82,000,000)" and replacing it with "Ninety One Million Dollars
($91,000,000)."
3. The second and third sentence of Section 1.1 are hereby deleted in
their entirety and replaced with the following:
"The number of shares of Common Stock to be purchased hereunder by the
Purchaser and the aggregate price to be paid by it will be reduced by
the aggregate number of shares of Common Stock purchased on the same
terms at or prior to the Closing (defined below) and the aggregate price
paid for such shares by certain members of management and agents of the
PennCorp Subsidiaries and by the former holders of the Series C-1 Shares
(defined below) of the Company listed on Schedule 1 hereto (collectively
known as the "Management/Pre-emptive Investors"). The number of Shares
to be subscribed by the Management/Pre-emptive Investors shall be as set
forth in their respective subscription agreements, which shall be in
form, substance and amount reasonably satisfactory to the Purchaser and
the Company. In no event shall the aggregate price to be paid, and the
aggregate number of shares of Common Stock to be purchased, by the
Management/Pre-emptive Investors exceed $10,000,000 and 3,174,603
shares, respectively."
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178
4. The third sentence of Section 1.1 of the Share Purchase Agreement
is hereby amended by deleting the reference to "Nineteen Million Eight
Hundred Forty One Thousand Two Hundred Seventy (19,841,270)" and replacing
it with "Twenty Two Million Six Hundred Ninety Eight Thousand Four Hundred
and Eleven (22,698,411)."
5. The first sentence of Sections 6.1(d) of the Share Purchase
Agreement is hereby amended by deleting the reference to "May 30, 1999" and
replacing it with "July 31, 1999."
IN WITNESS WHEREOF, the Purchaser and the Company have caused this
amendment to be duly signed as of the date first written above.
UNIVERSAL AMERICAN FINANCING CORP.
By: /s/ RICHARD A. BARASCH
------------------------------------
Name: Richard A. Barasch
Title: Chief Executive Officer
CAPITAL Z FINANCIAL SERVICES FUND II,
L.P.
By: Capital Z Partners, L.P., general
partner
By: Capital Z Partners Ltd., its
General Partner
By: /s/ ROBERT A. SPASS
------------------------------------
Name: Robert A. Spass
Title: Vice Chairman
A-29
179
ANNEX B
FORM OF AMENDED AND RESTATED PURCHASE AGREEMENT
AMONG
UNIVERSAL AMERICAN FINANCIAL CORP.,
AMERICAN EXCHANGE LIFE INSURANCE COMPANY
AND
PENNCORP FINANCIAL GROUP, INC.,
PACIFIC LIFE AND ACCIDENT INSURANCE COMPANY,
PENNSYLVANIA LIFE INSURANCE COMPANY,
SOUTHWESTERN FINANCIAL CORPORATION,
CONSTITUTION LIFE INSURANCE COMPANY
AND
PENNCORP FINANCIAL SERVICES, INC.
------------------------
DATED AS OF DECEMBER 31, 1998,
AS AMENDED AND RESTATED ON JULY 2, 1999.
------------------------
180
TABLE OF CONTENTS
PAGE
----
ARTICLE I
DEFINITIONS................................................................ B-2
SECTION 1.1 Definitions................................................. B-2
SECTION 1.2 Other Definitions........................................... B-5
SECTION 1.3 Reserves.................................................... B-8
SECTION 1.4 Certain Interpretive Matters................................ B-8
ARTICLE II
THE ACQUISITION............................................................ B-8
SECTION 2.1 Consideration for the Shares and the PCFS Assets............ B-8
SECTION 2.2 Closing Transactions........................................ B-8
SECTION 2.3 Purchase Price Adjustment................................... B-10
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PFG, PLAC, SFC AND PCFS.................. B-12
SECTION 3.1 Organization and Qualification.............................. B-12
SECTION 3.2 Authorization............................................... B-12
SECTION 3.3 No Violation................................................ B-13
SECTION 3.4 Capitalization of the Companies............................. B-13
SECTION 3.5 PFI Subsidiaries and PCFS Assets............................ B-14
SECTION 3.6 Consents and Approvals...................................... B-15
SECTION 3.7 Financial Statements; Reserves.............................. B-15
SECTION 3.8 Absence of Undisclosed Liabilities.......................... B-16
SECTION 3.9 Absence of Certain Changes.................................. B-16
SECTION 3.10 Litigation.................................................. B-17
SECTION 3.11 Property; Liens and Encumbrances............................ B-17
SECTION 3.12 Certain Agreements.......................................... B-17
SECTION 3.13 Employee Benefit Plans...................................... B-18
SECTION 3.14 Taxes....................................................... B-20
SECTION 3.15 Compliance with Applicable Law; Permits; Policies........... B-23
SECTION 3.16 Brokers Fees and Commissions................................ B-25]
SECTION 3.17 Proprietary Rights; Year 2000 Compliance.................... B-25
SECTION 3.18 Insurance................................................... B-26
SECTION 3.19 Environmental Matters....................................... B-26
SECTION 3.20 Books and Records........................................... B-26
SECTION 3.21 Bank Accounts............................................... B-26
SECTION 3.22 Insurance and Reinsurance................................... B-26
SECTION 3.23 Labor Matters............................................... B-27
SECTION 3.24 Affiliate Transactions...................................... B-28
SECTION 3.25 Bonuses..................................................... B-28
SECTION 3.26 All Related Assets.......................................... B-28
SECTION 3.27 Litigation Arising Between Signing and Closing.............. B-28
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF BUYER.................................... B-28
SECTION 4.1 Organization; Qualifications and Operations................. B-28
B-ii
181
PAGE
----
SECTION 4.2 Authorization............................................... B-29
SECTION 4.3 No Violation................................................ B-29
SECTION 4.4 Capitalization.............................................. B-30
SECTION 4.5 Consents and Approvals...................................... B-30
SECTION 4.6 Brokers' Fees and Commissions............................... B-30
SECTION 4.7 Purchase for Investment..................................... B-30
SECTION 4.8 Financing................................................... B-30
SECTION 4.9 SEC Reports................................................. B-31
SECTION 4.10 Absence of Undisclosed Liabilities.......................... B-31
SECTION 4.11 Absence of Certain Changes.................................. B-31
SECTION 4.12 Compliance with Applicable Law; Permits; Licenses........... B-31
ARTICLE V
COVENANTS.................................................................. B-32
SECTION 5.1 Conduct of Business Prior to the Closing.................... B-32
SECTION 5.2 Management of Companies..................................... B-34
SECTION 5.3 Access to Information....................................... B-34
SECTION 5.4 HSR Act Filings............................................. B-34
SECTION 5.5 State Regulatory Approvals.................................. B-35
SECTION 5.6 Pre-Closing Restructuring Transactions...................... B-35
SECTION 5.7 Estimated Statement......................................... B-35
SECTION 5.8 Transaction Bonuses......................................... B-35
SECTION 5.9 Payments to Agents.......................................... B-36
SECTION 5.10 All Reasonable Efforts...................................... B-36
SECTION 5.11 Public Announcements........................................ B-36
SECTION 5.12 Disclosure Supplements...................................... B-36
SECTION 5.13 Employment and Employee Benefits............................ B-37
SECTION 5.14 Nonsolicitation............................................. B-38
SECTION 5.15 Acquisition Proposals....................................... B-39
SECTION 5.16 Section 338(h)(10) Election, Allocation of Purchase Price
under Sections 338 and 1060 and Matters Relating to
SWLIC..................................................... B-39
SECTION 5.17 Tax Matters................................................. B-40
SECTION 5.18 Financial Matters; Proxy Statement.......................... B-41
SECTION 5.19 Peninsular Licenses......................................... B-41
SECTION 5.20 PCFS Licenses............................................... B-42
SECTION 5.21 Change of Name.............................................. B-42
SECTION 5.22 Litigation Arising Between Signing and Closing.............. B-42
SECTION 5.23 Union Bankers............................................... B-42
ARTICLE VI
CLOSING CONDITIONS......................................................... B-42
SECTION 6.1 Conditions to the Obligations of Buyer under this
Agreement................................................. B-42
SECTION 6.2 Conditions to the Obligations of Sellers under this
Agreement................................................. B-44
ARTICLE VII
CLOSING.................................................................... B-45
SECTION 7.1 Closing..................................................... B-45
B-iii
182
PAGE
----
ARTICLE VIII
SURVIVAL/INDEMNIFICATION................................................... B-46
SECTION 8.1 Survival of Representations and Warranties;
Indemnification Obligations............................... B-46
SECTION 8.2 Obligation of Buyer to Indemnify............................ B-48
SECTION 8.3 Notice and Opportunity to Defend............................ B-48
SECTION 8.4 Limitations on Indemnification.............................. B-49
SECTION 8.5 Adjustment to Purchase Price; Offsetting Tax Benefits....... B-50
SECTION 8.6 Exclusive Remedy............................................ B-50
ARTICLE IX
TERMINATION AND ABANDONMENT................................................ B-50
SECTION 9.1 Termination................................................. B-50
SECTION 9.2 Expenses in the Event of Termination........................ B-51
SECTION 9.3 Procedure and Effect of Termination......................... B-51
SECTION 9.4 Mutual Agreement of Parties................................. B-52
SECTION 9.5 Confidentiality............................................. B-52
ARTICLE X
MISCELLANEOUS PROVISIONS................................................... B-52
SECTION 10.1 Amendment and Modification.................................. B-52
SECTION 10.2 Waiver of Compliance; Consents.............................. B-52
SECTION 10.3 Validity.................................................... B-53
SECTION 10.4 Expenses and Obligations.................................... B-53
SECTION 10.5 Parties in Interest......................................... B-53
SECTION 10.6 Notices..................................................... B-53
SECTION 10.7 Governing Law............................................... B-54
SECTION 10.8 Counterparts................................................ B-54
SECTION 10.9 Headings.................................................... B-54
SECTION 10.10 Entire Agreement............................................ B-54
SECTION 10.11 Assignment.................................................. B-55
ANNEX A Disclosure Schedule
ANNEX B Form of Voting Agreement
ANNEX C Pre-Closing Restructuring Transactions
ANNEX D Opinions of Counsel to Sellers
ANNEX E Opinions of Counsel to Buyer
EXHIBIT A Terms of AmeriLife Marketing/Equity Arrangement
EXHIBIT B Terms of Cologne Re Reinsurance Agreement
EXHIBIT C Terms of Raleigh Lease Agreement
EXHIBIT D Form of ConLife-Peninsular Reinsurance Agreement
EXHIBIT E Terms of PCFS Services Agreement
EXHIBIT F NOL Example
EXHIBIT G Tax Allocation Agreements
B-iv
183
[Annexes and Exhibits have been intentionally omitted for
purposes of this proxy statement]
B-v
184
AMENDED AND RESTATED PURCHASE AGREEMENT
AMENDED AND RESTATED PURCHASE AGREEMENT (this "Agreement"), dated as of
December 31, 1998, as amended and restated on July 2, 1999, among Universal
American Financial Corp., a New York corporation ("Buyer"), American Exchange
Life Insurance Company, a Texas corporation ("American Exchange"), and PennCorp
Financial Group, Inc., a Delaware corporation ("PFG"), Pacific Life and Accident
Insurance Company, a Texas corporation ("PLAC"), Pennsylvania Life Insurance
Company, a Pennsylvania corporation ("PennLife"), Southwestern Financial
Corporation, a Delaware corporation ("SFC"), Constitution Life Insurance
Company, a Texas corporation ("ConLife"), and PennCorp Financial Services, Inc.,
a Delaware corporation ("PCFS"). PFG, PLAC, PennLife, SFC, ConLife and PCFS are
collectively referred to herein as the "Sellers."
The parties other than American Exchange entered into this Agreement on
December 31, 1998 and desire to amend and restate this Agreement in its entirety
as set forth herein. For purposes of this amended and restated Agreement, all
references to "as of the date hereof" means as of December 31, 1998.
R E C I T A L S:
WHEREAS, American Pioneer Life Insurance Company, a Florida Corporation and
a direct wholly owned subsidiary of Buyer ("American Pioneer"), is the record
and beneficial owner of all of the issued and outstanding shares of common
stock, par value $1.00 per share (the "American Exchange Shares"), of American
Exchange;
WHEREAS, PFG is the record and beneficial owner of all of the issued and
outstanding shares of common stock, par value $1.00 per share (the "PFI
Shares"), of PennCorp Financial, Inc., a Delaware corporation ("PFI");
WHEREAS, PLAC, a wholly owned Subsidiary of PFG, is the record and
beneficial owner of all of the issued and outstanding shares of common stock,
par value $100.00 per share (the "PennLife Shares"), of PennLife;
WHEREAS, PennLife is the record and beneficial owner of all of the issued
and outstanding shares of common stock, par value $2.25 per share (the
"Peninsular Shares"), of Peninsular Life Insurance Company, a North Carolina
corporation ("Peninsular");
WHEREAS, PennLife is the record and beneficial owner of all of the issued
and outstanding shares of common stock, no par value (the "PC-Canada Common
Shares"), of PennCorp Life Insurance Company, a Canadian corporation
("PC-Canada"), and all of the issued and outstanding preferred shares, no par
value (the "PC-Canada Preferred Shares" and, together with the PC-Canada Common
Shares, the "PC-Canada Shares"), of PC-Canada;
WHEREAS, SFC, a wholly owned Subsidiary of PFG, is the record and
beneficial owner of all of the issued and outstanding shares of common stock,
par value $60.00 per share (the "ConLife Shares"), of ConLife;
WHEREAS, ConLife is the record and beneficial owner of all of the issued
and outstanding shares of common stock, par value $2.00 per share (the "Union
Bankers Shares"), of Union Bankers Insurance Company, a Texas corporation
("Union Bankers");
WHEREAS, Union Bankers is the record and beneficial owner of all of the
issued and outstanding shares of common stock, par value $1.00 per share (the
"Marquette Shares"), of Marquette National Life Insurance Company, a Texas
corporation ("Marquette");
WHEREAS, PCFS is a wholly owned Subsidiary of PFG;
B-1
185
WHEREAS, PennLife and ConLife and their respective Subsidiaries are engaged
in the insurance business and PFI and its Subsidiaries are engaged in the
financial services business; and
WHEREAS, Buyer, acting through its Subsidiaries, is engaged in the life and
accident and health insurance business.
NOW, THEREFORE, in consideration of the mutual covenants, representations,
warranties and agreements herein contained, the parties hereto agree as follows:
ARTICLE I
DEFINITIONS
SECTION 1.1 Definitions. For purposes of this Agreement, the term:
(a) "affiliate" means, as to a specified Person, any other Person that
directly or indirectly, through one or more intermediaries, controls, is
controlled by, or is under common control with, the specified Person.
(b) "Allocation Schedule" means the Allocation Schedule relating to the
338(h)(10) Election.
(c) "Annual Statement" means, with respect to a referenced Person, the
annual statement of such Person filed with or submitted to the insurance
regulatory authority in the jurisdiction in which such Person is domiciled on
forms prescribed or permitted by such authority.
(d) "Assumed Liabilities" means all obligations under the PCFS Licenses and
other contracts (if any) included as part of the PCFS Assets, to the extent such
obligations arise after the Closing Date.
(e) "AVR" means, with respect to any Person domiciled in the United States,
the Asset Valuation Reserve set forth in the balance sheet of such Person in
accordance with SAP.
(f) "Business Day" means any day that is not a Saturday, Sunday or other
day on which banking institutions in the city of New York, New York are
authorized or required by law or executive order to be closed.
(g) "Chase Bank Facility" means the term loan facility and revolving credit
facility provided to Buyer upon the terms and subject to the conditions of the
Chase Commitment.
(h) "Closing Statement" means the statement prepared by PennLife and
ConLife calculating the capital and surplus (excluding AVR and IMR) of each of
the PennLife Companies and each of the ConLife Companies in accordance with SAP
as of the Closing Date (immediately prior to the Closing but after giving effect
to the Closing Transactions) using the same assumptions and methodologies
utilized in the preparation of such companies' December 31, 1998 Annual
Statements and the preparation of the Estimated Statement.
(i) "Code" means the Internal Revenue Code of 1986, as amended (including
any successor code), and the rules and regulations promulgated thereunder.
(j) "Commission" means the Securities and Exchange Commission.
(k) "Companies" means the ConLife Companies, the PennLife Companies and the
PFI Companies.
(l) "ConLife Companies" means ConLife, Union Bankers and Marquette, but
shall not include SWLIC.
(m) "ConLife Employees" means (i) those employees of Services who primarily
render services to or on behalf of any or all of the ConLife Companies as listed
on Schedule 1.1(m) and
B-2
186
(ii) all former employees of Services who, during the term of their employment
with Services, primarily rendered services to or on behalf of any or all of the
ConLife Companies and whose employment with Services was terminated for any
reason (including retirement) prior to the Closing Date and who, as of the
Closing Date, are not employed by PFG or any of its affiliates (excluding any of
the Companies).
(n) "ConLife Surplus Notes" mean (i) the Surplus Debenture, dated December
14, 1995, in the original principal amount of $80 million, issued by ConLife in
favor of SFC or a wholly owned Subsidiary of SFC and (ii) the Surplus Debenture
dated January 1, 1996, in the original principal amount of $40 million, issued
by ConLife in favor of SFC or a wholly owned Subsidiary of SFC, each as amended
from time to time to comply with requests or the requirements of the Texas
Department of Insurance.
(o) "Disclosure Schedule" means the Disclosure Schedule attached hereto as
Annex A.
(p) "Environmental Laws" means all applicable U.S. and Canadian federal,
state, provincial or local laws (including but not limited to federal and state
common law), statutes, codes, rules or regulations relating to the environment,
natural resources, and pollution including, without limitation, the
Comprehensive Environmental Response, Compensation and Liability Act (CERCLA),
the Hazardous Materials Transportation Act, 49 U.S.C. sec. 1801 et seq., as
amended from time to time (HMTA), the Resource Conservation and Recovery Act, 42
U.S.C. sec. 6901 et seq., as amended from time to time (RCRA), the Federal Water
Pollution Control Act, 33 U.S.C. sec. 1251 et seq., as amended from time to time
(FWPCA), the Clean Air Act, 42 U.S.C. sec. 7401 et seq., as amended from time to
time (CAA), and/or the Toxic Substances Control Act, 15 U.S.C. sec. 2601 et
seq., as amended from time to time (TSCA).
(q) "Exchange Act" means the Securities Exchange Act of 1934, as amended.
(r) "Governmental Authority" means any nation or government, any state or
other political subdivision thereof and any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government.
(s) "Hazardous Materials" means (i) any wastes, substances, or materials
which are defined as "hazardous material," "hazardous waste," "hazardous
substance," "toxic material" or other similar designations in, or otherwise
subject to regulation under, any applicable Environmental Laws; (ii) petroleum
or petroleum byproducts; (iii) friable asbestos and/or any material which
contains friable asbestos; and (iv) electrical equipment containing
polychlorinated biphenyls (PCBs) in excess of 50 parts per million.
(t) "IMR" means, with respect to any Person domiciled in the United States,
the Interest Maintenance Reserve set forth on the balance sheet of such Person
in accordance with SAP.
(u) "Lincoln National Agreement" means the reinsurance agreement, dated
September 30, 1998, between PennLife and Lincoln National Reassurance Company.
(v) "Material Adverse Effect" means a materially adverse effect on the
business, results of operations or financial condition of the PennLife
Companies, the PFI Companies and the PCFS Assets, taken as a whole, or the
ConLife Companies, taken as a whole, excluding the reserve deficiencies
specifically identified in the reports of the Reserves Consultants.
(w) "Nasdaq" means The Nasdaq Stock Market, Inc.
(x) "PennLife Companies" means PennLife, Peninsular and PC-Canada.
(y) "PennLife Employees" means (i) all employees of the PennLife Companies
and (ii) all former employees of the PennLife Companies whose employment with
the PennLife Companies was terminated for any reason (including retirement)
prior to the Closing Date and who, as of the Closing Date, are not employed by
PFG or any of its affiliates (excluding any of the Companies).
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187
(z) "Person" means an individual, corporation, limited liability company,
partnership, joint venture, association, trust, unincorporated organization or,
as applicable, any other entity.
(aa) "PCFS Assets" means those assets of PCFS listed on Schedule 1.1(aa).
(ab) "PCFS Employees" means (i) those employees of PCFS who primarily
render services to or on behalf of any or all of the Companies as listed on
Schedule 1.1(ab) and any other employees of PCFS performing services primarily
for the Companies who are hired between the date hereof and the Closing Date in
accordance with Section 5.13(a) and (ii) all former employees of PCFS who,
during the term of their employment with PCFS, primarily rendered services to or
on behalf of any or all of the Companies and whose employment with PCFS was
terminated for any reason (including retirement) prior to the Closing Date and
who, as of the Closing Date, are not employed by PFG or any of its affiliates
(excluding any of the Companies).
(ac) "PFI Companies" means PFI and its wholly owned Subsidiaries.
(ad) "PFI Employees" means (i) all employees of the PFI Companies and (ii)
all former employees of the PFI Companies whose employment with the PennLife
Companies was terminated for any reason (including retirement) prior to the
Closing Date and who, as of the Closing Date, are not employed by PFG or any of
its affiliates (excluding any of the Companies).
(ae) "Phase III Taxes" means Taxes imposed under Section 815(f) of the Code
by reference to Section 815 as in effect prior to the enactment of the Tax
Reform Act of 1984.
(af) "Quarterly Statement" means, with respect to a referenced Person, the
quarterly statement of such Person submitted to the insurance regulatory
authority in the state in which such Person is domiciled on forms prescribed or
permitted by such authority.
(ag) "Release" means any emission, spill, seepage, leak, escape, leaching,
discharge, injection, pumping, pouring, emptying, dumping, disposal, release, or
threatened release of Hazardous Materials into the environment.
(ah) "Reserves Consultants" means (i) with respect to the disability income
claims reserves of PennLife, Tillinghast, (ii) with respect to the
non-disability income claims reserves of PennLife, BAS Actuarial Services, and
(iii) with respect to all other reserves of PennLife (excluding life insurance
reserves), another independent actuarial firm of national reputation.
(ai) "SAP" means the statutory accounting practices required or permitted
by the National Association of Insurance Commissioners or the insurance
regulatory authority in the jurisdiction of domicile of the referenced Person.
(aj) "Services" means Southwestern Financial Services Corporation, a
Delaware corporation and wholly owned Subsidiary of SFC.
(ak) "Settlement Auditor" means PricewaterhouseCoopers or, if such firm is
not available, such other independent accounting firm of national reputation
selected by the mutual agreement of Buyer and PFG, or if Buyer and PFG cannot
agree, a nationally recognized accounting firm chosen by PricewaterhouseCoopers.
(al) "Shares" means the PFI Shares, the PennLife Shares, the Peninsular
Shares, the PC-Canada Shares, the ConLife Shares and the Union Bankers Shares,
collectively.
(am) "Subsidiary" means, as to any Person, any other Person of which at
least a majority of the outstanding shares or other equity interests having
ordinary voting power for the election of directors or comparable managers of
such Person is owned, directly or indirectly, by the referenced Person. For
purposes of this Agreement, Buyer's Subsidiaries shall not include any of the
Companies, notwithstanding the consummation of any of the Closing Transactions.
(an) "SWLIC" means Southwestern Life Insurance Company, a Texas corporation
and wholly owned Subsidiary of ConLife.
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(ao) "Taxes" means any and all federal, state, provincial, local, foreign
and other taxes, levies, fees, imposts, duties, and similar governmental charges
(including any interest, fines, assessments, penalties or additions to tax
imposed in connection therewith or with respect thereto) including, without
limitation, taxes imposed on, or measured by, income, franchise, profits or
gross receipts, ad valorem, value added, capital gains, sales, goods and
services, use, real or personal property, capital stock, license, branch,
payroll, Phase III Taxes, estimated withholding, employment, social security (or
similar), unemployment, compensation, utility, severance, production, excise,
stamp, occupation, premium, windfall profits, transfer and gains taxes, and
customs duties.
(ap) "Tax Returns" means any report, return, declaration, claim for refund,
information report or return or statement required to be supplied to a taxing
authority in connection with Taxes, including any schedule or attachment thereto
or amendment thereof.
(aq) "Union Bankers Special Dividend" means the dividend paid by Union
Bankers to ConLife in connection with the transactions set forth herein in the
amount of $37,800,000 or such lesser amount necessary to ensure that the capital
and surplus of Union Bankers (as indicated on the Estimated Statement) is equal
to the Union Bankers Target Capital Amount specified in Section 2.3(e).
(ar) "U.S. Insurance Companies" means ConLife, Union Bankers, Marquette,
PennLife and Peninsular, collectively.
(as) "Vanderhorst Note" means the promissory note, dated February 25, 1998,
issued by PFI in favor of PennLife, in the original principal amount of $7.2
million.
(at) "WARN" means the Worker Adjustment and Retraining Notification Act of
1988 and any similar state, local or Canadian "plant closing" or layoff statute.
SECTION 1.2 Other Definitions. When used in this Agreement, the following
terms shall have the meanings ascribed to them in Sections noted below:
TERM DEFINED IN
- ---- ----------
1998 SAP Financial Statements............................... Section 5.18(a)
338(h)(10) Election......................................... Section 5.16
Accounts.................................................... Section 3.21
Acquisition Note Purchase Price............................. Section 2.1
Acquisition Notes........................................... Section 2.1
Actual Loss Experience...................................... Section 2.4(a)
Advest...................................................... Section 4.6
Agent Compensation.......................................... Section 3.15(e)
Aggregate Target Capital Amount............................. Section 2.3(e)
Agreement................................................... Preamble
American Exchange........................................... Preamble
American Exchange Shares.................................... Recitals
Asserted Liability.......................................... Section 8.3(a)
Audited Financial Statements................................ Section 5.18
Banks....................................................... Section 3.21
Basket Amount............................................... Section 8.4(a)
Basket Exclusions........................................... Section 8.4(a)
Benefit Plans............................................... Section 3.13(a)
Bill of Sale, Assignment and Assumption Agreement........... Section 2.2
Buyer....................................................... Preamble
Buyer Actuary............................................... Section 2.4(a)
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TERM DEFINED IN
- ---- ----------
Buyer Approvals............................................. Section 4.5
Buyer Common Stock.......................................... Section 4.4
Buyer Indemnitees........................................... Section 8.1(b)
Buyer Material Adverse Effect............................... Section 4.1
Buyer Parties............................................... Section 4.1
Buyer Plans................................................. Section 5.13(b)
Capital Z................................................... Section 4.8
Cash Purchase Price......................................... Section 2.1
Chase Bank.................................................. Section 4.8
Chase Commitment............................................ Section 4.8
Chase Securities............................................ Section 4.6
Claim....................................................... Section 8.1(b)
Claims Notice............................................... Section 8.3(a)
Closing..................................................... Section 7.1
Closing Date................................................ Section 7.1
Closing Transactions........................................ Section 2.2
Cologne Re.................................................. Section 2.3(e)
Company Employees........................................... Section 5.13(a)
Confidentiality Agreement................................... Section 9.4(a)
ConLife..................................................... Preamble
ConLife Group............................................... Section 3.14(n)
ConLife Insurance Approvals................................. Section 3.6
ConLife Purchase Price...................................... Section 2.1(b)
ConLife Shares.............................................. Recitals
Deposit..................................................... Section 3.15(i)
DOJ......................................................... Section 3.6
ERISA....................................................... Section 3.13(a)
ERISA Affiliate............................................. Section 3.13(e)
Estimated Statement......................................... Section 5.7
Financial Statements........................................ Section 3.7(d)
Fundamental Representations................................. Section 8.1
GAAP........................................................ Section 3.7(d)
HSR Act..................................................... Section 3.6
Indemnifying Party.......................................... Section 8.3(a)
Indemnitee.................................................. Section 8.3(a)
Integon..................................................... Section 6.1(g)
Investment Agreements....................................... Section 5.9(b)
Intellectual Property....................................... Section 3.17
IRS......................................................... Section 1.1(k)
KPMG........................................................ Section 5.18(a)
Leased Properties........................................... Section 3.11(b)
Liens....................................................... Section 3.11(b)
Litigation.................................................. Section 3.10
Losses...................................................... Section 8.1(b)
Marquette................................................... Recitals
Marquette Shares............................................ Recitals
Material Contract........................................... Section 3.12(a)
MEC......................................................... Section 3.14(x)
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TERM DEFINED IN
- ---- ----------
Multiemployer Plan.......................................... Section 3.13(a)
New Employee Claims......................................... Section 5.22
New Litigation.............................................. Section 5.22
NOLs........................................................ Section 3.14(ac)
Offsetting Tax Benefit...................................... Section 8.6(b)
Owned Properties............................................ Section 3.11(b)
PBGC........................................................ Section 3.13(e)
PC-Canada................................................... Recitals
PC-Canada Common Shares..................................... Recitals
PC-Canada Preferred Shares.................................. Recitals
PC-Canada Purchase Price.................................... Section 2.1(d)
PC-Canada Shares............................................ Recitals
PCFS........................................................ Preamble
PCFS Licenses............................................... Section 5.20
PCFS Purchase Price......................................... Section 2.1(g)
Peninsular.................................................. Recitals
Peninsular Purchase Price................................... Section 2.1(c)
Peninsular Shares........................................... Recitals
PennLife.................................................... Preamble
PennLife Insurance Approvals................................ Section 3.6
PennLife Purchase Price..................................... Section 2.1(e)
PennLife Shares............................................. Recitals
PFG......................................................... Preamble
PFG Group................................................... Section 3.14(n)
PFI......................................................... Recitals
PFI Purchase Price.......................................... Section 2.1(f)
PFI Shares.................................................. Recitals
PFI Subsidiaries............................................ Section 3.5(a)
PLAC........................................................ Preamble
PLAC Group.................................................. Section 3.14(n)
Post-Closing Compensation Obligations....................... Section 5.9(b)
Pre-Closing Restructuring Transactions...................... Section 5.6
Pre-Sale Obligations........................................ Section 5.9(a)
Proxy Statement............................................. Section 5.18(c)
Purchase Price.............................................. Section 2.1
Reinsurance Agreements...................................... Section 3.22(a)
Required Permits............................................ Section 3.15(b)
Review Letter............................................... Section 5.18(a)
SAP Financial Statements.................................... Section 3.7(a)
SEC Reports................................................. Section 4.9
Seller Refund............................................... Section 5.17(d)
Seller Net Refund Amount.................................... Section 5.17(d)
Sellers..................................................... Preamble
Series C-1 Holders.......................................... Section 4.2
SFC......................................................... Preamble
Substituted Buyer........................................... Section 10.12
Surplus Note Amount......................................... Section 2.2(b)
SWLIC Basis Adjustments..................................... Section 5.16(c)
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TERM DEFINED IN
- ---- ----------
SWLIC Valuation Opinion..................................... Section 5.16(c)
SWLIC Value................................................. Section 5.16(c)
Target Capital Amount....................................... Section 2.3(e)
Tax Representation Claim.................................... Section 8.1(a)
Technology Systems.......................................... Section 3.17(b)
Transaction Bonus........................................... Section 3.25
Transaction Period.......................................... Section 5.13(f)
UAFC Share Purchase Agreement............................... Section 4.8
Unaudited Financial Statements.............................. Section 3.7(d)
Union Bankers............................................... Recitals
Union Bankers Purchase Price................................ Section 2.1(a)
Union Bankers Shares........................................ Recitals
SECTION 1.3 Reserves. With respect to health claims reserves, references
herein to such reserves include loss adjustment expenses.
SECTION 1.4 Certain Interpretive Matters. Unless otherwise noted, all
references herein to "$" or dollar amounts are to lawful currency of the United
States of America. Unless the context otherwise requires, all references to
Sections, Articles, Annexes or Exhibits are to Sections, Articles, Annexes or
Exhibits to this Agreement.
ARTICLE II
THE ACQUISITION
SECTION 2.1 Consideration for the Shares and the PCFS Assets. At the
Closing, upon the terms and subject to the conditions of this Agreement and in
reliance upon the representations, warranties and agreements contained herein,
Sellers shall sell to Buyer or American Exchange, and Buyer or American Exchange
shall purchase or cause to be purchased from Sellers, in the manner described in
Section 2.2, all of the Shares and the PCFS Assets for an amount in cash equal
to $130,500,000 (the "Purchase Price"), subject to adjustment as provided in
Section 2.3, allocable as set forth below, and subject to Section 5.19(c) and
5.23:
(a) for the Union Bankers Shares, $12,248,000 (the "Union Bankers
Purchase Price");
(b) for the ConLife Shares, $6,250,000 (the "ConLife Purchase Price");
(c) for the Peninsular Shares, $13,300,000 (the "Peninsular Purchase
Price");
(d) for the PC-Canada Shares, $18,000,000 (the "PC-Canada Purchase
Price");
(e) for the PennLife Shares, $74,542,000 (the "PennLife Purchase
Price");
(f) for the PFI Shares, $5,160,000 (the "PFI Purchase Price"); and
(g) for the PCFS Assets, $1,000,000 (the "PCFS Purchase Price").
SECTION 2.2 Closing Transactions. Subject to Section 5.19, at and
simultaneously with the Closing, on the terms and subject to the conditions of
this Agreement, the parties shall cause the following transactions (the "Closing
Transactions") to occur in the order set forth below:
(a) American Pioneer shall sell the American Exchange Shares to Buyer
causing American Exchange to be a direct, wholly-owned subsidiary of Buyer:
(b) Buyer shall purchase from American Exchange surplus notes of
American Exchange with an aggregate principal amount less than or equal to
the amount borrowed from Chase Bank and other financial institutions to
finance the acquisition contemplated hereby (the
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"Surplus Note Amount") and shall contribute to American Exchange an
aggregate amount in cash equal to the excess of (i) the Purchase price over
(ii) the sum of (A) the PFI Purchase price, (B) the PCFS Purchase Price,
(C) the PC-Canada Purchase Price and (D) the Surplus Note Amount;
(c) Union Bankers shall distribute to ConLife the Union Bankers
Special Dividend;
(d) in consideration for the Union Bankers Purchase Price, ConLife
shall sell, assign, transfer and convey to American Exchange, and American
Exchange shall purchase and acquire from ConLife, the Union Bankers Shares,
free and clear of any Liens, other than those which may be created by Buyer
or American Exchange;
(e) in full repayment of ConLife's obligations under the ConLife
Surplus Notes after which, without further action, such Notes shall be
canceled and shall be null and void and ConLife shall have no further
liability to SFC with respect thereto, ConLife (i) shall distribute all of
the issued and outstanding capital stock of SWLIC to SFC and (ii) shall pay
to SFC an amount in cash equal to the sum of (x) the Union Bankers Purchase
Price and (y) the Union Bankers Special Dividend; provided, that if, after
making such distribution and payment, (A) the capital and the surplus of
ConLife would be less than $3.3 million, the amount of the payment
described in clause (ii) above shall be reduced by such shortfall or (B)
the capital and surplus of ConLife would be greater than $3.3 million,
ConLife shall distribute and transfer to the SFC any remaining capital and
surplus of ConLife in excess of $3.3 million;
(f) in consideration for the ConLife Purchase Price, SFC shall sell,
assign, transfer and convey to American Exchange, and American Exchange
shall purchase and acquire from SFC, the ConLife Shares, free and clear of
any Liens, other than those which may be created by Buyer;
(g) in consideration for the PFI Purchase Price, PFG shall sell,
assign, transfer and convey to Buyer, and Buyer shall purchase and acquire
from PFG, the PFI Shares, free and clear of any Liens, other than those
which may be created by Buyer;
(h) Buyer shall contribute to PFI the PCFS Purchase Price;
(i) in consideration for the PCFS Purchase Price, PCFS shall sell,
assign, transfer and convey to PFI, and PFI shall purchase and acquire from
PCFS, the PCFS Assets, free and clear of any Liens, other than those which
may be created by Buyer;
(j) (i) in consideration for payment by PLAC of an amount equal to the
PC-Canada Purchase Price, PennLife shall sell, assign, transfer and convey
to PLAC, and PLAC shall purchase and acquire from PennLife, the PC-Canada
Shares, free and clear of any Liens, and (ii) in consideration for the
PC-Canada Purchase Price, PLAC shall sell, assign, transfer and convey to
Buyer or such other entity as Buyer may designate, and Buyer or Buyer's
designee shall purchase and acquire from PLAC, the PC-Canada Shares, free
and clear of any Liens, other than those which may be created by Buyer;
(k) in consideration for the Peninsular Purchase Price, PennLife shall
sell, assign, transfer and convey to American Exchange, and American
Exchange shall purchase and acquire from PennLife, the Peninsular Shares,
free and clear of any Liens, other than those which may be created by
Buyer; and
(l) in consideration for the PennLife Purchase Price, PLAC shall sell,
assign, transfer and convey to American Exchange, and American Exchange
shall purchase and acquire from PLAC, the PennLife Shares, free and clear
of any Liens, other than those which may be created by Buyer or American
Exchange.
If requested by Buyer, Sellers shall cooperate in good faith to restructure
the manner and order in which the Companies or their operations are acquired and
if Buyer designates a purchaser for the PC-Canada Shares as described in Section
2.2(j) above, Sellers shall transfer the PC-Canada Shares to Buyer's designee,
provided that such restructuring or designation
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either (x) does not result in additional cost to Sellers or additional
indemnification obligations of Sellers under Section 8.1 or (y) at Buyer's
option, Buyer unconditionally indemnifies Sellers with respect to any such
additional costs and waives any such additional indemnification obligations as
referenced in (x) above.
Upon each sale, assignment, transfer and conveyance of the respective
shares described above, the relevant Seller shall deliver to American Exchange,
in the case of (d), (f), (k) and (l) above, and to Buyer or Buyer's designee, in
the case of (g) and (j) above, share certificates constituting such Shares, duly
endorsed in blank or accompanied by stock powers duly executed in blank, in
proper form for transfer.
Upon the sale, assignment, transfer and conveyance of the PCFS Assets as
described above, PCFS and PFI will execute and deliver a bill of sale,
assignment and assumption agreement (the "Bill of Sale, Assignment and
Assumption Agreement") with respect to the sale by PCFS of the PCFS Assets and
the assumption by PFI of the Assumed Liabilities. Subject to the indemnification
provided in Section 8.1(b)(xiii), PFI waives compliance with any and all bulk
sales laws in connection with the sale and purchase of the PCFS Assets.
SECTION 2.3 Purchase Price Adjustment.
(a) As promptly as practicable (but in no event more than 90 days) after
the Closing Date, Buyer will cause PennLife and ConLife to prepare the Closing
Statement and will deliver it to PFG. The capital and surplus amounts reflected
in the Closing Statement shall be in sufficient detail to permit PFG to verify
the same. The Closing Statement to be delivered to PFG will be accompanied by a
certificate of Buyer's Chief Financial Officer certifying that the Closing
Statement has been prepared in accordance with SAP as of the Closing Date using
the same assumptions and methodologies utilized in the preparation of the
Estimated Statement. At the request of PFG, after the Closing Statement has been
prepared, Buyer will cause its personnel and independent auditors to (i) provide
to PFG and PFG's independent auditors (A) a reconciliation of the differences
between the Closing Statement and the Estimated Statement in sufficient detail
for PFG to reconcile such differences and (B) copies of financial statements and
such work papers and other documents relating to the preparation of the Closing
Statement as PFG or PFG's independent auditors may reasonably request and (ii)
cooperate with, and be reasonably available to, PFG and PFG's independent
auditors and provide such other information reasonably requested by PFG or PFG's
independent auditors concerning the Closing Statement and any accounting,
auditing and actuarial issues related thereto, in each case in good faith and in
a manner and at such times so as to enable PFG to complete its review and
analysis of the Closing Statement within the period specified in paragraph (b)
below.
(b) Within 20 Business Days after PFG's receipt of the Closing Statement,
PFG will provide Buyer with written notice indicating whether PFG agrees or
disagrees with the capital and surplus amounts (excluding AVR and IMR) reflected
in such statement. If PFG in such notice agrees with the capital and surplus
amounts (excluding the AVR and IMR) reflected in the Closing Statement or if PFG
fails to deliver to Buyer such written notice within such 20 Business Day
period, the Closing Statement shall be deemed final and binding upon the
parties. If PFG in such notice disagrees with the capital and surplus amounts
(excluding AVR and IMR) reflected in the Closing Statement, within ten Business
Days after PFG delivers such notice to Buyer of its disagreement with Buyer's
calculation, PFG and Buyer will begin good faith negotiations to resolve such
disagreement.
(c) If PFG and Buyer are unable to resolve such disagreement in good faith
within ten Business Days after such negotiations begin, such disagreement will
be submitted to the Settlement Auditor for resolution. PFG and Buyer will
cooperate with the Settlement Auditor and will proceed in good faith to cause
the Settlement Auditor to resolve such disagreement within 30 days after such
disagreement is submitted to the Settlement Auditor. PFG and Buyer will each pay
one-half of the fees and expenses of the Settlement Auditor; provided, however,
that if the
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Settlement Auditor's written report indicates that PFG or Buyer was the
prevailing party in the dispute, the non-prevailing party shall pay 100% of the
fees and expenses of the Settlement Auditor.
(d) The Settlement Auditor, in its sole discretion, will determine (i) the
nature and extent of the participation by PFG, Buyer, and their respective
agents in connection with any disagreement submitted to the Settlement Auditor
for resolution, (ii) the nature and extent of information that PFG and Buyer may
submit to the Settlement Auditor for consideration in connection with such
resolution and (iii) the personnel of the Settlement Auditor who will review
such information and resolve such disagreement. The Settlement Auditor's
resolution of any such disagreement, with respect to dollar amounts, must fall
within the range of the disputed amounts stated by PFG and Buyer and will be
reflected in a written report which will be delivered promptly to, and will be
final and binding upon, PFG and Buyer. The Closing Statement will be adjusted
accordingly to reflect any such resolution and, as adjusted, shall be final and
binding upon the parties.
(e) Upon the earlier to occur of (i) the parties' agreement with respect to
the capital and surplus amounts reflected in the Closing Statement or (ii) the
delivery of the report of the Settlement Auditor as provided in Section 2.3(d)
hereof with respect to a dispute relating to the Closing Statement: (A) PFG will
pay to Buyer the amount, if any, by which (x) in the case of the PennLife
Companies (excluding PC-Canada) or the ConLife Companies, the capital and
surplus (excluding AVR and IMR) reflected in the Closing Statement for such
Company is less than the Target Capital Amount (defined below) for such Company
and (y) in the case of PC-Canada, total shareholders equity (calculated in
accordance with Canadian generally accepted accounting principles) reflected in
the Closing Statement under the heading "PC-Canada Section 2.3(e)(A) Amount" is
less than the Target Capital Amount for PC-Canada; and (B) PFG will pay to Buyer
the amount, if any, by which the aggregate capital and surplus (for all PennLife
Companies, including PC-Canada, and all ConLife Companies, calculated in
accordance with SAP) of the PennLife Companies and the ConLife Companies
(excluding amounts attributable to the Vanderhorst Note), taken as a whole,
reflected in the Closing Statement is less than the sum of $65.8 million plus
the earnings of the PennLife Companies and the ConLife Companies for the period
commencing on January 1, 1999 and ending on the Closing Date, as reflected in
the Closing Statement (the "Aggregate Target Capital Amount") minus any amounts
payable by PFG pursuant to clause (A) above. For purposes of this Section
2.3(e), "earnings" means operating earnings of the Companies and specifically
excludes (A) earnings from wholly owned Subsidiaries that are not Companies and
the earnings of the Companies otherwise includable in another Company's earnings
if duplicative or redundant, (B) earnings that do not increase surplus,
including, without limitation, the amortization of the ceding commission of
Cologne Life Reinsurance Company ("Cologne Re") at Union Bankers, (C) tax
payments or liabilities from wholly owned Subsidiaries (including the Companies)
and (D) earnings associated with the transactions contemplated or required by
this Agreement, including without limitation those set forth in Annex C. Such
payment will be made by wire transfer of immediately available funds to such
account as the party entitled to receive such payment specifies in writing to
the party required to make such payment. "Target Capital Amount" means capital
and surplus of: (i) $3.3 million, in respect of ConLife; (ii) $14.0 million, in
respect of Union Bankers (including the capital and surplus of Marquette); (iii)
$5.1 million, in respect of Marquette; (iv) $36.0 million, in respect of
PennLife (excluding amounts attributable to the Vanderhorst Note); (v) $10.2
million, in respect of Peninsular (which amounts will be reflected in the Forms
A to be filed with the appropriate insurance regulatory authorities), and (vi)
Can.$21.946 million, in respect of PC-Canada. Sellers will use their reasonable
best efforts to cause any additional capital and surplus in the Companies over
and above the sum of their individual Target Capital Amounts (but not greater
than the Aggregate Target Capital Amount) to be contributed to PennLife;
provided, that for purposes only of this sentence, the Target Capital Amount for
PC-Canada will be deemed to be $500,000 or actual capital and surplus in
accordance with SAP, if greater.
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(f) At the Closing, PFI will have $4.5 million in cash recorded on its
balance sheet.
(g) If Buyer does not request that Sellers recapture the Lincoln National
Agreement prior to the Closing, the Target Capital Amount for PennLife and the
Aggregate Target Capital Amount will be calculated without giving effect to the
surplus generated as a result of the Lincoln National Agreement through the
Closing Date.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PFG, PLAC, SFC AND PCFS
PFG, with respect to all matters set forth in this Article III, jointly and
severally with PLAC, SFC and PCFS, represents and warrants to Buyer; PLAC, with
respect only to matters relating to itself and the PennLife Companies, severally
and not jointly with any other Seller (except PFG) represents and warrants to
Buyer; and SFC, with respect only to matters relating to itself and the ConLife
Companies, severally and not jointly with any other Seller (except PFG)
represents and warrants to Buyer; and PCFS, with respect to matters relating to
itself and the PCFS Assets, severally and not jointly with any other Seller
(except PFG) represents and warrants to Buyer, as follows:
SECTION 3.1 Organization and Qualification.
(a) Each of the Sellers and the Companies is a corporation duly organized,
validly existing and in good standing under the laws of its jurisdiction of
incorporation, which as to each of the Companies is set forth opposite its name
in Section 3.1(a) of the Disclosure Schedule, with all requisite corporate power
and authority to own, operate and lease its properties and to carry on its
business as it is now being conducted. Sellers have delivered or made available
to Buyer a true and complete copy of the Certificate or Articles of
Incorporation and Bylaws (or similar organizational documents) of each of the
Companies.
(b) Each of the Companies is qualified or licensed to do business as a
foreign corporation or extra-provincial corporation and is in good standing in
every jurisdiction where the nature of the business conducted by it or the
properties owned or leased by it requires qualification, except where the
failure to be so qualified, licensed or in good standing would not reasonably be
expected to have a Material Adverse Effect. Schedule T of each of the PennLife
Companies' (except PC-Canada) and ConLife Companies' Annual Statements for the
year ended December 31, 1997 and the Annual Statement of PC-Canada set forth a
true and complete list of each jurisdiction in which each of the respective
PennLife Companies (including PC-Canada) and ConLife Companies is qualified or
licensed to do business and is in good standing to transact the business of life
and/or accident and health insurance.
(c) Each U.S. domiciled PennLife Company and ConLife Company is domiciled
in its jurisdiction of incorporation, is not deemed to be domiciled in any other
jurisdiction, and is licensed to write the types of insurance shown in Section
3.1(c) of the Disclosure Schedule in the jurisdictions shown in such Section,
which are all the types of insurance issued by such Companies and all the
jurisdictions in which each such Company writes such insurance. Except as set
forth in Section 3.1(c) of the Disclosure Schedule, no such license is the
subject of a proceeding for suspension or revocation or any similar proceedings
and, to the knowledge of Sellers, there is no pending threat of such suspension
or revocation by any licensing authority. Each U.S. domiciled PennLife Company
and ConLife Company is a "life insurance company" within the meaning of Section
816 of the Code.
SECTION 3.2 Authorization. Sellers have full corporate power and
authority to execute and deliver this Agreement and to consummate the
transactions contemplated hereby. The execution and delivery of this Agreement
by Sellers, the performance by Sellers of their respective obligations
hereunder, and the consummation by Sellers of the transactions contemplated
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hereby, have been duly authorized by their respective Boards of Directors and,
where applicable, their respective shareholders. No other corporate action on
the part of Sellers is necessary to authorize the execution and delivery of this
Agreement or the consummation of the transactions contemplated hereby. This
Agreement has been duly and validly executed and delivered by each Seller and
constitutes a valid and binding obligation of each Seller, enforceable against
each Seller in accordance with its terms, subject to applicable bankruptcy,
insolvency, fraudulent conveyance, reorganization, moratorium and similar laws
affecting creditors' rights and remedies generally, and subject, as to
enforceability, to general principles of equity, including principles of
commercial reasonableness, good faith and fair dealing (regardless of whether
enforcement is sought in a proceeding at law or in equity).
SECTION 3.3 No Violation. Except as set forth in Section 3.3 of the
Disclosure Schedule, neither the execution and delivery of this Agreement by
Sellers, the performance by Sellers of their obligations hereunder nor the
consummation by Sellers or the Companies of the transactions contemplated hereby
will (a) violate, conflict with or result in any breach of any provision of the
Certificate or Articles of Incorporation or Bylaws (or similar organizational
documents) of any Seller or any of the Companies, (b) violate or conflict with
or result in a violation or breach of, or constitute a default or give rise to
any right of termination or acceleration (with or without due notice or lapse of
time or both) or result in the acceleration of any payments under the terms,
conditions or provisions of any note, bond, mortgage, indenture or deed of
trust, license, lease or agreement to which any Seller or any of the Companies
is a party or by which any of their assets is bound, (c) violate any order,
writ, judgment, injunction, decree, statute, rule or regulation of any
Governmental Authority applicable to any Seller or any of the Companies or any
of their respective assets or (d) result in the creation of any Lien upon any of
the assets of any Seller, any of the Companies or PCFS (other than any Liens
created by Buyer), except in the cases of clauses (b), (c) and (d) above, for
those violations, conflicts, breaches and defaults which would not reasonably be
expected to have a Material Adverse Effect.
SECTION 3.4 Capitalization of the Companies.
(a) The authorized capital stock of PennLife consists of 50,000 PennLife
Shares. As of the date this Agreement is being amended and restated, there are
45,946 PennLife Shares issued and outstanding, all of which have been validly
issued, are fully paid and non-assessable and were not issued in violation of
any preemptive rights. The authorized capital stock of PFI consists of 1,000 PFI
Shares. As of the date hereof, there are 1,000 PFI Shares issued and
outstanding, all of which have been validly issued, are fully paid and
non-assessable and were not issued in violation of any preemptive rights. The
authorized capital stock of ConLife consists of 50,000 ConLife Shares. As of the
date hereof, there are 49,998 ConLife Shares issued and outstanding, all of
which have been validly issued, are fully paid and non-assessable and were not
issued in violation of any preemptive rights. The authorized capital stock of
Union Bankers consists of 1,360,000 Union Bankers Shares. As of the date hereof,
there are 1,334,001 Union Bankers Shares issued and outstanding, all of which
have been validly issued, are fully paid and non-assessable and were not issued
in violation of any preemptive rights. The authorized capital stock of Marquette
consists of 2,100,000 Marquette Shares. As of the date hereof, there are 175,000
Marquette Shares issued and outstanding, all of which have been validly issued,
are fully paid and non-assessable and were not issued in violation of any
preemptive rights. The authorized capital stock of Peninsular consists of
7,200,000 Peninsular Shares. As of the date hereof, there are 1,208,599
Peninsular Shares issued and outstanding, all of which have been validly issued,
are fully paid and non-assessable and were not issued in violation of any
preemptive rights. The authorized capital stock of PC-Canada is unlimited. As of
the date hereof, there are 100 PC-Canada Common Shares and 100 PC-Canada
Preferred Shares issued and outstanding, all of which have been validly issued,
are fully paid and non-assessable and were not issued in violation of any
preemptive rights.
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(b) Except as set forth in Section 3.4(b) of the Disclosure Schedule, there
are no (i) options, warrants, calls, subscriptions, conversion or other rights,
agreements or commitments obligating any Company to issue any additional shares
of capital stock or any other securities convertible into, exchangeable for or
evidencing the right to subscribe for any shares of capital stock of such
Company, (ii) agreements or commitments obligating such Company to repurchase,
redeem or otherwise acquire any shares of its capital stock, (iii) restrictions
on transfer of any shares of capital stock of such Company (other than pursuant
to this Agreement) or (iv) voting or similar shareholder agreements relating to
any shares of capital stock of such Company.
(c) The Peninsular Shares and the PC-Canada Shares are owned beneficially
and of record by PennLife, free and clear of all Liens. The PFI Shares are owned
beneficially and of record by PFG, free and clear of all Liens. The ConLife
Shares are owned beneficially and of record by SFC, free and clear of all Liens,
except as set forth in Section 3.4(c) of the Disclosure Schedule. The Union
Bankers Shares are owned beneficially and of record by ConLife, free and clear
of all Liens, except as set forth in Section 3.4(c) of the Disclosure Schedule.
The Marquette Shares are owned beneficially and of record by Union Bankers, free
and clear of all Liens. The PennLife Shares are owned beneficially and of record
by PLAC, free and clear of all Liens. At the Closing, good and valid title to
the Shares shall be conveyed to Buyer or the other parties as provided for in
Section 2.2, in the manner contemplated by Section 2.2, free and clear of all
Liens, other than those which may be created by Buyer.
(d) Except as set forth in Section 3.4(d) of the Disclosure Schedule, none
of the Companies owns, directly or indirectly, 5% or more of the outstanding
voting securities of or otherwise possesses, directly or indirectly, the power
to direct or cause the direction of the management or policies of any Person,
other than capital stock of one of the Companies owned by another Company and
securities held for investment purposes only.
SECTION 3.5 PFI Subsidiaries and PCFS Assets.
(a) Section 3.5(a) of the Disclosure Schedule sets forth (i) the name of
all Subsidiaries of PFI (the "PFI Subsidiaries") and their respective
jurisdictions of incorporation and (ii) the name and number of all authorized,
issued and outstanding shares of capital stock of each PFI Subsidiary. Except
for the PFI Subsidiaries, PFI directly or indirectly does not own or have the
power to vote the shares of any capital stock or other ownership interest or
have ordinary voting power to elect the majority of directors of any corporation
or other entity or other Person or body performing a similar function of any
such entity, as the case may be.
(b) All of the outstanding shares of capital stock of each PFI Subsidiary
have been duly authorized and validly issued, are fully paid and non-assessable,
have not been issued in violation of any preemptive rights, and are owned of
record and beneficially by the entities named in Section 3.5(a) of the
Disclosure Schedule, free and clear of any Liens except as set forth in Section
3.5(a) of the Disclosure Schedule.
(c) Except as set forth in Section 3.5(c) of the Disclosure Schedule, there
are no (i) options, warrants, calls, subscriptions, conversion or other rights,
agreements or commitments obligating any of the PFI Subsidiaries to issue any
additional shares of capital stock of such Subsidiary or any other securities
convertible into, exchangeable for or evidencing the right to subscribe for any
shares of such capital stock, (ii) agreements or commitments obligating any such
Subsidiary to repurchase, redeem or otherwise acquire any shares of its capital
stock, (iii) restrictions on the transfer of any shares of capital stock of any
such Subsidiary (other than pursuant to this Agreement) or (iv) voting or
similar shareholder agreements relating to any shares of capital stock of any
such Subsidiary.
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(d) PCFS has good and indefeasible title to all of the PCFS Assets, in each
case free and clear of all Liens, and PCFS will convey to Buyer good and
indefeasible title to all of the PCFS Assets, in each case free and clear of all
Liens other than those which may be created by Buyer.
SECTION 3.6 Consents and Approvals. Except as set forth in Section 3.6 of
the Disclosure Schedule, no filing or registration with, no notice to and no
permit, authorization, consent or approval of any Governmental Authority is
necessary for the consummation by any Seller or the Companies of the
transactions contemplated by this Agreement other than consents and approvals of
or filings or registrations with (a) the Antitrust Division of the United States
Department of Justice (the "DOJ") pursuant to the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"), and (b) the insurance
departments of the States of Pennsylvania and North Carolina and the federal or
provincial government and other requisite federal and provincial regulatory
authorities of Canada (the "PennLife Insurance Approvals") and the insurance
department of the State of Texas (the "ConLife Insurance Approvals").
SECTION 3.7 Financial Statements; Reserves.
(a) Sellers have previously delivered to Buyer true and complete copies of
the following (the "SAP Financial Statements"):
(i) the Annual Statements for each PennLife Company and ConLife
Company for each of the years ended December 31, 1996 and 1997 and for
Executive Fund Life Insurance Company for the year ended December 31, 1995,
in each case as filed with the departments of insurance in the respective
states of domicile or Canada, as the case may be, of each PennLife Company
and ConLife Company including all exhibits, interrogatories, notes and
schedules thereto and any actuarial opinion, affirmation or certification
filed in connection therewith;
(ii) the Quarterly Statements for each PennLife Company and ConLife
Company for the quarters ended March 31, June 30 and September 30, 1998
including all exhibits, interrogatories, notes and schedules thereto; and
(iii) the statutory annual statements and quarterly statements of each
PennLife Company and ConLife Company which were filed for 1996, 1997 or
1998 (with respect to the quarters ended March 31, June 30 and September
30) in any jurisdiction other than such Company's jurisdiction of domicile
and that differ from the corresponding Annual Statements and Quarterly
Statements for such periods.
Except as set forth in Section 3.7(a) of the Disclosure Schedule, the SAP
Financial Statements were, and when delivered in accordance with the provisions
of Section 5.18, the 1998 SAP Financial Statements will be, prepared in all
material respects in accordance with SAP. Except as set forth in Section 3.7(a)
of the Disclosure Schedule, the SAP Financial Statements present fairly in all
material respects and, when delivered in accordance with the provisions of
Section 5.18, the 1998 SAP Financial Statements will present fairly in all
material respects, the statutory financial position of the applicable Company as
of the respective dates thereof and the related summary of operations and
changes in capital and surplus and in cash flows of such Company for and during
the respective periods covered thereby in conformity with SAP, applied on a
consistent basis.
(b) Except as set forth in Section 3.7(b) of the Disclosure Schedule, all
statutory reserves and other similar amounts with respect to insurance as
established or reflected in the December 31, 1997 Annual Statement and September
30, 1998 Quarterly Statement of each PennLife Company and ConLife Company were
determined (and, when delivered in accordance with the provisions of Section
5.18, all statutory reserves and other similar amounts with respect to insurance
as reflected or established in the 1998 SAP Financial Statements will be
determined) in all material respects in accordance with SAP and sound actuarial
practice, based on actuarial assumptions and methodologies that were (or will
be), as of the date of preparation,
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in compliance in all material respects with, and met (or will meet) in all
material respects the requirements of the insurance laws of the respective
states of domicile of, the PennLife Companies and ConLife Companies. Except as
set forth in Section 3.7(b) of the Disclosure Schedule, each PennLife Company
and ConLife Company owns assets that qualify as legal reserve assets under
insurance laws applicable to such Company in an amount at least equal to all
such reserves and other similar amounts required by such laws to be owned by
such Company.
(c) As of the date this Agreement was amended and restated, Sellers have
recorded in accordance with GAAP and SAP additional reserves of at least $25
million relating to adverse reserve development applicable to the disability
income claim reserves of PennLife for 1998 and prior years, which additional
reserves have not been released.
(d) Sellers have previously delivered or made available to Buyer a true and
complete copy of the unaudited combined financial statements for the Companies
(and PCFS, to the extent required under Item 13 of Schedule 14A under the
Exchange Act for purposes of the Proxy Statement) as at and for the nine-month
period ended September 30, 1998 (the "Unaudited Financial Statements"). The
Unaudited Financial Statements fairly present in all material respects and, when
delivered in accordance with the provisions of Section 5.18, the Audited
Financial Statements, taken together with the notes thereto, will fairly present
in all material respects the financial position and results of operations of the
Companies (and PCFS, to the extent required under Item 13 of Schedule 14A under
the Exchange Act for purposes of the Proxy Statement) as of the respective dates
and for the periods indicated therein, in each case in accordance with generally
accepted accounting principles ("GAAP") consistently applied except as
identified in the report delivered by the Reserves Consultants pursuant to
Section 5.3(b) hereof and, in the case of the Unaudited Financial Statements,
for the absence of notes. The Unaudited Financial Statements were prepared
consistent with past practices of the Companies in the preparation of unaudited
financial statements (subject to normal, recurring year-end audit adjustments
that in the aggregate are not materially adverse). As used herein, "Financial
Statements" means the Unaudited Financial Statements, the Audited Financial
Statements and the SAP Financial Statements, collectively.
SECTION 3.8 Absence of Undisclosed Liabilities. As of the date hereof,
and as of the date of the 1998 Audited Financial Statements, except for matters
relating to the transactions contemplated by this Agreement, there are and will
be no liabilities or obligations of the Companies or PCFS (including without
limitation any Liens) that are required to be reflected on a balance sheet
prepared in accordance with SAP or GAAP, as applicable, other than (a)
liabilities and obligations reserved against in the Financial Statements and not
heretofore discharged, (b) policyholder benefits payable or other liabilities or
obligations arising in the ordinary course of business after September 30, 1998,
or (c) liabilities and obligations disclosed in Section 3.8 of the Disclosure
Schedule.
SECTION 3.9 Absence of Certain Changes. Except as disclosed in Section
3.9 of the Disclosure Schedule or as permitted or contemplated by this
Agreement, since September 30, 1998, none of the Companies or PCFS has (a)
experienced any change, event or condition which, individually or in the
aggregate, has had or could reasonably be expected to have a Material Adverse
Effect, (b) conducted its business in any material respect other than in the
ordinary course, (c) except in the ordinary course of business, incurred any
indebtedness for borrowed money or issued any debt securities or assumed,
guaranteed or endorsed the obligations of any other Person, (d) except in the
ordinary course of business, (i) sold, transferred or otherwise disposed of any
of its property or assets or (ii) mortgaged or encumbered any of its property or
assets, (e) suffered any material casualty losses not covered by insurance, (f)
repurchased any of its capital stock or any capital stock of any of its
Subsidiaries, (g) declared, set aside or paid any dividend or other distribution
in respect of its capital stock, other than ordinary dividends and payments
pursuant to the ConLife Surplus Notes
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permitted under applicable insurance laws, (h) amended its Certificate or
Articles of Incorporation or Bylaws (or similar organizational documents) or
merged with or into or consolidated with any other Person, (i) split, combined
or reclassified its capital stock, (j) issued or sold (or agreed to issue or
sell) any of its equity securities or any options, warrants, conversion or other
rights to purchase any such securities or any securities convertible into or
exchangeable for such securities, or granted, or agreed to grant any such
rights, (k) increased the rates of compensation (including bonuses) payable or
to become payable to any of its officers, employees, agents, independent
contractors or consultants other than increases made in the ordinary course of
business, (l) entered into any new or amended any existing employment contracts,
severance agreements or consulting contracts or instituted or agreed to
institute any increase in benefits or altered its employment practices or the
terms and conditions of employment in each case other than in the ordinary
course of business, (m) changed in any material respect its underwriting,
actuarial or tax accounting methods, principles or practices, (n) in the case of
the PennLife Companies and the ConLife Companies, ceased its lead generation
activities other than in the ordinary course of business, (o) in the case of the
PennLife Companies and the ConLife Companies, terminated any material
reinsurance or coinsurance contract (including without limitation, any surplus
relief or financial reinsurance contract), whether as reinsurer or reinsured
other than in the ordinary course of business, (p) entered into any joint
ventures or partnerships of any kind, or (q) entered into any contract or other
agreements to do any of the foregoing.
SECTION 3.10 Litigation. Section 3.10 of the Disclosure Schedule sets
forth a list, as of the date hereof, of all material actions, suits,
arbitrations, investigations or proceedings ("Litigation") pending or, to the
knowledge of Sellers, threatened against any of the Companies or PCFS before any
Governmental Authority or arbitrator. Except as set forth in Section 3.10 of the
Disclosure Schedule, none of the Companies is in default under any material
judgment, decree, injunction or order of any Governmental Authority or
arbitrator outstanding against it.
SECTION 3.11 Property; Liens and Encumbrances.
(a) Section 3.11(a) of the Disclosure Schedule contains a complete and
accurate list of all real property owned or leased by the Companies as of the
date hereof.
(b) Except as set forth in Section 3.11(b) of the Disclosure Schedule or in
the Financial Statements, all properties and assets owned by the Companies (the
"Owned Properties") or leased by the Companies (the "Leased Properties") are
free and clear of all liens, pledges, claims, security interests, mortgages,
assessments, easements, rights of way, covenants, restrictions, rights of first
refusal, defects in title, encroachments and other burdens (collectively,
"Liens") except (i) statutory Liens not yet delinquent or the validity of which
are being contested in good faith by appropriate actions, (ii) purchase money
Liens arising in the ordinary course, (iii) Liens for taxes not yet delinquent,
(iv) Liens reflected in the Financial Statements (which have not been
discharged) and (v) Liens which in the aggregate do not materially detract from
the value or, in the case of personal property, materially impair the use by the
Companies of the property subject thereto or, in the case of real property,
materially impair the present and continued use of such property in the usual
and normal conduct of the business of the Companies. The Companies have good and
indefeasible title to the Owned Properties and good and valid leasehold
interests in the Leased Properties and there are no pending or, to the knowledge
of Sellers, threatened condemnation proceedings affecting any of the Owned
Properties or Leased Properties. To the knowledge of Sellers, the use, occupancy
and condition of each parcel of real property that is an Owned Property or a
Leased Property is in compliance in all material respects with all applicable
laws.
SECTION 3.12 Certain Agreements.
(a) Except as disclosed in Section 3.12 of the Disclosure Schedule or in
the Financial Statements, none of the Companies or PCFS is a party to any
written (a) agreement, contract,
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indenture or other instrument relating to the borrowing of money or the
guarantee of any obligation for the borrowing of money; (b) employment,
consulting, compensation or severance agreement with any of its directors,
employees or consultants; (c) agreement, contract or commitment limiting or
restraining it from engaging or competing in any business; (d) lease pursuant to
which it leases the real property set forth in Section 3.11(a) of the Disclosure
Schedule; (e) distribution, dealer, representation, commission or agency
agreement, other than agency agreements with insurance agents in the ordinary
course of business; (f) contract or agreement with any of its affiliates that
will continue after Closing; or (g) any other contract that is material to the
businesses of the Companies to the extent such contract would be required to be
filed pursuant to Item 601(b)(10) of Regulation S-K under the Exchange Act if
the Companies (as a whole) were subject to the reporting requirements thereunder
(each of the foregoing a "Material Contract"). Each Material Contract is in full
force and effect and has been complied with in all material respects by the
Companies and PCFS and, to the knowledge of Sellers, has been complied with in
all material respects by all other parties thereto. Except as set forth in
Section 3.12 of the Disclosure Schedule, no consent is required under any
Material Contract in connection with the consummation of the transactions
contemplated by this Agreement.
(b) Sellers have delivered to Buyer copies of all compensation agreements,
and have otherwise disclosed to Buyer in Section 3.12 of the Disclosure Schedule
all compensation arrangements, between Sellers and/or the Companies on the one
hand, and Gerald Weiner on the other hand.
SECTION 3.13 Employee Benefit Plans. Section 3.13(a) of the Disclosure
Schedule contains (i) a true and complete list by employer of all Persons
employed by the Companies, (ii) all ConLife Employees and PCFS Employees who
will be offered employment as contemplated by Section 5.13 and (iii) the terms
of any severance plans pursuant to which any Company Employee would be entitled
to receive payments.
(a) No Seller or any of their affiliates and none of the Companies (i)
currently maintains, administers or contributes to or has any liability
under or with respect to, other than benefits claims in the ordinary course
of business, or (ii) during the six year period preceding the Closing Date
maintained, administered or contributed to: (A) in respect of any plans or
employees in the United States, any employee benefit plan, as defined in
Section 3(3) of the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), including without limitation, any multiemployer plan as
defined in Section 3(37) of ERISA ("Multiemployer Plan") or any other plan
subject to Title IV of ERISA; or (B) any employment contract, bonus,
deferred compensation, incentive compensation, performance compensation,
stock purchase, stock option, stock appreciation, phantom stock, saving and
profit sharing, severance or termination pay other than statutory or the
common law requirements for reasonable notice, health or other medical,
salary continuation, vacation, sick leave, holiday pay, fringe benefit,
reimbursement program, incentive, life, disability or other (whether
insured or self-insured) insurance, supplementary unemployment benefit,
pension retirement, supplementary retirement, welfare or other employee
plan, program, policy or arrangement, whether written or unwritten, for the
benefit of PFI Employees, PCFS Employees, PennLife Employees or ConLife
Employees, except as described in Section 3.13(a) of the Disclosure
Schedule ("Benefit Plans"), but for greater certainty excluding any such
Benefit Plans which are required to be maintained, administered or complied
with under applicable law.
(b) All Benefit Plans comply in all material respects with and are
operated in all material respects in accordance with their terms and
applicable laws and, in respect of U.S. Benefit Plans, all such Benefit
Plans comply in all material respects with and are, and during the six year
period preceding the Closing Date have been, operated in all material
respects in accordance with their terms and in accordance with ERISA and
the Code.
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(c) True and complete copies of each written Benefit Plan and a
description of any unwritten benefit plan, summary plan descriptions, and
the most recent annual reports on Form 5500, including schedules, audited
financial statements and actuarial valuation reports and funding
agreements, if any, have been delivered to Buyer.
(d) Each Benefit Plan intended to be qualified under Section 401(a) of
the Code has received a favorable determination letter from the IRS as to
its qualification under the Code and to the effect that any trust of such
Benefit Plan is exempt from taxation under Section 501(a) of the Code, all
of which have been delivered or made available to Buyer; and nothing has
occurred since the date of such determination letter that reasonably would
be expected to negatively affect such qualification or exemption. Except as
disclosed in Section 3.13(d) of the Disclosure Schedule, all Canadian
Benefit Plans are duly registered where required by applicable law
(including registration with the relevant tax authorities where such
registration is required to qualify for tax exemption or other beneficial
tax status) and are in material compliance with, all applicable legislation
and administrative guidelines issued by the regulatory authorities having
jurisdiction over such plans.
(e) None of the Companies or any entity required to be aggregated with
any of the Companies pursuant to Code section 414 or ERISA section 4001(b)
("ERISA Affiliate") have incurred or are reasonably expected to incur,
either directly or indirectly, any liability (other than premiums) to the
Pension Benefit Guaranty Corporation ("PBGC"). No ERISA Affiliate has
contributed to or been obligated to contribute to a Multiemployer Plan
during the six year period preceding the Closing Date.
(f) Except as disclosed in Section 3.13(f) of the Disclosure Schedule,
there are no pending or, to the knowledge of Sellers, threatened actions,
suits, claims, trials, arbitrations, investigations or other proceedings by
any person, including any present or former participant or beneficiary
under any Benefit Plan (or any beneficiary of any such participant or
beneficiary) involving any Benefit Plan or any rights or benefits under any
Benefit Plan other than ordinary and usual claims for benefits by
participants or beneficiaries thereunder. There has been no failure to act
on the part of Sellers, their affiliates, the Companies, or, to the
knowledge of Sellers, any funding agent or any administrator of any of the
Benefit Plans that could reasonably be expected to subject Sellers, their
affiliates, the Companies or the fund of any such Benefit Plan to the
imposition of any penalty with respect to any Benefit Plans, whether by way
of indemnity or otherwise. All contributions required to have been made or
remitted by Sellers or the Companies to any Benefit Plan under the terms of
any such plan any agreement or any other applicable law have been made
within the time prescribed by any such plan, agreement or law. No
"reportable events" (as defined in ERISA section 4043), "prohibited
transactions" (as defined in ERISA section 406) or "accumulated funding
deficiency" (as defined in ERISA section 302) have occurred with respect to
any Benefit Plan for which liability would be incurred by Buyer.
(g) Except as disclosed in Section 3.13(g) of the Disclosure Schedule,
neither PFG nor any of its affiliates maintains or contributes to any
Benefit Plan which provides, or has any liability or obligation to provide,
life insurance, medical or other employee welfare benefits to PFI
Employees, PCFS Employees, PennLife Employees or ConLife Employees (or
their beneficiaries) upon and/or after their retirement, except as may be
required by U.S. or Canada federal, state, provincial or local laws, rules
or regulations, and all such Benefit Plans may be amended and terminated in
accordance with the terms thereof.
(h) Section 3.13(h) of the Disclosure Schedule properly and adequately
reflects, and in the case of clause (ii) below, reflects in accordance with
accounting principles agreed to by Buyer and the Companies and reflected in
Section 3.13(h) of the Disclosure Schedule, any and all liabilities and
obligations of the Companies, on a company-by-company basis, as of January
1, 1998 (or such more recent date as is practicable) for or in respect of:
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(i) severance benefits (except for statutory or common law requirements for
reasonable notice); (ii) post-retirement welfare benefits payable in
respect of any PFI Employees, PCFS Employee, PennLife Employees or ConLife
Employees who have retired as of such date; and (iii) any short term
disability compensation or benefits in respect of any active PFI Employees,
PCFS Employee, PennLife Employees or ConLife Employees.
(i) Except as disclosed in Section 3.13(i) of the Disclosure Schedule,
none of the Benefit Plans contains any provision which would result in any
additional benefits, accelerated vesting and/or accelerated payments or
which would subject any employee to an excise tax or result in the loss of
deductibility under Sections 280G or 4999 of the Code solely as a result of
the consummation of the transactions contemplated by this Agreement. No
step has been taken, no event has occurred and no condition or circumstance
exists that has resulted or could reasonably result in any Canadian Benefit
Plan being ordered or required to be terminated or wound-up in whole or in
part or having its registration under any applicable law being refused or
revoked or being placed under the administration of any trustee or receiver
or any regulatory authority.
(j) None of the Companies, or any organization with respect to which
such Company is a successor or parent corporation (within the meaning of
ERISA section 4069) has engaged in any transaction described in ERISA
section 4069.
(k) Since the date of the documents provided in accordance with
Section 3.13(c) above, no promises or commitments have been made by Sellers
or any of their affiliates or the Companies to amend any Benefit Plan or to
provide increased benefits thereunder, except as required by applicable law
or by the Benefit Plans.
(l) Any Benefit Plan that is a pension plan registered under the
Income Tax Act (Canada) which has been created as a result of the division
of a predecessor pension plan or the merger of one or more pension plans,
has received approval therefor from all appropriate regulatory authorities.
(m) Except as permitted by the Canadian Benefit Plans and applicable
law, there has been no withdrawal of surplus assets or any other amounts
from any of the Canadian Benefit Plans other than proper payments of
benefits to eligible beneficiaries, refunds of over-contributions to plan
members and permitted payments of reasonable expenses incurred by or in
respect of such Benefit Plan, for which there is any unsatisfied liability.
(n) All employer contribution holidays have been permitted by the
terms by the Canadian Benefit Plans and have been in accordance with
applicable law, except where there is no unsatisfied liability.
SECTION 3.14 Taxes. Except as set forth in Section 3.14 of the Disclosure
Schedule:
(a) all Tax Returns required to be filed by or with respect to each of
the Companies have been filed, and the Companies have paid all Taxes that
are shown to be due on such Tax Returns and all information provided with
respect to such Tax Returns is complete and accurate in all material
respects;
(b) the Companies have paid all Taxes owed by such Companies (whether
or not shown on any Tax Return) for all taxable periods through and
including the Closing Date and there are not and will not be any additional
liabilities for Taxes for any such period other than as reflected in the
Financial Statements as current Taxes and, with respect to any period
between the latest Financial Statements and the Closing Date, as reflected
in the Closing Statement;
(c) the Companies have given or otherwise made available to Buyer
correct and complete copies of all Tax Returns, examination reports and
statements of deficiencies for periods ending, or transactions consummated,
after December 31, 1994;
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(d) there are no outstanding agreements extending or waiving the
statutory period of limitation applicable to any claim for, or the period
for the collection or assessment or reassessment of, Taxes due from any
Company for any taxable period;
(e) no audit or other proceeding by any Governmental Authority is
pending or, to the knowledge of Sellers, threatened with respect to any
Taxes due from or with respect to any Company and no claim has been made by
any Governmental Authority in a jurisdiction where any of the Companies
does not file Tax Returns that it is or may be subject to taxation by that
jurisdiction;
(f) there are no Liens for Taxes upon the assets or properties of any
of the Companies, except for statutory Liens for current Taxes not yet due;
(g) no Company is a party to any agreement relating to the sharing or
allocation of, or indemnification agreement with respect to, Taxes, or any
similar contract or arrangement;
(h) each U.S. domiciled PennLife Company and ConLife Company is an
"insurance company" within the meaning of Treas. Reg. sec.1.801-3(a) (under
former Section 801 of the Code) and subject to taxation under Subchapter L
of the Code for the taxable period ending on the Closing Date and for all
prior taxable periods for which the statute of limitations has not expired;
(i) none of the Companies (i) has income that is includable in
computing the taxable income of a United States person (defined in Section
7701 of the Code) under Section 951 of the Code and (ii) is a passive
foreign investment company within the meaning of Section 1297 of the Code;
(j) none of the Companies has filed a consent under Section 341(f) of
the Code;
(k) no property owned by any of the Companies (i) is property required
to be treated as being owned by another Person pursuant to the provisions
of Section 168(f)(8) of the Internal Revenue Code of 1954, as amended and
in effect immediately prior to the enactment of the Tax Return Act of 1986,
(ii) constitutes "tax-exempt use property" within the meaning of Section
168(h)(1) of the Code or (iii) is tax-exempt bond financed property within
the meaning of Section 168(g) of the Code;
(l) none of the Companies is a party to any contract, agreement or
other arrangement which could result in the payment of amounts that could
be nondeductible by reason of Section 162(m) of the Code;
(m) none of the Companies has agreed, or is required to make, any
adjustment under Section 481(a) or Section 807(f) of the Code;
(n) none of the Companies has been a member of an affiliated group
filing a consolidated federal Income Tax Return (other than a group the
common parent of which was PLAC (the "PLAC Group"), in the case of the
PennLife Companies, ConLife (the "ConLife Group"), in the case of the
ConLife Companies, PFG (the "PFG Group"), in the case of the PFI Companies)
or has any liability for Taxes of any Person (other than any member of the
PLAC Group, the ConLife Group or the PFG Group, as the case may be) under
Treas. Reg. sec.1.1502-6, sec.1.1502-78 or similar provision of state,
local or foreign law or regulation, as a transferee or successor, by
contract or otherwise;
(o) federal consolidated income Tax Returns or extensions to file have
been (or will be timely) filed by or on behalf of the PLAC Group, the
ConLife Group and the PFG Group for periods with filing dates prior to the
Closing Date;
(p) the Companies have each withheld from their respective employees,
independent contractors, creditors, stockholders and third parties and
timely paid to the appropriate taxing authority proper and accurate amounts
in all respects through all periods in
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compliance with all Tax withholding and remitting provisions of applicable
laws and have each complied in all material respects with all Tax
information reporting provisions of all applicable laws;
(q) no Seller is a foreign person within the meaning of Section 1445
of the Code;
(r) the amount of the policyholders surplus account and shareholder
surplus account (as defined in Section 815 of the Code) of each of the U.S.
Insurance Companies is accurately set forth in Section 3.14 of the
Disclosure Schedule;
(s) each U.S. Insurance Company is taxable as a life insurance company
within the meaning of Section 816 of the Code;
(t) all life insurance contracts issued by each U.S. Insurance Company
(whether developed or administered by or reinsured with any unrelated
party) that are subject to Section 7702 of the Code qualify as "life
insurance contracts" within the meaning of Section 7702(a) of the Code;
(u) all contracts issued by each U.S. Insurance Company (whether
developed or administered by or reinsured with any unrelated party) that
are subject to Section 817 of the Code and the Treasury Regulations
promulgated thereunder have met the diversification requirements applicable
thereto since the issuance of the contract;
(v) all annuity contracts issued by each U.S. Insurance Company
(whether developed or administered by or reinsured with any unrelated
party) that are subject to Section 72(s) of the Code contain all of the
necessary provisions of Section 72(s) of the Code;
(w) the Tax treatment under the Code of all insurance, annuity or
investment policies or contracts; all financial products or annuities; or
any similar or related policy, contract, plan or product, whether
individual, group, or otherwise, issued or sold by any of the U.S.
Insurance Companies (whether developed or administered by or reinsured with
any unrelated party) is and at all times has been the same or not less
favorable to the purchaser, policyholder, or beneficiaries thereof than the
Tax treatment under the Code for which such contracts (products, etc.)
qualified or purported to qualify or which the Insurance Companies
represented could be obtained at the time of its issuance, purchase,
modification, or exchange. For purposes of this Section 3.14(w), the
provisions of the Code relating to the Tax treatment of such contracts
shall include, but shall not be limited to, Sections 72, 79, 101, 104, 105,
106, 125, 130, 401, 402, 403, 404, 408, 412, 415, 419, 419A, 457, 501, 505,
817, 817A, 818, 1035, 7702, and 7702A of the Code;
(x) any life insurance contract issued by any U.S. Insurance Company
(whether developed or administered or reinsured with any unrelated party)
which is a modified endowment contract under Section 7702A of the Code
(each, an "MEC") has been marketed as such at all relevant times or the
policyholder otherwise has consented to such MEC status;
(y) all U.S. Insurance Companies have computed their respective tax
reserves in accordance with the requirements of Sections 807, 811 and 846
of the Code;
(z) all annuity contracts issued by each U.S. Insurance Company
(whether developed or administered by or reinsured with any unrelated
party) that are provided under or connected with a plan described in
Section 401(a), 403(a) or 403(b) of the Code or which is an individual
retirement annuity or provided under an individual retirement account or
annuity, satisfies the federal income tax laws applicable to such annuity
contract;
(aa) there are no currently pending or, to the knowledge of Sellers,
threatened federal, state, provincial, local or foreign audits or other
administrative or judicial proceedings with
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regard to the Tax treatment of any product or plan sold, issued or
administered by the Insurance Companies (whether developed by or reinsured
with any unrelated third party);
(ab) no Insurance Company is a party to any hold harmless, sharing,
allocation or indemnification agreement with respect to the Tax
qualification or treatment of any product or plan sold, issued or
administered by any Insurance Company (whether developed by or reinsured
with any unrelated third party);
(ac) there is no claim, audit, action, suit, proceeding or
investigation now pending or threatened against, with respect to or in
limitation of the net operating loss carryforwards of the Companies as set
forth in Section 3.14 of the Disclosure Schedule (the "NOLs") as of the
Closing Date, including without limitation any limitations under Section
382 of the Code (other than limitations incurred in connection with the
Closing Transactions);
(ad) PennLife is a "qualified insurance corporation" within the
meaning of Section 810 of the Income Tax Regulations (Canada) for the
purposes of Section 116 of the Income Tax Act (Canada) and no Section 116
certificate is required to be obtained pursuant to the Income Tax Act
(Canada) in respect of the transfer of the PC-Canada Shares by PennLife to
PLAC;
(ae) PennLife is not and will not be required to pay any Taxes
pursuant to subsection 219(5.1) of the Income Tax Act (Canada) in respect
of any period ending on or prior to the Closing Date and neither PennLife
nor PC-Canada has made or will make in respect of any period ending on or
prior to the Closing Date any election pursuant to subsection 219(5.2) of
the Income Tax Act (Canada);
(af) PC-Canada is a "life insurance corporation" as defined for
purposes of the Income Tax Act (Canada);
(ag) PennLife and PC-Canada are registered under Part IX of the Excise
Tax Act (Canada); and
(ah) each of PennLife and PC-Canada has remitted all Canada Pension
Plan and Quebec Pension Plan contributions, employment insurance premiums,
employer health taxes, workers' compensation premiums and assessments and
any other Taxes payable by it for any period ending on or before the
Closing Date in respect of its employees to the appropriate taxing
authority within the time required by law.
SECTION 3.15 Compliance with Applicable Law; Permits; Policies.
(a) The businesses of the Companies and PCFS are being conducted in all
material respects in compliance with all applicable provisions of any U.S. and
Canadian federal, state, provincial, local or foreign statute, law, ordinance,
rule, regulation, judgment, decree, order, concession, grant, franchise, permit
or license or other governmental authorization or approval applicable to them,
except as set forth in Section 3.15(a) of the Disclosure Schedule and except for
such noncompliance as has not had or could not reasonably be expected to have a
Material Adverse Effect.
(b) Each Company and PCFS own or validly hold all licenses, franchises,
permits, approvals, authorizations, exemptions, classifications, certificates,
registrations and similar documents or instruments that are required for its
business and operations (in the case of PCFS, relating to the PCFS Assets),
except for those the failure of which to have has not had or could not
reasonably be expected to have a Material Adverse Effect (the "Required
Permits"). All Required Permits relating to insurance are set forth in Schedule
T of each of the PennLife Companies' and ConLife Companies' Annual Statements
for the year ended December 31, 1997, and all other Required Permits are listed
in Section 3.15(b) of the Disclosure Schedule. In all cases, the Required
Permits are valid and in full force and effect and, except as disclosed in
Section 3.15(b) of the Disclosure Schedule, none of Sellers or any Company has
received any notice of any inquiry or proceeding that could reasonably be
expected to result in the suspension, revocation or material limitation of any
such permit; and to the knowledge of Sellers,
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there is no reasonable basis for any such suspension, revocation or limitation.
None of the Companies or PCFS is currently the subject of any supervision,
conservation, rehabilitation, liquidation, receivership, insolvency or other
similar proceeding nor, other than as described in Section 3.15(b) of the
Disclosure Schedule, are any of the Companies or PCFS operating under any formal
or informal agreement or understanding with the licensing authority of any State
which restricts its authority to do business or requires it to take, or refrain
from taking, any action.
(c) Except as disclosed in Section 3.15(c) of the Disclosure Schedule, all
forms of insurance policies and riders thereto currently issued by any PennLife
Company or ConLife Company are, to the extent required under applicable laws, on
forms approved by applicable insurance regulatory authorities of the
jurisdictions in which issued or have been filed with and not objected to by
such insurance regulatory authorities within the period provided for such
objection and any premium rates with respect to such policies or riders required
to be filed with or approved by such applicable insurance regulatory authorities
have been so filed or approved and premiums charged conform thereto. No material
deficiencies have been asserted by any Governmental Authority with respect to
any such filings which have not been cured or otherwise resolved to the
satisfaction of such Governmental Authority.
(d) Except as set forth in Section 3.15(d) of the Disclosure Schedule, each
Company (exclusive of their independent agents) and, to the knowledge of
Sellers, their independent agents, have marketed, sold and issued products of
such Company in compliance in all material respects with all laws applicable to
the business of such Company in the respective jurisdictions in which such
products have been sold, including but not limited to laws regulating
advertisements, requiring mandatory disclosure of policy information, requiring
employment of standards to determine if the purchase of a policy or contract is
suitable for an applicant, prohibiting the use of unfair methods of competition
and deceptive acts or practices and regulating replacement transactions. For
purposes of this Section 3.15(d), "advertisement" means any material designed to
create public interest in life and health insurance policies, annuity contracts
or in an insurer, or in an insurance producer, or to induce the public to
purchase, increase, modify, reinstate, borrow on, surrender, replace or retain
such a policy or contract, and (ii) "replacement transaction" means a
transaction in which a new life or health insurance policy or annuity contract
is to be purchased by a prospective insured and the proposing producer should
know that one or more existing life or health insurance policies or annuity
contracts is to be lapsed, forfeited, surrendered, reduced in value or pledged
as collateral. Except as set forth in Section 3.15(d) of the Disclosure
Schedule, Sellers have not received notice (written or oral) and are not
otherwise aware of any review or investigation by any Governmental Authority of
any marketing conduct and/or selling practices of the Companies or their
independent agents, other than periodic market conduct examinations arising in
the ordinary course of business and Attorney General inquiries in connection
with which no material issues have been raised that have not been resolved to
the satisfaction of the relevant insurance authorities or Attorneys General, as
the case may be.
(e) Except as set forth in Section 3.15(e) of the Disclosure Schedule, no
agent of any of the Companies has any claim against any of the Companies for any
compensation or other amounts (the "Agent Compensation") (other than the
Pre-Sale Obligations, Post-Closing Compensation Obligations or sales commissions
and advances in the ordinary course of business and except for commitments made
by Buyer or by a designee of Buyer on Buyer's behalf, including PFG but only to
the extent PFG is specifically authorized by Buyer in writing).
(f) The Companies have previously delivered or made available to Buyer true
and complete copies of the reports (or the most recent draft thereof, to the
extent any final report is not available) reflecting the results of the two most
recent financial examinations and market conduct examinations of any of the
Companies issued by any insurance regulator.
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(g) Except as set forth in Section 3.15(g) of the Disclosure Schedule, no
insurance policy gives the holder thereof the right to receive dividends,
distributions or other benefits based on the earnings or revenues of such
Company.
(h) The PennLife Companies and the ConLife Companies have (i) timely paid
all material state and Canadian guaranty association assessments that are due,
or claimed or asserted by any insurance regulatory authority to be due, from
such Companies, or (ii) provided for all such material assessments in their
statutory financial statements, filed with the appropriate insurance regulatory
authority, to the extent necessary to be in conformity in all material respects
with SAP for such statements.
(i) Except as set forth in Section 3.15(i) of the Disclosure Schedule, the
December 31, 1997 SAP Financial Statements list all material funds maintained in
a state of licensure by any of the PennLife Companies or the ConLife Companies
under any applicable insurance law (each a "Deposit"), including, without
limitation, any Deposit the beneficial interest of which may have been
transferred in connection with a Reinsurance Agreement. Except as set forth in
Section 3.15(i) of the Disclosure Schedule, the December 31, 1997 SAP Financial
Statements accurately set forth as of December 31, 1997 the dollar amount of
each such Deposit and the name of the depository in which such Deposit is
maintained.
SECTION 3.16 Brokers Fees and Commissions. Except for Salomon Smith
Barney and Fox-Pitt, Kelton Inc., no Seller and no Company (or their respective
directors, officers, employees or agents) has employed any investment banker,
broker or finder in connection with the transactions contemplated hereby. PFG
shall be solely responsible for the fees and expenses of Salomon Smith Barney
and Fox-Pitt, Kelton Inc. in connection with the transactions contemplated
hereby.
SECTION 3.17 Proprietary Rights; Year 2000 Compliance. (a) Except as
disclosed in Section 3.17(a) of the Disclosure Schedule, each Company owns or
possesses the right to use all material trademarks, service marks, patents,
patent rights, assumed names, logos, trade secrets, copyrights and trade names
("Intellectual Property") and all material computer software, programs and
similar systems that are used by it in the conduct of its business and PCFS owns
or possesses the right to use all Intellectual Property and all material
computer software, programs and systems that are used by PCFS in the conduct of
its business, and all such assets and rights are included in the PCFS Assets.
All such Intellectual Property and material computer software, programs and
similar systems are in full force and effect in accordance with their terms.
None of the Companies or PCFS has received any notice of any conflict with or
violation or infringement of or any claimed conflict with or violation or
infringement of, any asserted rights of any other Person with respect to any
such Intellectual Property or computer software, programs, or similar systems.
None of the Companies or PCFS is in conflict with or in violation or
infringement of any asserted rights of any other Person with respect to any such
Intellectual Property or computer software, programs, or similar systems, except
to the extent that any such conflict, violation or infringement does not have,
or could not be reasonably expected to have, a Material Adverse Effect.
(b) Except as disclosed in Section 3.17(b) of the Disclosure Schedule, all
material computer hardware and software (including all computer hardware and
software in embedded systems) used by the Companies and PCFS (whether such
hardware and software is owned by the Companies or PCFS or licensed from third
parties) (collectively, the "Technology Systems") is designed or is being
modified to be used prior to, during and after the calendar year 2000 and the
Companies have taken measures they believe to be sufficient to prepare such
hardware and software to continue to operate during each such time period to
accurately process date data (including, but not limited to calculating,
comparing and sequencing) from, into and between the twentieth and twenty-first
centuries, including leap year calculations.
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SECTION 3.18 Insurance. Section 3.18 of the Disclosure Schedule
summarizes the amount and scope of the insurance currently in force insuring the
Companies and the PCFS Assets and their respective operations and properties
against loss or liability. All such policies or contracts of insurance are in
material compliance with all applicable laws and all Material Contracts to which
any of the Companies or PCFS is a party. All insurance policies pursuant to
which any such insurance is provided are in full force and effect. No notice of
cancellation or termination of any such insurance policy has been given to any
Company or PCFS and all premiums required to be paid in connection with such
insurance policies have been paid in full.
SECTION 3.19 Environmental Matters. Except as disclosed on Section 3.19
of the Disclosure Schedule:
(a) the operations of the Companies and the real property currently owned,
leased or operated by the Companies or included in the PCFS Assets are in
compliance and, during the period of the ownership or tenancy of the Companies
and PCFS have been in compliance, with all applicable Environmental Laws, except
for such noncompliance as would not reasonably be expected to have a Material
Adverse Effect;
(b) no judicial or administrative proceedings or investigations are pending
or, to the knowledge of Sellers, threatened against any of the Companies or to
the extent relating to the PCFS Assets, PCFS, pursuant to any applicable
Environmental Laws, except for judicial or administrative proceedings or
investigations that could not reasonably be expected to have a Material Adverse
Effect;
(c) no condition exists on any real property currently (or to the knowledge
of Sellers, formerly) owned, operated or leased by any of the Companies or
included in the PCFS Assets arising out of or resulting from any Release of any
Hazardous Material that could reasonably be expected to result in the Companies
or PCFS incurring any liability under Environmental Laws that would have a
Material Adverse Effect and no such property is listed or has been proposed for
listing on the National Priorities List, the Comprehensive Environmental
Response Compensation and Liability and Information System (CERCLIS) or any
analogous state or Canadian federal or provincial lists; and
(d) Sellers have delivered or made available to Buyer copies of all
environmental investigations, audits, assessments or other analyses conducted by
or on behalf of, or which are otherwise in the possession of, Sellers or any
Company relating to any real property currently or formerly owned or leased by
any of the Companies or included in the PCFS Assets.
SECTION 3.20 Books and Records. Copies of all the minute books and stock
record books of the Companies have been delivered or made available to Buyer for
inspection and contain accurate records of all meetings of, and written consents
by, the boards of directors (and any committees thereof) and shareholders of the
Companies from January 1, 1995 to the date hereof and, to the knowledge of
Seller, since their respective incorporations.
SECTION 3.21 Bank Accounts. Section 3.21 of the Disclosure Schedule
contains (a) a true and complete list of the names and locations of all banks,
trust companies, securities brokers, and other financial institutions ("Banks")
at which each of the Companies has an account or safe deposit box or maintains a
banking, custodial, trading, trust or other similar relationship ("Accounts"),
(b) a true and complete list and description of each such Account, including a
list of all authorized signatories and (c) a true and complete description of
all Accounts included in the PCFS Assets and a list of the names and locations
of all Banks where such Accounts are located.
SECTION 3.22 Insurance and Reinsurance.
(a) Section 3.22(a) of the Disclosure Schedule is a true and complete
description of each material contract providing for reinsurance, coinsurance,
excess insurance, ceding of insurance,
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assumption of insurance or indemnification of insurance liabilities to which any
PennLife Company or ConLife Company is a party which is currently in effect (the
"Reinsurance Agreements").
(b) Except as required by law or as disclosed in Section 3.22(b) of the
Disclosure Schedule, all amounts payable as of the date of this Agreement by any
PennLife Company or ConLife Company under any Reinsurance Agreement and, to the
knowledge of Sellers, all amounts payable as of the date of this Agreement by
any other Person that is a party to any Reinsurance Agreement have been paid in
accordance with the terms of the contracts under which they arose except, in
each case, for immaterial non-payments or discrepancies that would not adversely
affect any of the rights of any PennLife Company or ConLife Company under any
such Reinsurance Agreement. Except as disclosed in Section 3.22(b) of the
Disclosure Schedule, to the knowledge of Sellers, no reinsurer (other than the
Companies) that is a party to any of the Reinsurance Agreements has a valid
defense to payment of its material obligations under such Reinsurance Agreements
or is in default in any material respect under any Reinsurance Agreement and
Seller is not aware of any impairment of the financial condition of any such
other party to the extent that a default thereunder could reasonably be
anticipated. Each Reinsurance Agreement is in compliance in all material
respects with applicable insurance laws and regulations regarding life and
health reinsurance agreements. The Companies have not entered into any
transaction or series of transactions that are required to be recorded as
financial reinsurance pursuant to SAP.
(c) As of the date hereof, the A.M. Best rating presently held by any of
the Companies has not been reduced since August 27, 1998, and other than as set
forth in Section 3.22(c) of the Disclosure Schedule, the Sellers have not, as of
the date hereof, received any notice of any intended or potential downgrading by
A.M. Best.
SECTION 3.23 Labor Matters.
(a) None of the Companies is a party to any labor or collective bargaining
agreement.
(b) No employees of any Company and none of the ConLife Employees or PCFS
Employees are represented by any labor organization that is certified to
represent such employees under the National Labor Relations Act or other
applicable law. No labor organization or group of employees of any Company or
any ConLife Employees or PCFS Employees has made a pending demand for
recognition, certification, successor rights or a related employer declaration,
and there are no representation, certification, successor rights or related
employer proceedings or petitions or applications for certification seeking a
representation proceeding presently pending or threatened to be brought before
or filed with the National Labor Relations Board or any other labor relations
tribunal or authority. To the knowledge of Sellers, there are no organizing
activities involving any Company or PCFS or Services pending with any labor
organization or group of employees of any Company or any ConLife Employees or
PCFS Employees.
(c) Except as set forth in Section 3.23(c) of the Disclosure Schedule,
there are no strikes, work stoppages, slowdowns, lockouts, material arbitrations
or material grievances or other material labor disputes pending or threatened
against or involving any Company or Services or PCFS, to the extent applicable
to the ConLife Employees or PCFS Employees who are currently employed by
Services or PCFS, as the case may be.
(d) Each of the Companies and Services (with respect to the ConLife
Employees) and PCFS (with respect to the PCFS Employees) is in compliance with
all laws, regulations and orders applicable to such Company or the ConLife
Employees or PCFS Employees, as the case may be, relating to the employment of
labor, including all such laws, regulations and orders relating to wages, hours,
employment standards, WARN, collective bargaining, discrimination, civil rights,
safety and health, workers' compensation and the collection and payment of
withholding
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and/or social security taxes and any similar tax, other than such noncompliance
that could not reasonably be expected to have a Material Adverse Effect.
(e) There is no "mass layoff," "plant closing" or similar event as defined
by WARN or similar Canadian legislation with respect to any of the Companies;
provided, that no representation is made as to actions taken by Buyer in
connection with or after the Closing.
(f) Except as set forth in Section 3.23(f) of the Disclosure Schedule, as
of the date hereof, there are no pending or, to the knowledge of Sellers,
threatened complaints, charges or claims against any Company or Services or PCFS
brought or filed with any Governmental Authority, arbitrator or court based on,
arising out of, in connection with or otherwise relating to the employment or
termination of employment by any Company or Services or, to the extent relating
to the PCFS Employees, PCFS, of any individual.
SECTION 3.24 Affiliate Transactions. Section 3.24 of the Disclosure
Schedule sets forth, as of the date hereof, all contracts, agreements,
obligations, commitments and liabilities between any of the Companies and/or
between any of the Companies and PFG or any of PFG's affiliates (other than the
Companies). All such transactions which were required to have been identified or
reported to or approved by the applicable departments of insurance have been
identified, reported and/or approved.
SECTION 3.25 Bonuses. Except as set forth on Section 3.25 of the
Disclosure Schedule, no current or former officer, director or employee or agent
of any of the Companies is a party to or beneficiary of any contract or other
agreement pursuant to which such Person shall receive or is entitled to receive
any retention or other transaction bonus or other payment (a "Transaction
Bonus") from any Company in connection with the transactions contemplated
hereby.
SECTION 3.26 All Related Assets. As of the Closing Date, immediately
following the Closing Transactions, the Companies will own, lease or license all
property and assets necessary to carry on their business and operations as
presently conducted (except to the extent such property or assets have been
transferred or disposed of in connection with the Pre-Closing Restructuring
Transactions), all such assets and properties (other than as Buyer and Sellers
may mutually agree) will be conveyed to Buyer (either indirectly by means of the
transfer of Shares or through the transfer of the PCFS Assets in accordance with
Section 2.2) at the Closing and will as of the Closing permit Buyer to conduct
such businesses and operations in the same manner as such businesses and
operations have been conducted prior to the Closing (except to the extent such
property or assets have been transferred or disposed of in connection with the
Pre-Closing Restructuring Transactions).
SECTION 3.27 Litigation Arising Between Signing and Closing. The
Litigation pending or, to the knowledge of Sellers, threatened against any of
the Companies or PCFS before any Governmental Authority or arbitrator as of the
Closing Date (including the New Litigation and New Employee Claims), considered
in the aggregate, will not expose the Companies to any materially greater risks
or liabilities than the Litigation set forth on Section 3.10 of the Disclosure
Schedule, considered in the aggregate.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF BUYER AND AMERICAN EXCHANGE
Buyer and, where indicated, American Exchange, hereby represents and
warrants to Sellers as follows:
SECTION 4.1 Organization; Qualifications and Operations. Each of Buyer
and its Subsidiaries (collectively, the "Buyer Parties") is a corporation duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its organization, with all requisite corporate power and
authority to own, operate and lease its properties and to carry on its business
as it is now
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being conducted and, in the case of Buyer, to own directly or indirectly the
Shares and the PCFS Assets. Each Buyer Party is qualified or licensed to do
business and is in good standing in each jurisdiction in which the ownership or
leasing of property by it or the conduct of its business requires such licensing
or qualification, except where the failure to be so qualified or licensed will
not affect Buyer's ability to consummate the transactions contemplated by this
Agreement and will not have a material adverse effect on the business, results
of operations or financial condition of the Buyer Parties, taken as a whole (a
"Buyer Material Adverse Effect").
SECTION 4.2 Authorization. Buyer has full corporate power and authority
to execute and deliver this Agreement and each other document to be delivered by
Buyer in connection herewith, including the Acquisition Notes and the UAFC Share
Purchase Agreement, and to consummate the transactions contemplated hereby and
thereby. American Exchange has full corporate power and authority to execute and
deliver this Agreement and to consummate the transactions contemplated hereby.
The execution and delivery by each of Buyer and American Exchange of this
Agreement, the Acquisition Notes and the UAFC Share Purchase Agreement (in the
case of Buyer only), the performance by Buyer and American Exchange of their
respective obligations hereunder and thereunder, and the consummation by Buyer
and American Exchange of the transactions contemplated hereby and thereby, have
been duly authorized by Buyer's Board of Directors. Except for the approval of
the shareholders of Buyer of the matters requiring shareholder approval set
forth in the UAFC Share Purchase Agreement, no other corporate proceeding on the
part of Buyer is necessary to authorize the execution and delivery of this
Agreement and each other document to be delivered by Buyer in connection
herewith, including the UAFC Share Purchase Agreement, or to consummate the
transactions contemplated hereby and thereby. Simultaneously with the execution
of this Agreement on December 31, 1998, (i) shareholders owning at least 51% of
the issued and outstanding voting securities of Buyer and (ii) shareholders
owning at least 51% of the issued and outstanding Series C-1 Convertible
Preferred Stock of Buyer (the "Series C-1 Holders") executed a voting agreement
in the form attached hereto as Annex B, pursuant to which such shareholders
agreed to vote in favor of the matters requiring shareholder approval set forth
in the UAFC Share Purchase Agreement (which percentage of shareholders, in
respect of the issued and outstanding voting securities and in respect of the
Series C-1 Holders, voting as a separate class, is sufficient to approve such
matters). Each of this Agreement and the UAFC Share Purchase Agreement (in the
case of Buyer only) has been duly and validly executed and delivered by each of
Buyer and American Exchange and constitutes a valid and binding obligation of
Buyer enforceable against it in accordance with its terms, subject to applicable
bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and
similar laws affecting creditors' rights and remedies generally, and subject, as
to enforceability, to general principles of equity, including principles of
commercial reasonableness, good faith and fair dealing (regardless of whether
enforcement is sought in a proceeding at law or in equity).
SECTION 4.3 No Violation. Subject to the receipt by Buyer of the Buyer
Approvals identified in Section 4.5 below and except as set forth in Section 4.3
of the Disclosure Schedule, neither the execution and delivery by each of Buyer
and American Exchange of this Agreement or by Buyer of the UAFC Share Purchase
Agreement, the performance by Buyer and American Exchange of their respective
obligations hereunder and thereunder nor the consummation by each of Buyer and
American Exchange of the transactions contemplated hereby and thereby will (a)
violate, conflict with or result in any breach of any provision of the Articles
of Incorporation or Bylaws of any Buyer Party, (b) violate or conflict with or
result in a violation or breach of, or constitute a default (with or without due
notice or lapse of time or both) under the terms, conditions or provisions of
any note, bond, mortgage, indenture or deed of trust, or any license, lease or
agreement to which any Buyer Party is a party or by which any of their assets is
bound or (c) violate any order, writ, judgment, injunction, decree, statute,
rule or regulation of any Governmental Authority applicable to any Buyer Party
or any of their assets, except in each case as would not have a Buyer Material
Adverse Effect.
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SECTION 4.4 Capitalization. As of the date hereof, the authorized capital
stock of Buyer consists of: (i) 20,000,000 shares of common stock, par value
$0.01 per share ("Buyer Common Stock"); (ii) 500 shares of Series B Convertible
Preferred Stock, par value $1.00 per share, of the Company (the "Series B
Preferred"); (iii) 100,000 shares of Series C Convertible Preferred Stock, par
value $1.00 per share, of the Company (the "Series C Preferred"); (iv) 22,500
shares of Series D-1 Convertible Preferred Stock, par value $1.00 per share, of
the Company (the "Series D-1 Preferred"); and (v) 17,500 shares of Series D-2
Convertible Preferred Stock, par value $1.00 per share, of the Company (the
"Series D-2 Preferred"). As of the date hereof, Buyer has 7,638,057 shares of
Buyer Common Stock, 400 shares of Series B Preferred, 51,680 shares of Series C
Preferred, 22,500 shares of Series D-1 Preferred and no shares of Series D-2
Preferred issued and outstanding. All of such outstanding shares have been
validly issued, are fully paid and, except as provided under Section 630 of the
Business Corporation Law of New York (relating to employee wages),
nonassessable, and were not issued in violation of any preemptive rights. Except
as set forth in Section 4.4 of the Disclosure Schedule, as of the date hereof,
there are 2,673,991 warrants to purchase Buyer Common Stock issued and
outstanding.
SECTION 4.5 Consents and Approvals. Except as set forth in Section 4.5 of
the Disclosure Schedule, no filing or registration with, no notice to and no
permit, authorization, consent or approval of any third party or any
Governmental Authority is necessary for Buyer and American Exchange to enter
into this Agreement or the UAFC Share Purchase Agreement (in the case of Buyer
only) or for the consummation by Buyer and American Exchange of the transactions
contemplated by this Agreement or the UAFC Share Purchase Agreement other than
consents and approvals of or filings or registrations with (a) the DOJ pursuant
to the HSR Act, (b) the PennLife Insurance Approvals and the ConLife Insurance
Approvals, (c) the insurance departments of the States of New York, Texas,
Florida; (d) and the federal and provincial governments of Canada, (e) the
Commission pursuant to the requirements of the Exchange Act and (f) the approval
of the shareholders of Buyer at a special meeting of shareholders of Buyer of
the matters requiring shareholder approval as set forth in the UAFC Share
Purchase Agreement, in accordance with New York law and the rules of Nasdaq
(collectively, the "Buyer Approvals").
SECTION 4.6 Brokers' Fees and Commissions. Except for Chase Securities
Inc. ("Chase Securities"), Capital Z Management Inc., Chase Bank and Advest,
Inc. ("Advest"), neither Buyer nor any of its directors, officers, employees or
agents has employed any investment banker, broker or finder in connection with
the transactions contemplated hereby. Buyer shall be solely responsible for the
fees and expenses of Chase Securities, Capital Z Management Inc., Chase Bank and
Advest in connection with the transactions contemplated hereby.
SECTION 4.7 Purchase for Investment. Each of Buyer and American Exchange
is acquiring the Shares (as applicable) for its own account for investment
purposes and not with a view to the distribution of the Shares (as applicable).
Each of Buyer and American Exchange has such knowledge and experience in
financial and business matters so as to be capable of evaluating the merits and
risks of its investment in the Shares (as applicable). Each of Buyer and
American Exchange is an "accredited investor" as defined in Rule 501 of the
Securities Act of 1933, as amended. Neither Buyer nor American Exchange will,
directly or indirectly, dispose of the Shares except in compliance with
applicable federal and state securities laws.
SECTION 4.8 Financing. Concurrently with the initial execution of this
Agreement, Buyer entered into a Stock Purchase Agreement (the UAFC Share
Purchase Agreement"), with Capital Z Financial Services Fund II, L.P. ("Capital
Z") which is being amended on the date hereof, pursuant to which Buyer has
agreed to issue and sell to Capital Z, and Capital Z has agreed to purchase and
acquire from Buyer, on the terms and subject to the conditions contained
therein, shares of Buyer Common Stock (subject to adjustment in accordance with
the UAFC Share Purchase Agreement) for the purchase price set forth in the UAFC
Share Purchase Agreement. The proceeds of such issuance will be used to fund a
portion of the Purchase Price. In addition, Chase Manhattan Bank, N.A. ("Chase
Bank") and Chase Securities have issued a
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commitment letter (the "Chase Commitment") for the Chase Bank Facility, the
proceeds of which will be used to finance the balance of the Cash Purchase
Price. True and complete copies of the UAFC Share Purchase Agreement and the
Chase Commitment have been delivered to PFG.
SECTION 4.9 SEC Reports. Except as set forth in Section 4.9 of the
Disclosure Schedule, Buyer has timely filed with the Commission (a) Buyer's
Annual Report on Form 10-K for the year ended December 31, 1997, (b) Buyer's
Quarterly Reports on Form 10-Q for the quarters ended March 31, June 30, and
September 30, 1998, (c) all proxy statements relating to meetings of
shareholders of Buyer occurring in 1997 and 1998, (d) all Current Reports on
Form 8-K required to be filed since January 1, 1998, (e) all amendments and
supplements required to be filed to all such reports, and (f) all other forms,
reports, statements and other documents required to be filed with the Commission
(all such documents in clauses (a) through (f) herein are referred to as the
"SEC Reports"). Such SEC Reports filed with the Commission were prepared in all
material respects in accordance with the requirements of applicable law and did
not at the time they were filed contain any untrue statement of a material fact
or omit to state a material fact required to be stated therein or necessary in
order to make the statements therein not misleading in light of the
circumstances under which they were made. Buyer has delivered or made available
to Sellers true and complete copies of all of the SEC Reports.
SECTION 4.10 Absence of Undisclosed Liabilities. Except as set forth in
Section 4.10 of the Disclosure Schedule, as of the date hereof, and as of the
Closing Date, except for matters relating to the transactions contemplated by
this Agreement or as disclosed in the SEC Reports filed prior to the date
hereof, there are no liabilities or obligations of the Buyer Parties that are
required to be reflected on a balance sheet prepared in accordance with GAAP
other than (a) liabilities and obligations reserved against in the financial
statements constituting a part of the SEC Reports and not heretofore discharged,
(b) policyholder benefits payable or other liabilities or obligations arising in
the ordinary course of business, or (c) liabilities and obligations disclosed in
Section 4.10 of the Disclosure Schedule.
SECTION 4.11 Absence of Certain Changes. Except as disclosed in Section
4.11 of the Disclosure Schedule or the SEC Reports filed prior to the date
hereof or as permitted or contemplated by this Agreement, since September 30,
1998, none of the Buyer Parties has (a) experienced any change, event or
condition which, individually or in the aggregate, has had or could reasonably
be expected to have a Buyer Material Adverse Effect or (b) conducted its
business in any material respect other than in the ordinary course.
SECTION 4.12 Compliance with Applicable Law; Permits; Licenses. Except as
set forth in Section 4.12 of the Disclosure Schedule:
(a) The businesses of the Buyer Parties are being conducted in all
material respects in compliance with all applicable provisions of any
material federal, state, local or foreign statute, law, ordinance, rule,
regulation, judgment, decree, order, concession, grant, franchise, permit
or license or other governmental authorization or approval applicable to
them, except for such noncompliance as has not had or could not reasonably
be expected to have a Buyer Material Adverse Effect.
(b) Each Buyer Party owns or validly holds all material licenses,
franchises, permits, approvals, authorizations, exemptions,
classifications, certificates, registrations and similar documents or
instruments that are required for its business and operations, except for
those the failure of which to have has not had or could not reasonably be
expected to have a Buyer Material Adverse Effect. All such licenses,
franchises, permits, approvals, authorizations, exemptions,
classifications, certificates, registrations and similar documents or
instruments are valid and in full force and effect and none of the Buyer
Parties has received any notice of any inquiry or proceeding that could
reasonably be expected to result in the suspension, revocation or material
limitation of any such license; and to the knowledge of Buyer, there is no
reasonable basis for any such suspension, revocation or limitation. None
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of the Buyer Parties is currently the subject of any supervision,
conservation, rehabilitation, liquidation, receivership, insolvency or
other similar proceeding nor are any of the Buyer Parties operating under
any formal or informal agreement or understanding with the licensing
authority of any State which restricts its authority to do business or
requires it to take, or refrain from taking, any action.
ARTICLE V
COVENANTS
SECTION 5.1 Conduct of Business Prior to the Closing. Except as expressly
contemplated by this Agreement (including without limitation the Pre-Closing
Restructuring Transactions (defined below), the Closing Transactions and the
other transactions described as conditions to the consummation of the
transactions contemplated by this Agreement specified in Article VI hereof), as
set forth in Section 5.1 of the Disclosure Schedule or with the prior written
consent of Buyer (not to be unreasonably withheld or delayed), during the period
from the date of this Agreement to the Closing, PFG and PLAC will cause each
PennLife Company to, PFG and SFC will cause each ConLife Company and Services
to, and PFG will cause each PFI Company and PCFS to, conduct its business and
operations according to its ordinary and usual course of business and will use
all reasonable efforts consistent therewith to preserve intact and, as
applicable, maintain in good repair its properties, assets and business
organizations, to keep available the services of its officers, agents and
employees and to maintain satisfactory relationships with policyholders, agents
and regulators, in each case in the ordinary course of business. Without
limiting the generality of the foregoing, and except as otherwise provided in
this Agreement and as set forth in Section 5.1 of the Disclosure Schedule or
with the prior written consent of Buyer (not to be unreasonably withheld or
delayed), prior to the Closing, PFG and PLAC will not permit any of the PennLife
Companies to, PFG and SFC will not permit any of the ConLife Companies or
Services to, and PFG will not permit any of the PFI Companies or PCFS to:
(a) propose or adopt any amendment to its Certificate or Articles of
Incorporation or Bylaws (or similar organizational documents);
(b) except in the ordinary course of business, incur any indebtedness
for borrowed money or issue any debt securities or assume, guarantee or
endorse the obligations of any other Person except for obligations of its
Subsidiaries;
(c) (i) adopt any new Benefit Plan (including any stock option, stock
benefit or stock purchase plan) or amend any existing Benefit Plan in any
material respect, except for changes which are less favorable to
participants in such plans or as may be required by applicable law or (ii)
increase in any manner the rate or terms of compensation of any of its
directors, officers, agents or employees, except such increases as are
granted in the ordinary course of business consistent with past practice,
or enter into any employment, severance or collective bargaining agreement;
(d) enter into any agreement with any officer, director, employee,
general agent or sales agent of the Companies, Services or PCFS pursuant to
which such Persons will be entitled to receive from any Company any
Transaction Bonus;
(e) (i) sell, transfer or otherwise dispose of any of its property or
assets (not including those assets constituting investment securities of
the Companies, which are the subject of paragraph (f) below) other than in
the ordinary course consistent with past practices and, in any event, if
the value of such properties or assets would, individually or in the
aggregate, exceed $500,000 or (ii) mortgage or encumber any of its property
or assets;
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(f) except in the ordinary course consistent with past practices,
sell, transfer or otherwise dispose of any securities in the Companies'
investment portfolios;
(g) enter into or terminate any other material agreements, commitments
or contracts, except agreements, commitments or contracts made or
terminated in the ordinary course of business;
(h) (i) split, combine or reclassify the Shares, (ii) declare, set
aside or pay any dividend or other distribution payable in cash, stock or
property with respect to the Shares, other than those dividends or
distributions set forth in Section 5.1(h) of the Disclosure Schedule, (iii)
issue, sell or pledge, or authorize or propose the issuance, sale or pledge
of any additional shares of, or securities convertible into or exchangeable
for, or options, warrants, calls, commitments or rights of any kind to
acquire, the Shares or any of its capital stock, or (iv) redeem, purchase
or otherwise acquire directly or indirectly any of its capital stock;
(i) except in the ordinary course of business or with respect to
capital projects approved prior to the date hereof, enter into any
agreement or commitment involving an aggregate capital expenditure or
commitment exceeding $100,000;
(j) take any action that would intentionally result in a breach of the
representations and warranties contained in Article III of this Agreement;
(k) adopt a plan of complete or partial liquidation or resolutions
providing for or authorizing such liquidation or a dissolution, merger,
consolidation, restructuring, recapitalization or other reorganization;
(l) materially change any of the tax or financial accounting methods
or practices used by it unless required by GAAP, SAP or applicable law;
(m) settle or compromise any claim (including arbitration) or
litigation, which after insurance reimbursement involves an amount in
excess of $250,000 or otherwise is material to the Company involved or the
Companies taken as a whole;
(n) file any amended Tax Return or settle or compromise any claim
relating to Taxes;
(o) make any payment, loan or advance of any amount to or in respect
of, or engage in the sale, transfer or lease of any of its property or
assets to, or enter into any contract with, any affiliate (other than those
dividends or distributions set forth in Section 5.1(h) of the Disclosure
Schedule or pursuant to arrangements already in place prior to the date
hereof and described in Section 3.25 of the Disclosure Schedule);
(p) amend the terms of or terminate any (i) Material Contracts or
Reinsurance Agreements (other than an extension of the terms, or
termination in accordance with the scheduled termination, of such Material
Contract or Reinsurance Agreements expressly required by their terms) or
(ii) contracts, agreements or arrangements with any affiliate to cause any
change in the cost, services being provided, or term of any such
agreements, other than as specifically contemplated by this Agreement;
(q) enter into or renew (other than a renewal of such contract
expressly required by the terms of such contract) any contract that would
be considered a Material Contract or Reinsurance Agreement (including any
contracts, agreements or arrangements with any affiliates);
(r) engage in any transaction with any affiliate, except to the extent
provided in this Agreement; or
(s) agree to take any of the foregoing actions.
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SECTION 5.2 Management of Companies. Sellers shall, from the date of this
Agreement through the Closing Date, cause management of the Companies to consult
on a periodic basis and in good faith with the employees and representatives of
Buyer concerning the management of the Companies' businesses, including without
limitation the policies and practices of the Companies with respect to (i) the
ceding or assumption of reinsurance or the termination or modification of
existing Reinsurance Agreements (except as contemplated by this Agreement), (ii)
significant underwriting, actuarial, Tax or accounting issues (including matters
related to Tax audits or the establishment, review and modification of insurance
and other reserves), (iii) significant matters relating to the conditions, forms
and pricing of new kinds of policies and (iv) significant matters relating to
the agency force, product distribution, commissions and similar matters;
provided, however, that management of the Companies shall not consult with
employees and representatives of Buyer on any matter if, based on advice of
counsel, management determines that such consultation might violate the
provisions of the HSR Act or any other laws.
SECTION 5.3 Access to Information.
(a) Between the date hereof and the Closing Date, PLAC, PFG and SFC shall
cause the Companies, Services and PCFS to give to Buyer and its counsel,
accountants and other authorized representatives and agents, full access, during
regular business hours and upon reasonable advance notice, to any and all of
their respective premises, properties, contracts, books and records, and will
cause their respective officers and employees to furnish to Buyer and its
representatives, except where prohibited by law, any and all data and
information pertaining, directly or indirectly, to the Companies, the ConLife
Employees, the PCFS Employees and the PCFS Assets that Buyer shall from time to
time reasonably request, and shall permit Buyer and its representatives to make
extracts and copies thereof. Buyer shall not exercise its rights under this
Section 5.3(a) in such a manner as to unreasonably interfere with the ordinary
operations of any of the Companies, Services or PCFS.
(b) As part of the foregoing review, PennLife shall, and PFG and PLAC shall
cause PennLife to, retain and permit the Reserves Consultants to conduct
independent reviews of all insurance reserves of PennLife (other than life
insurance reserves), including but not limited to disability income claim
reserves.
(c) If the transactions contemplated herein are consummated, Buyer
covenants and agrees that it shall preserve and keep the records of the
Companies delivered to it hereunder for a period of seven years from the Closing
Date, and shall make such records available to PLAC, PFG and SFC (without
charge, other than reasonable photocopying expenses if copies are so requested
by PFC, PLAC or SFC), as reasonably requested by PLAC, PFG and SFC in connection
with any legal proceedings by or against, or governmental investigations of,
PLAC, PFG and SFC or any of their affiliates, or in connection with any tax
examination of PLAC, PFG and SFC or any consolidated group of which any of them
was a part or for any other proper business purpose of PLAC, PFG or SFC or their
affiliates.
(d) If the transactions contemplated herein are consummated, Buyer, Sellers
and the Companies jointly covenant and agree that, from and after the Closing
Date, each will use its reasonable best efforts to cooperate with each other in
connection with (i) the preparation of any Tax Return described in Section
5.17(e) or 5.17(f) of this Agreement and (ii) any action, suit, proceeding,
investigation or audit of any of them relating to any Tax liability that may be
the subject of indemnification under Article VIII of this Agreement. In
furtherance thereof, Buyer, Sellers and the Companies further covenant and agree
to promptly respond to all inquiries related to such matters and to provide, to
the extent reasonably possible, substantiation of transactions and to make
available and furnish appropriate documents and personnel in connection
therewith.
SECTION 5.4 HSR Act Filings. As soon as practicable after the date
hereof, PFG and Buyer shall make appropriate filings with the DOJ under the HSR
Act, with respect to the
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transactions contemplated by this Agreement. In connection with such filings,
the parties hereto shall, in cooperation with each other, and as promptly as
reasonably practicable from time to time hereafter, make all such further
filings and submissions, and take such further action, as may be required in
connection therewith. Each party shall furnish the others all information in its
possession necessary for compliance by the others with the provisions of this
Section 5.4. No party shall withdraw any such filing or submission prior to the
termination of this Agreement without the written consent of the other parties.
SECTION 5.5 State Regulatory Approvals. As soon as practicable after the
date hereof, Buyer shall file all applications and other documents, and shall
use its reasonable best efforts to obtain all consents and approvals, as are
required to be filed or obtained by it under the applicable laws of the States
of Texas, North Carolina, Pennsylvania, New York and Florida and the federal or
provincial government of Canada, as applicable, and of any other applicable
jurisdictions, including all requisite approvals of the insurance regulatory
authorities in such jurisdictions and all other governmental approvals required
for consummation of the transactions contemplated by this Agreement, in each
case as promptly as is practicable. PFG and PLAC shall cause the PennLife
Companies, PFG and SFC shall cause the ConLife Companies and Services, to the
extent necessary, and PFG shall cause the PFI Companies and PCFS, to the extent
necessary, to take all such actions (other than the payment of money not then
due and owing or the provision of other consideration) as are reasonably
requested by Buyer to assist Buyer in completing all such filings and obtaining
all such consents and approvals as are required to be made and obtained. Buyer
shall take all such actions (other than the payment of money not then due and
owing or the provision of other consideration) as are reasonably requested by
PLAC, PFG, SFC and ConLife to assist in completing all filings and obtaining all
consents and approvals as any of them may be required to make and obtain.
SECTION 5.6 Pre-Closing Restructuring Transactions; Other Pre-Closing
Matters.
(a) At or prior to the Closing, PLAC, PFG and SFC shall cause to occur the
transactions listed in Annex C (the "Pre-Closing Restructuring Transactions");
provided, however, that the parties acknowledge that a portion of the Purchase
Price will be used to effect certain Pre-Closing Restructuring Transactions
simultaneously with the Closing.
(b) Prior to the Closing, Sellers shall pay in full all amounts due or to
become due in respect of the lease for 3 Bethesda Metro Center, Suite 1600,
Bethesda, Maryland. In addition, prior to the Closing, PFG will assign the Jack
Kent Cook Stadium Lease Agreement to a Subsidiary of PFG (other than any of the
Companies); provided, that if PFG is unable to assign such lease agreement, PFG
shall pay all amounts owing and due with respect to such lease agreement for the
full term thereof and shall be entitled to all of the benefits thereof.
SECTION 5.7 Estimated Statement. PFG shall prepare and deliver (no later
than five Business Days prior to the Closing Date) to Buyer a pro forma
statement (the "Estimated Statement") reflecting PFG's good faith estimate of
the capital and surplus (excluding AVR and IMR) of the PennLife Companies and
the ConLife Companies as of the Closing Date assuming that the transactions
contemplated hereby (including the Closing Transactions and the Pre-Closing
Restructuring Transactions) occurred on and as of such date. The Estimated
Statement shall be prepared in accordance with SAP using the assumptions and
methodologies used in the preparation of the 1998 SAP Financial Statements. The
Estimated Statement will also include an estimate for each Company of its
respective tax liabilities under the tax allocation agreements listed on Exhibit
G hereto.
SECTION 5.8 Transaction Bonuses. PFG, PLAC or SFC shall pay at or prior
to Closing all Transaction Bonuses payable to those officers, directors,
employees or agents set forth on Section 3.25 of the Disclosure Schedule or
otherwise agreed by Buyer and Sellers prior to Closing in accordance with
Section 5.1(d). To the extent such payments are made by any of the Companies,
PFG, PLAC or SFC shall reimburse the relevant Companies for the full amount of
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such payments at Closing. Buyer shall cause the Companies to assume all
obligations under the retention agreements referenced in Section 3.25 of the
Disclosure Schedule arising after the Closing, other than the obligation to pay
the Transaction Bonuses.
SECTION 5.9 Payments to Agents. (a) Except as provided in Sections 5.9(b)
or (c) below, at or prior to Closing, PFG, PLAC or SFC shall pay any and all
amounts payable to any and all agents and other persons under compensation
arrangements made or allegedly made in connection with, in contemplation of or
otherwise relating to the proposed management-led buyout of PennLife (the
"Pre-Sale Obligations").
(b) At or prior to Closing, Buyer will (i) enter into investment agreements
(the "Investment Agreements") with respect to the Buyer Common Stock to be
purchased by certain agents of PennLife, (ii) adopt commission schedules and
(iii) adopt stock-based and other compensation plans, in each case on terms
consistent with Schedule 5.9(b) (the "Post-Closing Compensation Obligations").
(c) At and after the Closing, Buyer will cause PennLife to make all cash
payments that relate to the Pre-Sale Obligations to the extent that such amounts
are reserved for such purpose on the Unaudited Financial Statements and the
Audited Financial Statements and set forth in Section 5.9 of the Disclosure
Schedule.
SECTION 5.10 All Reasonable Efforts.
(a) Subject to the terms and conditions herein provided, each of the
parties hereto agrees to use all reasonable efforts to take, or cause to be
taken, all action, and to do, or cause to be done as promptly as practicable,
all things necessary, proper and advisable under applicable laws and regulations
to consummate and make effective as promptly as practicable the transactions
contemplated by this Agreement including, without limitation, all actions
necessary to satisfy any conditions set forth in the Chase Commitment. If at any
time after the Closing any further action is necessary or desirable to carry out
the purposes of this Agreement, including, without limitation, the execution of
additional instruments, the proper officers and directors of each party to this
Agreement shall take all such necessary action.
(b) At the Closing, PFG will assign to Buyer the non-exclusive right to
enforce the rights of PFG under the confidentiality agreements entered into
between Salomon Smith Barney, as agent for PFG and the Companies, and the
prospective purchasers of the Companies to the extent that such rights pertain
to the Companies.
SECTION 5.11 Public Announcements. The parties hereto will consult with
each other and will mutually agree (the agreement of each party not to be
unreasonably withheld or delayed) upon the content and timing of any press
release or other public statements with respect to the transactions contemplated
by this Agreement and shall not issue any such press release or make any such
public statement prior to such consultation and agreement, except as may be
required by applicable law or by obligations pursuant to any listing agreement
with any securities exchange or any stock exchange regulations as advised by
counsel; provided, however, that each party will give prior notice to the other
parties of the content and timing of any such press release or other public
statement required by applicable law or by obligations pursuant to any listing
agreement with any securities exchange or any stock exchange regulations.
SECTION 5.12 Disclosure Supplements. From time to time prior to the
Closing, PLAC, PFG and SFC may supplement or amend the Disclosure Schedule
delivered in connection herewith with respect to any matter which, if existing
or occurring at or prior to the date of this Agreement, would have been required
to be set forth or described in such Disclosure Schedule or which is necessary
to correct any information in such Disclosure Schedule which has been rendered
inaccurate thereby. Such supplements and amendments shall not be given effect
for purposes of Section 6.1(d); however, if the Closing occurs, Buyer shall be
deemed to have
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waived any right or claim it may otherwise have or have had on account of any
matter so disclosed in such supplement or amendment.
SECTION 5.13 Employment and Employee Benefits.
(a) Buyer shall offer or shall cause to be offered employment to all PCFS
Employees (other than such employees who are disabled for purposes of the
long-term disability plans, if any, applicable to such employees) employed
immediately prior to the Closing Date upon the same terms and conditions of
employment as in effect immediately prior to the Closing Date, which employment
shall be effective on the Closing Date; provided, however, that Buyer shall not
be obligated to offer employment to any PCFS Employees hired between the date
hereof and the Closing Date who were hired without the consent of Buyer other
than replacement employees performing functions substantially similar to his or
her predecessor. Buyer shall be liable, and shall indemnify and hold Sellers
harmless from any and all obligations or liabilities, contingent or otherwise,
relating to or arising from the employment or termination of employment of the
PennLife Employees or PFI Employees or any PCFS Employees hired pursuant to the
first sentence of this Section 5.13(a) (together, the "Company Employees"), with
respect to periods after the Closing Date. Sellers shall be liable for, and
shall indemnify and hold Buyer harmless from any and all obligations or
liabilities, contingent or otherwise, relating to or arising from the employment
or termination of employment of any other employees of PFG or any of its
affiliates (other than any of the Companies), including any PCFS Employees not
hired pursuant to the first sentence of this Section 5.13(a) and any ConLife
Employees with respect to periods up to and after the Closing Date, except to
the extent that such obligations and liabilities are accrued for and are
reflected on the Companies' balance sheets.
(b) At and following the Closing Date: (i) Buyer shall administer and pay
the claims, liabilities and expenses, and shall indemnify and hold Sellers
harmless with respect to Benefit Plans that are sponsored or maintained by the
Companies (the "Buyer Plans"), to the extent that such claims, liabilities and
expenses relate to the Company Employees and (A) relate to periods after the
Closing Date or (B) relate to periods prior to the Closing to the extent that
such claims, liabilities and expenses are accrued and are reflected on the
Companies' balance sheets; and (ii) Sellers shall indemnify and hold Buyer
harmless with respect to claims, liabilities and expenses under the Buyer Plans,
to the extent that such claims, liabilities and expenses relate to periods prior
to the Closing and are not accrued or reflected on the Companies' balance
sheets. At and following the Closing Date, Sellers shall administer and pay the
claims, liabilities and expenses, and shall indemnify and hold Buyer harmless,
with respect to all claims, liabilities and expenses relating to (i) any Benefit
Plans that are not Buyer Plans, (ii) any "employee benefit plans" (as defined in
Section 3(3) of ERISA) other than the Benefit Plans currently or previously
sponsored by Sellers, and (iii) any pension plans, whether or not subject to
Title IV of ERISA, and any liabilities or expenses incurred by any entity that
is required to be aggregated with the Companies pursuant to section 414(b), (c)
or (m) of the Code, immediately prior to, but not immediately after, the Closing
Date, to the extent that any such claims, liabilities and expenses are not
accrued or are not reflected in the Companies' balance sheets.
(c) Without limiting or expanding Buyer's obligations with respect to the
Post-Closing Stock-Based Compensation contemplated in Section 5.9(b) and subject
to the last sentence of Section 5.13(d), Buyer shall, and shall cause its
Subsidiaries (including the Companies), to provide employee benefits for Company
Employees that are at least substantially comparable in the aggregate to the
employee benefits and compensation provided to similarly situated Persons (i) by
Sellers or their affiliates under the Benefit Plans and compensation
arrangements in effect as of the Closing Date or (ii) by Buyer under its
employee benefit plans and compensation arrangements in effect for its
employees. Buyer shall or shall cause the Companies to pay all accrued and
unpaid compensation, including vacation pay, as of the Closing Date in respect
of the Company Employees except as provided in Section 5.8 or 5.13(b).
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(d) If Company Employees are included in any benefit plan (including
without limitation, provision for vacation) of Buyer or its Subsidiaries, such
employees shall receive credit for service prior to the Closing Date with
Sellers or any of their Subsidiaries or affiliates to the same extent such
service was counted under similar Benefit Plans for purposes of eligibility,
vesting and eligibility for retirement, and benefit accrual with respect to
vacation, disability and severance. Buyer shall use reasonable efforts to
provide medical, dental and health plan coverage to Company Employees as of the
Closing Date that shall not include pre-existing condition exclusions, except to
the extent such exclusions were applicable under the similar Benefit Plan as of
the Closing Date, and such plans shall provide credit for any deductibles and
co-payments applied or made with respect to each Company Employee in the
calendar year of the Closing. Buyer assumes the obligation, if any, to provide
coverage to the extent required by Part 6 of Title I of ERISA from and after the
Closing Date to Company Employees (but not any ConLife Employees or PCFS
Employees) who terminated their employment on or before the Closing Date. No
benefits are guaranteed or promised hereunder to any Company Employee with
respect to stock option, bonus or incentive plans, but may be so provided by
Buyer in its sole discretion.
(e) Prior to or effective as of the Closing Date, Sellers shall cause the
Companies to contribute or accrue employer matching contributions for the
portion of the calendar year prior to the Closing Date, with respect to all
Company Employees, and shall immediately thereafter fully vest all such Company
Employees' accounts under any 401(k) plan maintained by Sellers or their
Subsidiaries prior to the Closing Date for the benefit of Company Employees. As
soon as practicable after the Closing Date, Buyer shall cause a 401(k) plan
maintained by Buyer or the Companies to accept "eligible rollover
contributions," within the meaning of Section 402(f)(2)(A) of the Code, from any
401(k) plan maintained by Sellers or their Subsidiaries prior to the Closing
Date, for the benefit of Company Employees.
(f) Notwithstanding any other provision of this Section 5.13, for the
period from the Closing Date through the last day of the first calendar month
starting after the Closing Date (the "Transition Period"), Sellers agree (i) to
administer the Buyer Plans consistent with past practice in accordance with the
terms of such Buyer Plans and in compliance with applicable laws and (ii) to the
extent Company Employees on or prior to the Closing Date are benefitting under
or are covered by Benefit Plans that are not Buyer Plans, including without
limitation any medical and life insurance plan maintained by PFG or any other
Seller (but excluding any 401(k), pension or severance plan) such Company
Employees may continue to participate in and benefit under such Benefit Plans
through the last day of the Transition Period. Buyer shall bear the costs of (i)
administering the Buyer Plans for the Transition Period and (ii) maintaining the
participation of such Company Employees in the Benefit Plans that are not Buyer
Plans during the Transition Period. Buyer shall indemnify, defend and hold
harmless Sellers (other than, following the Closing, Sellers that are Companies)
from and against all Losses (as defined below) based upon, arising out of or
otherwise in respect of Sellers' services under this Section 5.13(f); provided,
however, that Sellers shall not, in the performance of their responsibilities
under this Section 5.13(f), intentionally violate the terms of such Buyer Plans
or Benefit Plans as applicable, and applicable laws including, but not limited
to, ERISA and the Code.
SECTION 5.14 Nonsolicitation. Each of PLAC, PFG and SFC and any of its
affiliates (other than the Companies) hereby agrees that, for a period
commencing on the Closing Date and ending on the second anniversary of the
Closing Date, it shall not, without Buyer's prior written consent, directly or
indirectly, solicit or hire any of the current officers, general agents or sales
agents (down to the level of district manager) of any of the Companies except
those officers disclosed in Section 5.14 of the Disclosure Schedule; provided,
however, that nothing herein shall prohibit it or any of its Subsidiaries from
publishing a general solicitation of employment in any newspaper, magazine,
trade publication or other medium or from soliciting or hiring any person who
was an officer of any of the Companies on the Closing Date but whose employment
by such
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Company thereafter ceases, except as a result of Sellers' solicitation or hiring
of such person in violation of the first clause of this Section 5.14.
SECTION 5.15 Acquisition Proposals. No Seller shall, nor shall it
authorize or permit any of its officers, directors or employees or any
investment banker, attorney or other advisor or representative acting on its
behalf to, directly or indirectly, (a) make any offer or proposal to any Person
or enter into any contract with any Person to (i) sell or otherwise transfer any
of the capital stock or assets or properties of the Companies or any of the PCFS
Assets or (ii) effect any recapitalization, refinancing, restructuring, merger,
consolidation or other business combination involving the Companies or any of
the PCFS Assets; (b) entertain, solicit, encourage, accept, negotiate or
otherwise hold substantive discussions regarding any offer or proposal from any
Person to (i) purchase or otherwise acquire any of the capital stock or assets
or properties of the Companies or any of the PCFS Assets, (ii) effect any
recapitalization, refinancing, restructuring, merger, consolidation, or other
business combination involving the Companies or any of the PCFS Assets, or (c)
provide any non-public information regarding the Companies or the PCFS Assets to
any prospective purchaser thereof. If any such offer or proposal is made to or
received from any Person, Sellers will promptly advise such Person by written
notice of the terms of this Section 5.15 and will promptly deliver a copy of
such notice to Buyer.
SECTION 5.16 Section 338(h)(10) Election, Allocation of Purchase Price
under Sections 338 and 1060 and Matters Relating to SWLIC. (a) An election
under Section 338(h)(10) of the Code and any corresponding elections under the
state, local or foreign tax law (the "338(h)(10) Election") shall be made by PFG
and Buyer in respect of the purchase and sale of the PFI Shares. The parties
agree that the Purchase Price will be allocated as provided in Section 2.1 to
the assets of PCFS and PFI for all purposes (including Tax and financial
accounting purposes) in accordance with the rules under Section 338(b)(5) and
Section 1060 of the Code and the Treasury Regulations promulgated thereunder.
The parties agree to cooperate in good faith in preparing the Allocation
Schedule as soon as practicable. Sellers, PCFS, PFI and Buyer will file all Tax
Returns (including amended returns and claims for refund) and information
reports in a manner consistent with such allocation.
(b) If requested by Buyer, Sellers shall also join in the filing of a
Section 338(h)(10) Election with respect to the purchase and sale of the ConLife
Shares. Any Tax liability resulting from such election and all costs associated
with such election shall be borne by Buyer. If such election is made, the
principles of the second, third and fourth sentences of Section 5.16(a) shall
apply.
(c) As promptly as practicable (but in no event more than 90 days) after
the Closing Date, PFG shall deliver to Buyer (i) a calculation certified by
PFG's Chief Financial Officer stating ConLife's estimated tax basis in the
shares of common stock, par value $1.00 per share, of SWLIC as of the Closing
Date, which shall separately state adjustments for income, losses,
distributions, contributions and other relevant adjustments from January 1, 1998
through the Closing Date with respect to such tax basis (the "SWLIC Basis
Adjustments") and (ii) if requested by Buyer, an updated appraisal from
Tillinghast setting forth the fair market value of SWLIC as of the latest
practical date up to and including the Closing Date (the "SWLIC Valuation
Opinion"). If Buyer requests the SWLIC Valuation Opinion, the costs thereof
shall be shared equally by Buyer and PFG. If Buyer requests the SWLIC Valuation
Opinion, an actuary selected by Buyer shall review the SWLIC Valuation Opinion
with Tillinghast in order to arrive at a mutually agreed upon fair market value
of SWLIC (the "SWLIC Value"). If the SWLIC Value is greater than $220 million
plus the SWLIC Basis Adjustments, 35% of such excess shall be recorded as a
liability for Taxes on the Closing Statement with respect to ConLife. PFG and
SFC agree that unless such a liability is recorded on the Closing Statement as
set forth in the preceding sentence, they shall not take the position in any Tax
Return that the Tax basis of SWLIC immediately after the Closing Transactions
exceeds $220 million plus or minus, as the case may be, the SWLIC Basis
Adjustments.
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SECTION 5.17 Tax Matters.
(a) Sellers shall be responsible for and shall pay all Taxes imposed on the
income of the Companies, including, without any limitation, any amounts included
in income under Treasury Regulation Sections 1.1502-13 and 1.1502-14, any excess
loss accounts taken into income under Treasury Regulation Section 1.1502-19 and
any Taxes resulting from the transactions contemplated under this Agreement, for
all periods through and including the Closing Date to the extent not provided as
a current Tax liability on the Closing Statement. Except as required by law,
PFG, PLAC and SFC shall take no position on such Tax Returns that relate to the
Companies that would adversely affect the Companies after the Closing Date. The
income of the Companies shall be apportioned to the period up to and including
the Closing Date (excluding income after the Closing but prior to the end of the
Closing Date (i) that is not incurred in the ordinary course of business, (ii)
that is not incurred pursuant to the transactions contemplated by this Agreement
and (iii) that is caused by Buyer, which in each case shall be attributed to the
period after the Closing Date) and the period after the Closing Date by closing
the books of the Companies as of the end of the Closing Date.
(b) PFG, PLAC and SFC shall make no election to retain any net operating
loss carryovers or capital loss carryovers of the Companies under Treasury
Regulation Section 1.1502-20(g) or any similar provision of federal, state,
local or foreign law.
(c) PFG, PLAC and SFC shall allow the Companies and its counsel to
participate in any audits of the consolidated federal income Tax Returns of PFG,
PLAC or SFC to the extent that such Tax Returns relate to the Companies.
(d) PFG, PLAC and SFC shall immediately pay to Buyer any Tax refund (or
reduction in Tax liability) resulting from a carryback of a postacquisition Tax
attribute of any of the Companies into a consolidated, combined or unitary Tax
Return of PFG, PLAC or SFC, when such refund or reduction is realized by PFG,
PLAC or SFC. PFG, PLAC and SFC shall cooperate with the Companies in obtaining
such refunds (or reduction in Tax liability), including through the filing of
amended Tax Returns. PFG shall be entitled to any Tax refund (or reduction in
Tax liability) from a Tax Return for a taxable year that ends on or prior to the
Closing Date or the portion ending on the Closing Date of any taxable year that
includes the Closing Date that was not reflected on the Closing Statement and is
not described in the first sentence of this Section 5.17(d) (a "Seller Refund"),
net of any tax payable by Buyer or the Companies in respect of the receipt or
accrual of such Seller Refund or any additional correlative tax liability in
another taxable year (a "Seller Net Refund Amount"). If Buyers or any of the
Companies realize such Seller Refund in cash or through the reduction of another
Tax liability for which Buyer is responsible hereunder after the Closing Date,
they shall pay the associated Seller Net Refund Amount over to PFG within five
days of receipt.
(e) PFG, PLAC and SFC will prepare or cause to be prepared, and file or
cause to be filed in a manner consistent with past practice and in the ordinary
course of business (subject to any departure required to comply with any
applicable law) (i) all consolidated, combined, or unitary Tax Returns of the
Sellers, the PLAC Group, the ConLife Group or the PFG Group that include the
Companies for all periods that begin prior to the Closing Date and (ii) all
other Tax Returns required to be filed by or on behalf of the Companies on or
prior to the Closing Date. PFG, PLAC and SFC agree to consult with Buyer with
respect to the Tax Returns described in this section, and shall deliver drafts
of such Tax Returns to Buyer no later than 10 Business Days prior to the date,
including extensions, on which such Tax Returns are required to be filed.
(f) Buyer will prepare or cause to be prepared, and file or cause to be
filed, all Tax Returns of the Companies other than those set forth in Section
5.17(e). Buyer will prepare all Tax Returns which reflect any Taxes for which
PFG, PLAC and SFC may be obligated to indemnify the Buyer Indemnitees under this
Agreement, in a manner consistent with past practice (subject to any departure
required to comply with any applicable law). Buyer agrees to consult with PFG
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with respect to the Tax Returns described in the preceding sentence, and shall
deliver drafts of such Tax Returns to PFG no later than 10 Business Days prior
to the date, including extensions, on which such Tax Returns are required to be
filed.
(g) The Consolidated Federal Income Tax Liability Allocation Agreement,
dated December 14, 1995, among ConLife, Union Bankers and Marquette, as amended
by the First Amendment to Consolidated Federal Income Tax Liability Allocation
Agreement, dated as of January 1, 1996, among ConLife, Union Bankers, Marquette
and SWLIC (other than Section 4 thereof) shall remain in effect solely as
between ConLife and SWLIC with respect to taxable periods through and including
the Closing Date. Except as provided in the foregoing sentence, effective as of
the Closing Date, PFG, PLAC and SFC shall terminate, or cause to be terminated,
any agreements relating to the sharing or allocation of, or indemnification
agreement with respect to, Taxes, or any similar contract or arrangement to
which any of the Companies is party such that none of the Companies has any
further Tax liability thereunder except as provided as a current Tax liability
on the Closing Statement, which shall be paid as soon as reasonably practicable
after the Closing.
SECTION 5.18 Financial Matters; Proxy Statement. (a) As soon as
reasonably practicable following the date of this Agreement, PFG shall deliver
to Buyer true and complete copies of (i) the audited combined financial
statements of the Companies (and PCFS, to the extent required under Item 13 of
Schedule 14A under the Exchange Act for purposes of the Proxy Statement) as at
and for the years ended December 31, 1995, 1996, 1997 and 1998, together with
the notes thereto (the "Audited Financial Statements"), which shall be certified
by KPMG Peat Marwick LLP ("KPMG"), independent public accountants for PFG and
(ii) the Annual Statements for each PennLife Company and ConLife Company for the
year ended December 31, 1998, including all exhibits, interrogatories, notes and
schedules thereto and any actuarial opinion, affirmation or certification filed
in connection therewith (the "1998 SAP Financial Statements"). In addition, PFG
shall, as promptly as practicable, provide all other financial data and other
information relating to the Companies reasonably requested by Buyer, so as to
permit Buyer to satisfy any reporting or disclosure obligations of Buyer
relating to the transactions contemplated by this Agreement.
(b) As soon as reasonably practicable after the delivery to Buyer of the
Audited Financial Statements for 1995, 1996 and 1997, Buyer shall file with the
Commission a preliminary proxy statement (the "Proxy Statement") with respect
to, among other things, the solicitation of shareholder votes to amend Buyer's
certificate of incorporation to increase its authorized capital stock. Buyer
shall use its commercially reasonable efforts to promptly respond to any
comments raised by the Commission with respect to the Proxy Statement and shall
cause the definitive Proxy Statement to be mailed to the shareholders of Buyer
at the earliest practicable date. If any event with respect to Buyer, or with
respect to other information supplied by the Companies or Sellers for inclusion
in the Proxy Statement, shall occur which is required to be described in a
supplement to the Proxy Statement, such event shall be so described, and such
supplement shall be promptly filed with the Commission and, as required by law,
disseminated to shareholders of Buyer. The Proxy Statement will comply as to
form in all material respects with the provisions of the Exchange Act and the
rules and regulations thereunder.
SECTION 5.19 Peninsular Licenses.
(a) Prior to the Closing, Sellers shall cooperate with and assist, and
shall cause the Companies to cooperate with and assist, Buyer in causing
Peninsular (i) to remove such restrictions as is reasonably necessary to permit
Peninsular to write new business in the states in which Peninsular holds
licenses to conduct insurance business as of the date hereof and (ii) to obtain
licenses to conduct insurance business in the states listed in Section 5.19 of
the Disclosure Schedule and to obtain such product approvals in such states as
Buyer reasonably requests.
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(b) Buyer will reimburse PFG and/or PLAC, as applicable, for all actual
out-of-pocket costs incurred in connection with obtaining the licenses and
product approvals contemplated in Section 5.19(a) above.
(c) If Buyer is unable to acquire the Peninsular Shares, (i) the Purchase
Price will be reduced by the Peninsular Purchase Price, (ii) PFG or its designee
will purchase the Peninsular Shares for an amount in cash equal to the
Peninsular Purchase Price, (iii) the Aggregate Capital Amount will be reduced by
$12,725,000 and the Target Capital Amount for Peninsular will be eliminated, and
(iv) all ConLife business being reinsured by Peninsular pursuant to the
reinsurance transaction contemplated in item 9 of Annex C will be transferred by
Peninsular to a party designated by Buyer under a reinsurance agreement
containing terms reasonably satisfactory to Buyer.
SECTION 5.20 PCFS Licenses. At or prior to Closing, Sellers shall use
their commercially reasonable best efforts to obtain all software licenses (the
"PCFS Licenses") required to be obtained in connection with the sale of the PCFS
Assets to Buyer. At the Closing, Buyer shall reimburse PFG for 50% of all costs
incurred in connection with obtaining the PCFS Licenses.
SECTION 5.21 Change of Name. As soon as reasonably practicable after the
Closing Date, Buyer shall cause PC-Canada and PFI (and, to the extent
applicable, any Subsidiaries thereof) to amend their respective organizational
documents and take all other regulatory and other actions to change their
respective names to a name that does not include the word "PennCorp" or any
variant thereof. Notwithstanding the foregoing, PC-Canada and PFI (and any
applicable Subsidiaries thereof) may, until such name change occurs, continue to
use stationery, letterhead, policy forms, business cards and other property or
assets on which the name "PennCorp" or any variant thereof appears so long as
Buyer uses its reasonable efforts to cause appropriate notations to be made
thereon indicating that such Companies are divisions of UAFC and are not part of
the PennCorp Financial Group, Inc. group of companies.
SECTION 5.22 Litigation Arising Between Signing and Closing. Sellers will
provide Buyer with prompt notice in reasonable detail of any Litigation,
complaints, charges or claims against any of the Companies or PCFS before any
Governmental Authority or arbitrator initiated or, to the knowledge of Sellers,
threatened between the date hereof and the Closing Date that would have been
required to be disclosed in Section 3.10 of the Disclosure Schedule ("New
Litigation") or Section 3.23(f) of the Disclosure Schedule ("New Employee
Claims") had they arisen or been in existence on or prior to the date of this
Agreement.
SECTION 5.23 Union Bankers. If the Union Bankers Special Dividend
distributed to ConLife in accordance with Section 2.2(c) of this Agreement is
limited by any regulatory authority such that the capital and surplus of Union
Bankers (as indicated on the Estimated Statement) exceeds the Union Bankers
Target Capital Amount specified in Section 2.3(e) hereof, the Purchase Price
specified in Section 2.1 hereof shall be increased by the amount of such excess;
provided, that in no event shall the Purchase Price be increased pursuant to
this Section 5.23 by more than $6,500,000. If the Purchase Price is increased
pursuant to this Section 5.23 by more than $6,500,000. If the Purchase Price is
increased pursuant to this Section 5.23, there will be a corresponding increase
in the Aggregate Target Capital Amount specified in Section 2.3(e) hereof.
ARTICLE VI
CLOSING CONDITIONS
SECTION 6.1 Conditions to the Obligations of Buyer and American Exchange
under this Agreement. The obligations of Buyer and American Exchange under this
Agreement to
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consummate the Closing Transactions shall be subject to the satisfaction, at or
prior to the Closing, of the following conditions:
(a) subject to Section 5.19(c) hereof, all authorizations, consents
and approvals contemplated by Sections 3.6 and 4.5, including the PennLife
Insurance Approvals, the ConLife Insurance Approvals (which shall include
approval to restructure the capital of the PennLife Companies and the
ConLife Companies to reset unassigned surplus to not less than zero) and
the Buyer Approvals, shall have been obtained and shall be in full force
and effect and applicable regulators shall not have imposed any material
and adverse prohibitions, limitations, conditions or restrictions on Buyer
or any of the Companies in connection with the approvals by such regulators
of the Forms A to be filed by the parties as contemplated hereby, including
but not limited to a restriction on the ability of any of the Companies to
pay ordinary dividends or to write any material line of business.
(b) any waiting period applicable to the consummation of the sale and
purchase of the Shares under the HSR Act shall have expired or been
terminated;
(c) no injunction, restraining order or other ruling or order issued
by any Governmental Authority or other legal restraint or prohibition
preventing the consummation of the Closing Transactions shall be in effect;
(d) each of the obligations of PLAC, PFG, SFC and PCFS required to be
performed by it at or prior to the Closing pursuant to this Agreement shall
have been duly performed and complied with in all material respects, and
the representations and warranties of PLAC, PFG, SFC and PCFS contained in
this Agreement shall be true and correct in all material respects as of the
date of this Agreement and as of the Closing Date as though made at and as
of the Closing Date (except (i) as to those representations or warranties
which specifically relate to an earlier date, which need to be true and
correct in all material respects as of such specified dates and (ii) to the
extent that the representation and warranty set forth in Section 3.15(e)
has been rendered inaccurate as the result of any claims asserted with
respect to Agent Compensation between the date hereof and the Closing), and
Buyer shall have received a certificate to that effect signed by a senior
officer of each of PLAC, PFG, SFC and PCFS;
(e) any and all material permits, consents, waivers, clearances,
approvals and authorizations of Governmental Authorities and all material
consents, licenses, waivers or approvals of any other third parties (other
than those contemplated by subparagraph (a) above), including the PCFS
Licenses, which are necessary in connection with the consummation of the
Closing Transactions and the consummation of the transactions contemplated
by the UAFC Share Purchase Agreement shall have been obtained;
(f) Buyer shall have received opinions of counsel to Sellers, in the
forms attached hereto as Annex D;
(g) Security Life and Trust Insurance Company ("Integon") and PennLife
shall have entered into a lease agreement containing the material terms set
forth on Exhibit C on terms reasonably satisfactory to Buyer pursuant to
which, following the Closing, PennLife will continue to occupy office space
currently occupied by PennLife Employees at the facility located at Wycliff
Road in Raleigh, North Carolina, for the term described in Exhibit C;
(h) Buyer or any of the Companies and AmeriLife Marketing Inc. shall
have entered into an agreement containing the material terms set forth on
Exhibit A and otherwise on terms reasonably satisfactory to Buyer;
(i) the capital and surplus (excluding AVR and IMR) of the PennLife
Companies and the ConLife Companies reflected on the Estimated Statement
shall equal or exceed the
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Target Capital Amount for each Company and the Aggregate Target Capital
Amount shall have been satisfied;
(j) all intercompany indebtedness owed by PFG and its affiliates
(other than the Companies) to any of the Companies or owed by the Companies
to PFG or its affiliates (other than the Companies) as listed on Section
3.24 of the Disclosure Schedule shall have been paid in full, and all other
affiliate transactions described on Section 3.24 of the Disclosure Schedule
shall have been terminated (other than such affiliate transactions solely
among the Companies), with no further liability to any of the Companies or
relating to the PCFS Assets;
(k) the conditions set forth in the Chase Commitment shall have been
satisfied, to the satisfaction of Chase Bank and Chase Securities;
provided, however, that upon receipt of notice from Chase Bank that the
reports delivered by the Reserves Consultants and the 1998 Audited
Financial Statements are satisfactory under the terms of the Chase
Commitment (which shall be deemed satisfactory for purposes of this clause
if no objection is made within 30 days of delivery of the last of such
reports and financial statements), the conditions specified in this Section
6.1(k) shall no longer be conditions to the consummation by Buyer of the
Closing Transactions;
(l) the Reserves Consultants shall have completed their review of the
active life reserves of PennLife and the results of such review shall be
reasonably satisfactory to Buyer; provided, however, that Buyer shall make
its determination of the adequacy of such report within 20 days of delivery
of such report;
(m) each of the Pre-Closing Restructuring Transactions shall have been
completed or otherwise provided for to the reasonable satisfaction of
Buyer;
(n) Sellers shall have delivered to Buyer for inclusion in the Proxy
Statement the 1998 Audited Financial Statements specified in Section
5.18(a)(i) and the shareholders of Buyer shall have approved at a special
meeting of shareholders of Buyer the matters requiring shareholder approval
as set forth in the UAFC Share Purchase Agreement, in accordance with New
York law and the rules of Nasdaq;
(o) the Companies shall have received either (i) a rating of B+ or
better from A.M. Best or (ii) assurances from A.M. Best satisfactory to
Buyer that on or immediately after the Closing, the Companies will be
assigned at least a B+ rating;
(p) Buyer or a designated subsidiary of Buyer shall have entered into
an agreement with Integon, Occidental Life Insurance Company of North
Carolina and Professional Insurance Company containing the material terms
set forth on Exhibit E or otherwise on terms reasonably satisfactory to
Buyer and PFG pursuant to which Buyer or such subsidiary shall have agreed
to provide the services specified in Exhibit E for the period specified in
Exhibit E; and
(q) Sellers shall have delivered to Buyer a certificate complying with
Treasury Regulations section 1.1445-2(b)(2), in form and substance
reasonably satisfactory to Buyer, duly executed and acknowledged,
certifying that Sellers are not foreign persons within the meaning of such
section.
SECTION 6.2 Conditions to the Obligations of Sellers under this
Agreement. The obligation of Sellers under this Agreement to consummate the
Closing Transactions shall be subject to the satisfaction, at or prior to the
Closing, of the following conditions:
(a) all authorizations, consents and approvals contemplated by
Sections 3.6 and 4.5, including the PennLife Insurance Approvals, the
ConLife Insurance Approvals and the Buyer Approvals shall have been
obtained and shall be in full force and effect and applicable regulators
shall not have imposed any material and adverse prohibitions, liabilities,
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limitations, conditions or restrictions on Sellers or (to the extent
Sellers would be prevented from consummating the transactions contemplated
by this Agreement) the Companies, in connection with the approvals by such
regulators of the Forms A to be filed by the parties as contemplated hereby
including but not limited to a restriction on the ability of Union Bankers
to pay the Union Bankers Special Dividend or on the ability of the Sellers
or the Companies to make any other reallocation of capital and surplus as
otherwise permitted or required by this Agreement;
(b) any waiting period applicable to the consummation of the sale and
purchase of the Shares under the HSR Act shall have expired or been
terminated;
(c) no injunction, restraining order or other ruling or order issued
by any Governmental Authority or other legal restraint or prohibition
preventing the consummation of the Closing Transactions shall be in effect;
(d) each of the obligations of Buyer and American Exchange required to
be performed by them or prior to the Closing pursuant to the terms of this
Agreement shall have been duly performed and complied with in all material
respects, and the representations and warranties of Buyer contained in this
Agreement shall be true and correct in all material respects as of the date
of this Agreement and as of the Closing Date as though made at and as of
the Closing Date except as to any representation or warranty which
specifically relates to an earlier date), and Sellers shall have received a
certificate to that effect signed by an officer of each of Buyer and
American Exchange and the representations and warranties of American
Exchange contained in this Agreement shall be true and correct in all
material respects as of the Closing Date as though made at and as of the
Closing Date in each case;
(e) Buyer or a designated subsidiary of Buyer shall have entered into
an agreement with Integon, Occidental Life Insurance Company of North
Carolina and Professional Insurance Company containing the material terms
set forth on Exhibit E or otherwise on terms reasonably satisfactory to
Buyer and PFG pursuant to which Buyer or such subsidiary shall have agreed
to provide the services specified in Exhibit E after the Closing for the
period specified in Exhibit E;
(f) Sellers shall have received an opinion of counsel to Buyer, in the
form attached hereto as Annex E; and
(g) the shareholders of Buyer shall have approved at a special meeting
of shareholders of Buyer the matters requiring shareholder approval as set
forth in the UAFC Share Purchase Agreement, in accordance with New York law
and the rules of Nasdaq.
ARTICLE VII
CLOSING
SECTION 7.1 Closing. The closing of the Closing Transactions (the
"Closing") shall take place at the offices of Weil, Gotshal & Manges LLP, 767
Fifth Avenue, New York, NY 10153, subject to the satisfaction or waiver of the
conditions set forth in Sections 6.1 and 6.2, as soon as practicable after the
date hereof and in any event not later than June 30, 1999, or at such
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other time and place and on such other date as Buyer and PFG shall agree (the
"Closing Date"). As a further condition to Closing, at the Closing:
(a) PLAC, PFG, SFC and PCFS, as applicable, shall deliver or cause to
be delivered to Buyer the following:
(i) the certificates described in Section 6.1(d);
(ii) share certificates representing all of the Shares in
appropriate form for transfer to Buyer, Buyer's designee or American
Exchange (as appropriate) duly endorsed in blank or accompanied by stock
powers duly executed in blank;
(iii) resignations of the directors of each of the Companies;
(iv) an executed Bill of Sale, Assignment and Assumption Agreement;
and
(v) a section 116 certificate in respect of the PC-Canada shares
bearing a certificate amount not less than the amount of the PC-Canada
Purchase Price; provided, that if the certificate is not so delivered,
Buyer shall make such withholdings as may be required pursuant to the
Income Tax Act (Canada).
(b) Buyer and American Exchange shall deliver or cause to be delivered
to Sellers the following:
(i) the certificate described in Section 6.2(d) and;
(ii) an executed Bill of Sale, Assignment and Assumption Agreement;
and
(c) Buyer shall pay or shall cause to be paid to Sellers, by wire
transfer of immediately available funds to such account or accounts as
Sellers shall have designated in writing at least two days prior to the
Closing Date, the Cash Purchase Price.
ARTICLE VIII
SURVIVAL/INDEMNIFICATION
SECTION 8.1 Survival of Representations and Warranties; Indemnification
Obligations.
(a) Notwithstanding any right of Buyer to investigate fully the affairs of
the Company and the Subsidiaries and notwithstanding any knowledge of facts
determined or determinable by Buyer pursuant to such investigation or right of
investigation, Buyer has the right to rely fully upon the representations,
warranties, covenants and agreements of Sellers contained in this Agreement or
in any documents delivered pursuant to this Agreement. All representations and
warranties contained in this Agreement shall survive the execution and delivery
of this Agreement and the Closing (except that the representations and
warranties contained in Sections 4.9, 4.10, 4.11 and 4.12 shall not survive the
Closing). The representations and warranties of Sellers contained in this
Agreement shall terminate and expire (i) with respect to any Claim (as defined
below) based on the representations and warranties contained in Section 3.14 (a
"Tax Representation Claim") on the date which is 30 days after the date upon
which the liability to which any such Tax Representation Claim may relate is
barred by all applicable statutes of limitations (including all periods of
extension, whether automatic or permissive); (ii) with respect to any Claim
based on the representations and warranties contained in Section 3.19, three
years after the Closing Date; (iii) with respect to any Claim based on the
representations and warranties contained in Section 3.13, on the date upon which
the liability to which any such Claim may relate is barred by all applicable
statutes of limitations (including all periods of extension, whether automatic
or permissive); and (iv) with respect to any Claim based on any other
representation and warranty (except for those representations and warranties in
Sections 3.1, 3.2, 3.4, 3.5 and 3.16 (the "Fundamental Representations"), all of
which Fundamental Representations shall survive without limitation), on the date
which is 18 months after the Closing Date. Unless a specified period is set
forth in this Agreement (in which event such
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specified period will control), the covenants and agreements of this Agreement
will survive the Closing and remain in effect indefinitely.
(b) PFG, with respect to all matters contemplated by this Agreement,
jointly and severally with PLAC, SFC and PCFS; PLAC, with respect only to
matters relating to itself and the PennLife Companies, severally and not jointly
with any other Seller (except PFG); SFC, with respect only to matters relating
to itself and the ConLife Companies, severally and not jointly with any other
Seller (except PFG); and PCFS, with respect only to matters relating to itself,
severally and not jointly with any other Seller (except PFG), will indemnify,
defend and hold harmless Buyer and, following the Closing, the Companies
(together with their respective directors, officers, employees, affiliates,
successors and assigns, the "Buyer Indemnitees") from and against all actions,
causes of action, suits, claims, complaints, demands, litigations, or legal,
administrative or arbitral proceedings or investigations ("Claim"), losses,
liabilities, damages (excluding any indirect, consequential or special damages),
deficiencies, judgments, assessments, fines, settlements, costs or expenses
(including interest, penalties and fees, reasonable expenses and disbursements
of outside attorneys, experts and consultants) incurred by the indemnified party
in any action or proceeding between the indemnifying party and the indemnified
party or between the indemnified party and any third party, or otherwise
("Losses") based upon, arising out of or otherwise in respect of:
(i) any inaccuracy in or any breach of any representation, warranty,
covenant or agreement of Sellers contained in this Agreement or in any
documents delivered by Sellers pursuant to this Agreement (including any
breach of the representation and warranty in Section 3.15(e) relating to
claims for Agent Compensation not listed in Section 3.15(e) of the
Disclosure Schedule); provided, that for purposes of this Section 8.1(b)(i)
only, any inaccuracy in or breach of a representation or warranty shall be
determined without reference to any materiality or Material Adverse Effect
qualifier (other than such qualifier contained in Section 3.27 hereof) that
may be set forth therein;
(ii) any derivative lawsuits or lawsuits based upon violations of
federal and state securities laws against PFG or its affiliates or their
respective officers and directors which are pending as of the date of this
Agreement or which may be brought after the date of this Agreement, whether
or not Buyer, the Companies or any Buyer Indemnitee is named or joined as a
party thereto; provided, that Buyer shall not be entitled to
indemnification under this Section 8.1(b)(ii) for any Losses incurred by
Buyer in connection with such lawsuits that result from any actions of
Buyer that are independent from, and not in breach or violation of, any of
the transactions or other matters contemplated by this Agreement or any
other documents executed and delivered in connection with the transactions
contemplated by this Agreement;
(iii) any Taxes of any member of an affiliated, consolidated,
combined, or unitary group of which any of the Companies is or was a member
on or prior to the Closing Date by reason of the liability of the Companies
pursuant to Treasury Regulation Section 1.1502-6(a) or any analogous or
similar state, local or foreign law or any contractual liability for Taxes
of any party other than the Companies;
(iv) any Phase III Taxes of any Company relating to any period up to
and including the Closing Date;
(v) any Phase III Taxes of any Company relating to any period after
the Closing Date up to and including five taxable years following the
Closing Date and all or any portion of any later taxable year through and
including the fifth anniversary of the Closing Date; provided, that if any
Phase III Taxes arise after the Closing Date as a result of any action
taken by Buyer, Buyer shall only be entitled to be indemnified for 75% of
such Taxes; provided further, that PFG, SFC and PLAC shall not be liable
hereunder with respect to any Phase III Taxes caused solely by Buyer's
failure to make reasonable efforts, for such period, to (A) maintain
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in force the reinsurance agreement between ConLife and Peninsular
contemplated by item 8 of Annex C (unless otherwise required by applicable
regulators) and (B) maintain Peninsular as a life insurance company within
the meaning of Section 816 of the Code;
(vi) any reductions in or limitations on the NOLs resulting from any
challenge by a Governmental Authority or limitation imposed under the Code
(other than limitations imposed solely by reason of the Closing
Transactions), including without limitation any increased liability or
Taxes with respect to periods after the Closing;
(vii) in the event the NOLs available for carryover, as provided in
Section 3.14(ac), are less than $20 million, the amount of the difference
multiplied by 35%, utilizing a discount rate of 15% per annum, utilizing
the date when such unavailable amount of NOLs would otherwise have been
available and reflecting the principles of Section 382 of the Code, will
constitute the amount of Buyer's loss. An example of the application of
this calculation is set forth in Exhibit F.
(viii) any of the Pre-Closing Restructuring Transactions (whether such
Losses relate to Taxes or otherwise);
(ix) any Taxes, or for any Loss of Tax benefits, incurred in
connection with or as a result of any 338(h)(10) Election pursuant to
Section 5.16 of this Agreement;
(x) any Taxes related to the Closing Transactions;
(xi) the Transaction Bonuses and the Pre-Sale Obligations (other than
any Losses resulting from the failure by Buyer to perform its obligations
under Section 5.9(b) or (c));
(xii) any liabilities of PCFS that Buyer has not expressly assumed;
(xiii) the failure of PCFS to comply, in connection with the sale of
the PCFS Assets, with all applicable bulk sales or bulk transfer laws;
(xiv) the presence at any time prior to the Closing of underground
fuel storage tanks at, or the use prior to the Closing as an auto service
station of, the commercial property located at 645 Riverside Avenue,
Jacksonville, Florida 32204 (referred to in Section 3.19 of the Disclosure
Schedule) and arising pursuant to Environmental Laws; and
(xv) the wrongful discharge claim by Mr. Ernie Brezden (item 16 of
Section 3.10 of the Disclosure Schedule), the discrimination claim by
Bernadette Somerville (item 6 of Section 3.10 of the Disclosure Schedule)
and the discrimination claim by Robert Foster (item 18 of Section 3.10 of
the Disclosure Schedule).
SECTION 8.2 Obligation of Buyer to Indemnify. Buyer agrees to indemnify,
defend and hold harmless Sellers (other than, following the Closing, the
Companies) and their respective directors, officers, employees, affiliates,
successors and assigns from and against all Losses based upon, arising out of or
otherwise in respect of (i) any inaccuracy in or any breach of any
representation, warranty, covenant or agreement of Buyer or American Exchange
contained in this Agreement or in any documents delivered by Buyer or American
Exchange pursuant to this Agreement and (ii) a breach by Buyer of its
obligations under Section 5.9(b) or (c) of this Agreement, including the
Post-Closing Compensation Obligations.
SECTION 8.3 Notice and Opportunity to Defend.
(a) Notice of Asserted Liability. The party making a claim under this
Article VIII is referred to as the "Indemnitee," and the party against whom such
claims are asserted under this Article VIII is referred to as the "Indemnifying
Party." All claims by any Indemnitee under this Article VIII shall be asserted
and resolved as follows: Promptly after receipt by the Indemnitee of notice of
any Claim or circumstances which, with the lapse of time, would or might give
rise to a Claim or the commencement (or threatened commencement) of a Claim
including any action,
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proceeding or investigation (an "Asserted Liability") that may result in a Loss,
the Indemnitee shall give notice thereof (the "Claims Notice") to the
Indemnifying Party. The Claims Notice shall describe the Asserted Liability in
reasonable detail, and shall indicate the amount (estimated, if necessary and to
the extent feasible) of the Loss that has been or may be suffered by the
Indemnitee.
(b) Opportunity to Defend. (i) The Indemnifying Party may elect to
compromise or defend, at its own expense and by its own counsel, any Asserted
Liability (excluding those related to Taxes relating to any period ending after
the Closing Date). If the Indemnifying Party elects to compromise or defend such
Asserted Liability, it shall within 30 days (or sooner, if the nature of the
Asserted Liability so requires) notify the Indemnitee of its intent to do so,
and the Indemnitee shall cooperate, at the expense of the Indemnifying Party, in
the compromise of, or defense against, such Asserted Liability. If the
Indemnifying Party elects not to compromise or defend the Asserted Liability,
fails to notify the Indemnitee of its election as herein provided or contests
its obligation to indemnify under this Agreement, the Indemnitee may pay,
compromise or defend such Asserted Liability. Notwithstanding the foregoing,
neither the Indemnifying Party nor the Indemnitee may settle or compromise any
Asserted Liability over the objection of the other; provided, however, that
consent to settlement or compromise shall not be unreasonably withheld. In any
event, the Indemnitee and the Indemnifying Party may participate, at their own
expense, in the defense of such Asserted Liability. If the Indemnifying Party
chooses to defend any Asserted Liability, the Indemnitee shall make available to
the Indemnifying Party any books, records or other documents within its control
as well as reasonable access to its employee and consultants, in each case to
the extent necessary or appropriate for such defense. In the event it is
determined by a court of competent jurisdiction that an Indemnitee is not
entitled to indemnification pursuant to this Article VIII for any Asserted
Liability, then the Indemnitee shall promptly reimburse the Indemnifying Party
for all fees, costs and expenses (including reasonable fees, expenses and
disbursements of outside attorneys, experts and consultants) incurred by the
Indemnitee in connection with the defense of such Asserted Liability.
SECTION 8.4 Limitations on Indemnification. The indemnification provided
for in Sections 8.1 and 8.2 shall be subject to the following limitations:
(a) The Indemnifying Parties shall not be obligated to indemnify the
Buyer Indemnitees for Losses arising under Section 8.1(b)(i) with respect
to breaches of representations and warranties until the aggregate amounts
for indemnification under Section 8.1(b)(i) equals $2.5 million (the
"Basket Amount"), whereupon the Indemnifying Parties shall be obligated to
pay only the amount of such Losses in excess of the Basket Amount;
provided, however, that the foregoing limitation shall not apply to, and
the Indemnifying Parties shall be obligated to indemnify the Buyer
Indemnitees for the full amount of, Losses arising under Section 8.1(b)(i)
based upon, arising out of or otherwise in respect of the Fundamental
Representations and Sections 3.13 and 3.14 (collectively, the "Basket
Exclusions") without regard to the Basket Amount; provided further, that
any Losses based upon, arising out of or otherwise in respect of the Basket
Exclusions shall not be counted against the Basket Amount.
(b) The Sellers, collectively, shall not be obligated to make any
payment for indemnification under Section 8.1(b) with respect to breaches
of representations and warranties (except those based upon, arising out of
or otherwise in respect of the Fundamental Representations and Sections
3.13(e) and 3.14(n)) and under Sections 8.1(b)(iv), (v), (vi), (ix) and (x)
in excess of the Purchase Price; provided, that (i) SFC shall not be
obligated to make any payment for indemnification under Section 8.1(b) in
excess of the sum of the Union Bankers Purchase Price and the ConLife
Purchase Price, (ii) PLAC shall not be obligated to make any payment for
indemnification under Section 8.1(b) in excess of the sum of the Peninsular
Purchase Price, the PC-Canada
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Purchase Price and the PennLife Purchase Price and (iii) PCFS shall not be
obligated to make any payment for indemnification under this Section 8.1(b)
in excess of $1.0 million.
(c) Buyer shall not be obligated to make any payment for
indemnification under Section 8.2 in excess of $50 million.
(d) The Indemnifying Parties shall not be obligated to indemnify the
Buyer Indemnitees for any Losses arising out of or otherwise in respect of
any beach of representation or warranty relating to or arising from, in
part or otherwise, the inadequacy of the reserves of any of the Companies;
provided, however, that nothing in this Section 8.4(d) shall relieve the
Indemnifying Parties from any obligation to indemnify the Buyer
Indemnitiees for any Losses arising out of or otherwise in respect of any
breach of Sections 3.7(b) and (c) of this Agreement to the extent such
breach does not relate to adequacy of reserves.
SECTION 8.5 Adjustment to Purchase Price; Offsetting Tax Benefits.
(a) It is the intention of the parties hereto that any payment under
Section 2.3 or under this Article VIII shall be treated as an adjustment to the
Purchase Price for all Tax purposes and the parties agree to file their Tax
returns accordingly. In the event that any such payment to Buyer or its
Subsidiaries (including the Companies) is not so treated, the amount of such
payment shall be increased so that, after payments of all Taxes due thereon, the
amount retained by Buyer is equal to the amount that Buyer would have retained
if no such Taxes had been due.
(b) The amount of an indemnified Loss shall be reduced by (or the
Indemnitee shall pay to the Indemnifying Party) any Tax benefits actually
realized by the Indemnitee or its affiliates which are directly attributable to
the Indemnifiable Loss (including, without limitation, any Tax benefits arising
from the payment or accrual of the indemnified Loss or any correlative
offsetting Tax benefit realized in a taxable period) (an "Offsetting Tax
Benefit"), promptly after realizing such Offsetting Tax Benefit in cash.
SECTION 8.6 Exclusive Remedy. Each party hereto agree that, to the
fullest extent permitted by law, such party's sole and exclusive remedy with
respect to any claim or cause of action asserted by it relating to or arising
from breaches of the representations and warranties or covenants and agreements
of any other party contained in this Agreement shall be limited to its rights
under, and subject to the terms and conditions of, this Article VIII.
Notwithstanding the foregoing, (i) the parties shall have the right to obtain
equitable relief in the form of a temporary or permanent injunction or order for
specific performance and (ii) each party shall have the right to assert any
claim for fraud against any other party for any breach of this Agreement.
ARTICLE IX
TERMINATION AND ABANDONMENT
SECTION 9.1 Termination. This Agreement may be terminated and the
transactions contemplated hereby may be abandoned at any time prior to the
Closing:
(a) by mutual consent of each of the Sellers and Buyer;
(b) by any of the Sellers or Buyer:
(i) if a Governmental Authority shall have issued an order, decree
or ruling or taken any other action (which order, decree or ruling the
parties hereto shall use their best efforts to lift), in each case
permanently restraining, enjoining or otherwise prohibiting any of the
Closing Transactions and such order, decree, ruling or other action
shall have become final and nonappealable; or
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(ii) if the Closing shall not have occurred on or before March 31,
1999; provided, however, that this Agreement shall automatically extend
for up to four consecutive 30-day periods commencing on March 31, 1999
if (A) Sellers prior to such time shall not have secured the PennLife
Insurance Approvals, ConLife Insurance Approvals and the Buyer Approvals
have not yet been obtained or (B) the Proxy Statement prior to such time
shall not have cleared review by the Commission or the Proxy Statement
has cleared review by the Commission but additional time is required to
hold the meeting of shareholders of Buyer contemplated by Section 4.5(e)
of this Agreement or to close the transactions contemplated by this
Agreement after such meeting; provided further, however, that the right
to terminate this Agreement shall not be available to any party whose
breach of this Agreement has been the cause of, or resulted in, the
failure of the Closing to occur on or before March 31, 1999 (or the end
of the fourth 30-day period, if applicable);
(c) by Buyer if a material default or breach shall be made by Sellers
with respect to the due and timely performance of any of their covenants or
agreements contained herein, or in any of their representations or
warranties contained in the Agreement, if such default or breach has not
been cured or waived within 30 days after written notice to such breaching
party specifying, in reasonable detail, such claimed material default or
breach and demanding its cure or satisfaction;
(d) by Sellers if a material default or breach shall be made by Buyer
or American Exchange with respect to the due and timely performance of any
of its covenants or agreements contained herein, or in any of its or
American Exchange's representations or warranties contained in the
Agreement, if such default or breach has not been cured or waived within 30
days after written notice to Buyer specifying, in reasonable detail, such
claimed material default or breach and demanding its cure or satisfaction;
or
SECTION 9.2 Expenses in the Event of Termination. If this Agreement is
terminated by Buyer or Sellers for any reason other than pursuant to Section
9.1(a), (b)(i), (b)(ii)(A) (with respect to approvals to be obtained in Florida
and New York by Buyer (only if such approvals are not obtained because of the
unsuitability of Buyer, Buyer Sub or Capital Z)), (b)(ii)(B) (except if the
Proxy Statement has not cleared review by the Commission solely because of the
Financial Statements required to be included in the Proxy Statement) or (d) or
the failure of Buyer to obtain the shareholder approval contemplated by Section
4.5, Sellers shall pay to Buyer and Capital Z an amount necessary to reimburse
Buyer and Capital Z for 75% of all actual out-of-pocket costs and expenses of
Buyer and Capital Z incurred through the date of termination by Capital Z and
Buyer in connection with the transactions contemplated by this Agreement
(exclusive of any bank commitment fees) and the UAFC Share Purchase Agreement
(including the negotiation of the Chase Bank Facility), which payment shall be
made by Sellers by wire transfer of immediately available funds within three
business days after receipt by Sellers from Buyer and/or Capital Z of an invoice
or invoices identifying such costs and expenses in reasonable detail, together
with all supporting invoices, and specifying the account or accounts into which
funds should be deposited.
SECTION 9.3 Procedure and Effect of Termination. In the event of
termination and abandonment of the transactions contemplated hereby pursuant to
Section 9.1, written notice thereof shall forthwith be given to the other
parties to this Agreement and this Agreement shall terminate and the
transactions contemplated hereby shall be abandoned, without further action by
any of the parties hereto. If this Agreement is terminated as provided herein:
(a) upon request therefor, each party will redeliver all documents,
work papers and other material of any other party relating to the
transactions contemplated hereby, whether obtained before or after the
execution hereof, to the party furnishing the same; and
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(b) no party hereto shall have any liability or further obligation to
any other party to this Agreement resulting from such termination except
(i) that the provisions of this Section 9.3 and Sections 9.2, 9.4 and 9.5
shall remain in full force and effect and (ii) no party waives any claim or
right against a breaching party to the extent that such termination results
from the breach by a party hereto of any of its representations,
warranties, covenants or agreements set forth in this Agreement.
SECTION 9.4 Mutual Agreement of Parties. (a) In the event of termination
of this Agreement, neither Buyer nor any Seller shall, for a period commencing
on the date of such termination and ending 18 months thereafter, without the
consent of the other, directly or indirectly solicit for employment or hire any
employee or agent of Buyer or any Seller, as the case may be, of whom Buyer or
any Seller, as the case may be, became aware as a result of the transactions
contemplated by this Agreement; provided, however, that no party shall be
prohibited from publishing a general solicitation of employment in any newspaper
or magazine or from hiring an employee or agent of another party who seeks
employment without solicitation. This Section 9.4 will supersede the agreement
between the parties with respect to the subject matter hereof contained in the
Confidentiality Agreement, dated May 29, 1998, between PFG and Capital Z (the
"Confidentiality Agreement").
(b) Notwithstanding the foregoing, nothing contained in Section 9.4(a)
shall mean or shall be interpreted to mean that, upon termination of this
Agreement, Buyer or Sellers in any way would be restricted or prohibited from
working with or engaging in business in any form whatsoever with Gary Boesch or
any affiliated entity.
SECTION 9.5 Confidentiality. Each party hereto acknowledges that the
other parties have legitimate and continuing proprietary interests in the
protection of their confidential information and that the parties have invested
substantial sums and will continue to invest substantial sums to develop,
maintain and protect such confidential information. Prior to and after the
Closing, each party agrees not to disclose, furnish or make accessible to anyone
or use for its own benefit (other than as contemplated hereby) any trade secrets
or other confidential or proprietary information of another party relating to
the Companies and/or their respective businesses, the PCFS Assets or the other
parties including, but not limited to, information obtained by or revealed to
such party during any investigations, negotiations or review relating to this
Agreement, the UAFC Share Purchase Agreement and any other document contemplated
hereby or thereby or any past or future actions taken in connection with,
pursuant to, in accordance with, or under this Agreement, including without
limitation any business plans, marketing plans, financial information,
strategies, systems, programs, methods, employee lists, computer programs,
insurance profiles and customer lists; provided, however, that such protected
information shall not include (i) information required to be disclosed by law,
legal or judicial process (including a court order, subpoena or order of a
Governmental Authority) or the rules of any stock exchange (including Nasdaq),
(ii) information that is or becomes available to the disclosing party on a
non-confidential basis from a source other than the other parties and not
obtained in violation of this Agreement and (iii) information known to the
public or otherwise in the public domain without violation of this Section 9.5.
ARTICLE X
MISCELLANEOUS PROVISIONS
SECTION 10.1 Amendment and Modification. This Agreement may only be
amended, modified or supplemented by a written instrument signed by all the
parties hereto.
SECTION 10.2 Waiver of Compliance; Consents. Any failure of Buyer to
comply with any obligation, covenant, agreement or condition contained herein
may be waived in writing by PFG, but such waiver or failure to insist upon
strict compliance with such obligation, covenant,
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agreement or condition shall not operate as a waiver of, or estoppel with
respect to, any other failure. Any failure of Sellers to comply with any
obligation, covenant, agreement or condition contained herein may be waived in
writing by Buyer, but such waiver or failure to insist upon strict compliance
with such obligation, covenant, agreement or condition shall not operate as a
waiver of, or estoppel with respect to, any other failure.
SECTION 10.3 Validity. The invalidity or unenforceability of any
provision of this Agreement shall not affect the validity or enforceability of
any other provisions of this Agreement, which shall remain in full force and
effect.
SECTION 10.4 Expenses and Obligations. PFG, PLAC, SFC and PCFS shall be
responsible for paying all third-party costs and expenses incurred by them and
all third-party costs and expenses in excess of $1.5 million incurred by the
Companies in connection with the Pre-Closing Restructuring Transactions (not
including those costs associated with the termination by Sellers prior to the
Closing of the Lincoln National Agreement) and in preparing the Companies for
sale to Buyer.
SECTION 10.5 Parties in Interest. This Agreement shall be binding upon
and inure solely to the benefit of each party hereto and their successors and
assigns. Except for Section 9.1(e), nothing in this Agreement, express or
implied, is intended to confer upon any other Person any rights or remedies of
any nature whatsoever under or by reason of this Agreement, whether by a claim
of third party beneficiary or otherwise, and PFG agrees that it has no third
party beneficiary rights or any other enforceable rights under the UAFC Share
Purchase Agreement and the Chase Commitment Letter.
SECTION 10.6 Notices. All notices and other communications hereunder
shall be in writing and shall be deemed given upon the earlier of delivery
thereof if by hand or upon receipt if sent by mail (registered or certified,
postage prepaid, return receipt requested) or on the second next Business Day
after deposit if sent by a recognized overnight delivery service or upon
transmission if sent by telecopy or facsimile transmission (with electronic
acknowledgment of transmission confirmed) as follows:
(a) If to Buyer, American Exchange or, after the Closing, any of the
Companies, to:
Universal American Financial Corp.
Six International Drive
Suite 190
Rye Brook, New York 10573-1068
Attention: Richard A. Barasch
Facsimile No.: (914) 934-9123
with copies to:
Capital Z Partners
One Chase Manhattan Plaza
44th Floor
New York, New York 10005
Attention: Bradley E. Cooper
Facsimile No.: (212) 898-8720
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and
Harnett Lesnick & Ripps P.A.
NationsBank Tower 150
East Palmetto Park Road
Suite 500
Boca Raton, Florida 33432-4832
Attention: Judge Bertram Harnett
Facsimile No.: (561) 368-4315
and
Simpson Thacher & Bartlett
425 Lexington Avenue
New York, New York 10017-3909
Attention: Gary I. Horowitz
Facsimile No.: (212) 455-2502
and
Paul, Weiss, Rifkind, Wharton & Garrison
1285 Avenue of the Americas
New York, New York 10019-6064
Attention: David K. Lakhdhir
Facsimile No.: (212) 757-3000
(b) If to any Seller including, prior to the Closing, any Seller
which is a Company, to:
PennCorp Financial Group, Inc.
c/o Southwestern Financial Services Corporation
717 North Harwood Street
Dallas, Texas 75201
Attention: Scott D. Silverman
Facsimile No.: (214) 954-7906
with a copy to:
Weil, Gotshal & Manges LLP
100 Crescent Court, Suite 1300
Dallas, Texas 75201
Attention: Glenn D. West
Facsimile No.: (214) 746-7777
SECTION 10.7 Governing Law. This Agreement shall be governed by and
construed in accordance with the laws of the State of New York applicable to
contracts to be performed within that state.
SECTION 10.8 Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same agreement.
SECTION 10.9 Headings. The article and section headings contained in this
Agreement are solely for the purpose of reference, are not part of the agreement
of the parties and shall not affect in any way the meaning or interpretation of
this Agreement.
SECTION 10.10 Entire Agreement. This Agreement, the Disclosure Schedule,
the Annexes hereto and the Confidentiality Agreement embody the entire agreement
and understanding of the parties hereto in respect of the subject matter
contained herein or therein. There are no
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238
agreements, representations, warranties or covenants other than those expressly
set forth herein or therein. This Agreement, the Disclosure Schedule and the
Annexes hereto supersede all prior agreements and understandings (other than the
Confidentiality Agreement) between the parties with respect to such subject
matter.
SECTION 10.11 Assignment. Except as otherwise provided in this Section
10.11, this Agreement shall not be assigned by operation of law or otherwise;
provided, however, that each of Buyer and PFG may assign all of its rights and
delegate all of its obligations under this Agreement to any Person in connection
with the sale of Buyer or PFG, as the case may be, or all or substantially all
of the assets of Buyer or PFG, as the case may be, to such Person, whether by
stock sale, merger, share exchange, asset sale, consolidation or otherwise, so
long as such Person expressly assumes Buyer's or PFG's (as the case may be)
obligations hereunder; provided, further, however, that Buyer will not assign
its rights or delegate its obligations under this Agreement to any Person prior
to the Closing. Notwithstanding anything in this Agreement to the contrary,
Buyer may give notice to PFG that, pursuant to the terms of the UAFC Share
Purchase Agreement, Buyer is assigning all of its rights and obligations under
this Agreement to an affiliate of Capital Z (the "Substituted Buyer"); provided,
that (a) such Substituted Buyer is a newly-formed acquisition company or other
entity, in each case, reasonably acceptable to PFG and (b) Capital Z shall have
committed to provide equity financing to the Substituted Buyer, and Chase Bank
(and/or other financial institutions) shall have committed to provide debt
financing to the Substituted Buyer, in an aggregate amount at least equal to
that necessary to consummate the Closing Transactions. If Buyer so elects to
assign its rights and obligations under this Agreement, (i) the date specified
in Section 9.1(ii) shall be extended for 90 days (or such later date as shall be
mutually agreed to by the Substituted Buyer and Sellers) and (ii) the
Substituted Buyer and Sellers shall agree to such conforming modifications to
this Agreement (such agreement or modifications not to be unreasonably withheld)
as may be necessary to reflect the assignment by Buyer (without recourse) of all
of its rights and obligations to the Substituted Buyer.
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IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to
be signed on its behalf by its duly authorized officers, all as of the day and
year first above written.
UNIVERSAL AMERICAN FINANCIAL CORP.
By: /s/ RICHARD A. BARASCH
------------------------------------
Name: Richard Barasch
Title: Chief Executive Officer
AMERICAN EXCHANGE LIFE INSURANCE
COMPANY
By: /s/ RICHARD A. BARASCH
------------------------------------
Name: Richard A. Barasch
Title: Chairman of the Board
PENNCORP FINANCIAL GROUP, INC.
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
PACIFIC LIFE AND ACCIDENT INSURANCE
COMPANY
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
SOUTHWESTERN FINANCIAL CORPORATION
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
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240
PENNSYLVANIA LIFE INSURANCE COMPANY
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
CONSTITUTION LIFE INSURANCE COMPANY
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title:
PENNCORP FINANCIAL SERVICES, INC.
By: /s/ SCOTT D. SILVERMAN
------------------------------------
Name: Scott D. Silverman
Title: Senior Vice President
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ANNEX C
ADVEST, INC.
1 ROCKEFELLER PLAZA
NEW YORK, NEW YORK 10020
May 24, 1999
Board of Directors
Universal American Financial Corp.
Six International Drive-Suite 190
Rye Brook, New York 10573
Members of the Board:
Universal American Financial Corp. ("UHCO" or the "Company") intends to
enter into amended and/or restated agreements (the "Amended and Restated
Agreements") dated as of December, 1998 to accept a controlling-interest
investment in the Company (the "Investment") by Capital Z Financial Services
Fund II, L.P. ("Capital Z"), together with the additional investment by UAFC
L.P. ("UAFC") and certain management and agents of the Career Sales Division
("CSD") of PennCorp Financial Group, Inc. ("PFG") (collectively referred to as
"Management"), the purpose of which is to provide the requisite funds, augmented
by a credit facility, to acquire Pennsylvania Life Insurance Company, PennCorp
Life Insurance Company, Peninsular Life Insurance Company, Constitution Life
Insurance Company, Union Bankers Insurance Company, Marquette National Life
Insurance Company, Penn Corp Financial, Inc. and certain assets of PennCorp
Financial Services Inc., (the "Acquisition"), all of which are hereafter
referred to as CSD. Hereafter, Capital Z, UAFC, and Management will be
collectively referred to as the "Investors".
The Amended and Restated Agreements provide that the Investors will invest
$96,375,000 for a 68.0% equity ownership (fully diluted basis) in UHCO; UHCO
will then borrow $70,000,000 from a bank consortium led by Chase Securities,
Inc. and purchase CSD for $137,000,000, which payment will be comprised of
$130,500,000 of cash and 6,500,000 through a retention of an increase in a
dividend being paid by Union Bankers to the seller. The remainder of the
proceeds raised ($38,875,000) will be utilized for transaction fees and working
capital ($16,375,000), to refinance debt ($4,500,000) and as additional capital
contributions ($15,000,000).
Capital Z and Management will invest in the Company through a direct
purchase of common stock at a price of $3.15 per share, subject to reduction in
the event of a material adverse event ("MAE") as defined in the Share Purchase
Agreement, as amended, between UHCO and Capital Z, but only if such MAE occurs
between the date of execution of a definitive agreement and that of transaction
closing.
In connection with the Acquisition, UAFC invested in UHCO through the
purchase of 40,000 shares of convertible preferred Series D stock, par value $1,
for a purchase price of $100 per share. The Series D stock was sold in two
separate tranches: 22,500 shares of Series D-1 stock and 17,500 shares of Series
D-2 stock. The Series D-1 stock is convertible to UHCO common stock at a price
of $2.70 per share. The effect of the conversion price of $2.70 for this tranche
is not material to the overall Investment. The Series D-2 stock is convertible
at the "change of control" price, which is expected to be $3.15, subject to
reduction in the event of a MAE.
You have asked us whether, in our opinion, the financial terms of (1) the
Investment by the Investors and (2) the Acquisition of CSD, are fair, from a
financial point of view, to the Company and its shareholders.
In arriving at our opinions set forth below, we have, among other things,
performed the following analyses and investigations: In the case of the
Investment, we have attempted to determine whether a fair value price was paid
for the equity interest purchased in the Company. In this regard, the price paid
was compared to UHCO's common stock price trading range and record; we also
compared the price paid on a price/earnings and price/book value basis to
current and recent market valuations of similar publicly traded life/health
insurers; we evaluated the share price/earnings and price/book valuations paid
for the new UHCO shares against valuations paid for life/health insurers in
similar take-over transactions; we also reviewed the
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Board of Directors May 24, 1999
price paid for the UHCO shares relative to liquidation values derived in an
independent actuarial valuation of UHCO, for its business in-force and other
assets, and weighed the price being paid by the Investors with a valuation
derived from a discounted cash flow analysis. In the process we reviewed the
Company's Forms 10-K and 10-Q for the years 1995-1998, its Annual Reports to
shareholders (1995-1998), statutory statements for each of the Company's
subsidiaries, American Pioneer Life, American Progressive Life and Health, and
American Exchange Life, and the GAAP basis statements of WorldNet Services
Corp., comparative financial and operating data for companies selected for each
of the peer groups, plus operating projections for UHCO prepared by the Company
and its advisors. In addition, we conducted discussions with members of
management concerning various aspects of the Company's operations, financial
prospects, and projections.
In the case of the Acquisition we also examined statutory financial results
for the CSD companies, years 1995-1998. We have also compared the pricing of the
CSD deal on a price/ earnings and price/book value basis relative to market and
transaction peer groups and, in doing so, we utilized several different
paradigms of value, and did so on both a current and Pro Forma basis. We have
also examined statutory audits for the CSD companies for the prior year. Future
period financial projections, on which much of our evaluation analysis is based,
were provided by the Company and its financial advisors.
We have independently performed sensitivity analyses to determine the
effects of leverage and earnings volatility on dividend capacity for debt
service coverage, in order to quantify the level of financial risk in the
transaction on a pro forma basis, and we have reviewed such other financial
information, studies and analyses and performed such other investigations and
took into account such other matters as we deemed necessary.
In preparing these opinions we have relied on the accuracy and completeness
of all information supplied or otherwise made available to us by the Company,
CSD and outside professional organizations retained, and we have not
independently verified such information, nor have we undertaken an independent
appraisal of the assets or liabilities of the Company. As part of our
engagement, the Company has agreed to pay Advest a fee for delivery of this
opinion letter. These opinions are necessarily based upon circumstances and
conditions as they exist and can be evaluated by us as of the date of this
letter. We have assumed for purposes of these opinions that there has been no
material change in the financial condition of the Company, CSD, or any other
party integral to either the Investment or Acquisition from those existing on
March 31, 1999.
In reliance upon and subject to the foregoing it is our opinion that, as of
the date hereof, the financial terms and effects of the Investment and the
Acquisition, both individually and in the aggregate, are fair, from a financial
point of view, to the Company and its shareholders.
Very truly yours,
ADVEST, INC.
By: /s/ ALEXANDER M. CLARK
------------------------------------
Alexander M. Clark
Managing Director
AMC:gc
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ANNEX D
PROPOSED AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF
UNIVERSAL AMERICAN FINANCIAL CORP.
UNDER SECTION 807 OF THE BUSINESS CORPORATION LAW
* * * * * * * * *
WE, THE UNDERSIGNED, RICHARD A. BARASCH and JOAN FERRARONE, being
respectively the president and secretary of UNIVERSAL AMERICAN FINANCIAL CORP.,
hereby certify:
A. The name of the corporation is:
UNIVERSAL AMERICAN FINANCIAL CORP.
B. The Certificate of Incorporation of said corporation was filed by the
Department of State on the 31st day of August, 1981, under the name "UNIVERSAL
HOLDING CORP."
C. The Certificate of Incorporation is amended to:
(1) increase the authorized number of Common Stock in Article FOURTH;
(2) delete the provisions in Article EIGHTH that relate to a
classified Board of Directors;
(3) change Article TENTH to specifically provide for action of the
stockholders by written consent in lieu of a meeting, and that such written
consent need only be by the number of stockholders required to approve such
action;
(4) delete Article ELEVENTH, which permits stockholders holding
66 2/3% of the total voting power of all outstanding voting shares of
capital stock to call a special meeting of stockholders, in its entirety
and add a new Article ELEVENTH to provide for supermajority approval by the
Board of Directors for a list of enumerated corporate actions; and
(5) revise Article FOURTEENTH to require supermajority approval by the
stockholders only to amend Article TWELFTH of the Certificate of
Incorporation which relates to certain transactions with interested
parties.
D. The Amendments to the Certificate of Incorporation made hereby and the
Restatement of the Certificate of Incorporation were authorized by the vote of
the majority of the Board of Directors at a duly called meeting at which a
quorum was present throughout.
E. The Certificate of Incorporation as heretofore and as hereby amended is
hereby restated as set forth below in full.
FIRST: The name of the corporation is:
"UNIVERSAL AMERICAN FINANCIAL CORP."
SECOND: The purposes for which it is formed are: To purchase, own, and hold
the stock of other corporations; to direct the operations of other corporations
through the ownership of stock therein; to purchase, subscribe for, acquire,
own, hold, sell, exchange, assign, transfer, create security interests in,
pledge, or otherwise dispose of, shares or voting trust certificates for shares
of the capital stock, or any bonds, notes, securities, or evidences of
indebtedness created by any other corporation or corporations organized under
the laws of this state or any other state or district or country, nation, or
government and also bonds or evidences of indebtedness of the United States or
of any state, district, territory, dependency or country or subdivision or
municipality thereof; to issue in exchange therefor shares of the capital stock,
bonds, notes or other obligations of the corporation and while the owner
thereof, to exercise all the rights, powers and privileges of ownership,
including the right to vote on any shares of stock or voting trust certificates
so owned; to promote, lend money to, and guarantee the dividends, stocks,
244
bonds, notes, evidences of indebtedness, contracts, or other obligations of, and
otherwise aid in any manner which shall be lawful, any corporation or
association of which any bonds, stocks, voting trust certificates, or other
securities or evidences of indebtedness shall be held by or for this
corporation, or in which, or in the welfare of which, this corporation shall
have any interest, and to do any acts and things permitted by law and designed
to protect, preserve, improve, or enhance the value of any such bonds, stocks,
or other securities or evidences of indebtedness or the property of this
corporation.
To engage in consultant and advisory work in connection with the
organization, financing, management, operation, and reorganization, of
industrial and commercial enterprises. To manage and to provide management for
and supervise all or part of any and every kind of investment or business
enterprise, and to contract or arrange with any corporation, association,
partnership, or individual for the management, conduct, operation, and
supervision of all kinds of investments and businesses. To advertise, promote,
merchandise, and otherwise purvey the services authorized herein; to negotiate
and contract with respect to furnishing of the same for or on behalf of any
person, firm or corporation, domestic or foreign; to enter into and carry out
agency or joint arrangements with other persons, firms, or corporations engaged
in like or similar activities; and generally to exploit the services and objects
of the corporation by all lawful means.
The corporation, in addition to and in furtherance of the corporate powers
above set forth, shall have all of the powers enumerated in Section 202 of the
Business Corporation Law, subject to any limitation provided in the Business
Corporation Law or any other statute of the State of New York.
THIRD: The office of the corporation is to be located in the Village of
Rye Brook, County of Westchester and State of New York.
FOURTH: (a) The total number of shares which the corporation is to be
authorized to issue is 82,000,000; consisting of 80,000,000 shares of Common
Stock of the par value of $.01 each, and 2,000,000 shares of Preferred Stock of
the par value of $1.00 each.
(b) The Preferred Stock may be issued in series, and the number,
designations, relative rights, preferences and limitations of shares of each
series of Preferred Stock, $1.00 par value, shall be fixed by the Board of
Directors.
FIFTH A: DESIGNATIONS, PREFERENCES AND SPECIAL RIGHTS OF SERIES B
PREFERRED STOCK(1)
Designation, Amount and Rank. Five hundred (500) shares of a preferred
stock, $1.00 par value per share, shall constitute a series of such preferred
stock designated as "Series B Convertible Preferred Stock" (the "Series B
Preferred Stock"). With respect to dividend rights, redemption rights and rights
on liquidation, winding up and dissolution, the Series A Preferred Stock shall
rank prior to the Series B Preferred Stock. With respect to dividend rights, the
Series B Preferred Stock shall rank pari passu with the Common Stock and shall
rank prior to the Common Stock and any other class of capital stock or series of
preferred stock hereafter created with respect to redemption rights, rights on
liquidation, winding up and dissolution. The
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1 Since the Series B Preferred Stock will be converted at the closing of the
Capital Z Issuance, after the closing, a second amended and restated certificate
of incorporation will be filed deleting references to the Series B Preferred
Stock.
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Series B Preferred Stock shall be issued pursuant to the following additional
terms and conditions:
1. Series B Convertible Preferred Stock.
1.1. Definitions. As used herein, unless the context otherwise requires,
the following terms have the following meanings:
1.1.1. "Additional Shares of Common Stock" means all shares (including
treasury shares) of Common Stock issued or sold (or, pursuant to Sections 1.7.2
or 1.7.3, deemed to be issued) by the corporation after the date hereof, whether
or not subsequently reacquired or retired by the corporation other than (a) the
issuance of shares upon conversion of the Series A Preferred Stock; (b) shares
issued upon the exercise of the Currently Outstanding Warrants; (c) shares to be
issued to directors and employees pursuant to corporation sponsored employee
benefit and compensation arrangements, but not to exceed 650,000 shares (subject
to equitable adjustment in the event of any combination, reclassification, stock
split, dividend or recapitalization of the corporation); and (d) such additional
number of shares, if any, as may become issuable upon the conversion or exercise
of any of the securities referred to in the foregoing clauses (a) through (d)
and by reason of adjustments required pursuant to the anti-dilution provisions
applicable to such Series A Preferred Stock as in effect on the date hereof, but
only if and to the extent that such adjustments are required as the result of
the original issuance of such Series B Preferred Stock.
1.1.2. "Business Day" means any day other than a Saturday or a Sunday or a
day on which commercial banking institutions in the City of New York are
authorized by law or other governmental action to be closed. Any reference to
"days" (unless Business Days are specified) shall mean calendar days.
1.1.3. "Closing", means the date of closing of any Triggering Event, as
contemplated by Section 1.6.2 hereof.
1.1.4. "Common Stock" means the corporation's Common Stock, $.01 par
value, such term to include any stock into which such Common Stock shall have
been changed of any stock resulting from any reclassification of such Common
Stock, and all other stock of any class or classes (however designated) of the
corporation the holders of which have the right, without limitation as to
amount, either to all or to a share of the balance of current dividends and
liquidating dividends and distributions after the payment of dividends and
distributions on any shares entitled to preference.
1.1.5. "Conversion Price", means $2.25, subject to adjustment pursuant to
Sections 1.7 and 1.9 hereof.
1.1.6. "Convertible Securities" means any evidences of indebtedness,
shares of stock (other than Common Stock) or other securities directly or
indirectly convertible into or exchangeable for Additional Shares of Common
Stock.
1.1.7. "Current Market Price" means on any date specified herein, the
average daily Market Price during the period of the most recent twenty (20)
days, ending on such date, on which the national securities exchanges were open
for trading, except that if no Common Stock is then listed or admitted to
trading on any national securities exchange or quoted in the over-the-counter
market, the Current Market Price shall be the Market Price on such date.
1.1.8. "Currently Outstanding Warrants" means the currently outstanding
Common Stock Purchase Warrants designated on Schedule 1 hereto, for the purchase
of an aggregate of 2,115,760 shares of the Common Stock.
1.1.9. "Market Price" means on any date specified herein, the amount per
share of the Common Stock, equal to (a) the last sale price of such Common
Stock, regular way, on such
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date or, if no such sale takes place on such date, the average of the closing
bid and asked prices thereof on such date, in each case as officially reported
on the principal national securities exchange on which such Common Stock is then
listed or admitted to trading, or (b) if such Common Stock is not then listed or
admitted to trading on any national securities exchange but is designated as a
national market system security by the NASD, the last trading price of the
Common Stock on such date, or (c) if there shall have been no trading on such
date or if the Common Stock is not so designated, the average of the closing bid
and asked prices of the Common Stock on such date as shown by the NASD automated
quotation system, or (d) if such Common Stock is not then listed or admitted to
trading on any national securities exchange or quoted in the over-the-counter
market, the value as determined by any firm of independent public accountants of
recognized national standing selected by the Board of Directors of the
corporation (and approved by the holders of a majority of the outstanding shares
of Series B Preferred Stock) as of the last day of any month ending within
thirty (30) days preceding the date as of which the determination is to be made.
1.1.10. "Options" means rights, options or warrants to subscribe for,
purchase or otherwise acquire either Additional Shares of Common Stock or
Convertible Securities.
1.1.11. "Other Securities" means any stock (other than Common Stock) and
other securities of the corporation or any other Person (corporate or otherwise)
which the holders of Preferred Stock at any time shall be entitled to receive,
or shall have received, upon the conversion of Preferred Stock, in lieu of or in
addition to Common Stock, or which at any time shall be issuable or shall have
been issued in exchange for or in replacement of Common Stock or other
Securities.
1.1.12. "Person" means a corporation, an association, a partnership, an
organization, a business, an individual, a government or political subdivision
thereof or a governmental agency.
1.1.13. "Preferred Stock" means, collectively, the Series A Preferred
Stock and the Series B Preferred Stock.
1.1.14. "Securities Act" means the Securities Act of 1933, as amended.
1.1.15. "Series A Preferred Stock" means the Series A Convertible
Preferred Stock, $1.00 par value, of the corporation created pursuant to a
Certificate of Amendment filed April 19, 1991 with the Secretary of State of the
State of New York.
1.1.16. "Series B Preferred Stock" means the Series B Convertible
Preferred Stock, $1.00 par value, of the corporation created pursuant to a
Certificate of Amendment filed December 21, 1994 with the Secretary of State of
the State of New York.
1.1.17. "Special Redemption Date" means any date fixed for redemption of
shares of Series B Preferred Stock pursuant to the provisions of Section 1.5.2
hereof.
1.1.18. "Special Redemption Event" has the meaning set forth in Section
1.5.4.
1.1.19. "Stated Value" per share means with respect to the Series B
Preferred Stock, Ten Thousand Dollars ($10,000).
1.1.20. "Triggering Event" means the consummation of a public offering
pursuant to an effective registration statement under the Securities Act
covering the offering and sale of shares of Common Stock (i) in which the
aggregate proceeds to the corporation exceed $8,000,000 and (ii) in which the
price per share at which the Common Stock is initially offered to the public
equals or exceeds $2.25 per share (which amount shall be equitably adjusted to
take into account any changes in capitalization of the corporation occurring
after August 1, 1994).
1.1.21. "Unpaid Dividends" means all dividends with respect to the Series
B Preferred Stock which have been declared but which have not been paid in cash.
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247
1.2. Dividends.
1.2.1. The holder of each issued and outstanding share of Series B
Preferred Stock shall be entitled to receive pari passu with holders of shares
of Common Stock any dividends or other distribution (including, without
limitation, any distribution of other Securities or property or options by way
of dividend, spinoff, reclassification, recapitalization or similar corporate
rearrangement) that are declared on the Common Stock by the Board of Directors
of the corporation, assuming for purposes of this Section 1.2.1 that the Series
B Preferred Stock had been converted into Common Stock immediately prior to the
record date for such Common Stock dividend.
1.3. Rights on Liquidation, Dissolution or Winding-Up.
1.3.1. In the event of any liquidation, dissolution or winding-up of the
corporation (including, without limitation, a liquidation or reorganization
under Chapter 7 or 11 of Title 11 of the United States Code, as amended), the
holders of shares of the Series A Preferred Stock and Series B Preferred Stock
then issued and outstanding shall be entitled to be paid out before any payment
shall be made to the holders of Common Stock or of shares of any other class or
series of stock of the corporation. If, upon any limitation, a liquidation or
reorganization under Chapter 7 or 11 of Title 11 of the United States Code, as
amended, the assets of the corporation available for distribution to its
stockholders shall be insufficient (a "Liquidation Insufficiency") to pay the
holders of shares of the Series A Preferred Stock and the Series B Preferred
Stock the full amounts to which they shall respectively be entitled, the holders
of shares of the Series A Preferred Stock shall be entitled to receive all the
assets of the corporation until such holders have received the full amounts to
which they are entitled pursuant to ARTICLE FIFTH of the Certificate of
Incorporation. Thereafter the holders of the Series B Preferred Stock shall be
entitled to receive pro rata the remaining assets of the corporation. If there
is no Liquidation Insufficiency and payment shall have been made to the holders
of the shares of the Series A Preferred Stock of the full amount to which they
shall be entitled, then the holders of shares of the Series B Preferred Stock
shall be entitled to receive the greater of (a) an amount equal to the Stated
Value per share, plus an amount equal to any Unpaid Dividends to and including
the date of Distribution with respect to such shares, and (b) the amount which
would be distributed on the shares of Common Stock into which the Series B
Preferred Stock is convertible at the date of the liquidation, dissolution or
winding up of the corporation (including, without limitation, a liquidation or
reorganization under Chapter 7 or 11 of Title 11 of the United States Code, as
amended).
1.4. Voting Power.
1.4.1. Except as otherwise expressly provided herein or as required by
law, (i) each holder of Series B Preferred Stock shall be entitled to vote on
all matters as to which stockholders of the corporation are entitled to vote,
and (ii) each holder of Series B Preferred Stock shall be entitled to cast a
number of votes equal to the greatest number of whole shares of Common Stock
into which such holder's shares of Series B Preferred Stock could be converted,
pursuant to the provisions of Section 1.6 hereof, at the record date for the
determination of stockholders entitled to vote on such matter or, if no such
record date is established, at the date such vote is taken or any written
consent of stockholders is solicited. Except as otherwise expressed provided
herein or as required by law, the holders of shares of Series B Preferred Stock
and Common Stock shall be entitled to vote together as a class with respect to
all matters as to which stockholders of the corporation are entitled to vote.
1.4.2. The holders of Series B Preferred Stock shall have the right,
voting separately as a class, to elect one (1) director to the Board of
Directors of the corporation, which, so long as any shares of Series B Preferred
Stock remain outstanding, shall be composed of no more than nine (9) directors.
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248
1.4.3. At any meeting held for the purpose of electing directors at which
the holders of Series B Preferred Stock shall have the right to elect directors
as provided herein, the presence in person or by proxy of the holders of
twenty-five percent (25%) of the then outstanding shares of Series B Preferred
Stock shall be required and shall be sufficient to constitute a quorum of such
class for the election of directors by such class. In the absence of a quorum of
the holders of the Series B Preferred Stock entitled to vote for the election of
directors, a majority of the holders present in person or by proxy of such class
shall have the power to adjourn the meeting for the election of directors which
the holders of such class are entitled to elect, from time to time, without
notice other than announcement at the meeting, until a quorum shall be present.
1.4.4. Unless the vote of the holders of a greater number of shares of
this Series B Preferred Stock shall then be required by law, the consent of the
holders of at least 66 2/3% of all of the shares of this Series B Preferred
Stock at the time outstanding, if any, voting together as a separate class,
shall be necessary for authorizing, effecting or validating any of the
following:
(a) the creation, authorization or issue of any shares of any class or
series of stock of the corporation, other than the Common Stock, ranking
prior to, or pari passu with, the shares of this Series B Preferred Stock
as to dividends or upon liquidation or otherwise, or the reclassification
of any authorized stock of the corporation into any such prior or pari
passu shares, or the creation, authorization or issue of any obligation or
security convertible into or evidencing the right to purchase any such
prior or pari passu shares; and
(b) the amendment, alteration or repeal of any of the provisions of
the Certificate of Incorporation or of any certificate amendatory thereof
or supplemental thereto so as to affect adversely the preferences, rights,
powers or privileges of this Series B Preferred Stock;
1.5. Special Redemption.
1.5.1. Upon occurrence of a Special Redemption Event (as hereinafter
defined), each holder of Series B Preferred Stock has the right to require that
the corporation redeem, to the extent the corporation lawfully may do so, all or
a portion of the shares of Series B Preferred Stock held by such holder, at a
redemption price in cash equal to the Stated Value per share (plus all Unpaid
Dividends thereon to the Special Redemption Date).
1.5.2. At least 30 days before the consummation of any Special Redemption
Event (as hereinafter defined), the corporation will mail to each holder of
Series B Preferred Stock a notice (the "Special Redemption Notice") (i) stating
that a Special Redemption Event is contemplated, (ii) setting forth a purchase
date (the "Special Redemption Date"), which shall be within five days prior to
or concurrently with the consummation of the Special Redemption Event; (iii)
setting forth the Conversion Price in effect with respect to such shares of
Preferred Stock, up to and including the date of consummation of the Special
Redemption Event; and (iv) setting forth the instructions reasonably determined
by the corporation, consistent with this Section 1.5 and applicable law, that a
holder must follow in order to require the redemption of his Series B Preferred
Stock.
Any holder of Series B Preferred Stock seeking to require that the
corporation redeem any shares will be required to (i) notify the corporation
within fifteen days after receipt of the Special Redemption Event Notice whether
it will elect to redeem any shares and (ii) surrender their shares to the
corporation prior to the close of business on the third Business Day prior to
the consummation of the Special Redemption Date.
1.5.3. Upon the Special Redemption Date, the redemption price of such
shares shall be payable to the order of the person whose name appears on the
certificate or certificates representing such shares as the owner thereof and
each surrendered certificate shall be canceled. In case fewer than all the
shares of Series B Preferred Stock represented by any surrendered certificate
are to be redeemed, a new certificate representing the shares of Series B
Preferred Stock not redeemed shall be issued without cost to the holder thereof.
From and after
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the date the corporation shall irrevocably deposit an amount equal to the
redemption price of the shares of Series B Preferred Stock to be redeemed in
trust for the holders of such shares with a bank having capital and surplus in
excess of $100 million, which bank shall be named in the redemption notice, all
rights of the holders of such Serious B Preferred Stock, except the right to
receive such redemption price without interest upon surrender of their
certificate or certificates, shall cease with respect to such shares, and such
shares shall not thereafter be transferred on the books of the corporation or be
deemed to be outstanding for any purpose whatsoever.
1.5.4. "Special Redemption Event" shall mean:
(a) consummation of any merger, reorganization or consolidation
transaction if consummation of such transaction results in another entity
or the stockholders of another entity having acquired voting securities of
the corporation sufficient to elect a majority of the Board of Directors of
the corporation; or
(b) the acquisition by purchase or otherwise of a controlling interest
in the business or assets of, or the stock or other evidence of beneficial
ownership of, any other Person if consummation of such transaction results
in a transfer of ownership of a majority of the voting securities of the
corporation to such other Person or its stockholders; or
(c) the sale, lease, conveyance, exchange, transfer, encumbrance or
other disposition, in one transaction or a series of related transactions,
of 40% or more of the assets of the corporation; or
(d) the sale, conveyance, exchange, transfer, encumbrance or other
disposition, on one transaction or a series of related transactions, of 40%
or more of the outstanding Common Stock of the corporation.
1.6. Conversion Rights.
1.6.1. Each holder of the shares of Series B Preferred Stock shall have
the right, at the election of such holder, exercised at any time and from time
to time, to convert, subject to the terms and provisions hereof, all or any
portion of such shares of Series B Preferred Stock into fully paid and
non-assessable shares of Common Stock of the corporation or any capital stock or
other securities into which such Common Stock shall have been changed or any
capital stock or other securities resulting from a reclassification thereof.
Such conversion of Series B Preferred Stock to shares of Common Stock shall be
made at the Conversion Price, subject to adjustments from time to time as set
forth herein. Series B Preferred Stock may be converted by the holder thereof
during normal business hours on any Business Day by surrender of the required
number of shares of the Series B Preferred Stock, accompanied by written
evidence (in form reasonably satisfactory to the corporation) of the holder's
election to convert such holder's Series B Preferred Stock or portion thereof,
out the corporation at its principal executive offices. Payment of the
Conversion Price for the shares of Common Stock specified in such election shall
be made by applying shares of Series B Preferred Stock, valued at the Stated
Value per share. Payment of Unpaid Dividends, if any, applicable to such
converted shares of Series B Preferred Stock shall be made in accordance with
Section 1.6.5.
1.6.2. All or part of the outstanding shares of Series B Preferred Stock
shall, at the option of the corporation and upon written notice to the holders
thereof given not less than ten (10) days prior to the Closing of a Triggering
Event be converted, by applying shares of Series B Preferred Stock valued at the
Stated Value per share, into shares of Common Stock at the Conversion Price as
of the date and time of the Closing, automatically and without any further
action by the holders of such shares and whether or not the certificates
representing such shares are surrendered to the corporation or its transfer
agent. Payment of Unpaid Dividends, if any, applicable to such converted shares
of Series B Preferred Stock shall be made in accordance with Section 1.6.5.
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1.6.3. Upon the conversion of Series B Preferred stock, the holders of
such Series B Preferred Stock shall surrender the certificates representing such
shares at the office of the corporation. The corporation shall not be obligated
to issue certificates evidencing the shares of Common Stock issuable upon such
conversion (or to pay any Unpaid Dividends in connection with such conversion)
unless certificates evidencing such shares of Series B Preferred Stock being
converted are either delivered to the corporation or the holder notifies the
corporation that such certificates have been lost, stolen, or destroyed and
delivers to the corporation an agreement satisfactory to the corporation, with a
surety satisfactory to the corporation, to indemnify the corporation from any
loss incurred by it in connection therewith.
1.6.4. Each conversion of Series B Preferred Stock shall be deemed to have
been effected immediately prior to the close of business on the Business Day on
which such Series B Preferred Stock shall have been surrendered to the
corporation as provided herein (except that if such conversion is in connection
with a Triggering Event, then such conversion shall be deemed to have been
effected concurrently with the Closing of such Triggering Event), and such
conversion shall be at the Conversion Price in effect at such time. On each such
day that the conversion of shares of Series B Preferred Stock is deemed
effected, the person or persons in whose name or names any certificate or
certificates for shares of Common Stock are issuable upon such conversion shall
be deemed to have become the holder or holders of record thereof.
1.6.5. As promptly as practical after the conversion of shares of Series B
Preferred Stock, in whole or in part, and in any event within five (5) Business
Days thereafter (unless such conversion is in connection with a Triggering
Event, in which event concurrently with such conversion), the corporation at its
expense (including the payment by it of any applicable issue, stamp or other
taxes, other than any income taxes and other than any taxes arising by reason of
issuance of shares of Common Stock to any person other than such holder) will
cause to be issued in the name of and delivered to the holder thereof or as such
holder may direct, (i) a certificate or certificates for the number of shares of
Common Stock to which such holder shall be entitled upon such conversion plus,
in lieu of any fractional shares to which such holder would otherwise be
entitled, cash in an amount equal to the same fraction of the Current Market
Price per share of Common Stock and (ii) Unpaid Dividends, if any, applicable as
of the time of conversion to those shares of Series B Preferred Stock which are
converted. Such Unpaid Dividends shall be paid in cash, without interest. In
case fewer than all the shares of Series B Preferred Stock represented by any
surrendered certificate are converted into Common Stock, a new certificate
representing the shares of Series B Preferred Stock not converted shall be
issued without cost to the holder thereof.
1.7. Anti-Dilution Adjustments. The number of shares of Common Stock
issuable upon any conversion provided for in Section 1.6 shall be subject to
adjustment, from time to time, in accordance with the following provisions:
1.7.1. Issuance of Additional Shares of Common Stock. In case the
corporation at any time or from time to time after the date hereof shall issue
or sell Additional Shares of Common Stock (including Additional Shares of Common
Stock deemed to be issued pursuant to Section 1.7.2 or 1.7.3) without
consideration or for a consideration per share less than the Conversion Price in
effect immediately prior to such issue or sale, then, in each such case, subject
to Section 1.7.7, such Conversion Price shall be reduced, concurrently with such
issue or sale, to a price (calculated to the nearest .001 of a cent) determined
by multiplying such Conversion Price by a fraction
(a) the numerator of which shall be (i) the number of shares of Common
Stock into which the outstanding Series B Preferred Stock is convertible
immediately prior to such issue or sale plus (ii) the number of shares of
Common Stock which the aggregate consideration received by the corporation
for the total number of such Additional Shares of Common Stock so issued or
sold would purchase at such Conversion Price, and
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(b) the denominator of which shall be (i) the number of shares of
Common Stock into which the outstanding Series B Preferred Stock is
convertible immediately prior to such issue or sale plus (ii) the number of
Additional Shares so issued or sold immediately after such issue or sale,
provided that, for the purpose of this Section 1.7.1, (x) immediately after
any Additional Shares of Common Stock are deemed to have been issued
pursuant to Section 1.7.2 or 1.7.3, such Additional Shares shall be deemed
to be outstanding and (y) treasury shares shall not be deemed to be
outstanding. This Section 1.7.1 shall not apply to dividends pursuant to
Section 1.2.1 that are payable in Additional Shares of the Common Stock.
1.7.2. Treatment of Options and Convertible Securities. In case the
corporation at any time or from time to time after the date hereof shall issue,
sell, grant or assume, or shall fix a record date for the determination of
holders of any class of securities entitled to receive, any options or
Convertible Securities, then and in each such case, the maximum number of
Additional Shares of Common Stock (as set forth in the instrument relating
thereto, without regard to any provisions contained therein for a subsequent
adjustment of such number) issuable upon the exercise of such options or, in the
case of Convertible Securities and Options therefor, the conversion or exchange
of such Convertible Securities, shall be deemed to be Additional Shares of
Common Stock issued as of the time of such issue, sale, grant or assumption or,
in case such a record date shall have been fixed, as of the close of business on
such record date (or, if the Common Stock trades on an ex-dividend basis, on the
date prior to the commencement of ex-dividend trading), provided that such
Additional Shares of Common Stock shall not be deemed to have been issued unless
the consideration per shares (determined pursuant to Section 1.7.4) of such
shares would be less than the Conversion Price in effect on the date of and
immediately prior to such issue, sale, grant or assumption or immediately prior
to the close of business on such record date (or, if the Common Stock trades on
an ex-dividend basis, on the date prior to the commencement of ex-dividend
trading), as the case may be, and provided, further, that in any such case in
which Additional Shares of Common Stock are deemed to be issued
(a) no further adjustment of the Conversion Price shall be made upon
the subsequent issue or sale of Convertible Securities or shares of Common
Stock upon the exercise of such options or the conversion or exchange of
such Convertible Securities;
(b) if such Options or Convertible Securities by their terms provide,
with the passage of time or otherwise, for any increase in the
consideration payable to the corporation or decrease in the number of
Additional Shares of Common Stock issuable, upon the exercise, conversion
or exchange thereof (by change of rate or otherwise), the Conversion Price
computed upon the original issue, sale, grant or assumption thereof (or
upon the occurrence of the record date, or date prior to the commencement
of ex-dividend trading, as the case may be, with respect thereto), and any
subsequent adjustments based thereon, shall, upon any such increase or
decrease becoming effective, be recomputed to reflect such increase or
decrease insofar as it affects such Options, or the rights of conversion or
exchange under such Convertible Securities, which are outstanding at such
time;
(c) upon the expiration (or purchase by the corporation and
cancellation or retirement) of any such options which shall not have been
exercised or the expiration of any rights of conversion or exchange under
any such Convertible Securities which shall not have been exercised (or
purchase by the corporation and cancellation or retirement of any such
Convertible Securities the rights of conversion or exchange under which
shall not have been exercised), the Conversion Price computed upon the
original issue, sale, grant or assumption (or upon the occurrence of the
record date, or date prior to the commencement of occurrence of the record
date, or date prior to the commencement of ex-dividend trading, as the case
may be, with respect thereto), and any subsequent adjustments based
thereon, shall, upon such expiration (or such cancellation or retirement,
as the case may be), be recomputed as if
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(i) in the case of Options for Common Stock or Convertible
Securities, the only Additional Shares of Common Stock issued or sold
were the Additional Shares of Common Stock, if any, actually issued or
sold upon the exercise of such Options or the conversion or exchange of
such Convertible Securities and the consideration received therefor was
the consideration actually received by the corporation for the issue,
sale, grant or assumption of all such options, whether or not exercised,
plus the consideration actually received by the corporation upon such
exercise, or for the issue or sale of all such Convertible Securities
which were actually converted or exchanged, plus the additional
consideration, if any, actually received by the corporation upon such
conversion or exchange, and
(ii) in the case of Options for Convertible Securities, only the
Convertible Securities, if any, actually issued or sold upon the
exercise of such options were issued at the time of the issue, sale,
grant or assumption of such Options, and the consideration received by
the corporation for the Additional Shares of Common Stock deemed to have
then been issued was the consideration actually received by the
corporation for the issue, sale, grant or assumption of all such
Options, whether or not exercised, plus the consideration deemed to have
been received by the corporation (pursuant to Section 1.7.4) upon the
issue or sale of such Convertible Securities with respect to which such
Options were actually exercised;
(d) no readjustment pursuant to subdivision (b) or (c) above shall
have the effect of increasing Conversion Price by an amount in excess of
the amount of the adjustment thereof originally made in respect of the
issue, sale, grant or assumption of such Options or Convertible Securities;
and
(e) in the case of any such options which expire by their terms not
more than thirty (30) days after the date of issue, sale, grant or
assumption thereof, no adjustment of the Conversion Price shall be made
until the expiration or exercise of all such Options, whereupon such
adjustment shall be made in the manner provided in subdivision (c) above.
1.7.3. Treatment of Stock Dividends, Stock Splits, etc. In case the
corporation at any time or from time to time after the date hereof shall declare
or pay any dividend on the Common Stock payable in Common Stock, or shall effect
a subdivision of the outstanding shares of Common Stock into a greater number of
shares of Common Stock (by reclassification or otherwise than by payment of a
dividend in Common Stock), then, and in each such case, Additional Shares of
Common Stock shall be deemed to have been issued (a) in the case of any such
dividend, immediately after the close of business on the record date for the
determination of holders of any class of securities entitled to receive such
dividend, or (b) in the case of any such subdivision, at the close of business
on the date immediately prior to the day upon which such corporate action
becomes effective.
1.7.4. Computation of Consideration. For the purposes of this Section
1.7,
(a) the consideration for the issue or sale of any Additional Shares
of Common Stock shall, irrespective of the accounting treatment of such
consideration,
(i) insofar as it consists of cash, be computed at the net amount
of cash received by the corporation, without deducting any expenses paid
or incurred by the corporation or any commissions or compensation paid
or concessions or discounts allowed to underwriters, dealers or others
performing similar services in connection with such issue or sale,
(ii) insofar as it consists of property (including securities)
other than cash, be computed at the fair value thereof at the time of
such issue or sale, as determined in good faith by the Board of
Directors of the corporation (subject to confirmation by a firm
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of independent certified public accountants of recognized national
standing approved by the holders of a majority of the Series B Preferred
Stock), and
(iii) in case Additional shares of Common Stock are issued or sold
together with other stock or securities or other assets of the
corporation for a consideration which covers both, be the portion of
such consideration so received, computed as provided in clauses (i) and
(ii) above, allocable to such Additional Shares of Common Stock, all as
determined in good faith by the Board of Directors of the corporation
(subject to confirmation by a firm of independent certified public
accountants of recognized national standing approved by holders of a
majority of the Series B Preferred Stock);
(b) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.2, relating to Options and Convertible Securities,
shall be deemed to have been issued for a consideration per share
determined by dividing
(i) the total amount, if any, received and receivable by the
corporation as consideration for the issue, sale, grant or assumption of
the options or Convertible Securities in question, plus the minimum
aggregate amount of additional consideration (as set forth in the
instruments relating thereto, without regard to any provision contained
therein for a subsequent adjustment of such consideration to protect
against dilution) payable to the corporation upon the exercise in full
of such Options or the conversion or exchange of such Convertible
Securities or, in the case of Options for Convertible Securities, the
exercise of such Options for Convertible Securities and the conversion
or exchange of such Convertible Securities, in each case computing such
consideration as provided in the foregoing subdivision (a),
(ii) the maximum number of shares of Common Stock (as set forth in
the instruments relating thereto, without regard to any provision
contained therein for a subsequent adjustment of such number to protect
against dilution) issuable upon the exercise of such options or the
conversion or exchange of such Convertible Securities; and
(c) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.3, relating to stock dividends, stock splits, etc.,
shall be deemed to have been issued for no consideration.
1.7.5. Adjustments for Combinations, etc. In case the outstanding shares
of Common Stock shall be combined or consolidated, by reclassification or
otherwise, into a lesser number of shares of Common Stock, the Conversion Price
in effect immediately prior to such combination or consolidation shall,
concurrently with the effectiveness of such combination or consolidation, be
proportionately increased.
1.7.6. Dilution in Case of Other Securities. In case any Other Securities
shall be issued or sold or shall become subject to issue or sale upon the
conversion or exchange of any stock (or other Securities) of the corporation (or
any issuer of other Securities or any other Person referred to in Section 1.8)
or to subscription, purchase or other acquisition pursuant to any options issued
or granted by the corporation (or any such other issuer or Person) for a
consideration such as to dilute, on a basis consistent with the standards
established in the other provisions of this Section 1.7, the conversion rights
granted to holders of Series B Preferred Stock, then, and in each such case, the
computations, adjustments and readjustments provided for in this Section 1.7
with respect to the Conversion Price shall be made as nearly as possible in the
manner so provided and applied to determine the amount of other Securities from
time to time receivable upon the conversion of the shares of Series B Preferred
Stock, so as to protect the holders of the Series B Preferred Stock against the
effect of such dilution.
1.7.7. Minimum Adjustment of Conversion Price. If the amount of any
adjustment of the Conversion Price required pursuant to this Section 1.7 would
be less than five percent (5%) of
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the Conversion Price in effect at the time such adjustment is otherwise so
required to be made, such amount shall be carried forward and adjustment with
respect thereto made at the time of and together with any subsequent adjustment
which, together with such amount and any other amount or amounts so carried
forward, shall aggregate at least five percent (5%) of such Conversion Price.
Notwithstanding the foregoing, the Conversion Price shall be adjusted at the
time of, and be effective with respect to, any conversion or redemption of any
shares of Series B Preferred Stock.
1.8. Consolidation Merger, etc.
1.8.1. Adjustments for Consolidation, Merger, Sale of Assets,
Reorganization, etc. In case the corporation after the date hereof (a) shall
consolidate with or merge into any other Person and shall not be the continuing
or surviving corporation of such consolidation or merger, or (b) shall permit
any other Person to consolidate with or merge into the corporation and the
corporation shall be the continuing or surviving Person but, in connection with
such consolidation or merger, the Common Stock or Other Securities shall be
changed into or exchanged for stock or other securities of any Other Person or
cash or any other property, or (c) shall transfer 40% or more of its properties
or assets to any other Person in a single transaction or a related series of
transactions, or (d) shall effect a capital reorganization or reclassification
of the Common Stock or Other Securities (other than a capital reorganization or
reclassification resulting in the issue of Additional Shares of Common Stock for
which adjustment in the Conversion Price is provided in subsection 1.7.1), then,
and in the case of each such transaction (excluding any such transaction which
constitutes a Triggering Event and in connection with which the corporation
requires conversion of the Series B Preferred Stock), proper provision shall be
made so that, upon the basis and the terms and in the manner provided herein,
the holders of shares of Series B Preferred Stock, upon the conversion thereof
at any time after the consummation of such transaction, shall be entitled to
receive (at the aggregate Conversion Price in effect at the time of such
consummation for all Common Stock or other Securities issuable upon such
exercise immediately prior to such consummation), in lieu of the Common Stock or
Other Securities issuable upon such exercise prior to such consummation, the
highest amount of securities, cash or other property to which such holder would
actually have been entitled as a stockholder upon such consummation if such
holder had exercised the conversion rights pertaining to the Series B Preferred
Stock immediately prior thereto.
1.8.2. Assumption of Obligations. Notwithstanding anything to the
contrary herein provided, the corporation will not effect any of the
transactions described in subsections (a) through (d) of Section 1.8.1
(excluding any such transaction which constitutes a Triggering Event and in
connection with which the corporation requires conversion of the Series B
Preferred Stock) unless, prior to the consummation thereof, each Person (other
than the corporation) which may be required to deliver any stock, securities,
cash or property upon the conversion of shares of Series B Preferred Stock as
provided herein shall assume, by written instrument delivered to, and reasonably
satisfactory to, the holders of the Series B Preferred Stock (a) the obligations
of the corporation with respect to the Series B Preferred Stock (and if the
corporation shall survive the consummation of such transactions such assumption
shall be in addition to, and shall not release the corporation from, any
continuing obligations of the corporation with respect to the Series B Preferred
Stock), and (b) the obligation to deliver to such holder such shares of stock,
securities, cash or property as, in accordance with the foregoing provisions of
this Section 1.8, such holder may be entitled to receive, and such Person shall
have similarly delivered to such holders of Series B Preferred Stock an opinion
of counsel for such Person, which counsel shall be reasonably satisfactory to
such holders, stating that the rights and privileges of the Series B Preferred
Stock shall thereafter continue in full force and effect and the terms thereof
(including, without limitation, all of the provisions of this Section 1.8) shall
be applicable to the stock, securities, cash or property which such Person may
be required to deliver upon any conversion of shares of Series B Preferred Stock
or the exercise of any rights pursuant hereto.
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1.9. Other Dilutive Events. In case any event shall occur as to which the
provisions of Section 1.7 or Section 1.8 are not strictly applicable but the
failure to make any adjustment would not fairly protect the conversion rights
pertaining to shares of Series B Preferred Stock in accordance with the
essential intent and principles of such sections, then, in each such case, the
corporation shall appoint a firm of independent certified public accountants of
recognized national standing (such firm to be subject to the approval of the
holders of a majority of the outstanding Series B Preferred Stock), which shall
give their opinion regarding the adjustment, if any, on a basis consistent with
the essential intent and principles established in Sections 1.7 and 1.8,
necessary to preserve, without dilution, the conversion rights of the Series B
Preferred Stock. Upon receipt of such opinion, the corporation will promptly
mail a copy thereof to each holder of Series B Preferred Stock and shall make
the adjustments described therein.
1.10. No Dilution or Impairment. The corporation will not, by amendment
of its certificate of incorporation or by-laws or through any consolidation,
merger, reorganization, transfer of assets, dissolution, issue or sale of
securities or any other voluntary action, avoid or seek to avoid the observance
or performance of any of the terms of the Series B Preferred Stock, but will at
all times in good faith assist in the carrying out of all such terms and in the
taking of all such action as may be necessary or appropriate in order to protect
the rights of the holders of shares of Series B Preferred Stock against dilution
or other impairment. Without limiting the generality of the foregoing, the
corporation (a) will not permit the par value of any shares of stock receivable
upon the conversion of Series B Preferred Stock to exceed the amount payable
therefor upon such exercise, (b) will take all such action as may be necessary
or appropriate in order that the corporation may validly and legally issue fully
paid and non-assessable shares of stock on the conversion of the shares of
Series B Preferred Stock from time to time outstanding, and (c) will not take
any action which results in any adjustment of the Conversion Price if the total
number of shares of Common Stock (or Other Securities) issuable after the action
upon the conversion of all of the outstanding shares of the Series B Preferred
Stock would exceed the total number of shares of Common Stock (or Other
Securities) then authorized by the corporation's certificate of incorporation
and available for the purpose of issue upon such exercise.
1.11. Accountants' Report as to Adjustments. In each case of any
adjustment or readjustment in the shares of Common Stock (or Other Securities)
issuable upon the conversion of shares of Series B Preferred Stock, the
corporation at its expense will promptly compute such adjustment or readjustment
in accordance with the terms hereof and, if requested by the holders of 20% of
the outstanding shares of Series B Preferred Stock, cause independent certified
public accountants of recognized national standing (such firm to be subject to
the approval of the holders of a majority of the outstanding Series B Preferred
Stock) selected by the corporation to verify such computation and prepare a
report setting forth such adjustment or readjustment and showing in reasonable
detail the method of calculation thereof and the facts upon which such
adjustment or readjustment is based, including a statement of (a) the
consideration received or to be received by the corporation for any Additional
Shares of Common Stock issued or sold or deemed to have been issued, (b) the
number of shares of Common Stock outstanding or deemed to be outstanding, and
(c) the Conversion Price in effect immediately prior to such issue or sale and
as adjusted and readjusted (if required by Section 1.7) on account thereof. The
corporation will forthwith mail a copy of each such report to each holder of
shares of Series B Preferred Stock and will, upon the written request at any
time of any holder of shares of Series B Preferred Stock, furnish to such holder
a like report setting forth the Conversion Price at the time in effect and
showing in reasonable detail how it was calculated. The corporation will also
keep copies of all such reports at its principal office and will cause the same
to be available for inspection at such office during normal business hours by
any holder of Series B Preferred Stock or any prospective purchaser of Series B
Preferred Stock designated by the holder thereof.
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1.12. Notices of Corporate Action. In the event of
(a) any taking by the corporation of a record of the holders of any
class of securities for the purpose of determining the holders thereof who
are entitled to receive any dividend or other distribution, or any right to
subscribe for, purchase or otherwise acquire any shares of stock of any
class or any other securities or property, or to receive any other right,
or
(b) any capital reorganization of the corporation, any
reclassification or recapitalization of the capital stock of the
corporation or any consolidation or merger involving the corporation and
any other Person or any transfer, in a single transaction or a related
series of transactions, of 40% or more of the assets of the corporation to
any other Person or any sale or transfer, in a single transaction or a
related series of transactions, by the corporation of Common Stock
amounting to 40% or more of the then outstanding Common Stock of the
corporation, or
(c) any voluntary or involuntary dissolution, liquidation or
winding-up of the corporation, the corporation will mail to each holder of
shares of Series B Preferred Stock a notice specifying (i) the date or
expected date on which any such record is to be taken for the purpose of
such dividend, distribution or right, and the amount and character of such
dividend, distribution or right, and (ii) the date or expected date on
which any such reorganization, reclassification, recapitalization,
consolidation, merger, transfer, dissolution, liquidation or winding-up is
to take place and the time, if any such time is to be fixed, as of which
the holders of record of Common Stock (or other Securities) shall be
entitled to exchange their shares of Common Stock (or Other Securities) for
the securities or other property deliverable upon such reorganization,
reclassification, recapitalization, consolidation, merger, transfer,
dissolution, liquidation or winding-up. Except for notices relating to
mandatory conversion in connection with a Triggering Event or to a Special
Redemption Event, such notices shall be mailed at least twenty (20)
Business Days prior to the date of the action therein specified.
1.13. Retirement of Converted or Redeemed Shares. No share or shares of
Series B Preferred Stock acquired by the corporation by reason of redemption,
purchase, conversion or otherwise shall be re-issued and all such shares shall
be canceled, retired and eliminated from the shares which the corporation shall
be authorized to issue. The corporation may from time to time take such
appropriate corporate action as may be necessary to reduce the authorized number
of shares of Series B Preferred Stock accordingly.
FIFTH B: DESIGNATIONS, PREFERENCES AND SPECIAL RIGHTS OF SERIES C
PREFERRED STOCK ((2))
Designation, Amount and Rank. One Hundred Thousand (100,000) shares of a
preferred stock, $1.00 par value per share, shall constitute a series of such
preferred stock designated as a "Series C Convertible Preferred Stock" (the
"Series C Preferred Stock"). The Series C Preferred Stock will be issued as one
of two sub-series of preferred stock. Series C-1 Voting Preferred Stock (the
"Series C-1 Preferred Stock") and Series C-2 Non-Voting Preferred Stock (the
"Series C-2 Preferred Stock"), the number of shares of each such series to be
determined by resolution of the Board of Directors of the corporation. The
respective rights and preferences of the Series C Preferred Stock, with respect
to dividend rights, redemption rights and rights on
- ---------------
(2) The Series C Preferred Stock was converted in April 1999. Some terms of
the Series D Preferred Stock make reference to the provisions governing the
Series C Preferred Stock. Following the conversion of all of the Series D
Preferred Stock, Universal American will file a second amended and restated
certificate of incorporation deleting references to the Series C Preferred
Stock. See footnote 3.
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liquidation, winding up and dissolution, shall be as set forth herein. The
Series C Preferred Stock shall be issued pursuant to the following additional
terms and conditions:
1. Series C Convertible Preferred Stock.
1.1. Definitions. As used herein, unless the context otherwise requires,
the following terms have the following meanings:
1.1.1. "Additional Shares of Common Stock" means all shares (including
treasury shares) of Common Stock issued or sold (or, pursuant to Sections 1.7.2
or 1.7.3, deemed to be issued) by the corporation after January 8, 1997, whether
or not subsequently reacquired or retired by the corporation other than (i) the
issuance of shares upon conversion of the Series B Preferred Stock; (ii) shares
issued upon the exercise of the Common Stock Purchase Warrants outstanding on
January 8, 1997; (iii) shares to be issued to directors, employees, agents and
others, pursuant to the corporation's Incentive Stock Option Plan for Employees,
Stock Option Plan for Directors and Stock Option Plan for Agents and Others, as
in effect on January 8, 1997; and (iv) such additional number of shares, if any,
as may become issuable upon the conversion or exercise of any of the securities
referred to in the foregoing clauses (i) through (iii) pursuant to the terms of
the instruments governing such securities as in effect on April 7, 1997.
1.1.2. "Adjusted Stated Value" shall mean the Stated Value, increased at
the rate of 8% per annum from the date of original issuance of each share of
Series C Preferred Stock, accruing daily, compounded annually. The date on which
the corporation initially issues any share of Series C Preferred Stock will be
deemed to be its "date of issuance" regardless of the number of times transfer
of such share of Series C Preferred Stock is made on the stock records
maintained by or for the corporation and regardless of the number of
certificates which may be issued to evidence such share of Series C Preferred
Stock.
1.1.3. "Affiliate" as applied to any Person means any other Person
directly or indirectly controlling, controlled by, or under common control with,
that Person. The term "control" (including, with correlative meanings, the terms
"controlling," "controlled by" and "under common control with"), as applied to
any Person, means the possession, directly or indirectly, of the power to vote
10% or more of the voting stock (or in the case of a Person which is not a
corporation, 10% or more of the ownership interest, beneficial or otherwise) of
such Person or otherwise to direct or cause the direction of the management and
polices of that Person, whether through the ownership of voting stock or other
ownership interest, by contract or otherwise. All of the corporation's executive
officers, 10% stockholders, directors, Subsidiaries, joint ventures and partners
shall be deemed to be Affiliates of the corporation for purposes of this
Agreement.
1.1.4. "Business Day" means any day other than a Saturday or a Sunday or a
day on which commercial banking institutions in the City of New York are
authorized by law or other governmental action to be closed. Any reference to
"days" (unless Business Days are specified) shall mean calendar days.
1.1.5. "Call Price" means the following price per share plus eight percent
(8%) accrued on the Stated Value thereof from the original date of issuance of
such Series C Preferred Stock through the applicable Redemption Date, compounded
annually.
REDEMPTION
DATE PRICE
- ---------- -----
Prior to or on December 31, 2000........................... $150
After December 31, 2000.................................... $175
1.1.6. "Common Stock" means the corporation's Common Stock, $.01 par
value, such term to include any stock into which such Common Stock shall have
been changed or any stock resulting from any reclassification of such Common
Stock, and all other stock of any class or classes (however designated) of the
corporation the holders of which have the right, without
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limitation as to amount, either to all or to a share of the balance of current
dividends and liquidating dividends and distributions after the payment of the
dividends and distributions on any shares entitled to preference.
1.1.7. "Conversion Event" shall mean (a) any public offering, or public
sale of securities of the corporation (including a public offering registered
under the Securities Act of 1933 and a public sale pursuant to Rule 144 of the
Securities and Exchange Commission or any similar rule then in force), (b) any
sale of securities of the corporation to a person or group of persons (within
the meaning of the Securities Exchange Act of 1934, as amended (the "1934 Act"))
if, after such sale, such person or group of persons in the aggregate would own
or control securities which possess in the aggregate the ordinary voting power
to elect a majority of the corporation's directors (provided that such sale has
been approved by the corporation's Board of Directors or committee thereof, (c)
any sale of securities of the corporation to a person or group of persons
(within the meaning of the 1934 Act) if, after such sale, such person or group
of persons in the aggregate would own or control securities of the corporation
(excluding any Series C-2 Preferred Stock being converted and disposed of in
connection with such Conversion Event) which possess in the aggregate the
ordinary voting power to elect a majority of the corporation's directors, (d)
any sale of securities of the corporation to a person or group of persons
(within the meaning of the 1934 Act) if, after such sale, such person or group
of persons would not, in the aggregate, own, control or have the right to
acquire more than two percent (2%) of the outstanding securities of any class of
voting securities of the corporation and (e) a merger, consolidation or similar
transaction involving the corporation if, after such transaction, a person or
group of persons (within the meaning of the 1934 Act) in the aggregate would own
or control securities which possess in the aggregate the ordinary voting power
to elect a majority of the surviving corporation's directors (provided that the
transaction has been approved by the corporation's Board of Directors or a
committee thereof).
1.1.8. "Conversion Price" means $2.375, subject to adjustment from time to
time pursuant to Section 1.7.
1.1.9. "Convertible Securities" means any evidences of indebtedness,
shares of stock (other than Common Stock) or other securities directly or
indirectly convertible into or exchangeable for Additional Shares of Common
Stock.
1.1.10. "Indebtedness" shall mean at a particular time, without
duplication, (i) indebtedness for borrowed money or for the deferred purchase
price of property or services in respect of which any Person is liable,
contingently or otherwise, as obligor or otherwise (other than trade payables
and other current liabilities incurred in the ordinary course of business) or
any commitment by which any Person assures a creditor against loss, including
contingent reimbursement obligations with respect to letters of credit, (ii)
indebtedness guaranteed in any manner by any Person, including guarantees in the
form of an agreement to repurchase or reimburse, (iii) obligations under
capitalized leases in respect of which obligations any Person is liable,
contingently or otherwise, as obligor, guarantor or otherwise, or in respect of
which obligations any Person assures a creditor against loss and (iv) any
unsatisfied obligation of any Person for "withdrawal liability" to a
"multiemployer plan" as such terms are defined under the Employee Retirement
Income Security Act of 1974, as amended.
1.1.11. "Junior Securities" means any of the corporation's equity
securities other than the Series C Preferred Stock (including the Series B
Preferred Stock and the Common Stock) whether now outstanding or hereafter
issued.
1.1.12. "Liquidation" means liquidation, dissolution or winding-up
(including, without limitation, a liquidation or reorganization under Chapter 7
or 11 of Title 11 of the United States Code, as amended).
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1.1.13. "Options" means rights, options or warrants to subscribe for,
purchase or otherwise acquire either Additional Shares of Common Stock or
Convertible Securities.
1.1.14. "Organic Change" means any capital reorganization,
reclassification, consolidation, merger, lease, or sale of all or substantially
all of the corporation's assets to another Person which is effected in such a
way that holders of Common Stock are entitled to receive (either directly or
upon subsequent liquidation) stock, securities or assets with respect to or in
exchange for shares of Common Stock.
1.1.15. "Other Securities" means any stock (other than Common Stock) and
other securities of the corporation or any other Person (corporate or otherwise)
which the holders of Series B Preferred Stock at any time shall be entitled to
receive, or shall have received, upon the conversion of Series B Preferred
Stock, in lieu of or in addition to Common Stock, or which at any time shall be
issuable or shall have been issued in exchange for or in replacement of Common
Stock or Other Securities.
1.1.16. "Person" means an individual, a partnership, a corporation, a
limited liability company, an association, a joint stock company, a trust, a
joint venture, an unincorporated organization or a governmental entity or any
department, agency or political subdivision thereof.
1.1.17. "Regulated Stockholder" means any Series C Preferred Stockholder
that is subject to the provisions of Regulation Y of the Board of Governors of
the Federal Reserve System, 12 C.F.R. Part 225 (or any successor to such
Regulation).
1.1.18. "Regulatory Problem" means any set of facts or circumstances
wherein it has been asserted by any governmental regulatory agency (or a
Regulated Stockholder reasonably believes that there is a risk of such
assertion) that such Regulated Stockholder is not entitled to acquire, own, hold
or control, or exercise any significant right (including the right to vote) with
respect to any securities of the corporation or any subsidiary of the
corporation.
1.1.19. "Restricted Stock" means, with respect to any Regulated
Stockholder, any outstanding shares of stock ever held of record by such
Regulated Stockholder or its Affiliates, excluding treasury shares; provided,
however, that any such shares shall cease to be Restricted Stock with respect to
such Regulated Stockholder when such shares are transferred in a transaction
which is a Conversion Event or when such shares are acquired by the corporation
or any subsidiary of the corporation; and provided, further, that the
corporation shall have no responsibility for determining whether any outstanding
shares of stock constitute Restricted Stock with respect to a particular
Regulated Stockholder, but shall instead be entitled to receive, and rely
exclusively upon, a written notice provided by such Regulated Stockholder
designating such shares as Restricted Stock.
1.1.20. "Series B Preferred Stock" means the Series B Convertible
Preferred Stock, $1.00 par value, of the corporation created pursuant to a
Certificate of Amendment filed December 21, 1994 with the Secretary of State of
the State of New York.
1.1.21. "Stated Value" per share means, with respect to the Series C
Preferred Stock, One Hundred Dollars ($100) per share, as adjusted for any stock
splits, stock combinations, stock dividends or reclassifications affecting the
Series C Preferred Stock after the date of filing of this Certificate of
Amendment.
1.1.22. "Subsidiary" means any corporation of which the shares of stock
having a majority of the general voting power in electing the board of directors
are, at the time as of which any determination is being made, owned by the
corporation either directly or indirectly through Subsidiaries.
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1.1.23. "Triggering Amount" means the following amount in any 60-day
period ending in the applicable calendar year:
TRIGGERING AMOUNT CALENDAR YEAR
----------------- -------------
$3.45................................................. 1999
$4.25................................................. 2000
$5.15................................................. 2001
in each case as adjusted for stock splits, stock combinations, stock dividends
or reclassifications affecting the Common Stock after the date of filing of this
Certificate of Amendment. If the sixty (60) day period includes portions in two
calendar years, the Triggering Amount applicable shall be the average of the
figures shown above of the two years, weighted to reflect in number the days in
each year included such sixty (60) day period.
1.1.24. "Triggering Bid Price" means that the average of the high and low
bid price reported on (i) the principal national securities exchange on which
the Common Stock is then listed or admitted to trading, or (ii) if not so listed
or admitted, the NASD automated quotation system, on those days on which a bid
price was so reported during each period of sixty (60) consecutive calendar days
between January 1, 1999 and December 31, 2001.
1.1.25. "Triggering Event" means the consummation of a public offering
pursuant to an effective registration statement under the Securities Act of
1933, as amended, covering the offering and sale of shares of Common Stock or of
securities convertible into Common Stock (i) in which the aggregate proceeds to
the corporation exceed $10,000,000 and (ii) in which the price per share at
which the Common Stock is initially offered to the public equals or exceeds
$3.45 per share or the other securities are initially offered to the public with
a conversion price of $3.45 or more per share (in each case as adjusted for
stock splits, stock combinations, stock dividends or reclassifications affecting
the Common Stock after April 7, 1997).
1.2. Dividends. The corporation shall not, without the prior written
consent of the holders of a majority of the shares of Series C Preferred Stock
then outstanding, pay or declare any dividend or distribution on any Junior
Securities (other than on Common Stock, and on Series B Preferred Stock to the
extent of participation in dividends declared on the Common Stock). In the event
that the corporation declares a dividend or distribution on the Common Stock,
the holders of the Series C Preferred Stock and the holders of the Series B
Preferred Stock and the Common Stock shall share pro rata (based, in the case of
holders of Series C and Series B Preferred Stock, on the number of shares of
Common Stock which each holder of Series C and Series B Preferred Stock would be
entitled to receive upon conversion of its Series C and Series B Preferred Stock
into Common Stock, respectively) in such dividend or distribution; provided,
that if the dividend consists of voting securities or options, warrants, or
rights to acquire such voting securities, or securities convertible into or
exchangeable for such voting securities (the "Voting Securities") of the
corporation, the corporation shall make available to each holder of Series C-2
Preferred Stock, at such holder's request, dividends consisting of non-voting
securities or options, warrants or rights to acquire such non-voting securities,
or securities convertible into or exchangeable for such non-voting securities of
the corporation which are otherwise identical to the Voting Securities and which
are convertible into or exchangeable for such Voting Securities. In the
application of this Section 1.2, Series C and Series D Preferred Stock shall be
treated equally, pari passu.
1.3. Rights on Liquidation. In the event of any liquidation, the holders
of shares of the Series C Preferred Stock then issued and outstanding shall be
entitled to be paid the amount specified below out of the assets of the
corporation available for distribution to its stockholders, pari-passu with the
holders of the Series B Preferred Stock and before any payment shall be made to
the holders of any other Junior Securities. If, upon any Liquidation of the
corporation, the assets of the corporation available for distribution to its
stockholders (the "Available
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Assets") shall be insufficient (a "Liquidation Insufficiency") to pay the
holders of shares of the Series B Preferred Stock and Series C Preferred Stock
the full amounts to which they shall respectively be entitled, the holders of
the Series B Preferred Stock and Series C Preferred Stock shall be entitled to
receive the Available Assets as follows:
(i) the holders of Series C Preferred Stock shall be entitled to
receive (pro rata based on the number of shares of Series C Preferred Stock
held by them) an amount equal to the Available Assets times the quotient
derived by dividing (x) the amount of the Available Assets the holders of
Series C Preferred Stock would be entitled to upon Liquidation if there had
been no Liquidation Insufficiency by (y) the total amount of the Available
Assets the holders of Series B Preferred Stock and Series C Preferred Stock
would be entitled to upon Liquidation if there had been no Liquidation
Insufficiency; and
(ii) the holders of Series B Preferred Stock shall be entitled to
receive (pro rata based on the number of shares of Series B Preferred Stock
held by them) an amount equal to the Available Assets times the quotient
derived by dividing (x) the amount of the Available Assets the holders of
Series B Preferred Stock would be entitled to upon Liquidation if there had
been no Liquidation Insufficiency by (y) the total amount of the Available
Assets the holders of Series B Preferred Stock and Series C Preferred Stock
would be entitled to upon Liquidation if there had been no Liquidation
Insufficiency; and if there is no Liquidation Insufficiency, then the
holders of shares of the Series C Preferred Stock shall be entitled to
receive the greater of (a) an amount equal to the Adjusted Stated Value per
share, calculated to and including the date of Distribution with respect to
such shares of Series C Preferred Stock, or (b) the amount which would be
distributed in such liquidation on the shares of Common Stock into which
the series C Preferred Stock is convertible at the date of the Liquidation
of the corporation, had such Series C Preferred Stock been converted. In
the application of this Section 1.3, Series C and Series D Preferred Stock
shall be treated equally, pari passu.
1.4. Voting Power.
1.4.1. Series C-1 Preferred Stock.
(a) In General. Except as otherwise expressly provided herein or as
required by law,
(i) the holders of shares of Series C-1 Preferred Stock and Common
Stock shall vote together as a single class with respect to all matters
as to which stockholders of the corporation are entitled to vote;
provided, however, the holders of the Series C-1 Preferred Stock shall
not be entitled to vote with respect to the election of directors to the
Board of Directors of the corporation except with respect to the
election of the Series C Director as set forth in Section 1.4.1(b);
(ii) each holder of Series C-1 Preferred Stock shall be entitled to
cast a number of votes equal to the greatest number of whole shares of
Common Stock into which such holder's shares of Series C-1 Preferred
Stock could be converted, pursuant to the provisions of Section 1.6
hereof, at the record date for the determination of stockholders
entitled to vote on such matter or, if no such record date is
established, at the date such vote is taken or any written consent of
stockholders is first solicited.
(b) Election of Directors. As long as at least 20% of the shares of
Series C Preferred Stock originally issued are outstanding, the holders of
Series C-1 Preferred Stock shall have the right, voting separately as a
class, unless waived in writing by the holders of a majority of the
outstanding Series C-1 Preferred Stock, and to the exclusion of all other
classes of the corporation's stock, to elect, remove and replace (including
the filling of a vacancy) one (1) director to the Board of Directors of the
corporation (the "Series C Director"), which, so long as the Series C-1
Preferred Stock has the right to elect a director, shall be composed of no
more than twelve (12) directors. Any and all committees of the Board of
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Directors of the corporation shall have as a member the Series C Director,
unless no such director is willing or able to so serve. The special right
of the holders of Series C-1 Preferred Stock to elect and remove the Series
C Director contained in this Section 1.4.1(b) may be exercised either at a
special meeting of the holders of Series C-1 Preferred Stock called as
provided below, at any annual or special meeting of the stockholders of the
corporation, or by written consent of the holders of Series C-1 Preferred
Stock in lieu of a meeting. At any time when the holders of Series C-1
Preferred Stock have the special rights set forth in this Section 1.4.1(b),
the secretary of the corporation shall, upon the written request of the
holders of record of shares of Series C-1 Preferred Stock having at least
10% of the votes possessed by the then outstanding Series C-1 Preferred
Stock, call a special meeting of the holders of Series C-1 Preferred Stock
for the purpose of electing or removing the Series C Director. Such meeting
shall be held at the earliest practicable date at the corporation's
principal office or at such other place designated by the holders of Series
C-1 Preferred Stock having at least 10% of the votes possessed by the then
outstanding Series C-1 Preferred Stock. If such meeting shall not be called
by a proper officer of the corporation within ten (10) days after personal
service of such written request upon the secretary of the corporation or
within twenty (20) days after mailing the same to the secretary of the
corporation at the corporation's principal office, then the holders of
record of Series C-1 Preferred Stock having at least 10% of the votes
possessed by the then outstanding Series C-1 Preferred Stock may designate
in writing one of their number to call such meeting at the expense of the
corporation, and such meeting may be called by such persons so designated
upon the shortest legally permissible notice. Any holders of Series C-1
Preferred Stock so designated shall have reasonable access to the stock
books of the corporation during regular business hours, at the principal
office of the corporation or its transfer agent, for the purpose of calling
a meeting of the stockholders pursuant to these provisions.
At any stockholders meeting at which the holders of Series C-1
Preferred Stock shall have the special right to elect or remove the Series
C Director as provided in this Section 1.4.1(b), the presence, in person or
by proxy, of the holders of record of shares of Series C-1 Preferred Stock
having a majority of the votes possessed by the then outstanding Series C-1
Preferred Stock shall be required to constitute a quorum of the Series C-1
Preferred Stock for such election of removal. At any such meeting or
adjournment thereof, the absence of a separate quorum of the Series C
Preferred Stock shall not prevent the election of those directors to be
elected at such meeting, other than the Series C Director. In the absence
of a separate quorum of the Series C-1 Preferred Stock, the holders of
record of shares representing a majority of the voting power present in
person or by proxy of the Series C-1 Preferred Stock shall have power to
adjourn the meeting for the election of the Series C Director without
notice other than announcement at the meeting.
(c) Special Matters. The corporation shall not authorize, effect or
validate any of the following without (i) the consent in writing or by
votes at a meeting of the holders of at least 50% of all of the shares of
the Series C-1 Preferred Stock at the time outstanding, if any, voting
together as a separate class and to the exclusion of all other classes of
the corporation's stock or (ii) complying with the terms of Section 1.5.3.
below:
(i) Ten Percent Redemptions. Subject to Section 1.8 below,
directly or indirectly redeem, purchase or otherwise acquire, or permit
any Subsidiary to directly or indirectly redeem, purchase or otherwise
acquire, ten percent (10%) or more of any of the corporation's, or any
Subsidiary's (except wholly-owned Subsidiary's), outstanding equity
securities except as required by the terms of the Series C Preferred
Stock and other than pursuant to the terms of the agreements with
employees, officers, directors and consultants of the corporation,
pursuant to which the corporation may repurchase such shares upon the
occurrence of certain events, in all cases as in effect on April 7,
1997.
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(ii) Security Issuances. Authorize, issue, or enter into any
agreement providing for the issuance (contingent or otherwise) by the
corporation or any of its Subsidiaries of, (x) any notes or debt
securities convertible into or exchangeable for equity securities,
issued in connection with the issuance of equity securities or
containing profit participation features or (y) any equity securities
(or any securities convertible into or exchangeable for any equity
securities), provided, however, that this Section 1.4.1(c)(ii) shall not
prevent the issuance of Junior Securities, or securities convertible or
exchangeable for Junior Securities.
(iii) Mergers. Merge or consolidate with any Person or permit any
Subsidiary to merge or consolidate with any Person except for (i)
mergers of a wholly-owned Subsidiary with or into the corporation or any
other wholly-owned Subsidiary or (ii) mergers or consolidations in which
the corporation or Subsidiary is the surviving corporation and at the
conclusion of which the stockholders of the corporation immediately
preceding such consolidation or merger own greater than fifty percent
(50%) of the equity securities of the surviving corporation.
(iv) Liquidations. Liquidate, dissolve or effect a
recapitalization or reorganization in any form of transaction or make an
assignment for the benefit of creditors or admit in writing the
corporation's or any Subsidiary's inability to pay its debts generally
as they become due; or petition or apply to any tribunal for the
appointment of a custodian, trustee, receiver or liquidator of the
corporation or a Subsidiary, or of any substantial part of the assets of
the corporation or a Subsidiary, or commence any proceeding (other than
a proceeding for the voluntary liquidation and dissolution of a
Subsidiary) relating to the corporation or a Subsidiary under any
bankruptcy, reorganization, arrangement, insolvency, readjustment of
debt, dissolution or liquidation law of any jurisdiction.
(v) Certificate of Incorporation Amendments. Make or authorize any
amendment to the corporation's articles of incorporation or by-laws, or
any Subsidiary's organizational documents, or file any resolution of the
Board of Directors of the corporation or any Subsidiary, with the
Secretary of State or any other incorporation agency in the state in
which it is organized, in each case which would have the effect of
amending, altering or changing the designations, powers, preferences,
rights, privileges or restrictions of the Series C Preferred Stock or
otherwise have an adverse effect on the Series C Preferred Stock.
(vi) Affiliate Transactions. Enter into, or permit any subsidiary
to enter into, any transaction with any of its or any Subsidiary's
Affiliates, except for (i) normal employment arrangements and benefit
programs on reasonable terms, (ii) transactions among Universal and/or
one or more of its wholly-owned Subsidiaries, and (iii) transactions not
less favorable to Universal and its subsidiaries, taken as a whole, than
would be one entered into at arm's length with unaffiliated parties.
(vii) Sale of Assets. Sell, lease or otherwise dispose of, all or
substantially all assets of the corporation, directly or through a
Subsidiary of the corporation, in any transaction or series of related
transactions, including the sale by the corporation of any one of
American Pioneer Life Insurance Corporation or American Progressive Life
and Health Insurance corporation of New York (together, the "Insurance
Corporation Subsidiaries"). This Section 1.4.1(c)(vii) shall not,
however, prevent transactions in which ownership of assets is
transferred among Universal and/or one or more of its wholly-owned
Subsidiaries.
(viii) Indebtedness. Create, incur, assume or suffer to exist, or
permit the corporation and its Subsidiaries, taken as a whole, to
create, incur, assume or suffer to exist, Indebtedness in an aggregate
amount which result in the sum of (i) the aggregate
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principal amount of all Indebtedness outstanding, plus (ii) the par
value of all Preferred Stock outstanding, to exceed 80% of the statutory
book value (including "Asset Valuation Reserve" and "Interest
Maintenance Reserve") of both Insurance corporation Subsidiaries, except
(x) trade debt incurred in the normal course of business and (y)
Indebtedness, if any, provided for in the corporation's annual budget
approved by the Board of Directors.
The taking by the corporation of an action described in (i) through
(vi) above without obtaining the consent required by this Section
1.4.1(c) shall be referred to as a "Call Price Action" and the taking by
the corporation of an action described in (vii) and (viii) above without
first obtaining the consent required by this Section 1.4.1(c) shall be
referred to as an "Adjusted Stated Value Action."
1.4.2. Voting Rights of Series C-2 Preferred Stock. Except as set forth
herein or as otherwise required by law, no outstanding share of Series C-2
Preferred Stock shall be entitled to vote on any matter on which the
stockholders of the company shall be entitled to vote, and no shares of Series
C-2 Preferred Stock shall be included in determining the number of shares voting
or entitled to vote on any such matters; provided that the holders of Series C-2
Preferred Stock shall have the right to vote as a separate class on any merger
or consolidation of the corporation with or into another entity or entities, or
any recapitalization or reorganization, in which shares of Series C-2 Preferred
Stock would receive or be exchanged for consideration different on a per share
basis from consideration received with respect to or in exchange for the shares
of Series C-1 Preferred Stock or would otherwise be treated differently from
shares of Series C-1 Preferred Stock in connection with such transaction, except
that if the consideration received with respect to, or in exchange for, Series
C-1 includes voting securities, shares of Series C-2 Preferred Stock may,
without such a separate class vote, receive or be exchanged for non-voting
securities which are otherwise identical on a per share basis in amount and form
to the voting securities received with respect to or exchanged for the Series
C-1 Preferred Stock so long as (i) such non-voting securities are convertible
into such voting securities on the same terms as the Series C-2 Preferred Stock
is convertible into voting stock and (ii) all other consideration is equal on a
per share basis. Notwithstanding the foregoing, holders of shares of Series C-2
Preferred Stock shall be entitled to vote as a separate class on any amendment
to this paragraph (2) of this Section A and on any amendment, repeal or
modification of any provision of this Certificate of Incorporation that
adversely affects the powers, preferences or special rights of holders of the
Series C-2 Preferred Stock.
1.4.3. Series D Preferred Stock. In the application of this Section 1.4,
Series C-2 and Series D Preferred Stock shall be treated equally, pari passu.
1.5. Redemption.
1.5.1. Fixed Redemption. On December 31, 2002 (the "Fixed Redemption
Date") all of the then issued and outstanding Series C Preferred Stock shall be
redeemed at a redemption price (the "Fixed Redemption Price") equal to the
Adjusted Stated Value on December 31, 2002. One-half of the Fixed Redemption
Price shall be paid in cash to the person whose name appears in the records of
the corporation as the owner of the shares redeemed, by check mailed to such
person's address on such records on the Fixed Redemption Date, and the other
half shall be payable in the same manner, on the first anniversary of the Fixed
Redemption Date.
1.5.2. Call of the Corporation. The Series C Preferred Stock may be
redeemed by the corporation, at its option, upon ninety (90) days prior written
notice to the Holders, at the Call Price then in effect.
Such redemption may be effected under this Section 1.5.2 at any time after
January 1, 2000 and before December 31, 2002. The conversion right set forth in
Section 1.6.1 shall not be
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affected by the giving of a redemption notice hereunder until the close of
business the Business Day prior to the date specified in such notice as the
proposed effective date of the redemption.
1.5.3. Non-Compliance Provisions. If the corporation proposes to take any
action which constitutes either a Call Price Action or an Adjusted Stated Value
Action without securing the approval by vote or in writing required by Section
1.4.1(c) (each such action or breach, an "Event of Non-Compliance") then each of
the holders of the Series C Preferred Stock may require redemption of all or any
part of such holder's Series C Preferred Stock at a redemption price in cash
equal to (i) in the event of a Call Price Action, the Call Price in effect on
the Non-Compliance Redemption Date and (ii) in the event of an Adjusted Stated
Value Action, the Adjusted Stated Value in effect on the Non-Compliance
Redemption Date. In implementation of this Section 1.5.3:
(a) At least 15 days before the consummation of any Event of
Non-Compliance, each holder of Series C Preferred Stock will receive a
notice from the corporation (i) stating that an Event of Non-Compliance is
contemplated, (ii) setting forth a redemption date (the "Non-Compliance
Redemption Date"), which shall be the date of the Event of Non-Compliance,
(iii) setting forth the Conversion Price in effect with respect to such
shares of Series C Preferred Stock, up to and including the date of
consummation of the Event of Non-Compliance, and (iv) stating that during
such 15-day period, each stockholder wishing to require the corporation to
redeem all or any part of its Series C Preferred Stock, pursuant to
subsection (b) below, must give the corporation written notice of its
intention to require such redemption prior to the consummation of the Event
of Non-Compliance.
(b) Any holder of Series C-1 Preferred Stock that withheld its consent
to the Event of Non-Compliance and any holder of Series C-2 Preferred Stock
that has advised the corporation in writing prior to consummation of an
Event of Non-Compliance of its intention to require the corporation to
redeem its shares, may require that the corporation redeem any shares
hereunder by surrendering its shares to the corporation on the
Non-Compliance Redemption Date or within thirty (30) days thereafter and
will be entitled to payment therefor within ten (10) days of such surrender
in full satisfaction of such shares.
(c) Any holder of shares of Series C-1 Preferred Stock that does not
tender such shares pursuant to Section 1.5.3(b) above shall be deemed to
have consented to the subject Event of Non-Compliance.
(d) It is an express condition of this Series C Preferred Stock that
this Section 1.5.3 shall constitute the sole remedy of the Series C
Preferred Stockholders with respect to the corporation's failure to obtain
the consent otherwise required by Section 1.4.1(c) above. Without
limitation, there shall be no right to injunctive or any other kind of
equitable relief, or to any other remedy at law whatsoever, by virtue of
the corporation's failure to obtain the consent otherwise required by
Section 1.4.1(c) above with respect to such Event of Non-Compliance.
1.5.4. Failure to Pay Redemption Price or Installment. If payment of the
Fixed Redemption Price is not made as provided in Section 1.5.1 and said default
is not cured within fifteen (15) days, the holder of each share of Series C
Preferred Stock which was redeemed shall be entitled to require the corporation
to issue a promissory note for the unpaid portion of the Fixed Redemption Price,
including any amount which would otherwise not have been payable until the first
anniversary of the Fixed Redemption Date, which note shall be due one year after
the Fixed Redemption Date (or the first anniversary thereof, whichever is
applicable), together with interest at twenty (20%) percent per annum until
paid, subject to pre-payment at any time, with interest accrued, without
penalty. Any such promissory note shall contain substantially the same terms and
conditions of the Series C Preferred Stock, including negative and affirmative
covenants equal to the rights of the holders of the Series C-1 Preferred Stock
set forth in
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Section 1.4.1(c) and board observation rights comparable to the rights of the
holders of Series C-1 Preferred Stock set forth in Section 1.4.1(b).
1.5.5. Legal Availability. If the funds of the corporation legally
available for redemption of Series C Preferred Stock on any Redemption Date are
insufficient to redeem the total number of Series C Preferred Stock to be
redeemed on such date, those funds which are legally available shall be used to
redeem the maximum possible number of Series C Preferred Stock ratably among the
holders of the Series C Preferred Stock to be redeemed. At any time thereafter
when additional funds of the corporation are legally available for the
redemption of Series C Preferred Stock, such funds shall immediately be used to
redeem the balance of the Series C Preferred Stock which the corporation has
become obligated to redeem on any Redemption Date but which it has not redeemed.
In case fewer than the total number of Series C Preferred Shares represented by
any certificate are redeemed, a new certificate representing the number of
unredeemed Series C Preferred Stock shall be issued to the holder thereof
without cost to such holder within three Business Days after surrender of the
certificate representing the redeemed Series C Preferred Stock. In the event
that any Series C Preferred Stock is redeemed under Section 1.5.1, 1.5.2 or
1.5.3 and the certificates for the Series C Preferred Stock to be redeemed have
not been delivered to the corporation, from and after the date on which the
corporation makes the entire Fixed Redemption Price or Call Price, as the case
may be, available or irrevocably deposits an amount equal to such Fixed
Redemption Price or Call Price, as the case may be, for the shares of Series C
Preferred Stock to be redeemed in trust for the holders of such shares with a
bank having capital and surplus in excess of $100 million, which bank shall be
named in the redemption notice, all rights of the holders of such Series C
Preferred Stock, except the right to receive the Fixed Redemption Price or Call
Price, as the case may be (whether in cash or in the form of the promissory note
provided for in Section 1.5.4, above, without interest except as provided with
respect to the promissory note), upon surrender of their certificate or
certificates, shall cease with respect to such shares, and such shares shall not
thereafter be transferred on the books of the corporation or be deemed to be
outstanding for any purpose whatsoever.
1.5.6. Other Redemptions or Acquisitions. Neither the corporation nor any
Subsidiary shall redeem or otherwise acquire any share of Series C Preferred
Stock, except as expressly authorized herein or pursuant to a purchase offer
made pro rata to all holders of Series C Preferred Stock on the basis of the
number of shares owned by each such holder.
1.5.7. Series D Preferred Stock. In the application of this Section 1.5,
Series C and Series D Preferred Stock shall be treated equally, pari passu.
1.6. Conversion Rights.
1.6.1. At the Option of the Holder. Each holder of the outstanding shares
of Series C Preferred Stock shall have the right to convert all or any portion
of such shares of Series C Preferred Stock into the number of fully paid and
non-assessable shares of Common Stock computed by multiplying the number of
shares of Series C Preferred Stock to be converted times the Stated Value and
dividing the result by the Conversion Price. Within 15 days of any such
conversion of Series C-2 Preferred Stock into Common Stock, such converted
shares may be converted back into the same number of Series C-2 Preferred
Shares, provided that such shares were not voted following the initial
conversion of Series C-2 Preferred Stock into Common Stock. Series C Preferred
Stock may be converted by the holder thereof during normal business hours on any
Business Day by surrender of the required number of shares of Series C Preferred
Stock, accompanied by written evidence (in form reasonably satisfactory to the
corporation) of the holder's election to convert such holder's Series C
Preferred Stock or portion thereof, to the corporation at its principal
executive offices.
1.6.2. At the Option of a Transferee of Series C-2 Preferred
Stock. Subject to Section 1.6.4, below, each outstanding share of Series C-2
Preferred Stock may be converted into one fully
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paid and nonassessable share of Series C-1 Preferred Stock by any transferee of
such shares of Series C-2 Preferred Stock, provided that each holder of Series
C-2 Preferred Stock may convert such shares into Series C-1 Preferred Stock if
such holder reasonably believes that such converted shares will be transferred
within fifteen (15) days pursuant to a Conversion Event and such holder agrees
not to vote any such shares of Series C-1 Preferred Stock prior to such
Conversion Event and undertakes to promptly convert such shares back into Series
C-2 Preferred Stock if such shares are not transferred pursuant to a Conversion
Event. Series C-2 Preferred Stock may be converted by the transferee during
normal business hours on any Business Day by surrender of the certificate or
certificates representing the Series C-2 Preferred Stock (or, if no stock
certificate has yet been issued to the holder of the Series C-2 Preferred Stock,
a written statement that the holder has not yet received a stock certificate and
instructing the corporation to treat such certificate, when and if issued, as if
such certificate had been surrendered by the holder) to the corporation at its
principal executive offices. The surrendered certificate or certificates shall
be accompanied by written evidence (in form reasonably satisfactory to the
corporation) of the transferee's election to convert its Series C-2 Preferred
Stock or portion thereof.
1.6.3. At the Option of the Corporation. Upon the occurrence of a
Triggering Event, or if the Triggering Bid Price for any period of sixty (60)
consecutive calendar days has exceeded the Triggering Amount, the corporation
may require that each of the outstanding shares of Series C Preferred Stock be
converted into Common Stock computed by multiplying the number of shares of
Series C Preferred Stock to be converted times the Stated Value and dividing the
result by the Conversion Price in effect at the time of such conversion. Such
right may be exercised by written notice to the holders thereof given (i) not
less than ten (10) days prior to the date of closing of a Triggering Event or
(ii) within thirty (30) days after the end of any sixty (60) day period in which
the Triggering Bid Price has exceeded the Triggering Amount, which notice shall
specify the record date set for conversion. Such conversion shall be effected,
automatically and without any further action by the holders of such shares and
whether or not the certificates representing such shares are surrendered to the
corporation or its transfer agent.
1.6.4. Restricted Stock. Series C-2 Preferred Stock constituting
Restricted Stock with respect to a particular Regulated Stockholder may not be
converted into Common Stock or Series C-1 Preferred Stock to the extent that
immediately prior thereto, or as a result of such conversion, the number of
shares of Common Stock or Series C-1 Preferred Stock which constitute such
Restricted Stock held by all holders thereof would exceed the number of shares
of Common Stock or Series C-1 Preferred Stock which such Regulated Stockholder
reasonably determines it and its Affiliates may own, control or have the power
to vote under any law, regulation, rule or other requirement of any governmental
authority at the time applicable to such Regulated Stockholder or its
Affiliates. Each Regulated Stockholder may provide for further restrictions upon
the conversion of any shares of Restricted Stock by providing the corporation
with signed, written instruction specifying such additional restrictions and
legending such shares as to the existence of such restrictions.
1.6.5. Conversion Procedure. Upon the conversion of Series C Preferred
Stock, the holders of such Series C Preferred Stock shall surrender the
certificates representing such shares at the office of the corporation. The
corporation shall not be obligated to issue certificates evidencing the shares
of stock issuable upon such conversion unless certificates evidencing such
shares of Series C Preferred Stock being converted are either delivered to the
corporation or the holder notifies the corporation that such certificates have
been lost, stolen, or destroyed and delivers to the corporation an agreement
satisfactory to the corporation, with a surety satisfactory to the corporation,
to indemnify the corporation from any loss incurred by it in connection
therewith.
1.6.6. Time of Conversion. Each conversion of Series C Preferred Stock
pursuant to Sections 1.6.1 and 1.6.2 shall be deemed to have been effected
immediately prior to the close of
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business on the Business Day on which such Series C Preferred Stock shall have
been surrendered to the corporation as provided herein (except that, in the case
of a conversion subject to Section 1.6.7 below, the conversion shall be deemed
to be effective upon the expiration of the Deferral Period referred to therein).
Each conversion pursuant to Section 1.6.3 shall be deemed to have been effected
as of the record date specified in the notice therefor, and such conversion
shall be at the Conversion Price in effect at such time (except that, in the
case of a conversion subject to Section 1.6.7 below, the conversion shall be
deemed to be effective upon the expiration of the Deferral Period referred to
therein). On each such day that the conversion of shares of Series C Preferred
Stock is deemed effected, the Person or Persons in whose name or names any
certificate or certificates for shares of stock are issuable upon such
conversion shall be deemed to have become the holder or holders of record
thereof.
1.6.7. Notice of Conversion to Regulated Stockholders. The corporation
shall not convert or directly or indirectly redeem, purchase or otherwise
acquire any shares of any class of capital stock of the corporation or take any
other action affecting the voting rights of such shares, if such action will
increase the percentage of any class of outstanding voting securities owned or
controlled by any Regulated Stockholder (other than any such stockholder which
requested that the corporation take such action, or which otherwise waives in
writing its rights under this Section 1.6.7), unless the corporation gives
written notice (the "Deferral Notice") of such action to each Regulated
Stockholder. The corporation will defer making any such conversion, redemption,
purchase or other acquisition, or taking any such other action for a period of
twenty (20) days (the "Deferral Period") after giving the Deferral Notice in
order to allow each Regulated Stockholder to determine whether it wishes to
convert or take another action with respect to the stock it owns, controls or
has the power to vote, and if any such Regulated Stockholder then elects to
convert any shares of its stock, it shall notify the corporation in writing
within ten (10) days of the issuance of the Deferral Notice, in which case the
corporation shall (i) promptly notify from time to time prior to the end of such
20-day period each other Regulated Stockholder holding shares of each proposed
conversion, and (ii) effect the conversions requested by all Regulated
Stockholders in response to the notices issued pursuant to this Section 1.6.7 at
the end of the Deferral Period. Upon complying with the procedures herein above
set forth in this Section 1.6.7, the corporation may so convert or directly or
indirectly redeem, purchase or otherwise acquire any shares of any other class
of capital stock of the corporation or take any other action affecting the
voting rights of such shares.
1.6.8. Issuance of Certificate for Common Stock. As promptly as practical
after the conversion of shares of Series C Preferred Stock, in whole or in part,
and in any event within five (5) Business Days thereafter, the corporation at
its expense (including the payment by it of any applicable issue, stamp or other
taxes, other than any income taxes and other than any taxes arising by reason of
issuance of shares of stock to any Person other than such holder) will cause to
be issued in the name of and delivered to the holder thereof or as such holder
may direct, a certificate or certificates for the number of shares of stock to
which such holder shall be entitled upon such conversion; provided, however,
that if such conversion is subject to Section 1.6.7 above, the corporation shall
not issue such certificate or certificates until the expiration of the Deferral
Period referred to therein. In case fewer than all the shares of Series C
Preferred Stock represented by any surrendered certificate are converted, a new
certificate representing the shares of Series C Preferred Stock not converted
shall be issued without cost to the holder thereof.
1.6.9. Books of Corporation. The corporation will not close its books
against the transfer of Series C Preferred Stock or of stock issued or issuable
upon conversion of Series C Preferred Stock in any manner which interferes with
the timely conversion of Series C Preferred Stock. The corporation shall at all
times reserve and keep available out of its authorized but unissued shares of
Common Stock and Series C-1 Preferred Stock, solely for the purpose of issuance
upon the conversion of the Series C Preferred Stock, such number of shares of
Common Stock issuable
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upon the conversion of all outstanding Series C Preferred Stock and such number
of shares of Series C-1 Preferred Stock issuable upon the conversion of all
outstanding Series C-2 Preferred Stock. All shares of Common Stock which are so
issuable shall, when issued, be duly and validly issued, fully paid and
nonassessable and free from all taxes, liens and charges. The corporation shall
take all such actions as may be necessary to assure that all such shares of
Common Stock and Series C-1 Preferred Stock may be so issued without violation
of any applicable law or governmental regulation or any requirements of any
domestic securities exchange upon which shares of Common Stock and Series C-1
Preferred Stock may be listed (except for official notice of issuance which
shall be immediately delivered by the corporation upon each such issuance).
1.6.10. Series D Preferred Stock. In the application of this Section 1.6,
Series C and Series D Preferred Stock shall be treated equally, pari passu.
1.7. Anti-Dilution Adjustments. The number of shares of Common Stock
issuable upon any conversion provided for in Section 1.6 shall be subject to
adjustment, from time to time, in accordance with the following provisions:
1.7.1. Issuance of Additional Shares of Common Stock. In case the
corporation at any time or from time to time after the date hereof shall issue
or sell Additional Shares of Common Stock (including Additional Shares of Common
Stock deemed to be issued pursuant to Section 1.7.2 or 1.7.3) without
consideration or for a consideration per share less than the Conversion Price in
effect immediately prior to such issue or sale, then, in each such case, subject
to Section 1.7.7, such Conversion Price shall be reduced, concurrently with such
issue or sale, to a price (calculated to the nearest .001 of a cent) determined
by multiplying such Conversion Price by a fraction
(a) the numerator which shall be (i) the number of shares of Common
Stock into which the outstanding Series C Preferred Stock is convertible
immediately prior to such issue or sale plus (ii) the number of shares of
Common Stock which the aggregate consideration received by the corporation
for the total number of such Additional Shares of Common Stock so issued or
sold would purchase at such Conversion Price, and
(b) the denominator of which shall be (i) the number of shares of
Common Stock into which the outstanding Series C Preferred Stock is
convertible immediately prior to such issue or sale plus (ii) the number of
Additional Shares so issued or sold immediately after such issue or sale,
provided that, for the purposes of this Section 1.7.1, (x) immediately
after any Additional Shares of Common Stock are deemed to have been issued
pursuant to Section 1.7.2 or 1.7.3, such Additional Shares shall be deemed
to be outstanding and (y) treasury shares shall not be deemed to be
outstanding.
1.7.2. Treatment of Options and Convertible Securities. In case the
corporation at any time or from time to time after the date hereof shall issue,
sell, grant or assume, or shall fix a record date for the determination of
holders of any class of securities entitled to receive, any Options or
Convertible Securities, then and in each such case, the maximum number of
Additional Shares of Common Stock (as set forth in the instrument relating
thereto, without regard to any provisions contained therein for a subsequent
adjustment of such number) issuable upon the exercise of such Options or, in the
case of Convertible Securities and Options therefor, the conversion or exchange
of such Convertible Securities, shall be deemed to be additional Shares of
Common Stock issued as of the time of such issue, sale, grant or assumption or,
in case such a record date shall have been fixed, as of the close of business on
such record date (or, if the Common Stock trades on an ex-dividend basis, on the
date prior to the commencement of ex-dividend trading), provided that such
Additional Shares of Common Stock shall not be deemed to have been issued unless
the consideration per share (determined pursuant to Section 1.7.4) of such
shares would be less than the Conversion Price in effect on the date of and
immediately prior to such issue, sale, grant or assumption or immediately prior
to the close of business on such record date (or, if the Common Stock trades on
an ex-dividend basis, on the date prior to the
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commencement of ex-dividend trading), as the case may be, and provided, further,
that in any such case in which Additional Shares of Common Stock are deemed to
be issued
(a) no further adjustment of the Conversion Price shall be made upon
the subsequent issue or sale of Convertible Securities or shares of Common
Stock upon the exercise of such Options or the conversion or exchange of
such Convertible Securities;
(b) if such Options or Convertible Securities by their terms provide,
with the passage of time or otherwise, for any increase in the
consideration payable to the corporation, or decrease in the number of
Additional Shares of Common Stock issuable, upon the exercise, conversion
or exchange thereof (by change of rate or otherwise), the Conversion Price
computed upon the original issue, sale, grant or assumption thereof (or
upon the occurrence of the record date, or date prior to the commencement
of ex-dividend trading, as the case may be, with respect thereto), and any
subsequent adjustments based thereon, shall, upon any such increase or
decrease becoming effective, be recomputed to reflect such increase or
decrease insofar as it affects such Options, or the rights of conversion or
exchange under such Convertible Securities, which are outstanding at such
time;
(c) upon the expiration (or purchase by the corporation and
cancellation or retirement) of any such Options which shall not have been
exercised or the expiration of any rights of conversion or exchange under
any such Convertible Securities which shall not have been exercised (or
purchase by the corporation and cancellation or retirement of any such
Convertible Securities the rights of conversion or exchange under which
shall not have been exercised), the Conversion Price computed upon the
original issue, sale, grant or assumption (or upon the occurrence of the
record date, or date prior to the commencement of ex-dividend trading, as
the case may be, with respect thereto), and any subsequent adjustments
based thereon, shall, upon such expiration (or such cancellation or
retirement, as the case may be), be recomputed as if:
(i) in the case of Options for Common Stock or Convertible
Securities, the only Additional Shares of Common Stock issued or sold
were the Additional Shares of Common Stock, if any, actually issued or
sold upon the exercise of such Options or the conversion or exchange of
such Convertible Securities and the consideration received therefor was
the consideration actually received by the corporation for the issue,
sale, grant or assumption of all such options, whether or not exercised,
plus the consideration actually received by the corporation upon such
exercise, or for the issue or sale of all such Convertible Securities
which were actually converted or exchanged plus the additional
consideration, if any, actually received by the corporation upon such
conversion or exchange, and
(ii) in the case of Options for Convertible Securities, only the
Convertible Securities, if any, actually issued or sold upon the
exercise of such Options were issued at the time of the issue, sale,
grant or assumption of such Options, and the consideration received by
the corporation for the Additional Shares of Common Stock deemed to have
then been issued was the consideration actually received by the
corporation for the issue, sale, grant or assumption of all such
Options, whether or not exercised, plus the consideration deemed to have
been received by the corporation (pursuant to Section 1.7.4) upon the
issue or sale of such Convertible Securities with respect to which such
Options were actually exercised;
(d) no readjustment pursuant to subdivision (b) or (c) above shall
have the effect of increasing the Conversion Price by an amount in excess
of the amount of the adjustment thereof originally made in respect of the
issue, sale, grant or assumption of such Options or Convertible Securities;
and
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(e) in the case of any such Options which expire by their terms not
more than thirty (30) days after the date of issue, sale, grant or
assumption thereof, no adjustment of the Conversion Price shall be made
until the expiration or exercise of all such Options, whereupon such
adjustment shall be made in the manner provided in subdivision (c) above.
1.7.3. Treatment of Stock Dividends, Stock Splits, etc. In case the
corporation at any time or from time to time after the date hereof shall declare
or pay any dividend on the Common Stock payable in Common Stock, or shall effect
a subdivision of the outstanding shares of Common Stock into a greater number of
shares of Common Stock (by reclassification or otherwise than by payment of a
dividend in Common Stock), then, and in each such case, Additional Shares of
Common Stock shall be deemed to have been issued (a) in the case of any such
dividend, immediately after the close of business on the record date for the
determination of holders of any class of securities entitled to receive such
dividend, or (b) in the case of any such subdivision, at the close of business
on the date immediately prior to the day upon which such corporate action
becomes effective.
1.7.4. Computation of Consideration. For the purposes of this Section
1.7,
(a) the consideration for the issue or sale of any Additional Shares
of Common Stock shall, irrespective of the accounting treatment of such
consideration,
(i) insofar as it consists of cash, be computed at the net amount
of cash received by the corporation, without deducting any expenses paid
or incurred by the corporation or any commissions or compensation paid
or concessions or discounts allowed to underwriters, dealers or others
performing similar services in connection with such issue or sale,
(ii) insofar as it consists of property (including securities)
other than cash, be computed at the fair value thereof at the time of
each issue or sale, as determined in good faith by the Board of
Directors of the corporation (subject to confirmation by a firm of
independent certified public accountants of recognized national standing
approved by either the holders of a majority of the Series C Preferred
Stock or the Series C Director), and
(iii) in case Additional Shares of Common Stock are issued or sold
together with other stock or securities or other assets of the
corporation for a consideration which covers both, be the portion of
such consideration so received, computed as provided in clauses (i) and
(ii) above, allocable to such Additional Shares of Common Stock, all as
determined in good faith by the Board of Directors of the corporation
(subject to confirmation by a firm of independent certified public
accountants of recognized national standing approved by either the
holders of a majority of the Series C Preferred Stock or the Series C
Director);
(b) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.2, relating to Options and Convertible Securities,
shall be deemed to have been issued for a consideration per share
determined by dividing
(i) the total amount, if any, received and receivable by the
corporation as consideration for the issue, sale, grant or assumption of
the Options or Convertible Securities in question, plus the minimum
aggregate amount of additional consideration (as set forth in the
instruments relating thereto, without regard to any provision contained
therein for a subsequent adjustment of such consideration to protect
against dilution) payable to the corporation upon the exercise in full
of such Options or the conversion or exchange of such Convertible
Securities or, in the case of Options for Convertible Securities, the
exercise of such Options for Convertible Securities and the conversion
or exchange of such Convertible Securities, in each case computing such
consideration as provided in the foregoing subdivision (a),
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by
(ii) the maximum number of shares of Common Stock (as set forth in
the instruments relating thereto, without regard to any provision
contained therein for a subsequent adjustment of such number to protect
against dilution) issuable upon the exercise of such Options or the
conversion or exchange of such Convertible Securities; and
(c) Additional Shares of Common Stock deemed to have been issued
pursuant to Section 1.7.3, relating to stock dividends, stock splits, etc.,
shall be deemed to have been issued for no consideration.
1.7.5. Adjustments for Combinations, etc. In case the outstanding shares
of Common Stock shall be combined or consolidated, by reclassification or
otherwise, into a lesser number of shares of Common Stock, the Conversion Price
in effect immediately prior to such combination or consolidation shall,
concurrently with the effectiveness of such combination or consolidation, be
proportionately increased.
1.7.6. Dilution in Case of Other Securities. In case any Other Securities
shall be issued or sold or shall become subject to issue or sale upon the
conversion or exchange of any stock (or Other Securities) of the corporation (or
any issuer of Other Securities or any other Person referred to in Section 1.9)
or to subscription, purchase or other acquisition pursuant to any Options issued
or granted by the corporation (or any such other issuer or Person) for a
consideration such as to dilute, on a basis consistent with the standards
established in the other provisions of this Section 1.7, the conversion rights
granted to holders of Series C Preferred Stock, then, and in each such case, the
computations, adjustments and readjustments provided for in this Section 1.7
with respect to the Conversion Price shall be made as nearly as possible in the
manner so provided and applied to determine the amount of Common Stock from time
to time receivable upon the conversion of the shares of Series C Preferred
Stock, so as to protect the holders of the Series C Preferred Stock against the
effect of such dilution.
1.7.7. Minimum Adjustment of Conversion Price. If the amount of any
adjustment of the Conversion Price required pursuant to this Section 1.7 would
be less than five percent (5%) of the Conversion Price in effect at the time
such adjustment is otherwise so required to be made, such adjustment shall not
then be made and such amount shall be carried forward and adjustment with
respect thereto made at the time of and together with any subsequent adjustment
which, together with such amount and any other amount or amounts so carried
forward, shall aggregate at least five percent (5%) of such Conversion Price.
Notwithstanding the foregoing, the Conversion Price shall be adjusted at the
time of, and be effective with respect to, any conversion or redemption of any
shares of Series C Preferred Stock.
1.7.8. Reorganization, Reclassification, Consolidation, Merger or Sale.
(a) Corporation Survives. Upon the consummation of an Organic Change
(other than a transaction in which the corporation is not the surviving
entity) the terms of the Series C Preferred Stock shall be deemed modified,
without payment of any additional consideration therefor, so as to provide
that upon the conversion of shares of Series C Preferred Stock following
the consummation of such Organic Change, the holder of such shares of
Series C Preferred Stock shall have the right to acquire and receive (in
lieu of or in addition to the shares of Common Stock acquirable and
receivable prior to the Organic Change) such shares of stock, securities or
assets as such holder would have received if such holder had converted its
shares of Series C Preferred Stock into Common Stock immediately prior to
such Organic Change, in each case giving effect to any adjustment of the
Conversion Price made after the date of consummation of the Organic Change.
All other terms of the Series C Preferred Stock shall remain in full force
and effect following such an Organic Change. The provisions of this Section
1.7.8(a) shall similarly apply to successive Organic Changes.
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(b) Corporation Does Not Survive. No Organic Change that is a
transaction in which the corporation is not the surviving entity shall
become effective unless the surviving entity shall have issued new
securities to the holders of shares of Series C Preferred Stock, without
payment of any additional consideration therefor, with terms that provide
that upon the conversion of such securities following the consummation of
such Organic Change, the holder of such securities shall have the right to
acquire and receive (in lieu of or in addition to the shares of Common
Stock acquirable and receivable prior to the Organic Change) such shares of
stock, securities or assets as such holder would have received if such
holder had converted its shares of Series C Preferred Stock into Common
Stock immediately prior to such Organic Change, in each case giving effect
to any adjustment of the Conversion Price of such new securities made after
the date of consummation of the Organic Change on an equivalent basis to
the adjustments provided for the Conversion Price herein. All other terms
of the new securities shall be equivalent to the terms of the Series C
Preferred Stock provided for herein. The provisions of this Section
1.7.8(b) shall similarly apply to successive Organic Changes.
1.7.9. Series D Preferred Stock. In the application of this Section 1.7,
Series C and Series D Preferred Stock shall be treated equally, pari passu.
1.8. Restrictions on Redemptions, Purchases and Acquisitions. The
corporation shall not redeem, purchase, acquire or take any other action
affecting outstanding shares of stock if, after giving effect to such
redemption, purchase, acquisition or other action, a Regulated Stockholder would
own more than 4.99% of any class of voting securities of the corporation (other
than any class of voting securities which is (or is made prior to any such
redemption, purchase, acquisition or other action) convertible into a class of
non-voting securities which are otherwise identical to the voting securities and
convertible into such voting securities on terms reasonably acceptable to such
Regulated Stockholder) or more than 24.99% of the total equity of the
corporation or more than 24.99% of the total value of all capital stock and
subordinated debt of the corporation (in each case determined by assuming such
Regulated Stockholder (but no other holder) has exercised, converted or
exchanged all of its options, warrants and other convertible or exchangeable
securities). The corporation shall not be a party to a merger, consolidation,
recapitalization, reorganization or other transaction pursuant to which a
Regulated Stockholder would be required to take any securities or subordinated
debt which might reasonably be expected to cause such person to have a
Regulatory Problem. In the application of this Section 1.8, the Series C and
Series D Preferred Stock shall be treated equally, pari passu.
1.9. Notices.
(a) Immediately upon any adjustment of the Conversion Price, the
corporation will give written notice thereof to all holders of Series C
Preferred Stock.
(b) The corporation will give written notice to all holders of Series C
Preferred Stock at least twenty (20) days prior to the date on which the
corporation closes its books or takes a record (1) with respect to any dividend
or distribution upon Common Stock, (2) with respect to any pro rata subscription
offer to holders of Common Stock or (3) for determining rights to vote with
respect to any Organic Change, dissolution or liquidation.
(c) The corporation will also give written notice to the holders of Series
C Preferred Stock at least twenty (20) days prior to the date on which any
Organic Change will take place.
(d) All notices which are required or may be given pursuant to the terms of
this Article shall be in writing and shall be delivered personally (and
receipted for) or by facsimile (provided receipt is acknowledged in writing),
certified mail, return receipt requested, postage prepaid, or by Federal Express
or other recognized overnight courier, and any such notice shall be deemed
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effective when delivered. In the application of this Section 1.9, the Series C
and Series D Preferred Stock shall be treated equally, pari passu.
1.10. Other Rights.
1.10.1. Purchase Rights. If at any time the corporation distributes,
grants or sells any Options, Convertible Securities or rights to purchase stock,
warrants, securities or other property to all record holders of any class of
Common Stock (the "Purchase Rights"), then each holder of Series C Preferred
Stock will be entitled to acquire, upon the terms applicable to such Purchase
Rights, the aggregate Purchase Rights which such holder could have acquired if
such holder had held the number of shares of Common Stock acquirable upon
conversion of such holder's Series C Preferred Stock immediately before the date
on which a record is taken for the grant, issuance or sale of such Purchase
Rights, or, if no such record is taken, the date as of which the record holders
of Common Stock are to be determined for the distribution, issue or sale of such
Purchase Rights. In the application of this Section 1.10.1, Series C and Series
D Preferred Stock shall be treated equally, pari passu.
1.10.2. Pre-Emptive Rights. If the corporation authorizes the issuance
and sale of any Additional Shares of Common Stock, other than a sale to the
public, the corporation will offer to sell to the holders of Series C Preferred
Stock, and each holder of Series C Preferred Stock may elect to purchase, up to
that number of Additional Shares of Common Stock such that following such
purchase, the holder is able to maintain the same percentage ownership (on a
fully-diluted basis) of the outstanding shares of Common Stock of the
corporation which such holder possessed by virtue of its ownership of shares of
Series C Preferred Stock (or Common Stock issued upon the conversion thereof)
immediately prior to the issuance and sale of the Additional Shares of Common
Stock. Holders of Series C Preferred Stock will be entitled to purchase the
Additional Shares of Common Stock at the same price and upon the same terms as
such shares of Common Stock are being offered to any other Persons; provided
that, if such Persons are to pay for such Additional Securities in whole or in
part with consideration other than cash, then the Board of Directors shall make
a good faith determination of the fair market value of such non-cash
consideration and the holders of the Series C Preferred Stock will be entitled
to pay cash equal to the fair market value of the non-cash consideration such
holders would otherwise pay hereunder in the purchase of such Additional Shares
of Common Stock. Notwithstanding the foregoing, a holder of Series C Preferred
Stock will not be permitted to exercise its rights under this Section 1.10.2
unless such holder agrees to purchase all securities offered as a package or
unit in the issuance of the Additional Shares of Common Stock. The corporation
must give written notice of the issuance of Additional Shares of Common Stock,
which notice shall set forth the price and other terms of such issuance, to the
holders of Series C Preferred Stock no later than thirty (30) days following the
issuance date of the Additional Shares of Common Stock (the "Issuance Date").
Upon receipt of such notice, the holders may exercise the right granted by this
Section 1.10.2 by giving written notice to the Company within thirty (30) days
following receipt of the aforesaid notice, which written notice from a holder
shall specify the number of Additional Shares of Common Stock being purchased by
such holder, and be accompanied by a cashier's or certified check in the full
amount of the price for the Additional Shares of Common Stack being purchased.
The corporation shall promptly make delivery to such holders of certificates for
the Additional Shares of Common Stock or other securities upon execution of such
documents and instruments as shall govern the issuance of such Additional Shares
of Common Stock or other Securities. Notwithstanding the foregoing, if a holder
of Series C Preferred Stock shall exercise its rights under this Section 1.10.2
such holder shall not be required to pay for the Additional Shares of Common
Stock purchased by it unless and until all other parties have paid for their
Additional Shares of Common Stock. In addition, if a holder of Series C
Preferred Stock shall exercise its rights under this Section 1.10.2 following
the Issuance Date, then such holder shall be deemed to have owned the Additional
Shares of Common Stock purchased by it as of the Issuance Date for the purpose
of any benefits of ownership relating to
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such Additional Shares of Common Stock, including the right to receive cash or
stock dividends declared or other distributions, to participate in a merger or
reorganization or to reflect any reclassification of Additional Shares of Common
Stock between the Issuance Date and the date upon which such holder purchases
the Additional Shares of Common Stock.
1.11. Registration of Transfer. The corporation will keep at its
principal office or at the principal office of its transfer agent a register for
the registration of the Series C Preferred Stock. Upon the surrender of any
certificate representing Series C Preferred Stock at such place, the corporation
will, at the request of the record holder of such certificate, execute and
deliver (at the corporation's expense) a new certificate or certificates in
exchange therefor representing in the aggregate the number of shares of Series C
Preferred Stock represented by the surrendered certificate. Each such new
certificate will be registered in such name and will represent such number of
shares of Series C Preferred Stock as is requested by the holder of the
surrendered certificate and will be substantially identical in form to the
surrendered certificate; provided, however, that any transfer shall be subject
to any applicable restrictions on the transfer of such shares and the payment of
any applicable transfer taxes, if any, by the holder thereof.
1.12. Replacement. Upon receipt of evidence reasonably satisfactory to
the corporation (an affidavit of the registered holder will be satisfactory) of
the ownership and the loss, theft, destruction or mutilation of any certificate
evidencing shares of Series C Preferred Stock, and in the case of any such loss,
theft or destruction, upon receipt of indemnity reasonably satisfactory to the
corporation (provided that if the holder is an institutional investor its own
agreement will be satisfactory), or, in the case of any such mutilation, upon
surrender of such certificate, the corporation will (at its expense) execute and
deliver in lieu of such certificate a new certificate of like kind representing
the number of shares of Series C Preferred Stock represented by such lost,
stolen, destroyed or mutilated certificate and dated the date of such lost,
stolen, destroyed or mutilated certificate.
1.13. Retirement of Converted or Redeemed Shares. No share or shares of
Series C Preferred Stock acquired by the corporation by reason of redemption,
purchase, conversion or otherwise shall be re-issued and all such shares shall
be canceled, retired and eliminated from the shares which the corporation shall
be authorized to issue. The corporation may from time to time take such
appropriate corporate action as may be necessary to reduce the authorized number
of shares of Series C Preferred Stock accordingly.
FIFTH C: DESIGNATIONS, PREFERENCES AND SPECIAL RIGHTS OF SERIES D PREFERRED
STOCK.((3))
Designation, Amount and Rank. Forty Thousand (40,000) shares of a preferred
stock, $1.00 par value per share, shall constitute a series of such preferred
stock designated as "Series D Convertible Preferred Stock" (the "Series D
Preferred Stock"). The Series D Preferred Stock will be issued as one or more
subseries of preferred stock: Series D-1 Preferred Stock (the "Series D-1
Preferred Stock"), and Series D-2 Preferred Stock (the "Series D-2 Preferred
Stock"), provided that the Board of Directors of the Company may hereafter
provide for additional shares of Preferred Stock in this series or different
sub-series. The respective rights and preferences of the Series D Preferred
Stock, with respect to dividend rights, redemption rights and rights on
liquidation, winding up and dissolution, shall be as set forth herein. The
- ---------------
(3)Since the Series D Preferred Stock will be converted at the closing of
the Capital Z Issuance, after the closing, a second amended and restated
certificate of incorporation will be filed deleting references to the Series D
Preferred Stock.
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Series D Preferred Stock shall be issued pursuant to the following additional
terms and conditions:
1. Series D Convertible Preferred Stock.
1.1. Definitions. As used herein, unless the context otherwise requires,
the terms defined in Section 1.1 of Article Fifth-B, as in effect on December
30, 1998, (the "Effective Date") except that (a) Sections 1.1.17, 1.1.18 and
1.1.19, shall not apply to this Article Fifth-C, and (b) the terms defined
below, shall have the following meanings:
1.1.1 "Additional Shares of Common Stock" means all shares (including
treasury shares) of Common Stock issued or sold (or, pursuant to Sections 1.7.2
or 1.7.31 deemed to be issued) by the Company after the Effective Date, whether
or not subsequently reacquired or retired by the Company other than (i) the
issuance of shares upon conversion of the Series B Preferred Stock; (ii) shares
issued upon the exercise of the Common Stock Purchase Warrants outstanding on
the Effective Date; (iii) shares to be issued to directors, employees, agents
and others, pursuant to the Company's Incentive Stock Option Plan for Employees,
Stock Option Plan for Directors and Stock Option Plan for Agents and Others, as
in effect on January 8, 1997; and (iv) such additional number of shares, if any,
as may become issuable upon the conversion or exercise of any of the securities
referred to in the foregoing clauses (i) through (iii) pursuant to the terms of
the instruments governing such securities as in effect on the Effective Date.
1.1.2 "Conversion Price" as to Series D-1 means $2.70, subject to
adjustment from time to time pursuant to Section 1.7, and as to Series D-2 means
$2.70, subject to adjustment from time to time pursuant to Section 1.7, provided
that if there is a "Change of Control" (as defined below) of this Corporation as
a result of a sale by the Corporation of Common Stock pursuant to a contract or
contracts, entered into on or prior to December 31, 1999 ("the Change of Control
Common"), the Series D-2 Preferred Stock shall be mandatorily converted to
Common Stock at a conversion price equal to the price per share at which the
Change of Control Common is issued by the Corporation. As used herein, "Change
of Control" shall mean the issuance, in a transaction or series of transactions,
of Common Stock, or securities convertible into Common Stock, having voting
power equal to or exceeding 30% of the voting power of all Common Stock, or
securities convertible into Common Stock, outstanding immediately after such
transaction or series of transactions.
1.1.3. "Junior Securities" means any of the Company's equity securities
other than the Series C or Series D Preferred Stock (including the Series B
Preferred Stock and the Common Stock) whether now outstanding or hereafter
issued.
1.2. Dividends. The Company shall not, without the prior written consent
of the holders of a majority of the shares of Series C and D Preferred Stock
then outstanding, pay or declare any dividend or distribution on any Junior
Securities (other than on Common Stock, and on Series B Preferred Stock to the
extent of participation in dividends declared on the Common Stock). In the event
that the Company declares a dividend or distribution on the Common Stock, the
holders of the Series C and D Preferred Stock and the holders of the Series B
Preferred Stock and the Common Stock shall share pro rata (based, in the case of
holders of Series C, D and Series B Preferred Stock, on the number of shares of
Common Stock which each holder of Series D, Series C and Series B Preferred
Stock would be entitled to receive upon conversion of its Series D, Series C and
Series B Preferred Stock into Common Stock, respectively) in such dividend or
distribution.
1.3. Rights on Liquidation. In the event of any Liquidation, the holders
of shares of the Series D Preferred Stock then issued and outstanding shall be
entitled to be paid pari passu on the same basis as the holders of the Series C
Preferred Stock.
1.4. Voting Power. For purposes of Section 1.4 of Article Fifth-B, shares
of Series D Preferred Stock can be treated as if it were Series C-2 Preferred
Stock.
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1.5. Redemption. The provisions of Section 1.5 of Article Fifth-B shall
apply to the Series D Preferred Stock, pari passu with the Series C Preferred
Stock.
1.6. Conversion Rights. The provisions of Section 1.6 of Article Fifth-B
shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock, subject (i) to the mandatory conversion of the Series D-2
Preferred Stock as provided in Section 1.1.2, above, and (ii) except that Series
D Preferred Stock shall not be converted into voting stock unless and until (A)
any applicable requirements of the insurance law of each state in which an
insurance company subsidiary of the Corporation is domiciled or deemed to be
domiciled relating to acquisition of control of an insurance company have been
complied with and (B) any applicable bank regulatory laws have been complied
with.
1.7. Anti-Dilution Adjustments. The provisions of Section 1.7 of Article
Fifth-B shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock, except that if such provisions are inapplicable to any shares
of Series D Preferred Stock because they were converted immediately before the
closing of a transaction which would have resulted in an adjustment under the
anti-dilution provisions of Section 1.7, but for such conversation, such
antidilution provisions shall be applied in connection with such conversion as
if such conversion had occurred immediately after such closing.
1.8. Restrictions on Redemptions, Purchases and Acquisitions. The
provisions of Section 1.8 of Article Fifth-B shall apply to the Series D
Preferred Stock pari passu with the Series C Preferred Stock.
1.9. Notices. The provisions of Section 1.9 of Article Fifth-B shall
apply to the Series D Preferred Stock pari passu with the Series C Preferred
Stock.
1.10. Other Rights.
1.10.1. Purchase Rights. The provisions of Section 1.10.1 of Article
Fifth-B shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock.
1.10.2. Preemptive Rights. The provisions of Section 1.10.1 shall apply
to the Series D Preferred Stock pari passu, but shall not apply to stock issued
pursuant an agreement between the Corporation and Capital Z Financial Services
Fund II L.P., dated December 31, 1998.
1.11. Registration of Transfer. The provisions of Section 1.11 of Article
Fifth-B shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock.
1.12. Replacement. The provisions of Section 1.12 of Article Fifth-B
shall apply to the Series D Preferred Stock pari passu with the Series C
Preferred Stock.
1.13. Retirement of Converted or Redeemed Shares. The provisions of
Section 1.13 of Article Fifth-B shall apply to the Series D Preferred Stock pari
passu with the Series C Preferred Stock.
SIXTH: The Secretary of State is designated as the agent of the corporation
upon whom process against the corporation may be served. The post office address
to which the Secretary of State shall mail a copy of any process against the
corporation served on the Secretary of State is: c/o Harnett Lesnick & Ripps
P.A., NationsBank Tower 150, East Palmetto Park Road, Suite 500, Boca Raton,
Florida, 33432.
SEVENTH: Except to the extent required by the New York Business Corporation
Law, no director of the corporation shall have any personal liability of
directors to the corporation or its stockholders for damages for any breach of
duty as such director, provided that this provision shall not eliminate or
limit:
(1) the liability of any director if a judgment or other final
adjudication adverse to him establishes that his acts or omissions were in
bad faith, involved intentional misconduct or a
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knowing violation of law or that he personally gained in fact a financial
profit or other advantage to which he was not legally entitled or that his
acts violated Section 719 of the New York Business Corporation Law, or
(2) the liability of any director for any act or omission prior to the
adoption of this Article.
Neither the amendment nor repeal of this Article, nor the adoption of any
provision of the Certificate of Incorporation inconsistent with this Article,
shall eliminate or reduce the effect of this Article in respect of any matter
occurring, or any cause of action, suit or claim that, but for this Article
would accrue or arise, prior to such amendment, repeal or adoption of an
inconsistent provision.
EIGHTH: The number of directors of the corporation shall be not less than
three (3), and the number to be chosen shall be determined in the manner
prescribed by the by-laws of this corporation. No director need be a stockholder
of the corporation. Any director may be removed with cause at any time by a vote
of the majority of the directors then in office or the affirmative vote of
stockholders of record holding a majority of the outstanding shares of stock of
the Corporation entitled to vote, given at a meeting of the stockholders called
for that purpose.
The terms of office of the directors shall be until the next annual
meeting. The foregoing notwithstanding, each director shall serve until his
successor shall have been duly elected and qualified, unless he shall resign,
become disqualified, disabled or shall otherwise be removed. Whenever a vacancy
occurs on the Board of Directors, a majority of the remaining directors have the
power to fill the vacancy by electing a successor director to fill that portion
of the unexpired term resulting from the vacancy.
NINTH: In furtherance and not in limitation of the powers conferred by
statute, the Board of Directors is expressly authorized:
To make, alter or repeal the By-Laws of the corporation.
To authorize and cause to be executed mortgages and liens upon the real and
personal property for the corporation.
To set apart out of any of the funds of the corporation available for
dividends a reserve or reserves for any proper purpose and to abolish any such
reserve in the manner in which it was created.
By a majority of the whole Board, to designate one or more committees, such
committee to consist of one or more of the directors of the corporation. The
Board may designate one or more directors as alternate members of any committee,
who may replace any absent or disqualified member at any meeting of the
committee. The By-Laws may provide that in the absence or disqualification of a
member of a committee, the member or members thereof present at any meeting and
not disqualified from voting, whether or not he or they constitute a quorum, may
unanimously appoint another member of the Board of Directors to act at the
meeting in the place of any such absent or disqualified member. Any such
committee, to the extent provided in the resolution of the Board of Directors,
or in the By-Laws of the corporation, shall have and may exercise all the powers
and authority of the Board of Directors in the management of the business and
affairs of the corporation and may authorize the seal of the corporation to be
affixed to all papers which may require it; but no such committee shall have the
power or authority in reference to amending the Certificate of Incorporation,
adopting an agreement of merger or consolidation, recommending to the
stockholders, the sale, lease or exchange of all or substantially all of the
corporation's property and assets, recommending to the stockholders a
dissolution of the corporation of a revocation or a dissolution, or amending the
By-Laws for the corporation; and, unless the resolution or By-Laws expressly so
provide, no such committee shall have the power or authority to declare a
dividend or to authorize the issuance of stock.
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When and as authorized by the stockholders in accordance with statute, to
sell, lease or exchange all or substantially all of the property and assets of
the corporation, including its goodwill and its corporate franchises, upon such
terms and conditions and for such consideration, which may consist in whole or
in part of money or property, including shares of stock in, and/or other
securities of, any other corporation or corporations as its Board of Directors
shall deem expedient and for the best interests of the corporation.
TENTH: Action required to be taken or which may be taken at any annual or
special meeting of stockholders of the corporation may be taken by written
consent of the stockholders in lieu of a meeting, setting forth the action so
taken, signed by the stockholders holding a sufficient amount of outstanding
shares to approve such action at any annual or special meeting.
ELEVENTH: Supermajority Approvals. The corporation shall not take, cause to
be taken, or approve any of the following actions unless such action has been
specifically approved or ratified at a meeting of the Board of Directors by the
affirmative vote of not less than 66 2/3% of the total number of directors:
(a)(i) entering into any merger or consolidation in which either the corporation
or a material Subsidiary is a constituent corporation or its securities are
being issued and the stockholders following such transaction do not own,
directly or indirectly, in the aggregate a majority of the shares or equity
securities of the surviving corporation of any such merger or consolidation
entitled to elect members of the Board of Directors, (ii) the sale of all or
substantially all of the corporation's assets or properties in a single
transaction or in a series of related transactions, or (iii) the sale, lease,
exchange or other disposition of any shares of a material Subsidiary or all or
substantially all assets of any material Subsidiary; (b) changing the authorized
number of directors; (c) amending or modifying the Certificate of Incorporation
or By-laws; (d) electing or removing any of the President, Chief Financial
Officer or other executive officers and amending or modifying the employment
agreement to be entered into between the Corporation and the Chief Executive
Officer of the Corporation on the closing date of the acquisition of certain
assets and subsidiaries of PennCorp Financial Group, Inc.; (e) voluntarily
dissolving or winding-up the corporation or any material Subsidiary or filing
with respect to the corporation or any material Subsidiary a voluntary petition
in bankruptcy or for reorganization or for the adoption of any plan or
arrangement with creditors or an admission seeking the relief therein provided
under any existing future law of any jurisdiction relating to bankruptcy,
insolvency, reorganization or relief of debtors; and (f) approving any dividend
or other distribution in respect of the Common Stock.
TWELFTH: In the event that it is proposed that the corporation enter into a
merger or consolidation with any other corporation and such other corporation or
its affiliates singly or in the aggregate own or control directly or indirectly
five percent (5%) or more of the outstanding voting power of the capital stock
of this corporation, or that the corporation shall sell substantially all of its
assets or business to such other corporation, the affirmative vote of the
holders of not less than sixty-six and two-thirds percent (66 2/3%) of the total
voting power of all outstanding shares of capital stock of this corporation
shall be required for the approval of any such proposal; provided, however, that
the foregoing shall not apply to any such merger, consolidation or sale of
assets or business which was approved by resolutions of the Board of Directors
of this corporation prior to the acquisition of the ownership or control of five
percent (5%) of the outstanding shares of this corporation by such other
corporation or its affiliates, nor shall it apply to any such merger,
consolidation or sale of assets or business between this corporation and another
corporation fifty percent (50%) or more of the total voting power of which is
owned by this corporation. For the purposes hereof, an "affiliate" is any person
(including a corporation, partnership, trust, estate or individual) who directly
or indirectly, through one or more intermediaries, controls, or is controlled
by, or is under common control with, the person specified; and "control" means
the possession, directly or indirectly, of the power to direct or cause the
direction of management and policies of a person, whether through the ownership
of voting securities, by contract or otherwise.
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THIRTEENTH: The corporation reserves the right to amend, alter, change or
repeal any provisions contained in this Certificate of Incorporation, in the
manner now or hereafter prescribed by statute, and all rights conferred upon
stockholders herein are granted subject to this reservation.
FOURTEENTH: The provisions set forth in Article TWELFTH above may not be
altered, amended or repealed in any respect unless such alteration, amendment or
repeal is approved by the affirmative vote of the holders of not less than
sixty-six and two-thirds (66 2/3%) of the total voting power of all outstanding
shares of capital stock of the corporation.
IN WITNESS WHEREOF, we have signed this Restated Certificate of
Incorporation on the day of , 1999, and we affirm that the
statements made herein are true under penalties of perjury.
By:
------------------------------------
Richard A. Barasch
President
By:
------------------------------------
Joan Ferrarone
Secretary
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ANNEX E
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS (AUDITED)
AND FINANCIAL STATEMENT SCHEDULES:
Independent Auditors' Report.............................. E-2
Consolidated Balance Sheets as of December 31, 1997 and
1998................................................... E-3
Consolidated Statements of Operations for the Three Years
Ended December 31, 1998................................ E-4
Consolidated Statements of Stockholders' Equity for the
Three Years Ended December 31, 1998.................... E-5
Consolidated Statements of Cash Flows for the Three Years
Ended December 31, 1998................................ E-6
Notes to Consolidated Financial Statements................ E-7
Schedule I -- Summary of Investments -- other than
investments in related parties (incorporated in Note 5
to Consolidated Financial Statements)
Schedule II -- Condensed Financial Information of
Registrant............................................. E-42
Schedule III -- Supplementary Insurance Information....... E-45
Schedule IV -- Reinsurance (incorporated in Note 11 of
Notes to Consolidated Financial Statements)
Other schedules were omitted because they were not
applicable
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Consolidated Balance Sheets at March 31, 1999 and December
31, 1998............................................... E-46
Consolidated Statements of Operations for the three months
ended March 31, 1999 and March 31, 1998................ E-47
Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and March 31, 1998................ E-48
Notes to Consolidated Financial Statements................ E-49
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
COMBINED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER
31, 1998, 1997 AND 1996:
Independent Auditors' Report.............................. E-58
Combined Balance Sheets as of December 31, 1998 and
1997................................................... E-59
Combined Statements of Income for the years ended December
31, 1998, 1997 and 1996................................ E-60
Combined Statements of Changes in Business Equity for the
years ended December 31, 1998, 1997 and 1996........... E-61
Combined Statements of Comprehensive Income for the years
ended December 31, 1998, 1997 and 1996................. E-62
Combined Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996....................... E-63
Notes to Combined Financial Statements.................... E-65
UNAUDITED COMBINED FINANCIAL STATEMENTS FOR THE THREE MONTHS
ENDED MARCH 31, 1999 AND 1998:
Independent Accountants' Review Report.................... E-97
Combined Balance Sheets as of March 31, 1999 (unaudited)
and December 31, 1998.................................. E-98
Combined Statements of Income for the three months ended
March 31, 1999 and 1998 (unaudited).................... E-99
Combined Statements of Changes in Business Equity for the
three months ended March 31, 1999 and 1998
(unaudited)............................................ E-100
Combined Statements of Comprehensive Income for the three
months ended March 31, 1999 and 1998 (unaudited)....... E-101
Combined Statements of Cash Flow for the three months
ended March 31, 1999 and 1998 (unaudited).............. E-102
Notes to Unaudited Combined Financial Statements.......... E-103
E-1
282
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Universal American Financial Corp.:
We have audited the accompanying consolidated balance sheets of Universal
American Financial Corp. and subsidiaries as of December 31, 1998 and 1997 and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1998.
Our audits also included the financial statement schedules as listed in the
Index at Page E-1. These consolidated financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Universal American Financial Corp. and subsidiaries at December 31, 1998 and
1997 and the consolidated results of its operations and its cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
Ernst & Young LLP
New York, New York
March 30, 1999
E-2
283
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
1997 1998
------------ ------------
ASSETS
Investments (Notes 2c and 5):
Fixed maturities available for sale, at fair value
(amortized cost $121,119,346 and $132,227,114,
respectively)........................................... $123,585,708 $134,797,634
Equity securities, at fair value (cost $987,095 and
$1,063,186, respectively)............................... 945,116 1,019,780
Policy loans.............................................. 7,185,014 7,276,163
Property tax liens........................................ 136,713 30,696
Mortgage loans............................................ 2,562,008 4,456,516
------------ ------------
Total investments.................................. 134,414,559 147,580,789
Cash and cash equivalents................................... 25,014,019 17,092,938
Accrued investment income................................... 3,357,624 3,538,573
Deferred policy acquisition costs (Note 2d)................. 20,832,060 24,282,771
Amounts due from reinsurers (Note 11)....................... 76,576,040 77,393,653
Due and unpaid premiums..................................... 548,271 525,909
Deferred income tax asset (Note 6).......................... 105,413 --
Goodwill.................................................... 4,508,596 4,354,584
Present value of future profits............................. 1,281,807 1,569,601
Other assets................................................ 5,936,947 6,963,481
------------ ------------
Total assets....................................... 272,575,336 283,302,299
============ ============
LIABILITIES, SERIES C PREFERRED STOCK, REDEMPTION ACCRUAL ON
SERIES C PREFERRED STOCK, SERIES D PREFERRED STOCK AND
STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances (Note 2e)..................... 145,085,687 154,886,059
Reserves for future policy benefits......................... 38,327,612 47,442,966
Policy and contract claims -- life.......................... 1,167,213 2,297,446
Policy and contract claims -- health........................ 22,592,441 24,332,141
Loan payable (Note 12)...................................... 3,500,000 4,750,000
Amounts due to reinsurers................................... 17,769,695 1,810,696
Deferred revenues........................................... 264,745 201,389
Deferred income tax liability (Note 6)...................... -- 1,218,547
Other liabilities........................................... 12,743,775 9,943,970
------------ ------------
Total liabilities.................................. 241,451,168 246,883,214
------------ ------------
Series C Preferred Stock (Issued and outstanding 51,680)
(Note 7).................................................. 5,168,000 5,168,000
------------ ------------
Redemption accrual on Series C Preferred Stock.............. 249,790 683,214
------------ ------------
Series D Preferred Stock (Issued and outstanding 22,500)
(Note 8).................................................. -- 2,250,000
------------ ------------
Commitments and contingencies (Note 13)
STOCKHOLDERS' EQUITY (Note 9)
Series B Preferred Stock (Issued and outstanding 400)....... 4,000,000 4,000,000
Common stock (Authorized, 20,000,000 issued and outstanding
7,325,860 and 7,638,057, respectively).................... 73,259 76,381
Common stock warrants (Authorized, issued and outstanding
668,481 and 658,231, respectively)........................ -- --
Additional paid-in capital.................................. 15,992,497 16,410,412
Accumulated other comprehensive income...................... 841,620 857,872
Retained earnings........................................... 4,799,002 6,973,206
------------ ------------
Total stockholders' equity......................... 25,706,378 28,317,871
------------ ------------
Total liabilities, Series C Preferred Stock,
Redemption accrual on Series C Preferred Stock,
Series D Preferred Stock and stockholders'
equity........................................... $272,575,336 $283,302,299
============ ============
See notes to consolidated financial statements.
E-3
284
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
1996 1997 1998
------------ ------------ ------------
REVENUE: (Notes 2e and f)
Gross premiums and policyholder fees earned...... $ 55,286,610 $ 99,339,251 $131,044,411
Reinsurance premiums assumed..................... 10,521,987 997,836 997,891
Reinsurance premiums ceded....................... (25,663,224) (62,622,721) (89,546,238)
------------ ------------ ------------
Net premiums and policyholder fees earned (Note
11)............................................ 40,145,373 37,714,366 42,496,064
Net investment income (Note 5)................... 9,850,083 10,022,658 10,721,351
Realized gains on investments (Note 5)........... 240,075 1,132,521 255,671
Fee income....................................... 2,871,319 2,367,763 2,552,664
Amortization of deferred revenue (Note 2g)....... 280,335 93,212 63,356
------------ ------------ ------------
Total revenues......................... 53,387,185 51,330,520 56,089,106
------------ ------------ ------------
BENEFITS, CLAIMS AND OTHER DEDUCTIONS:
Increase in future policy benefits............... 1,854,539 440,936 5,355,787
Claims and other benefits........................ 24,042,876 23,719,208 25,638,642
Interest credited to policyholders............... 6,614,176 6,645,716 7,240,241
Increase in deferred acquisition costs........... (2,257,617) (2,945,672) (3,529,521)
Amortization of present value of future
profits........................................ -- -- 174,400
Amortization of goodwill......................... -- 111,819 170,898
Commissions...................................... 16,080,245 21,089,466 27,146,850
Commission and expense allowances on reinsurance
ceded.......................................... (11,004,623) (20,300,483) (31,219,549)
Other operating costs and expenses............... 17,684,697 19,358,303 21,179,767
------------ ------------ ------------
Total benefits, claims and other
deductions........................... 53,014,293 48,119,293 52,157,515
------------ ------------ ------------
Operating income before taxes.................... 372,892 3,211,227 3,931,591
Federal income tax expense (Note 6).............. 269,017 1,091,818 1,323,963
------------ ------------ ------------
Net income....................................... 103,875 2,119,409 2,607,628
Redemption accrual on Series C Preferred Stock
(Note 7)....................................... -- 249,790 433,424
------------ ------------ ------------
Net Income applicable to common shareholders..... $ 103,875 $ 1,869,619 $ 2,174,204
============ ============ ============
Earnings per common share (Note 2 j):
Basic............................................ $ 0.01 $ 0.26 $ 0.29
============ ============ ============
Diluted.......................................... $ 0.01 $ 0.18 $ 0.20
============ ============ ============
See notes to consolidated financial statements.
E-4
285
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
ACCUMULATED
SERIES B ADDITIONAL OTHER
PREFERRED COMMON PAID-IN COMPREHENSIVE RETAINED
STOCK STOCK CAPITAL INCOME EARNINGS TOTAL
---------- ------- ----------- ------------- ---------- -----------
BALANCE, JANUARY 1, 1996....... $4,000,000 $69,575 $15,849,542 $ 1,369,651 $2,825,508 $24,114,276
Net income..................... -- -- -- -- 103,875 103,875
Change in net unrealized
investment gain (loss)....... -- -- -- (2,341,888) -- (2,341,888)
-----------
Comprehensive income........... -- -- -- -- -- (2,238,013)
-----------
Issuance of common stock....... -- 1,917 200,346 -- -- 202,263
---------- ------- ----------- ----------- ---------- -----------
BALANCE, DECEMBER 31, 1996..... 4,000,000 71,492 16,049,888 (972,237) 2,929,383 22,078,526
---------- ------- ----------- ----------- ---------- -----------
Net income..................... -- -- -- -- 2,119,409 2,119,409
Change in net unrealized
investment gain (loss)....... -- -- -- 1,813,857 -- 1,813,857
-----------
Comprehensive income........... 3,933,266
-----------
Issuance of common stock....... -- 1,767 272,253 -- -- 274,020
Issuance of Series C Preferred
Stock........................ -- -- (329,644) -- -- (329,644)
Redemption accrual on Series C
Preferred Stock.............. -- -- -- -- (249,790) (249,790)
---------- ------- ----------- ----------- ---------- -----------
BALANCE, DECEMBER 31, 1997..... 4,000,000 73,259 15,992,497 841,620 4,799,002 25,706,378
---------- ------- ----------- ----------- ---------- -----------
Net income..................... -- -- -- -- 2,607,628 2,607,628
Change in net unrealized
Investment gain (loss)....... -- -- -- 16,252 -- 16,252
-----------
Comprehensive income........... 2,623,880
-----------
Issuance of common stock....... -- 3,122 524,920 -- -- 528,042
Issuance of Series D Preferred
Stock........................ -- -- (107,005) -- -- (107,005)
Redemption accrual on Series C
Preferred Stock.............. -- -- -- -- (433,424) (433,424)
---------- ------- ----------- ----------- ---------- -----------
BALANCE, DECEMBER 31, 1998..... $4,000,000 $76,381 $16,410,412 $ 857,872 $6,973,206 $28,317,871
========== ======= =========== =========== ========== ===========
See notes to consolidated financial statements.
E-5
286
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
1996 1997 1998
------------ ------------ ------------
Cash flows from operating activities:
Net income................................................. $ 103,875 $ 2,119,409 $ 2,607,628
Adjustments to reconcile net income to net cash used by
operating activities:
Deferred income taxes...................................... 269,017 1,091,818 1,323,963
Change in reserves for future policy benefits.............. 3,526,269 (3,997,414) 6,927,945
Change in policy and contract claims....................... 677,167 (2,713,062) (270,067)
Change in deferred policy acquisition costs................ (2,257,617) (2,945,673) (3,529,521)
Change in deferred revenue................................. (280,336) (93,212) (63,356)
Amortization of present value of future profits............ -- -- 174,400
Amortization of goodwill................................... -- 111,819 154,012
Change in policy loans..................................... (746,103) (589,250) (91,149)
Change in accrued investment income........................ (427,870) (368,951) (180,949)
Change in reinsurance balances............................. (11,773,467) (4,963,108) (5,320,077)
Change in due and unpaid premium........................... 114,812 2,269,874 22,362
Realized gains on investments.............................. (240,075) (1,132,521) (255,671)
Other, net................................................. 1,125,463 4,336,972 (1,873,773)
------------ ------------ ------------
Net cash used by operating activities...................... (9,908,865) (6,873,299) (374,253)
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for
sale..................................................... 18,329,599 35,962,815 26,887,431
Proceeds from redemption of fixed maturities available for
sale..................................................... 25,436,976 9,029,804 7,941,450
Cost of fixed maturities purchased available for sale...... (48,466,456) (37,932,859) (45,886,182)
Change in amounts held in trust for reinsurer.............. -- (5,154,802) (5,182,289)
Proceeds from sale of equity securities.................... 506,250 337,022 511,678
Cost of equity securities purchased........................ (501,250) (689,802) (591,280)
Change in other invested assets............................ 269,702 (1,367,882) (107,532)
Proceeds from sale of subsidiary, net of cash held......... -- 2,020,496 --
Purchase of business, net of cash acquired................. 1,685,010 (4,080,033) (2,562,824)
------------ ------------ ------------
Net cash used by investing activities...................... (2,740,169) (1,875,241) (18,989,548)
------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from issuance of common stock................. 202,263 274,020 421,037
Proceeds from the issuance of Series C Preferred Stock..... -- 4,838,356 --
Proceeds from the issuance of Series D Preferred Stock..... -- -- 2,250,000
Increase in policyholder account balances.................. 15,930,118 10,546,733 7,521,683
Change in short-term debt.................................. -- (800,000) --
Increase in loan payable................................... -- 3,500,000 1,850,000
Principle repayment on loan payable........................ -- -- (600,000)
Change in notes payable.................................... (369,698) -- --
------------ ------------ ------------
Net cash provided from financing activities................ 15,762,683 18,359,109 11,442,720
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents....... 3,113,649 9,610,569 (7,921,081)
------------ ------------ ------------
Cash and cash equivalent at beginning of year.............. 12,289,801 15,403,450 25,014,019
------------ ------------ ------------
Cash and cash equivalent at end of year.................... $ 15,403,450 $ 25,014,019 $ 17,092,938
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest................................................. $ 83,852 $ 77,389 $ 306,578
============ ============ ============
Income taxes............................................. $ -- $ 62,000 $ --
============ ============ ============
See notes to consolidated financial statements.
E-6
287
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND COMPANY BACKGROUND:
Universal American Financial Corp. (the "Company" or "Universal" formerly,
Universal Holding Corp.) was incorporated under the laws of the State of New
York in August 1981, for the purpose of conducting insurance and related
business primarily through its then wholly-owned subsidiary, John Adams Life
Insurance Company of New York ("John Adams"). On May 17, 1991, the Company
acquired 100% of the outstanding common stock of American Progressive Life &
Health Insurance Company of New York ("American Progressive") and on June 27,
1991 merged John Adams into American Progressive. In 1988, the Company organized
Quincy Coverage Corp. ("Quincy") an insurance agent and broker. In January 1992,
the Company began operations in WorldNet Services Corp. ("WorldNet"), a provider
of managed care and assistance to travelers. On May 26, 1993, the Company
acquired 100% of the outstanding common stock of American Pioneer Life Insurance
Company ("American Pioneer"). On December 4, 1997, the Company acquired 100% of
the outstanding common stock of American Exchange Life Insurance Company
("American Exchange") (See Note 4).
The Company's marketing emphasis is to sell products particularly appealing
to the senior market place, and largely through marketing organizations with
concentrations in this market. The Company began to sell senior market life and
accident & health insurance products in 1993 in New York and expanded its sales
effort to Florida in 1996 and to Texas in 1997. The momentum into Florida was
accelerated by the acquisition of business from First National Life Insurance
Company ("First National"), while the expansion into Texas was accelerated by
the acquisition of American Exchange (See Note 4). The core products sold to the
senior age market include Medicare supplement, home health care, nursing home,
hospital indemnity and senior life insurance. In addition, the Company sells
certain program life insurance and annuity products through independent
marketing organizations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. BASIS OF PRESENTATION: The significant accounting policies followed by
Universal American Financial Corp. and subsidiaries that materially affect
financial reporting are summarized below. The accompanying consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles ("GAAP") which, as to American Progressive, American
Pioneer and American Exchange, differ from statutory accounting practices
prescribed or permitted by regulatory authorities. The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported revenues and expenses during the reporting period.
Actual results could differ from those estimates.
b. PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial
statements include the accounts of Universal American Financial Corp. and its
wholly-owned subsidiaries, including the operations of American Exchange since
December 4, 1997, the date of its acquisition. All material intercompany
transactions and balances have been eliminated.
c. INVESTMENTS: Investments are shown on the following bases:
The Company follows Financial Accounting Standards Board ("FASB") Statement
No. 115, "Accounting for Certain Debt and Equity Securities" ("Statement No.
115"). Statement No. 115 requires that debt and equity securities be classified
into one of three categories and accounted for as follows: Debt securities that
the Company has the positive intent and the ability to hold to maturity are
classified as "held to maturity" and reported at amortized cost. Debt and equity
securities that
E-7
288
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
are held for current resale are classified as "trading securities" and reported
at fair value, with unrealized gains and losses included in earnings. Debt and
equity securities not classified as held to maturity or as trading securities
are classified as "available for sale" and reported at fair value. Unrealized
gains and losses on available for sale securities are excluded from earnings and
reported as accumulated other comprehensive income, net of tax and deferred
policy acquisition cost adjustment.
As of December 31, 1997 and 1998, all fixed maturity securities were
classified as available for sale and were 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. Equity
securities are carried at current fair value. Policy loans and mortgage loans
are stated at the unpaid principal balance. Short-term investments are carried
at cost, which approximates fair value. Property tax liens are carried at cost.
Investment income is recorded when earned. Realized investment gains and losses
on the sale of securities are based on the specific identification method.
d. DEFERRED POLICY ACQUISITION COSTS: The cost of acquiring new business,
principally commissions and certain expenses of the agency, policy issuance and
underwriting departments, all of which vary with, and are primarily related to
the production of new and renewal business, have been deferred. These costs are
being amortized in relation to the present value of expected gross profits on
the policies arising principally from investment, mortality and expense margins
for FASB Statement No. 97, "Accounting and Reporting by Insurance Enterprises
for Certain Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments", ("Statement No. 97") products and in proportion to premium
revenue using the same assumptions used in estimating the liabilities for future
policy benefits for FASB Statement No. 60, "Accounting and Reporting by
Insurance Enterprises", ("Statement No. 60") products. Deferred policy
acquisition costs are written off to the extent that it is determined that
future policy premiums and investment income or gross profits would not be
adequate to cover related losses and expenses. No deferred policy acquisition
costs were written off for the years ended December 31, 1996, 1997 and 1998.
The Company has several reinsurance arrangements in place on its life and
accident & health insurance risks (see Note 11). In the accompanying statement
of operations, the Company reports commissions incurred on direct premium
written and commission and expense allowances on reinsurance ceded on separate
lines to correspond to the presentation of the premiums earned by the Company.
In determining the amounts capitalized for deferred acquisition costs, the
Company includes an amount for gross commissions and direct issue expenses, net
of the related allowances received from the reinsurer on these costs.
Details with respect to deferred policy acquisition costs for the three
years ended December 31, 1998 are as follows:
Balance at January 1, 1996.................................. $16,564,450
Capitalized costs......................................... 5,042,137
Adjustment relating to unrealized loss on fixed
maturities............................................. 269,447
Amortization.............................................. (2,784,520)
-----------
Balance at December 31, 1996................................ 19,091,514
Capitalized costs......................................... 6,712,207
Adjustment relating to unrealized gain on fixed
maturities............................................. (1,205,127)
Amortization.............................................. (3,766,534)
-----------
E-8
289
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Balance at December 31, 1997................................ 20,832,060
Capitalized costs......................................... 8,791,732
Adjustment relating to unrealized gain on fixed
maturities............................................. (78,810)
Amortization.............................................. (5,262,211)
-----------
Balance at December 31, 1998................................ $24,282,771
===========
e. RECOGNITION OF REVENUES, CONTRACT BENEFITS AND EXPENSES FOR INVESTMENT
AND UNIVERSAL LIFE TYPE POLICIES: Revenues for universal life-type policies and
investment products consist of mortality charges for the cost of insurance and
surrender charges assessed against policyholder account balances during the
period. Benefit claims incurred in excess of policyholder account balances are
expensed. The liability for policyholder account balances for universal
life-type policies and investment products under Statement No. 97 are determined
following a "retrospective deposit" method. The retrospective deposit method
establishes a liability for policy benefits at an amount determined by the
account or contract balance that accrues to the benefit of the policyholder,
which consist principally of policy account values before any applicable
surrender charges. Premium receipts are not reported as revenues when the
retrospective deposit method is used. Credited interest rates for these products
range from 4.50% to 7.25%. For the three years ended December 31, 1996, 1997 and
1998, one general agency of American Progressive produced $5.8 million, $2.9
million and $1.1 million of annuity receipts, respectively, which represented
approximately 43%, 24% and 10% respectively, of total annuity receipts of
American Progressive.
f. RECOGNITION OF PREMIUM REVENUES AND POLICY BENEFITS FOR ACCIDENT &
HEALTH INSURANCE PRODUCTS: Premiums are recorded when due and recognized as
revenue over the period to which the premiums relate. Benefits and expenses
associated with earned premiums are recognized as the related premiums are
earned so as to result in recognition of profits over the life of the policies.
This association is accomplished by recording a provision for future policy
benefits and amortizing deferred policy acquisition costs. The liability for
future policy benefits for accident & health policies consists of active life
reserves and the estimated present value of the remaining ultimate net cost of
incurred claims. Active life reserves include unearned premiums and additional
reserves. The additional reserves are computed on the net level premium method
using assumptions for future investment yield, mortality and morbidity
experience. The assumptions are based on past experience and include provisions
for possible adverse deviation. Claim reserves are established for future
payments not yet due on incurred claims, primarily relating to individual
disability insurance and group long-term disability insurance products. These
reserves are established based on past experience and are continuously reviewed
and updated with any related adjustments recorded to current operations. Claim
liabilities represent policy benefits due but unpaid at year-end and primarily
relates to individual health insurance products.
Activity in the accident & health policy and contract claim liability is as
follows:
1996 1997 1998
----------- ------------ ------------
Balance at beginning of year.................. $ 8,681,136 $ 24,628,019 $ 22,592,441
Less reinsurance recoverables............... (2,650,646) (15,269,309) (17,033,804)
----------- ------------ ------------
Net balance at beginning of year.............. 6,030,490 9,358,710 5,558,637
----------- ------------ ------------
Balance acquired with First National.......... 3,374,535 -- --
Balance acquired with American Exchange....... -- 551,126 --
Balance acquired with Dallas General.......... -- -- 785,000
E-9
290
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1996 1997 1998
----------- ------------ ------------
Incurred related to:
Current year................................ 23,029,175 19,363,347 18,043,448
Prior years................................. (2,511,056) (2,424,332) (782,037)
----------- ------------ ------------
Total incurred................................ 20,518,119 16,939,015 17,261,411
----------- ------------ ------------
Paid related to:
Current year................................ 15,671,699 14,405,575 13,673,436
Prior years................................. 4,892,735 6,884,639 4,675,761
----------- ------------ ------------
Total paid.................................... 20,564,434 21,290,214 18,349,197
----------- ------------ ------------
Net balance at end of year.................... 9,358,710 5,558,637 5,255,851
Plus reinsurance recoverables................. 15,269,309 17,033,804 19,076,290
----------- ------------ ------------
Balance at end of year........................ $24,628,019 $ 22,592,441 $ 24,332,141
=========== ============ ============
g. DEFERRED REVENUE: The Company entered into a 90% quota share
reinsurance agreement with an unaffiliated reinsurer on certain life insurance
policies in force as of June 30, 1993. The Company ceded $3.7 million of life
insurance reserves and received $1.7 million as a ceding commission, which was
recorded as deferred revenue. The deferred revenue amount is being amortized
into income over the expected life of the underlying policies reinsured. The
Company amortized $122,433, $93,212 and $63,356 of deferred revenue during 1996,
1997 and 1998, respectively.
The Company entered into a 75% quota share reinsurance agreement with an
unaffiliated reinsurer on the $60,000 retention of certain individual accident &
health insurance policies in force as of June 30, 1995. The Company received
$0.9 million as a ceding commission, $0.6 million of which was offset by the
amortization of the deferred acquisition cost asset related to this business.
The remaining $0.2 million was recorded as deferred revenue and $0.2 million was
recognized as income during 1996. The agreement was canceled effective December
31, 1996.
h. INCOME TAXES: The Company's method of accounting for income taxes is
the asset and liability method. Under the asset and liability method, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date of a change in tax rates.
i. REINSURANCE ACCOUNTING: Recoverables under reinsurance contracts are
included in total assets as amounts due from reinsurers. The cost of reinsurance
related to long-duration contracts is accounted for over the life of the
underlying reinsured policies using assumptions consistent with those used to
account for the underlying policies.
E-10
291
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
j. EARNINGS PER COMMON SHARE: Basic EPS excludes dilution and is computed
by dividing income available to common shareholders, (after deducting the
redemption accrual on the Series C Preferred Stock), by the weighted average
number of shares outstanding for the period. Diluted EPS gives the dilutive
effect of the stock options, warrants and Series B, C and D Preferred Stock
outstanding during the year. A reconciliation of the numerators and the
denominators of the basic and diluted EPS for the years ended December 31, 1996,
1997 and 1998 is as follows:
FOR THE YEAR ENDED DECEMBER 31, 1996
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Net income........................................... $103,875
Basic EPS
Net income applicable to common shareholders......... 103,875 6,999,293 $0.01
=====
Effect of Dilutive Securities
Series B Preferred stock............................. 1,777,777
Non-registered warrants.............................. 2,015,760
Registered warrants.................................. 668,481
Incentive stock options.............................. 266,000
Director stock option................................ 9,000
Treasury stock purchased from proceeds of exercise of
options and warrants............................... (1,198,376)
-------- ----------
Diluted EPS
Net income applicable to common shareholders plus
assumed conversions................................ $103,875 10,537,935 $0.01
======== ========== =====
FOR THE YEAR ENDED DECEMBER 31, 1997
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Net income........................................... $2,119,409
Less: Redemption accrual on Series C Preferred
Stock.............................................. (249,790)
----------
Basic EPS
Net income applicable to common shareholders......... 1,869,619 7,241,931 $0.26
=====
Effect of Dilutive Securities
Series B Preferred Stock............................. 1,777,777
Series C Preferred Stock............................. 249,790 1,356,421
Non-registered warrants.............................. 2,015,760
Registered warrants.................................. 668,481
Incentive stock options.............................. 296,000
Director stock option................................ 16,000
Treasury stock purchased from proceeds of options and
warrants........................................... (1,331,515)
---------- ----------
Diluted EPS
Net income applicable to common Shareholders plus
assumed conversions................................ $2,119,409 12,040,855 $0.18
========== ========== =====
E-11
292
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Net income........................................... $2,607,628
Less: Redemption accrual on Series C Preferred
Stock.............................................. (433,424)
----------
Basic EPS
Net income applicable to common shareholders......... 2,174,204 7,532,758 $0.29
=====
Effect of Dilutive Securities
Series B Preferred Stock............................. 1,777,777
Series C Preferred Stock............................. 433,424 2,176,000
Series D Preferred Stock............................. --
Non-registered warrants.............................. 2,015,760
Registered warrants.................................. 658,231
Incentive stock options.............................. 229,000
Director stock option................................ 7,000
Treasury stock purchased from proceeds of exercise of
options and warrants............................... (1,241,022)
---------- ----------
Diluted EPS
Net income applicable to common Shareholders plus
assumed conversions................................ $2,607,628 13,155,504 $0.20
========== ========== =====
k. COMPREHENSIVE INCOME: As of January 1, 1998, the Company adopted
Statement 130, "Reporting Comprehensive Income". Statement 130 establishes new
rules for the reporting and display of comprehensive income and its components;
however, the adoption of this Statement had no impact on the Company's net
income or shareholders' equity. Statement 130 requires unrealized gains or
losses on the Company's available-for-sale securities, which prior to adoption
were reported separately in shareholders' equity, to be included in other
comprehensive income. Prior year financial statements have been reclassified to
conform to the requirements of Statement 130.
The components of comprehensive income, net of related tax, for the year
ended December 31, 1996, 1997 and 1998 are as follows:
1996 1997 1998
----------- ---------- ----------
Net income................................ $ 103,875 $2,119,409 $2,607,628
Net unrealized gain (loss) arising during
the year................................ (2,223,062) 2,796,624 115,630
Reclassification adjustment for gains
(losses) included in net income......... (118,826) (982,767) (99,378)
----------- ---------- ----------
Comprehensive income (loss)............... $(2,238,013) $3,933,266 $2,623,880
=========== ========== ==========
l. CASH FLOW INFORMATION: Included in cash and cash equivalents are cash
on deposit, money market funds, and short term investments which had an original
maturity of three months or less from the time of purchase.
m. FASB STATEMENT NO. 133: In June 1998, the FASB issued Statement 133,
"Accounting for Derivative Instruments and Hedging Activities", which is
required to be adopted in years beginning after June 15, 1999. Because of the
Company's minimal use of derivatives, management does not
E-12
293
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
anticipate that the adoption of the new Statement will have a significant effect
on earnings or the financial position of the Company.
n. RECLASSIFICATIONS: Certain reclassifications have been made to prior
years' financial statements to conform to current period classifications.
3. PENDING TRANSACTIONS:
Universal American Financial Corp. Share Purchase Agreement with Capital Z
Financial Services Fund II, L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement ("UA
Purchase Agreement") with Capital Z Financial Services Fund II, L.P. ("Capital
Z"), whereby Capital Z has agreed to purchase up to 26,031,746 shares of
Universal common stock for a purchase price of up to $82.0 million (the "Capital
Z Transaction") subject to adjustment as outlined in the Purchase Agreement.
Pursuant to terms of the UA Purchase Agreement, the number of shares of
Universal common stock and the aggregate purchase price to be paid by Capital Z
will be reduced based upon the aggregate number of shares of Universal common
stock purchased by certain members of management and agents of the companies
being acquired pursuant to the Penn Union Purchase Agreement discussed below,
but in no event will it be less than 19,841,270 shares. Thus, as a result of the
closing of the transactions contemplated by the UA Purchase Agreement, Capital Z
will acquire a controlling interest in Universal. Specifically, if Capital Z
purchases the minimum number shares under the UA Purchase Agreement, it will
acquire 45.6% of the then outstanding shares of Universal common stock on a
fully diluted basis, and if Capital Z purchases the maximum number of shares, it
will acquire 59.8% of the then outstanding shares of Universal common stock on a
fully diluted basis.
The UA Purchase Agreement is subject to (i) regulatory approvals in the
states in which Universal's insurance subsidiaries are domiciled, (ii)
shareholder approval and (iii) the consummation of the Penn Union Transaction
(see below).
Penn Union Acquisition
On December 31, 1998, Universal entered into a purchase agreement (the
"Penn Union Purchase Agreement") with PennCorp Financial Group, Inc. ("PFG") and
certain subsidiaries of PFG to acquire all of the outstanding shares of common
stock of certain direct and indirect subsidiaries of PFG, including the
insurance companies as follows (the "Penn Union Transaction"):
STATE OR PROVINCE
NAME OF INSURANCE COMPANY OF DOMICILE
- ------------------------- -----------------
Pennsylvania Life Insurance Company Pennsylvania
Peninsular Life Insurance Company North Carolina
Union Bankers Insurance Company Texas
Constitution Life Insurance Company Texas
Marquette National Life Insurance Company Texas
Penncorp Life of Canada Ottawa
The Penn Union Purchase Agreement calls for a purchase price of $175
million with $136 million in cash and $39 million in seller financing. In
addition, the Company will incur approximately $12 million in transaction costs
associated with this transaction. The Company will finance the cash portion of
the acquisition with the $82 million of proceeds generated from the UA Purchase
E-13
294
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Agreement discussed above and from the execution of a $80 million credit
facility that consists of a $70 million term loan and $10 million revolving loan
facility.
The Penn Union Purchase Agreement is subject to approval by the insurance
regulators of the jurisdictions in which the acquired companies are domiciled.
Management expects this transaction to close in the second quarter of 1999,
although no assurances can be given that it will occur. Based on unaudited
financial information as of September 30, 1998, the assets and liabilities to be
acquired in connection with the Penn Union Transaction are approximately $831
million and $656 million, respectively.
4. RECENT ACQUISITIONS:
Dallas General
On March 19, 1998, the Company acquired a $12.6 million block of annual
premiums in force of Medicare Supplement business from Dallas General Life
Insurance Company ("Dallas General") for a purchase price of $0.8 million. At
the time of the acquisition, the Company entered into a reinsurance agreement
with Reassurance Company of Hannover ("RCH") to cede 75% of the business
acquired to RCH for a ceding allowance of $0.6 million. In connection with this
assumption, the Company incurred $0.3 million of expenses. The Company recorded
an asset of $0.5 million as present value of future profits, which will be
amortized over the expected lives of the underlying policies. During the year
ended December 31, 1998, the Company amortized $35,000 of this asset. The amount
of reserves assumed totaled $5.4 million and the Company received assets
consisting of cash, real estate and mortgage loans totaling $5.4 million.
American Pioneer, with the approval of the Texas and Florida Departments of
Insurance, assumed the business.
American Exchange Life Insurance Company
On December 4, 1997, the Company, through its wholly owned subsidiary,
American Pioneer, acquired 100% of the outstanding common stock of American
Exchange for $6.6 million in cash, which acquisition was approved by both the
Texas and Florida Departments of Insurance. This acquisition was accounted for
using the purchase method. American Exchange, which is licensed in Texas and two
other states, had annual premium in force in excess of $16.6 million, primarily
in Medicare Supplement and other limited benefit accident & health products and
had 19,800 policies in force and 1,000 insurance agents, all based in Texas.
E-14
295
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following schedule summarizes the assets acquired and liabilities
assumed, at fair value, on the date of acquisition:
ASSETS ACQUIRED:
Fixed maturities............................................ $ 6,826,474
Equity securities........................................... 317,413
Cash and cash equivalents................................... 2,679,665
Policy loans................................................ 174,513
Accrued investment income................................... 159,528
Other assets................................................ 298,397
-----------
Total assets acquired....................................... 10,455,990
===========
LIABILITIES ASSUMED
Reserves for future policy benefits......................... 737,290
Policy and contract claims.................................. 266,048
Amounts due to reinsurers................................... 4,036,450
Deferred Federal income taxes............................... 435,814
Other liabilities........................................... 768,367
-----------
Total liabilities assumed................................... 6,243,969
===========
Net assets acquired......................................... 4,212,021
Present value of future profits............................. 1,281,807
Goodwill.................................................... 1,265,868
-----------
Total purchase price........................................ $ 6,759,696
===========
The value of the inforce business ($1,281,807), the principal intangible
asset acquired, is recorded under the caption present value of future profits
and is amortized over the expected lives of the underlying products. The
remaining excess of purchase price over net assets acquired of $1,265,868
related to other immaterial intangible assets (e.g. distribution platform, sales
force and state licenses) and goodwill have been classified as goodwill and are
being amortized over a composite useful life of 30 years on a straight line
basis.
First National Life
In the fourth quarter of 1996, the Company acquired, through an assumption
reinsurance agreement, approximately $56.0 million of annualized senior market
premium from First National. American Pioneer initially contracted with First
National to assume $4.0 million of annualized premium on group Medicare
Supplement coverage issued to the members of the Florida Retired Educators
Association ("FREA"). Then, after First National was placed into Receivership by
the Alabama Insurance Department in October, 1996, American Pioneer assumed, in
addition to the FREA block, approximately $50.0 million of annualized Individual
Medicare Supplement premium, $1.2 million of annualized Home Health Care premium
and $0.8 million of annualized miscellaneous life and accident & health
insurance premiums, under terms negotiated with the Receiver. All of these
assumptions were effective as of October 1, 1996. Simultaneously with the second
assumption by American Pioneer, American Pioneer entered into a reinsurance
agreement with Transamerica Occidental Life Insurance Company ("Transamerica"),
ceding 90% of the $50.0 million Individual Medicare Supplement to Transamerica.
E-15
296
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As part of the First National transaction, the Company acquired in
Pensacola, Florida a relatively low cost administrative operation with
particular experience in the senior market. This has given the Company an
opportunity to consolidate many of its administrative functions in Pensacola and
save a significant amount of fixed overhead. The assets and liabilities acquired
included no individually significant intangible assets (e.g. distribution
platform, sales force and assembled workforce). Accordingly, the excess of the
fair value of liabilities assumed over assets assumed of $3.5 million was
allocated to goodwill that is being amortized over a composite useful life of 30
years on a straight-line basis.
In December 1996, the Company formulated a plan to move most of American
Progressive's policy administrative functions, particularly in its senior market
business, from its office in Brewster, NY to Pensacola, Florida. This, along
with other cost saving efforts, resulted in a reduction in the work force at the
American Progressive office from 62 as of June 30, 1996 to approximately 25 as
of December 31, 1997, with a modest resultant increase in personnel in
Pensacola, including some personnel employed by American Progressive. In
December 1996, these plans were announced to certain key individuals who were to
be relocated under this reorganization. The remaining employees who were to be
terminated were notified in March 1997. The cost of this consolidation,
including severance costs, relocation costs and the non-renewal fee on the
Brewster office lease, was approximately amounted to $0.3 million and was
expensed in the fourth quarter of 1996.
5. INVESTMENTS:
As of December 31, 1997 and 1998, investments consisted of the following:
DECEMBER 31, 1997
------------------------------------------------------------
FACE AMORTIZED FAIR CARRYING
CLASSIFICATION VALUE COST VALUE VALUE
- -------------- ------------ ------------ ------------ ------------
US Treasury bonds and
notes..................... $ 7,610,000 $ 7,697,324 $ 7,802,780 $ 7,802,780
Corporate bonds............. 113,902,686 113,422,022 115,782,928 115,782,928
Equity Securities........... 987,095 945,116 945,116
------------ ------------ ------------
Sub-total.............. $122,106,441 $124,530,824 $124,530,824
============
Property tax liens.......... 136,713 136,713
Policy loans................ 7,185,014 7,185,014
Mortgage loans.............. 2,562,008 2,562,008
------------ ------------
Total investments...... $131,990,176 $134,414,559
============ ============
E-16
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UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
------------------------------------------------------------
FACE AMORTIZED FAIR CARRYING
CLASSIFICATION VALUE COST VALUE VALUE
- -------------- ------------ ------------ ------------ ------------
US Treasury bonds and
notes..................... $ 3,800,000 $ 3,848,038 $ 3,947,957 $ 3,947,957
Corporate bonds............. 129,150,377 128,379,076 130,849,677 130,849,677
Equity Securities........... 1,063,186 1,019,780 1,019,780
------------ ------------ ------------
Sub-total.............. 133,290,300 $135,817,414 $135,817,414
============
Property tax liens.......... 30,696 30,696
Policy loans................ 7,276,163 7,276,163
Mortgage loans.............. 4,456,516 4,456,516
------------ ------------
Total investments...... $145,053,675 $147,580,789
============ ============
The amortized cost and fair value of fixed maturities as of December 31,
1997 and 1998 are as follows:
DECEMBER 31, 1997
--------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
CLASSIFICATION COST GAINS LOSSES VALUE
- -------------- ------------ ---------- ---------- ------------
US Treasury securities and
obligations of US government... $ 10,821,981 $ 224,552 $ (20,088) $ 11,026,445
Corporate debt securities........ 52,427,251 1,668,511 (261,644) 53,834,118
Mortgage-backed securities....... 57,870,114 1,506,116 (651,085) 58,725,145
------------ ---------- --------- ------------
$121,119,346 $3,399,179 $(932,817) $123,585,708
============ ========== ========= ============
DECEMBER 31, 1998
---------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
CLASSIFICATION COST GAINS LOSSES VALUE
- -------------- ------------ ---------- ----------- ------------
US Treasury securities and
obligations of US government.. $ 6,444,302 $ 181,694 $ (28,440) $ 6,597,556
Corporate debt securities....... 63,502,687 1,680,539 (472,027) 64,711,199
Mortgage-backed securities...... 62,280,125 1,821,084 (612,330) 63,488,879
------------ ---------- ----------- ------------
$132,227,114 $3,683,317 $(1,112,797) $134,797,634
============ ========== =========== ============
The amortized cost and fair value of fixed maturities at December 31, 1998
by contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
E-17
298
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
AMORTIZED FAIR
COST VALUE
------------ ------------
Due in 1 year or less........................ $ 2,769,318 $ 2,782,948
Due after 1 year through 5 years............. 23,928,906 24,514,144
Due after 5 years through 10 years........... 23,729,941 24,246,138
Due after 10 years........................... 16,922,605 17,115,927
Mortgage-backed securities................... 64,876,344 66,138,477
------------ ------------
$132,227,114 $134,797,634
============ ============
Included in fixed maturities at December 31, 1997 and 1998 were securities
with carrying values of $7.1 million and $7.7 million, respectively, held by
various states as security for the policyholders of the Company within such
states.
Gross unrealized gains and gross unrealized losses of equity securities as
of December 31, 1997 and 1998 are as follows:
1997 1998
-------- --------
Gross unrealized gains............................... $ 29,378 $ 44,102
Gross unrealized losses.............................. (71,357) (87,508)
-------- --------
Net unrealized losses................................ $(41,979) $(43,406)
======== ========
The components of the change in unrealized gains and losses included in the
consolidated statements of stockholders' equity for the three years ended
December 31, 1998 are as follows:
1996 1997 1998
----------- ----------- --------
Change in net unrealized gains
(losses):
Fixed maturities................. $(3,335,207) $ 3,485,207 $104,158
Equity securities................ 18,264 (29,393) (1,427)
Adjustment relating to deferred
policy acquisition costs...... 269,477 (1,205,127) (78,810)
----------- ----------- --------
Change in net unrealized gains
(losses) before income tax....... (3,047,466) 2,250,687 23,921
Income tax expense (benefit)....... (705,578) 436,830 7,669
----------- ----------- --------
Change in net unrealized gains
(losses)......................... $(2,341,888) $ 1,813,857 $ 16,252
=========== =========== ========
E-18
299
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The details of net investment income for the three years ended December 31,
1998 are as follows:
1996 1997 1998
----------- ----------- -----------
Investment Income:
Fixed maturities.............. $ 9,048,143 $ 8,961,283 $ 9,198,632
Cash and cash equivalents..... 731,924 801,987 919,724
Equity securities............. -- 29,044 58,580
Property tax liens............ (1,297) 22,639 4,906
Policy loans.................. 487,740 495,623 612,629
Mortgage loans................ 86,858 102,737 363,036
----------- ----------- -----------
Gross investment income......... 10,353,368 10,413,313 11,157,507
Investment expenses............. 503,285 390,655 436,156
----------- ----------- -----------
Net investment income........... $ 9,850,083 $10,022,658 $10,721,351
=========== =========== ===========
Gross realized gains and gross realized losses included in the consolidated
statements of operations for the three years ended December 31, 1998 are as
follows:
1996 1997 1998
--------- ---------- -----------
Realized gains:
Fixed maturities......................... $ 363,927 $ 760,381 $ 1,250,224
Equity securities........................ 5,000 629,847 25,708
--------- ---------- -----------
Total realized gains....................... 368,927 1,390,228 1,275,932
--------- ---------- -----------
Realized losses:
Fixed maturities......................... (128,852) (257,707) (991,033)
Equity securities........................ -- -- (29,228)
--------- ---------- -----------
Total realized losses...................... (128,852) (257,707) (1,020,261)
--------- ---------- -----------
Net realized gains......................... $ 240,075 $1,132,521 $ 255,671
========= ========== ===========
During the year ended December 31, 1998, the Company wrote down the value
of certain fixed maturity securities by $0.6 million which represents
management's estimate of other than temporary declines in value and was included
in net realized gains on investments. In 1997, the Company realized a gain of
$0.6 million on the sale of AmeriFirst Insurance Company, a non-operating
subsidiary.
6. INCOME TAXES:
The Company files a consolidated return for federal income tax purposes, in
which American Pioneer and American Exchange are not currently permitted to be
included. American Pioneer and American Exchange file a separate consolidated
federal income tax return.
The Company's federal income tax expense consisted of:
1996 1997 1998
-------- ---------- ----------
Current...................... $ -- $ -- $ --
Deferred..................... 269,017 1,091,818 1,323,963
-------- ---------- ----------
Total tax expense............ $269,017 $1,091,818 $1,323,963
======== ========== ==========
E-19
300
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the "expected" tax expense at 34% with the Company's
actual tax expense applicable to operating income before taxes reported in the
Consolidated Statements of Operations is as follows:
1996 1997 1998
-------- ---------- ----------
Expected tax expense......................... $126,783 $1,091,818 $1,336,741
Change in the beginning of the year balance
of the valuation allowance for deferred tax
assets allocated to income tax expense..... 187,414 -- --
Nondeductible expenses....................... 15,947 -- --
Realized gains on investment................. (11,030) -- --
Tax exempt income............................ (50,533) -- --
Other........................................ 436 -- (12,778)
-------- ---------- ----------
Actual tax expense........................... $269,017 $1,091,818 $1,323,963
======== ========== ==========
In addition to Federal income tax, the Company is subject to state premium
and income taxes, which taxes are included in other operating costs and expenses
in the accompanying statement of operations.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. The tax effects of
temporary differences that give rise to significant portions of the deferred tax
assets and deferred tax liabilities at December 31, 1997 and 1998 are as
follows:
1997 1998
----------- -----------
Deferred tax assets:
Reserves for future policy benefits............ $ 3,617,347 $ 3,309,830
Deferred revenues.............................. 90,013 68,472
Net operating loss carryforwards............... 5,125,637 5,219,133
AMT credit carryforward........................ 107,262 107,262
Investment valuation differences............... 120,488 189,039
Other.......................................... 159,555 23,386
----------- -----------
Total gross deferred tax assets........... 9,220,302 8,917,122
Less valuation allowance.................. (1,342,838) (1,342,838)
----------- -----------
Net deferred tax assets................... 7,877,464 7,574,284
----------- -----------
Deferred policy acquisition costs.............. (5,796,879) (6,755,687)
Unrealized gains on investments................ (436,830) (444,472)
Goodwill....................................... (1,102,528) (1,059,008)
Present value of future profits................ (435,814) (533,664)
----------- -----------
Total gross deferred tax liabilities...... (7,772,051) (8,792,831)
----------- -----------
Net deferred tax asset (liability)........ $ 105,413 $(1,218,547)
=========== ===========
In 1997, a deferred tax liability related to the present value of future
profits recorded as a result of the acquisition of American Exchange was
established and amounted to $0.4 million. In 1996, a deferred tax asset related
to the tax liabilities assumed in excess of tax assets received in the
acquisition of certain business from First National was established and amounted
to $0.3 million.
E-20
301
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998 the Company (exclusive of American Pioneer and
American Exchange) had net operating tax loss ("NOL") carry forwards of
approximately $11.6 million which are available to offset future taxable income
of the Company. The losses will expire in the years 1999 to 2012. Although a
portion of the NOL carry forward was utilized to offset 1998 consolidated
taxable income of the Company, it is likely that part of these NOL's may not be
realized and for this purpose a valuation allowance has been established. At
December 31, 1998 the Company also has Alternative Minimum Tax (AMT) credit
carry forward for Federal income tax purposes of approximately $0.3 million
which can be used indefinitely.
At December 31, 1998 American Pioneer and American Exchange had net
operating tax loss carry forwards, most of them incurred prior to their
acquisition by the Company, of approximately $3.7 million which expire in the
years 1999 to 2013. As a result of changes in ownership of American Pioneer in
May 1993, use of most of the loss carry forwards of American Pioneer are subject
to annual limitations. It is likely that part of these NOL's may not be realized
and for this purpose a valuation allowance has been established.
At December 31, 1997 and 1998, the Company has established valuation
allowances of $1.3 million with respect to its net operating loss carryforwards
deferred tax asset. As indicated above, it is anticipated that some of the NOL's
of the Company may expire in 1999 and 2000 before their utilization. The Company
determines a valuation allowance based upon an analysis of projected taxable
income and through its ability to implement prudent and feasible tax planning
strategies. The tax planning strategies include the Company's recent
reorganization and use of its administration company WorldNet to generate
taxable income. These changes resulted in the Company increasing taxable income
in the non-life companies by $1.2 million and $0.4 million in 1997 and 1998,
respectively. Management believes it is more likely than not that the Company
will realize the recorded deferred tax assets.
7. SERIES C PREFERRED STOCK:
During 1997, the Company issued 51,680 shares (par value $100) of Series C
Preferred Stock for $5.2 million, of which $2.4 million was purchased by UAFC
L.P. ("AAM") an unaffiliated investment firm, $0.6 million by Chase Equity
Partners, L.P., $1.4 million by Richard A. Barasch (the Chairman and Chief
Executive Officer of the Company), members of his family, and members and
associates of the Company's management and $0.8 million by owners and employees
of Ameri-Life & Health Services, a general agency that sells the Company's
senior market products. This transaction received the approval of the Florida
Insurance Department.
Under the terms of the Series C Preferred Stock, the Company has the right
to require conversion of the Series C Preferred Stock into the Company's common
stock at a conversion price of $2.375 per common share if the average reported
bid price of its common stock on the days during any 60 day period in 1999 on
which such bid prices are reported exceeds $3.45 per common share. This
condition was satisfied on March 5, 1999 and all of the 51,680 outstanding
shares of Series C Preferred Stock will be converted to 2,176,000 shares of
common stock in April 1999.
The Company, AAM, the holders of the Series C Preferred Stock, Barasch
Associates Limited Partnership ("BALP") and Richard A. Barasch entered into a
stockholders' agreement at the closing of the transaction which contained the
following conditions:
- The holders of the Series C Preferred Stock were given registration
rights and informational rights.
- The Series C Preferred Stockholders agreed to vote their shares for the
election of a person designated by AAM as the director elected by that
Series.
E-21
302
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- BALP and Mr. Barasch granted the Series C holders a co-sale right should
they sell any shares of the Company's common stock held by them, except
to certain "permitted transferees".
This stockholders' agreement will be superceded by a new agreement upon the
closing of the Capital Z transaction. (See Note 3).
8. SERIES D PREFERRED STOCK:
On December 31, 1998, the Company contracted to sell 40,000 shares (par
value $100) of Series D Preferred Stock to UAFC, L.P. for $4.0 million. The
Series D Preferred Stock was divided into two sub-series, Series D-1 and Series
D-2. The 22,500 Series D-1 Shares were issued on December 31, 1998 and the
17,500 Series D-2 shares were issued on February 12, 1999. The Series D
Preferred Stock has the same provisions as the Series C-1, Preferred Stock,
except (i) that the Series D has no voting rights except as required by law,
(ii) the conversion price on the Series D-1 was $2.70 rather than $2.375 per
share, (iii) the conversion price of the series D-2 was $2.70 or, if a "change
of control" transaction, as defined, occurs in 1999, the conversion price will
be equal to the per share price at which common stock is issued in the change of
control transaction, and (iv) if the issuance of voting shares to a Series D
shareholder requires regulatory approval, the conversion will be postponed until
such approval is obtained or ceases to be required. The pending Capital Z
Transaction will be a "change of control" within the meaning of the terms of the
Series D Preferred Stock.
On March 11, 1999, the Company gave notice of conversion of the Series D-1
and D-2 Preferred Stock. Since the conversion of the Series D-1 and D-2
Preferred Stock held by UAFC, L.P. to common stock would result in its owning
more than 10% of the Company's voting stock, implementation of the conversion
would require that the New York Insurance Department either (i) approve of UAFC,
L.P. becoming a controlling shareholder of the Company or (ii) determine that
such conversion would not result in UAFC, L.P. becoming a controlling person of
Universal. The completion of the conversion of the Series D Preferred Stock was
therefore deferred until such conditions are satisfied or are no longer
applicable. If the pending Capital Z Transaction closes, no approval of the
conversion of the Series D Preferred Stock will be required, because the UAFC,
L.P. will, after conversion of the Series D Preferred Stock, hold less than 10%
of Universal's then outstanding stock. If the Capital Z Transaction does not
close, the Company anticipates that it will obtain the required approval of a
change of control or determination that no change of control is involved in the
conversion of the Series D Preferred Stock.
The shareholder agreement applicable to the Series C Preferred Stock also
applies to the Series D Preferred Stock.
9. STOCKHOLDERS' EQUITY:
Preferred Stock
The Company has 2,000,000 authorized shares of preferred stock to be issued
in series with 52,080 and 74,580 shares issued and outstanding at December 31,
1997 and 1998, respectively (see Note 7 for a discussion of Series C Preferred
Stock and Note 8 for a discussion of Series D Preferred Stock).
E-22
303
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Series B Preferred Stock
The Company has 400 shares of Series B Preferred Stock issued and
outstanding, with a par value of $10,000 per share, which are held by
Wand/Universal Investments L.P. ("Wand"). The Series B Preferred Stock is
convertible into Common Stock at $2.25 per share (subject to anti-dilution
adjustment) and is entitled to dividends as if already converted, only when and
if dividends are declared on the Common Stock. The holder of the Series B
Preferred Stock may not require the Company to redeem it unless the Company
engages in (i) a merger with, or acquisition of, another entity which results in
that entity or its shareholders having sufficient voting power to elect a
majority of the Company's Board of Directors or (ii) the sale or other exchange
of 40% or more of the Company's assets or of its outstanding Common Stock. The
Company has the right to require a conversion if it raises additional equity
from the public on pricing terms that meet certain criteria.
The holders of the Series B Preferred Stock have the right to elect one
Director of the Company, and have the right to vote on all other matters
submitted to the vote of the holders of the Common Stock, as if their Series B
Preferred Stock had been converted to Common Stock. In addition, under the New
York Business Corporation Law, any amendment to the Certificate of Incorporation
which would make certain changes affecting the Series B Preferred Stock must be
approved by the holders of a majority of the outstanding Series B Preferred
Stock, voting separately as a class.
Pursuant to the stock subscription agreement, Wand, the Company and certain
shareholders of the Company, including Barasch Associates Limited Partnership
("BALP"), entered into a shareholders' agreement contemporaneously with the
issuance of the Series B Preferred Stock to Wand. Under the shareholders'
agreement, the holder of the Series B Preferred Stock agreed to vote such
shares, and the Common Stock issued upon their conversion, for the nominees of
BALP for election as directors of the Company and, after the conversion of the
Series B Preferred Stock to Common Stock, all parties agreed to vote their
shares for the election of one director designated by Wand. The shareholders'
agreement also contained "stand still," "tag along" and registration rights
provisions. The stand still provision will prohibit Wand from acquiring more
than an additional 5% of the Company's outstanding Common Stock without the
Company's consent, as long as BALP and certain partners in BALP continue to hold
at least certain percentages of the Company's Common Stock, on an outstanding
and fully diluted basis. The tag along provision will prohibit BALP and certain
of its partners from making private sales of their shares of Common Stock unless
Wand is given the opportunity to sell a proportionate part of its holding on the
same terms. This stockholders' agreement will be superceded by a new agreement
upon the closing of the Capital Z transaction.
The Company and Wand Partners L.P., an affiliate of Wand, have also entered
into a financial advisory agreement, under which the Wand affiliate is to render
advisory services to the Company and is to be paid a fee of $100,000 per year
for such services as long as Wand owns 500,000 shares of Common Stock, or its
common stock equivalent, reduced by any directors' fee paid to the director
designated by Wand.
In connection with the determination by the New York Superintendent of
Insurance (the "Superintendent") that Wand is not a controlling shareholder of
the Company, within the meaning of the New York Insurance Law, certain
commitments were made to the Superintendent. These commitments included a
commitment by Wand, Wand's general partner and Wand's general partner's
shareholders that, as long as Wand owns 10% or more of the voting power of
Universal's outstanding stock, Wand will not acquire any additional shares of
Universal, except by exercise of its conversion rights, and will not attempt to
obtain or exercise control of Universal, without the consent of the
Superintendent. Universal, American Progressive, BALP, BALP's general partner
and certain limited partners, and the shareholders of BALP's general partner
also entered into commit-
E-23
304
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ments, including commitments that, as long as Wand owns 10% or more of the
voting power of Universal's outstanding shares, the size of Universal's Board
would not be reduced below ten directors and that no transaction between
Universal or American Progressive, on the one hand, and Wand or its partners of
controlling parties, on the other hand, would be entered without the approval of
the Superintendent, except for the shareholders agreement and the financial
advisory agreement referred to herein.
Common Stock
The par value of common stock is $.01 per share with 20,000,000 shares
authorized for issuance. The shares issued and outstanding at December 31, 1997
and 1998 were 7,325,860 and 7,638,057, respectively. During the years ended
December 31, 1996, 1997 and 1998, the Company issued 191,689, 176,639 and
312,197 shares, respectively, of its common stock.
Common Stock Warrants
The Company had 668,481 and 658,231 common stock warrants issued and
outstanding at December 31, 1997 and 1998, which are registered under the
Securities Exchange Act of 1934. During the year ended December 31, 1998, 10,250
warrants were exercised to purchase common shares at $1.00 per share. At
December 31, 1997 and 1998, the Company had 2,015,760 warrants outstanding which
are not registered under the Securities Exchange Act of 1934. The warrants have
no par value, have an exercise price to purchase common stock on a one to one
basis at $1.00 and expire on December 31, 1999.
Option Plans
On May 28, 1998, the Company's shareholders approved the 1998 Incentive
Compensation Plan (the "1998 ICP"). The 1998 ICP superceded the Company's
Incentive Stock Option Plan, Stock Option Plan For Directors, and Non-Qualified
Stock Option Plan for Agents and Others (the "Pre-Existing Plans"). Options
previously granted under these plans will remain outstanding in accordance with
their terms and the terms of the respective plans.
Incentive Stock Option Plan
In 1983, the Company adopted an Incentive Stock Option Plan for employees.
Under this Plan, as amended, 1,000,000 shares of common stock were reserved. As
of December 31, 1998, 516,500 of these shares have been issued and 442,500
shares were subject to options granted prior to the adoption of the 1998 ICP.
Options under this plan expire ten years after the date granted or upon the
earlier termination of employment. Options vest 50% in the first year after
grant and 50% in the second year after grant, and at December 31, 1998, 369,254
options are exercisable. Additional information with respect to options under
the Company's Incentive Stock Option Plan is as follows:
SHARES UNDER
OPTIONS EXERCISE
OUTSTANDING PRICE
------------ -------------
BALANCE, JANUARY 1, 1996........................ 611,000
Granted....................................... 141,000 $2.00 - $2.20
Exercised..................................... (135,000) $0.50 - $1.35
Terminated.................................... (47,000) $2.87 - $3.25
--------
E-24
305
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SHARES UNDER
OPTIONS EXERCISE
OUTSTANDING PRICE
------------ -------------
BALANCE, DECEMBER 31, 1996...................... 570,000
Granted....................................... 166,500 $2.00 - $3.03
Exercised..................................... (95,000) $1.25 - $1.44
Terminated.................................... (21,000) $1.25 - $3.33
--------
BALANCE, DECEMBER 31, 1997...................... 620,500 $1.44 - $3.33
Granted....................................... --
Exercised..................................... (165,000) $1.25 - $1.63
Terminated.................................... (13,000) $0.80 - $2.00
--------
BALANCE, DECEMBER 31, 1998...................... 442,500 $2.00 - $3.33
========
Stock Option Plan for Directors
At the 1992 Annual Shareholders' Meeting, the Universal American Financial
Corp. non-employee Directors Plan ("Stock Option Plan for Directors") was
approved. The Stock Option Plan for Directors reserves 75,000 shares of common
stock and provides that options shall be granted on June 30 of each year to each
eligible Director, then in office, at the rate of 1,000 options for each
additional year of service completed since the last grant. Options under this
plan are exercisable one year after grant. Since inception, 19,000 options have
been exercised. Additional information with respect to the Company's stock
option plan for Directors is as follows:
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- -------------
BALANCE, JANUARY 1, 1996......................... 21,000
Granted........................................ 7,000 $2.50
------
BALANCE, DECEMBER 31, 1996....................... 28,000
Granted........................................ 8,000 $1.88
------
BALANCE, DECEMBER 31, 1997....................... 36,000
Granted........................................ -- $2.62
Exercised...................................... (8,700) $0.56 - $1.63
Terminated..................................... (4,300) $1.88 - $3.50
------
BALANCE, DECEMBER 31, 1998....................... 23,000 $1.88 - $3.50
======
Stock Option Plan for Agents and Others
On December 15, 1995, the Board of Directors approved a plan under which up
to 200,000 options could be granted to agents of the Company's subsidiaries
(subject to insurance law restrictions) and to other persons as to whom the
Board of Directors believes the grant of such options will serve the best
interests of the Corporation, provided that no options may be granted under this
plan to officers, directors or employees of the Company or of any subsidiary,
while they
E-25
306
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
are serving as such. Such options will expire 10 years from the date of the
grant. Additional information with respect to the Company's Stock Option Plan
for Agents and Others is as follows:
OPTIONS EXERCISE
OUTSTANDING PRICE
----------- -------------
BALANCE, JANUARY 1, 1996......................... 40,000 $2.50
Granted........................................ 46,393 $2.50 - $2.97
-------
BALANCE, DECEMBER 31, 1996....................... 86,393
Granted........................................ 16,393 $2.50
-------
BALANCE, DECEMBER 31, 1997....................... 102,786
Granted........................................ --
-------
BALANCE, DECEMBER 31, 1998....................... 102,786 $2.50 - $2.97
=======
1998 ICP
The 1998 ICP provides for grants of stock options, stock appreciation
rights ("SARs"), restricted stock, deferred stock, other stock-related awards,
and performance or annual incentive awards that may be settled in cash, stock,
or other property ("Awards").
The total number of shares of the Corporation's Common Stock reserved and
available for delivery to participants in connection with Awards under the 1998
ICP is (i) 1.5 million, plus (ii) the number of shares of Common Stock subject
to awards under Preexisting Plans that become available (generally due to
cancellation or forfeiture) after the effective date of the 1998 ICP, plus (iii)
13% of the number of shares of Common Stock issued or delivered by the
Corporation during the term of the 1998 ICP (excluding any issuance or delivery
in connection with Awards, or any other compensation or benefit plan of the
Corporation), provided, however, that the total number of shares of Common Stock
with respect to which incentive stock options ("ISOs") may be granted shall not
exceed 1.5 million. As of December 31, 1998, 691,000 shares were reserved for
outstanding Awards under the 1998 ICP and 850,945 shares were reserved for
issuance under future Awards.
The 1998 ICP imposes individual limitations on the amount of certain Awards
in order to comply with Section 162(m) of the Internal Revenue Code (the
"Code"). Under these limitations, during any fiscal year the number of options,
SARs, shares of restricted stock, shares of deferred stock, shares of Common
Stock issued as a bonus or in lieu of other obligations, and other stock-based
Awards granted to any one participant shall not exceed one million shares for
each type of such Award, subject to adjustment in certain circumstances, the
maximum cash amount that may be earned as a final annual incentive award or
other annual cash Award in respect of any fiscal year by any one participant is
$5 million, and the maximum cash amount that may be earned as a final
performance award or other cash Award in respect of a performance period other
than an annual period by any one participant on an annualized basis is $5
million.
Executive officers, directors, and other officers and employees of the
Corporation or any subsidiary, as well as other persons who provide services to
the Corporation or any subsidiary, are eligible to be granted Awards under the
1998 ICP, which is administered by Board or a Committee established pursuant to
the Plan.
The 1998 ICP provides that unless otherwise determined by the Board, each
non-employee director would be granted an option to purchase 4,500 shares of
Common Stock upon approval of the 1998 ICP by shareholders or, as to directors
thereafter elected, his or her initial election to the Board, and at each annual
meeting of shareholders starting in 1999 at which he or she qualifies as a
E-26
307
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
non-employee director. Unless otherwise determined by the Board, such options
will have an exercise price equal to 100% of the fair market value per share on
the date of grant and will become exercisable in three equal installments after
each of the first, second and third anniversaries of the date of grant based on
continued service as a director.
The Committee, may, in its discretion, accelerate the exercisability, the
lapsing of restrictions, or the expiration of deferral or vesting periods of any
Award, and such accelerated exercisability, lapse, expiration and vesting shall
occur automatically in the case of a "change in control" of the Corporation,
except to the extent otherwise determined by the Committee at the date of grant
or thereafter.
During 1998, the options amounting to 520,500, 36,000 and 134,500 were
granted to employees, non-employee directors and others, respectively, under the
1998 ICP.
Accounting for Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation", ("Statement No.
123") requires use of option valuation models that were not developed for use in
valuing employee stock options.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock option under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1996, 1997 and 1998, respectively: risk-free interest rates of
6.32% - 6.38%, 6.13% - 6.63% and 5.63% - 6.63%; dividend yields of 0%, 0% and
0%; volatility factors of the expected market price of the Company's common
stock of 51.96% - 52.74%, 49.97% - 53.48% and 43.74% - 46.08%; and a
weighted-average expected life of the option of 4.5 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock option.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
1996 1997 1998
-------- ---------- ----------
Net Income........................... $103,875 $2,119,409 $2,607,628
Less: Pro forma estimated fair value
options granted.................... 156,756 234,664 525,809
-------- ---------- ----------
Pro forma net income (loss).......... $(52,881) $1,884,745 $2,081,819
======== ========== ==========
Pro forma diluted earnings per
share.............................. $ 0.07 $ 0.16 $ 0.16
======== ========== ==========
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308
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the Company's three stock option plans as of
December 31, 1997 and 1998, and changes during the years ending on those dates
is presented below:
1997 1998
--------------------------- -----------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
FIXED OPTIONS OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
- ------------- -------- ---------------- ---------- ----------------
Outstanding-beginning of
year....................... 684,400 $2.09 $ 759,300 $2.22
Granted...................... 190,900 2.48 691,000 2.61
Exercised.................... (95,000) 1.33 (173,700) 1.49
Terminated................... (21,000) 2.83 (17,300) 1.83
-------- ----- ---------- -----
Outstanding-end of year...... 759,300 $2.22 $1,259,300 $2.57
======== ===== ========== =====
Options exercisable at end of
year....................... 568,400 485,000
======== ==========
Weighted-average fair value
of Options granted during
the year................... $ 1.20 $ 1.12
======== ==========
The following table summarizes information about stock options outstanding
at December 31, 1998:
NUMBER WEIGHTED-AVERAGE NUMBER
RANGE OF OUTSTANDING AT REMAINING WEIGHTED-AVERAGE EXERCISABLE AT WEIGHTED-AVERAGE
EXERCISE PRICES 12/31/98 CONTRACTUAL LIFE EXERCISE PRICE 12/31/98 EXERCISE PRICE
- --------------- -------------- ---------------- ---------------- -------------- ----------------
$1.88 7,000 8.5 years $1.88 7,000 $1.88
2.00 to 2.97 1,024,300 8.9 years 2.44 367,536 2.35
3.03 to 3.50 228,000 7.7 years 3.20 110,500 3.17
--------- -------
$1.88 to 3.50 1,259,300 8.7 years 2.57 485,036 2.53
========= =======
10. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS:
American Progressive, American Pioneer and American Exchange are required
to maintain minimum amounts of capital and surplus as determined by statutory
accounting. The minimum statutory capital and surplus requirements of American
Progressive, American Pioneer and American Exchange as of December 31, 1998 for
the maintenance of authority to do business were $2.5 million, $2.7 million and
$0.8 million, respectively. However, in these states 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.
During 1998, the Company made capital contributions totaling $2.0 million
to American Pioneer. These amounts were generated by the proceeds of the First
Amendment to the Company's credit agreement and from the proceeds of the Series
D Preferred Stock issuance. The capital contributions were made to support the
growth in new business production at American Pioneer.
The NAIC risk based capital ("RBC") rules have been adopted by New York,
Florida and Texas. The RBC rules provide for various actions when the ratio of a
company's total adjusted surplus to its RBC falls below 200%. At December 31,
1998, American Progressive, American Pioneer and American Exchange's ratios of
total adjusted capital to RBC were in excess of the Authorized Control Levels.
E-28
309
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a reconciliation of the Company's consolidated GAAP net
income and stockholders' equity to the corresponding statutory amounts for its
insurance subsidiaries:
AS OF DECEMBER 31,
----------------------------
1997 1998
------------ ------------
GAAP stockholders' equity............................ $ 25,706,378 $ 28,317,871
Deferred acquisition costs......................... (20,832,060) (24,282,771)
Unrealized gain on investments, net................ (2,087,515) (1,657,533)
Goodwill........................................... (4,508,596) (4,354,584)
Present value of future profits.................... (1,281,807) (1,569,601)
Policyholder reserve adjustments................... 7,185,234 6,466,969
Asset valuation and interest maintenance reserve... (1,580,569) (2,544,527)
Deferred revenue................................... 264,745 201,389
Deferred Federal income taxes...................... 550,547 1,560,547
Loan payable....................................... 3,500,000 4,750,000
Series C and D preferred stock..................... 5,168,000 7,418,000
Universal debenture payable to American
Progressive..................................... 5,925,000 7,900,000
Other, including non-insurance subsidiaries........ (2,123,954) (1,129,834)
------------ ------------
Consolidated statutory surplus....................... $ 15,885,403 $ 21,075,926
============ ============
YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
----------- ----------- -----------
GAAP net income applicable to common
shareholders.......................... $ 103,875 $ 1,869,619 $ 2,174,204
Redemption accrual on Series C preferred
stock................................. -- 249,790 433,424
Deferred acquisition costs.............. (2,257,617) (2,945,672) (3,529,521)
Amortization of goodwill................ -- 111,819 170,898
Amortization of present value of future
profits............................... -- -- 174,400
Realized gains on investments........... (369,428) (891,761) (322,030)
Amortization of the interest maintenance
reserve............................... 229,768 249,789 323,120
Deferred revenue........................ (280,335) (93,212) (63,356)
Policyholder benefits and expenses...... 1,081,369 18,079 (814,875)
Deferred Federal income tax expense..... 269,017 1,091,818 994,681
Interest expense on loan payable........ 83,852 77,389 306,578
Interest expense on Universal debenture
payable to American Progressive....... -- 78,311 603,686
Other, including non-insurance
subsidiaries.......................... 467,372 (495,354) (1,075,146)
----------- ----------- -----------
Consolidated statutory net income....... $ (672,127) $ (679,385) $ (623,937)
=========== =========== ===========
Dividend payments from American Progressive to the Company would require
regulatory approval which, in all likelihood, would not be obtained until
American Progressive generated enough statutory profits to offset its entire
negative unassigned surplus, which was approximately
E-29
310
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$8.8 million at December 31, 1998. American Progressive made no dividends or
distributions during 1996, 1997 or 1998.
American Pioneer may pay a dividend or make a distribution without the
prior written approval of the Florida Insurance Department when (a) the dividend
is equal to or less than the greater of (1) 10% of the insurer's surplus as to
policyholders derived from net operating profits on its business and net
realized capital gains ("policyholder surplus from operations"); or (2) the
insurer's entire net operating profits and realized net capital gains derived
during the immediately preceding calendar year but not more than its
policyholder surplus from operations; (b) the insurer will have surplus as to
policyholders equal to or exceeding 115% of the minimum required statutory
surplus as to policyholders after the dividend or distribution is made; and (c)
the insurer has filed notice with the department at least 10 business days prior
to the dividend payment or distribution. American Pioneer paid American
Progressive $500,000 and $185,455 in dividends during 1996 and 1997,
respectively and paid Universal $425,000 in dividends in 1997. American Pioneer
did not pay any dividends in 1998 and has the capacity to make $0.2 million in
dividend payments in 1999. During 1998, Universal contributed $2,000,000 to the
surplus of American Pioneer to support the growth in new business in American
Pioneer.
Under current Texas insurance law, a life insurer may pay dividends or make
distributions without the prior approval of the Insurance Department as long as
the dividend distributions do not exceed the greater of (i) 10% of the insurer's
surplus as to policyholders as of the preceding December 31st; or (ii) the
insurer's net gain from operations for the immediately preceding calendar year.
American Exchange made no dividends or distributions in 1997 or 1998.
The Insurance Subsidiaries' statutory basis financial statements are
prepared in accordance with accounting practices prescribed or permitted by
their respective domiciliary states. "Prescribed" statutory accounting practices
include state laws, regulations and general administrative rules, as well as
publications of the NAIC. "Permitted" statutory accounting practices encompass
all accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state and may change
in the future. The Company does not utilize any permitted accounting practices.
The NAIC currently is in the process of codifying statutory accounting
practices. That project, when completed, may change prescribed statutory
accounting practices and thus may result in changes to the accounting practices
that the Insurance Subsidiaries use to prepare their statutory basis financial
statements.
11. REINSURANCE:
The Company is party to several reinsurance agreements on its life and
accident & health insurance risks. The Company's senior market accident & health
insurance products are reinsured under coinsurance treaties with unaffiliated
insurers, while the life insurance risks are reinsured under either coinsurance
or yearly-renewable term treaties with unaffiliated insurers. Under coinsurance
treaties, the reinsurer receives an agreed upon percentage of all premiums and
reimburses the Company that same percentage of any losses. In addition, the
Company receives certain allowances from the reinsurers to cover commissions,
expenses and premium taxes. Under yearly-renewable term treaties, the reinsuring
company receives premiums at an agreed upon rate and holds the required reserves
for its share of the risk on a yearly-renewable term basis. The Company
evaluates the financial condition of its reinsurers and monitors concentrations
of credit risk to minimize its exposure to significant losses from reinsurer
insolvencies. A contingent liability exists with respect to reinsurance that may
become a liability of the Company in the event that the reinsurers should be
unable to meet the obligations that they assumed.
E-30
311
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has several quota share reinsurance agreements in place with
RCH, Cologne Life Reinsurance Company ("CLR") and Transamerica Occidental Life
("TA") (collectively, the "Reinsurers"), which Reinsurers are rated A or better
by A.M. Best. These agreements cover various accident & health insurance
products written or acquired by the Company and contain ceding percentages
ranging between 50% and 90%. The Reinsurers receive their pro-rata premium and
pay their pro-rate benefits. In addition, the Company receives allowances from
the Reinsurers to reimburse the commission, administration and premium tax
expenses associated with the business reinsured. At December 31, 1997 and 1998,
amounts due from these Reinsurers were as follows:
REINSURER 1997 1998
--------- ----------- -----------
RCH.................................... $20,485,857 $29,176,800
TA..................................... 20,823,260 21,760,558
CLR.................................... 2,721,061 3,685,663
----------- -----------
Total........................ $44,030,178 $54,623,021
=========== ===========
A summary of reinsurance activity for the three years ended December 31,
1998 is presented below:
AS OF DECEMBER 31,
--------------------------------------
1996 1997 1998
---------- ---------- ----------
Life insurance in force
(amounts in thousands)
Gross amount............................... $2,118,265 $2,118,492 $2,038,438
Ceded to other companies................... (889,132) (842,624) (735,791)
Assumed from other companies............... 25,484 42,237 47,084
---------- ---------- ----------
Net Amount................................. $1,254,617 $1,318,105 $1,349,731
========== ========== ==========
Percentage of assumed to net............... 2% 3% 4%
========== ========== ==========
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
Premiums
Life insurance............................. $ 9,923,021 $ 12,660,147 $ 15,242,667
Accident & health.......................... 44,853,225 86,177,075 115,801,744
------------ ------------ ------------
Total gross premiums............... 54,776,246 98,837,222 131,044,411
------------ ------------ ------------
Ceded to other companies
Life insurance............................. (2,870,540) (5,585,289) (7,238,165)
Accident & health.......................... (22,792,684) (57,037,432) (82,308,073)
------------ ------------ ------------
Total ceded premiums............... (25,663,224) (62,622,721) (89,546,238)
------------ ------------ ------------
Assumed from other companies
Life insurance............................. 391,456 997,836 997,891
Accident & health.......................... 10,130,531 -- --
------------ ------------ ------------
Total assumed premium.............. 10,521,987 997,836 997,891
------------ ------------ ------------
E-31
312
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
Net amount
Life insurance............................. 7,443,937 8,072,694 9,002,393
Accident & health.......................... 32,191,072 29,139,643 33,493,671
------------ ------------ ------------
Total net premium.................. $ 39,635,009 $ 37,212,337 $ 42,496,064
============ ============ ============
Percentage of assumed to net
Life insurance............................. 5% 12% 11%
============ ============ ============
Accident & health.......................... 31% 0% 0%
============ ============ ============
Total assumed to total net......... 27% 3% 2%
============ ============ ============
12. LOAN PAYABLE:
On December 10, 1997, the Company entered into an agreement with Chase
Manhattan Bank for a $3.5 million five-year secured term loan. The loan proceeds
were used to finance a portion of the intercompany sale of American Pioneer from
American Progressive to Universal and to retire the $0.8 million amount
outstanding on the term loan agreement with another commercial bank. The loan
agreement calls for interest at the London Interbank Offered Rate (LIBOR) plus
200 basis points. In connection with this loan agreement, the Company entered
into a three-year interest rate swap agreement, (the "Swap Agreement") with
Chase Securities Corp., effective January 1, 1998, to lock in a fixed rate of
8.19% for the three year period. Upon expiration of the Swap Agreement, the
Company's interest rate reverts to the LIBOR plus 200 basis points.
On September 30, 1998, the Company executed the First Amendment to its
Credit Agreement with Chase Manhattan Bank that refinanced the current loan
agreement with the bank. Under the Amendment, the Company executed a new $5.0
million five-year secured term loan. The loan proceeds were used to pay off the
principal amount outstanding on the prior loan of $3.2 million and for a capital
contribution to American Pioneer for $1.0 million. The new loan agreement calls
for interest at the London Interbank Offered Rate (LIBOR) plus 200 basis points.
The Company's three-year interest rate swap agreement on the original $3.5
million loan with the Bank remains in effect.
The loan is secured by a first priority interest in all the assets of
WorldNet Services Corp. and Quincy Corp., a pledge of 9.9% of the outstanding
common shares of American Progressive and 100% of the shares of Quincy Coverage
Corp.
E-32
313
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth certain summary information with respect to
total borrowings of the Company for the three years ended December 31, 1998:
AS OF DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------
WEIGHTED
MAXIMUM AVERAGE(A) AVERAGE
AMOUNT INTEREST AMOUNT AMOUNT INTEREST
OUTSTANDING RATE OUTSTANDING OUTSTANDING RATE(B)
----------- -------- ----------- ----------- --------
1996................... $ 800,000 9.50% $ 800,000 $ 800,000 10.48%
========== ==== ========== ========== =====
1997................... $3,500,000 8.19% $3,500,000 $ 952,000 9.76%
========== ==== ========== ========== =====
1998................... $4,750,000 7.97% $5,000,000 $3,743,750 8.19%
========== ==== ========== ========== =====
- ---------------
(a) The average amounts of borrowings outstanding were computed by determining
the arithmetic average of the months' average outstanding in borrowings.
(b) The weighted-average interest rates were determined by dividing interest
expense related to total borrowings by the average amounts outstanding of
such borrowings.
13. COMMITMENTS:
The Company is obligated under certain lease arrangements for its executive
and administrative offices in New York, Orlando, Florida and Texas. Rent expense
for the three years ended December 31, 1996, 1997 and 1998 was $0.6 million,
$0.8 million and $0.7 million, respectively. The minimum rental commitments,
subject to escalation clauses, at December 31, 1998 under non-cancelable
operating leases are as follows:
1999.......................................... $ 776,000
2000.......................................... 758,000
2001.......................................... 769,000
2002.......................................... 500,000
2003.......................................... 274,000
2004.......................................... 193,000
----------
Totals.............................. $3,270,000
==========
14. UNIVERSAL AMERICAN FINANCIAL CORP. 401(K) SAVINGS PLAN:
Effective April 1, 1992, the Company adopted the Universal American
Financial Corp. 401(k) Savings Plan ("Savings Plan"). The Savings Plan is a
voluntary contributory plan under which employees may elect to defer
compensation for federal income tax purposes under Section 401(k) of the
Internal Revenue Code of 1986. The employee is entitled to participate in the
Savings Plan by contributing through payroll deductions up to 20% of the
employee's compensation. In the two year period ended December 31, 1997, the
Company matched the employee's contribution up to 1% of the employee's
compensation. Beginning in 1998, the Company matched the employee's contribution
up to 2% of the employee's compensation. The Company's matching contributions
are made with Company common stock. As of December 31, 1998, 298,554 shares of
the Company's common stock were held by the Savings Plan.
The participating employee is not taxed on these contributions until they
are distributed. Moreover, the employer's contributions vest at the rate of 25%
per plan year. Amounts credited to employee's accounts under the Savings Plan
are invested by the employer-appointed investment
E-33
314
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
committee. Generally, a participating employee is entitled to distributions from
the Savings Plan upon termination of employment, retirement, death or
disability. Savings Plan participants who qualify for distributions may receive
a single lump sum, have the assets transferred to another qualified plan or
individual retirement account, or receive a series of specified installment
payments. Total matching contributions by the Company under the Savings Plan
were $38,478, $40,546 and $92,487 in 1996, 1997 and 1998, respectively.
15. FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK:
For the years ended December 31, 1997 and 1998, the Company held unrated or
less-than-investment grade corporate debt securities with carrying and estimated
fair values as follows:
1997 1998
---------- ----------
Carrying value.................... $2,616,470 $3,356,577
========== ==========
Estimated fair value.............. $2,616,470 $3,356,577
========== ==========
Percentage of total assets........ 1.0% 1.2%
========== ==========
The holdings of less-than-investment grade securities are widely
diversified and the investment in any one such security is currently less than
$1,000,000, which is approximately 0.4% of total assets.
16. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
a. Fixed maturities available for sale: For those securities
available for sale, fair value equals quoted market price, if available. If
a quoted market price is not available, fair value is estimated using
quoted market prices for similar securities.
b. Equity securities: For equity securities carried at fair value,
fair value equals quoted market price.
c. Cash and cash equivalents: For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value.
d. Investment contract liabilities: For annuity and universal life
type contracts, the carrying amount is the policyholder account value (see
Note 2e); estimated fair value equals the policyholder account value less
surrender charges.
e. Short term debt and loan payable: For short-term borrowings and
loan payable, the carrying value is a reasonable estimate of fair value due
to their short-term nature.
f. Accounts receivable and uncollected premiums: Accounts receivable
and uncollected premiums are primarily insurance contract related
receivables, which are determined based upon the underlying insurance
liabilities and added reinsurance amounts.
E-34
315
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The estimated fair values of the Company's financial instruments as of
December 31, 1997 and 1998 are as follows:
1997
----------------------------
CARRYING FAIR
AMOUNT VALUE
------------ ------------
Financial assets:
Fixed maturities available for sale........ $123,585,708 $123,585,708
Equity securities.......................... 945,116 945,116
Policy loans(a)............................ 7,185,014
Property tax liens(b)...................... 136,713
Mortgage loans(c).......................... 2,562,008
Cash and cash equivalents.................. 25,014,019 25,014,019
Financial liabilities:
Investment contract liabilities............ 145,085,687 132,208,242
Loan Payable............................... 3,500,000 3,500,000
1998
---------------------------
CARRYING FAIR
AMOUNT VALUE
------------ ------------
Financial assets:
Fixed maturities available for sale......... $134,797,634 $134,797,634
Equity securities........................... 1,019,780 1,019,780
Policy loans(a)............................. 7,276,163
Property tax liens(b)....................... 30,696
Mortgage loans(c)........................... 4,456,516
Cash and cash equivalents................... 17,092,938 17,092,938
Financial liabilities:
Investment contract liabilities............. 159,882,986 147,910,709
Loan payable................................ 4,750,000 4,750,000
- ---------------
(a) It is not practicable to estimate the fair value of policy loans, as they
have no stated maturity and their rates are set at a fixed spread to related
policy liability rates. Policy loans are carried at the aggregate unpaid
principal balances in the consolidated balance sheets, and earn interest at
rates between 6% to 8%. Individual policy liabilities, in all cases, equal
or exceed outstanding policy loan balances.
(b) Property tax liens are carried at cost. The determination of fair value for
these invested assets is not practical because there is no active trading
market for such invested assets. Individual liens in all cases are first
priority liens with collateral in excess of 300% of the carrying value of
the lien.
(c) Mortgage loans are carried at the aggregate unpaid balances and the fair
market value was not determined as the amount involved was considered to be
immaterial.
E-35
316
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The quarterly results of operations for the three years ended December 31,
1998 are presented below:
1996 THREE MONTHS ENDED
- ---- --------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
----------- ----------- ------------- ------------
Total revenue............... $12,257,842 $11,737,328 $14,199,901 $15,192,114
Total benefits, claims &
other expenses............ 11,930,299 11,550,317 14,049,636 15,484,041
----------- ----------- ----------- -----------
Operating income before
income taxes.............. 327,543 187,011 150,265 (291,927)
Federal income tax expense
(benefit)................. 45,948 63,584 49,011 110,474
----------- ----------- ----------- -----------
Net income applicable to
common Shareholders....... $ 281,595 $ 123,427 $ 101,254 $ (402,401)
=========== =========== =========== ===========
Basic earnings per share.... $ 0.04 $ 0.02 $ 0.01 $ (0.06)
=========== =========== =========== ===========
Diluted earnings per
share..................... $ 0.03 $ 0.01 $ 0.01 $ (0.04)
=========== =========== =========== ===========
1997 THREE MONTHS ENDED
- ---- --------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
----------- ----------- ------------- ------------
Total revenue............... $12,884,699 $13,274,793 $14,029,877 $11,141,151
Total benefits, claims &
other expenses............ 12,325,071 12,565,533 12,792,167 10,436,522
----------- ----------- ----------- -----------
Operating income (loss)
before income taxes....... 559,628 709,260 1,237,710 704,629
Federal income tax expense.. 190,013 241,410 420,820 239,575
----------- ----------- ----------- -----------
Net Income.................. 369,615 467,850 816,890 465,054
Redemption accrual on
Series C
Preferred Stock........... -- 55,200 91,230 103,360
----------- ----------- ----------- -----------
Net income applicable to
common Shareholders....... $ 369,615 $ 412,650 $ 725,660 $ 361,694
=========== =========== =========== ===========
Basic earnings per share.... $ 0.05 $ 0.06 $ 0.10 $ 0.05
=========== =========== =========== ===========
Diluted earnings per
share..................... $ 0.03 $ 0.04 $ 0.07 $ 0.04
=========== =========== =========== ===========
E-36
317
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998 THREE MONTHS ENDED
- ---- --------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
----------- ----------- ------------- ------------
Total revenue............... $13,814,716 $14,330,825 $14,068,314 $13,875,251
Total benefits, claims &
other expenses............ 13,040,302 13,070,914 13,050,164 12,996,135
----------- ----------- ----------- -----------
Operating income before
income taxes.............. 774,414 1,259,911 1,018,150 879,116
Federal income tax expense.. 241,361 450,309 346,172 286,121
----------- ----------- ----------- -----------
Net Income.................. 533,053 809,602 671,978 592,995
Redemption accrual on
Series C
Preferred Stock........... 108,356 108,356 108,356 108,356
----------- ----------- ----------- -----------
Net income applicable to
common Shareholders....... $ 424,697 $ 701,246 $ 563,622 $ 484,639
=========== =========== =========== ===========
Basic earnings per share.... $ 0.06 $ 0.09 $ 0.07 $ 0.07
=========== =========== =========== ===========
Diluted earnings per
share..................... $ 0.04 $ 0.06 $ 0.05 $ 0.05
=========== =========== =========== ===========
During the fourth quarter of 1996, the Company accrued $0.3 million for its
restructuring (see Note 3) and $0.5 million for its withdrawal from its
participation in the National Accident Insurance Underwriters accident pool as
of December 31, 1996. Offsetting these amounts was the amount received by the
Company on the sale of its New York State DBL business, which amounted to $0.2
million, net of additional reserves established.
18. INTERCOMPANY SALE OF AMERICAN PIONEER:
When American Pioneer was acquired in 1993, it became a wholly owned
subsidiary of American Progressive. This ownership structure (the "stacking")
had a significant negative impact on the Risk-Based Capital ratio of American
Progressive as computed by the regulators and the rating agencies and adversely
affected the ratings of both companies and their ability to write new business.
Pursuant to an agreement between Universal and American Progressive,
entered into with the consent of the New York Insurance Department on June 27,
1996 (the "Unstacking Agreement"), Universal is obligated to purchase all of the
outstanding stock of American Pioneer from American Progressive over a five-year
period for a total purchase price of $15.8 million. Under the terms of the
Unstacking Agreement, the purchase was implemented in segments with the purchase
price of the shares included in each segment being paid one half in cash and one
half in five-year debentures, paying interest at 8.5%. The debentures are
payable by Universal to American Progressive.
The Unstacking Agreement is intended to make American Pioneer a direct
subsidiary of Universal, rather than an indirect subsidiary, owned through
American Progressive. This unstacking is expected to have a beneficial effect on
the ratings of both insurers. In addition, the unstacking increases the surplus
of American Progressive, improves American Progressive's Risk Based Capital
Ratio and, when and to the extent that American Pioneer is able to pay
dividends, permits the payment of such dividends directly to Universal.
The first segments of the unstacking were consummated in September and
December of 1997. In the aggregate, Universal acquired 75% of American Pioneer
from American Progressive for $11.9 million consisting of $5.9 million in cash
and $5.9 million in debentures payable to American Progressive. The cash portion
of the unstacking was obtained by Universal from the proceeds of the
E-37
318
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Series C Preferred Stock transaction with AAM, a dividend from American Pioneer,
and from the proceeds of a loan from Chase Manhattan Bank.
In May 1998, Universal purchased the remaining 25% of American Pioneer for
$4.0 million consisting of $2.0 million in cash and $2.0 million in debentures.
The cash portion of the proceeds was obtained from the cash flow from the
operations of WorldNet.
19. BUSINESS SEGMENT INFORMATION:
Universal has four business segments: Senior Market Accident & Health
Insurance, Other Accident & Health Insurance, Life Insurance, and Non-insurance
Businesses. The Senior Market Accident & Health segment offers Medicare
supplement, home health care, nursing home, and hospital indemnity products. The
Other Accident & Health Insurance segment offers mainly major medical insurance
and some products that are not currently material. Products offered by the Life
Insurance segment include annuities, universal life, asset enhancer, SL 2000 and
other individual and group products. The Non-insurance Businesses segment
consists mainly of the Parent Company and WorldNet, a third party administrator.
E-38
319
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial data by segment for the three years ended December 31, 1998 is as
follows:
DECEMBER 31, 1996
---------------------------------------------------------------------
SENIOR OTHER NON-
ACCIDENT & ACCIDENT & LIFE INSURANCE
HEALTH HEALTH INSURANCE BUSINESSES TOTAL
----------- ----------- ------------ ----------- ------------
Net premiums and policyholder
fees earned................. $ 7,424,224 $24,766,849 $ 7,954,300 $ -- $ 40,145,373
Net investment income......... 196,135 642,840 8,978,091 33,017 9,850,083
Realized gains................ 4,780 16,473 218,822 -- 240,075
Fee and other income.......... -- 450,000 411,583 2,290,071 3,151,654
----------- ----------- ------------ ----------- ------------
Total revenues............ 7,625,139 25,876,162 17,562,796 2,323,088 53,387,185
Policyholder benefits......... 4,488,845 17,586,363 10,436,383 -- 32,511,591
Increase in deferred
acquisition costs........... (447,347) (54,503) (1,755,767) -- (2,257,617)
Commissions and general
expenses.................... 3,423,190 9,162,378 7,300,442 2,874,309 22,760,379
----------- ----------- ------------ ----------- ------------
Total benefits, claims and
other deductions........ 7,464,688 26,694,238 15,981,058 2,874,309 53,014,293
Operating income (loss)
before taxes................ 160,451 (818,076) 1,581,738 (551,221) 372,892
Federal income tax
expense/(benefit)........... 46,709 (238,149) 460,457 -- 269,017
----------- ----------- ------------ ----------- ------------
Net income (loss) to common
shareholders................ $ 113,742 $ (579,927) $ 1,121,281 $ (551,221) $ 103,875
=========== =========== ============ =========== ============
ASSETS
Cash and investments.......... $ 4,830,823 $11,622,056 $125,318,018 $ 2,910,372 $144,681,269
Deferred policy acquisition
costs....................... 2,673,952 699,926 15,717,636 -- 19,091,514
Accrued investment income..... 1,538,661 982,583 354,253 -- 2,875,497
Goodwill...................... -- -- -- -- --
Present value of future
profits..................... 3,529,529 -- -- -- 3,529,529
Due and unpaid premiums....... 406,207 1,253,677 1,052,137 -- 2,712,021
Reinsurance recoverable....... 26,528,972 6,463,932 27,845,385 -- 60,838,289
Other assets.................. -- -- -- 8,508,619 8,508,619
----------- ----------- ------------ ----------- ------------
Total assets.............. $39,508,144 $21,022,174 $170,287,429 $11,418,991 $242,236,738
=========== =========== ============ =========== ============
E-39
320
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1997
-----------------------------------------------------------------------
SENIOR OTHER
ACCIDENT & ACCIDENT & LIFE NON-INSURANCE
HEALTH HEALTH INSURANCE BUSINESSES TOTAL
----------- ----------- ------------ ------------- ------------
Net premiums and
policyholder fees
earned................. $15,973,157 $13,168,808 $ 8,572,401 $ -- $ 37,714,366
Net investment income.... 610,850 304,091 9,043,727 63,990 10,022,658
Realized gains........... 34,536 17,193 511,318 569,474 1,132,521
Fee and other income..... -- -- 365,980 2,094,995 2,460,975
----------- ----------- ------------ ---------- ------------
Total revenues....... 16,618,543 13,490,092 18,493,426 2,728,459 51,330,520
Policyholder benefits.... 11,218,500 9,117,256 10,470,104 -- 30,805,860
Increase in deferred
acquisition costs...... (1,703,473) (67,833) (1,174,366) -- (2,945,672)
Commissions and general
expenses............... 6,605,284 4,410,798 7,721,476 1,521,547 20,259,105
----------- ----------- ------------ ---------- ------------
Total benefits,
claims and other
deductions........ 16,120,311 13,460,221 17,017,214 1,521,547 48,119,293
Operating income before
taxes.................. 498,232 29,871 1,476,212 1,206,912 3,211,227
Federal income tax
expense................ 169,399 10,156 501,913 410,350 1,091,818
----------- ----------- ------------ ---------- ------------
Net income before Series
C dividend............. 328,833 19,715 974,299 796,562 2,119,409
Series C dividend........ -- -- -- 249,790 249,790
----------- ----------- ------------ ---------- ------------
Net income to common
shareholders........... $ 328,833 $ 19,715 $ 974,299 $ 546,772 $ 1,869,619
=========== =========== ============ ========== ============
ASSETS
Cash and investments..... $13,909,644 $12,332,925 $130,583,170 $2,602,839 $159,428,578
Deferred policy
acquisition costs...... 4,376,593 735,071 15,720,396 -- 20,832,060
Accrued investment
income................. 204,637 101,872 3,029,679 21,436 3,357,624
Goodwill................. 3,875,662 632,934 -- -- 4,508,596
Present value of future
profits................ 640,904 640,903 -- -- 1,281,807
Due and unpaid
premiums............... 255,607 126,786 165,878 -- 548,271
Reinsurance recoverable.. 27,851,574 8,375,214 40,349,252 -- 76,576,040
Other assets............. -- -- -- 6,042,360 6,042,360
----------- ----------- ------------ ---------- ------------
Total assets......... $51,114,621 $22,945,705 $189,848,375 $8,666,635 $272,575,336
=========== =========== ============ ========== ============
E-40
321
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998
----------------------------------------------------------------------------
SENIOR OTHER
ACCIDENT & ACCIDENT & LIFE NON-INSURANCE
HEALTH HEALTH INSURANCE BUSINESSES TOTAL
----------- ----------- ----------------- ------------- ------------
Net premiums and
policyholder fees
earned.................. $23,856,580 $ 9,637,090 $ 9,002,394 $ -- $ 42,496,064
Net investment income..... 682,736 633,746 9,381,653 23,216 10,721,351
Realized gains............ 16,281 15,667 223,723 -- 255,671
Fee and other income...... -- -- 364,623 2,251,397 2,616,020
----------- ----------- ------------ ---------- ------------
Total revenues........ 24,555,597 10,286,503 18,792,393 2,274,613 56,089,106
Policyholder benefits..... 18,455,546 6,962,521 12,816,603 -- 38,234,670
Increase in deferred
acquisition costs....... (2,883,858) (367,988) (277,675) -- (3,529,521)
Commissions and general
expenses................ 7,409,242 3,640,553 5,132,793 1,269,778 17,452,366
----------- ----------- ------------ ---------- ------------
Total benefits, claims
and other
deductions......... 22,980,930 10,235,086 17,671,721 1,269,778 52,157,515
Operating income before
taxes................... 1,574,667 51,417 1,300,672 1,004,835 3,931,591
Federal income tax
expense................. 530,269 17,315 438,001 338,378 1,323,963
----------- ----------- ------------ ---------- ------------
Net income before Series C
dividend................ 1,044,398 34,102 862,671 666,457 2,607,628
Series C dividend......... -- -- -- 433,424 433,424
----------- ----------- ------------ ---------- ------------
Net income to common
shareholders............ $ 1,044,398 $ 34,102 $ 862,671 $ 233,033 $ 2,174,204
=========== =========== ============ ========== ============
ASSETS
Cash and investments...... $10,677,277 $ 9,836,378 $141,177,535 $2,982,537 $164,673,727
Deferred policy
acquisition costs....... 7,138,963 1,224,547 15,919,261 -- 24,282,771
Accrued investment
income.................. 225,336 209,167 3,096,407 7,662 3,538,572
Goodwill.................. 3,742,748 611,836 -- -- 4,354,584
Present value of future
profits................. 992,788 576,813 -- -- 1,569,601
Due and unpaid premiums... 200,418 172,928 152,563 -- 525,909
Reinsurance recoverable... 33,166,226 8,432,300 35,795,127 -- 77,393,653
Other assets.............. -- -- -- 6,963,475 6,963,482
----------- ----------- ------------ ---------- ------------
Total assets.......... $56,143,756 $21,063,969 $196,140,893 $9,953,681 $283,302,299
=========== =========== ============ ========== ============
E-41
322
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
1997 1998
----------- -----------
ASSETS
Cash and cash equivalents................................... $ 969,878 $ 1,794,470
Investments in subsidiaries at equity....................... 38,069,090 47,824,471
Note receivable from American Pioneer....................... 1,000,000 1,000,000
Due from subsidiary......................................... 259,848 368,093
Deferred tax asset.......................................... 983,540 1,327,899
Other assets................................................ 304,965 797,637
----------- -----------
Total assets...................................... 41,587,321 53,112,570
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Loan Payable................................................ 3,500,000 4,750,000
Note Payable to American Progressive........................ 5,925,000 7,900,000
Due to subsidiary........................................... 949,099 3,863,313
Amounts payable and other liabilities....................... 89,054 180,172
----------- -----------
Total liabilities................................. 10,463,153 16,693,485
----------- -----------
Series C Preferred Stock.................................... 5,168,000 5,168,000
----------- -----------
Redemption accrual on Series C Preferred Stock.............. 249,790 683,214
----------- -----------
Series D Preferred Stock.................................... -- 2,250,000
----------- -----------
Total stockholders' equity........................ 25,706,378 28,317,871
----------- -----------
Total liabilities and stockholders' equity........ $41,587,321 $53,112,570
=========== ===========
See notes to consolidated financial statements.
E-42
323
SCHEDULE II -- CONTINUED
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
1996 1997 1998
--------- ---------- -----------
REVENUES:
Net investment income.............................. $ 75 $ 73,397 $ 98,216
Other income....................................... -- -- 37,500
Dividends received from American Pioneer........... -- 425,000 --
--------- ---------- -----------
Total revenues........................... 75 498,397 135,716
--------- ---------- -----------
EXPENSES:
Selling, general and administrative expenses....... 301,235 501,998 1,661,575
--------- ---------- -----------
Total expenses........................... 301,235 501,998 1,661,575
--------- ---------- -----------
Operating loss before provision for federal income
taxes and equity income.......................... (301,160) (3,601) (1,525,859)
Federal income taxes (benefit)..................... -- (119,099) (344,360)
--------- ---------- -----------
Net income (loss) before equity income............. (301,160) 115,498 (1,181,499)
Equity in undistributed income..................... 405,035 2,003,911 3,789,127
--------- ---------- -----------
Net income......................................... 103,875 2,119,409 2,607,628
Redemption accrual on Series C Preferred Stock..... -- 249,790 433,424
--------- ---------- -----------
Net income applicable to common shareholders....... $ 103,875 $1,869,619 $ 2,174,204
========= ========== ===========
See notes to consolidated financial statements.
E-43
324
SCHEDULE II -- CONTINUED
UNIVERSAL AMERICAN FINANCIAL CORP.
(PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
1996 1997 1998
--------- ------------ -----------
Cash flows from operating activities:
Net income....................................... $ 103,875 $ 2,119,409 $ 2,607,628
Adjustments to reconcile net income to net cash
used by operating activities:
Amortization and depreciation, net............. -- -- --
Increase in investment in subsidiaries......... (392,557) (1,729,891) (5,805,378)
Change in amounts due to/from subsidiaries..... 176,160 185,535 2,914,214
Change in other assets and liabilities......... (32,860) (205,395) (837,909)
--------- ------------ -----------
Net cash (used by) provided from operating
activities..................................... (145,382) 369,658 (1,121,445)
--------- ------------ -----------
Cash flows from investing activities:
Cost of note receivable from American Pioneer.... -- (1,000,000) --
Purchase of American Pioneer..................... -- (11,850,000) (3,950,000)
--------- ------------ -----------
Net cash used by investing activities............ -- (12,850,000) (3,950,000)
--------- ------------ -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock....... 202,263 274,020 421,037
Proceeds from the issuance of Series C Preferred
Stock.......................................... -- 4,838,356 --
Proceeds from the issuance of Series D Preferred
Stock.......................................... -- -- 2,250,000
Increase in note payable to American
Progressive.................................... -- 5,925,000 1,975,000
Increase in loan payable......................... -- 3,500,000 1,250,000
Change in short-term debt........................ -- (800,000) --
--------- ------------ -----------
Net cash provided from financing activities...... 202,263 13,373,376 5,896,037
--------- ------------ -----------
Net increase in cash and cash equivalents........ 56,881 893,034 824,592
Cash and cash equivalents:
At beginning of year............................. 19,963 76,844 969,878
--------- ------------ -----------
At end of year................................... $ 76,844 $ 969,878 $ 1,794,470
========= ============ ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest....................................... $ 83,852 $ 77,389 $ 306,578
========= ============ ===========
Income taxes................................... $ -- $ -- $ --
========= ============ ===========
See notes to consolidated financial statements.
E-44
325
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
1996 1997 1998
------------ ------------ ------------
Deferred policy acquisition costs............ $ 19,091,514 $ 20,832,060 $ 24,282,771
============ ============ ============
Policyholder account balances................ $134,538,954 $145,085,687 $154,886,059
============ ============ ============
Policy and contract claims................... $ 25,814,721 $ 23,759,654 $ 26,629,587
============ ============ ============
Premiums and policyholders fees earned....... $ 40,145,373 $ 37,714,366 $ 42,496,064
============ ============ ============
Net investment income........................ $ 9,850,083 $ 10,022,658 $ 10,721,351
============ ============ ============
Interest credited to policyholders........... $ 6,614,176 $ 6,645,716 $ 7,240,241
============ ============ ============
Claims and other benefits and Change in
future policy benefits..................... $ 25,897,415 $ 24,160,144 $ 30,994,429
============ ============ ============
Increase in deferred acquisition costs....... $ 2,257,617 $ 2,945,672 $ 3,529,521
============ ============ ============
Commissions and other operating costs and
expenses................................... $ 22,760,319 $ 20,147,286 $ 17,452,366
============ ============ ============
E-45
326
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1999 DEC. 31, 1998
-------------- -------------
(UNAUDITED)
ASSETS
Investments:
Fixed maturities available for sale, at fair value
(amortized cost $136,623,611 and $132,227,114,
respectively)........................................... $136,777,895 $134,797,634
Equity securities, at fair value (cost $981,283 and
$1,063,186, respectively)............................... 876,609 1,019,780
Policy loans.............................................. 7,353,133 7,276,163
Property tax liens........................................ 30,696 30,696
Mortgage loans............................................ 4,417,797 4,456,516
------------ ------------
Total investments.................................. 149,456,130 147,580,789
Cash and cash equivalents................................... 8,925,729 17,092,938
Accrued investment income................................... 3,707,145 3,538,573
Deferred policy acquisition costs........................... 26,368,465 24,282,771
Amounts due from reinsurers................................. 81,551,520 77,393,653
Due and unpaid premiums..................................... 724,254 525,909
Goodwill.................................................... 4,316,081 4,354,584
Present value of future profits............................. 1,526,001 1,569,601
Other assets................................................ 7,639,612 6,963,481
------------ ------------
Total assets....................................... 284,214,937 283,302,299
============ ============
LIABILITIES, SERIES C PREFERRED STOCK, SERIES D PREFERRED
STOCK, REDEMPTION ACCRUAL ON SERIES C AND SERIES D
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances............................... 156,195,547 154,886,059
Reserves for future policy benefits......................... 46,795,895 47,442,966
Policy and contract claims -- life.......................... 1,991,458 2,297,446
Policy and contract claims -- health........................ 25,097,224 24,332,14
Loan payable................................................ 4,500,000 4,750,000
Amounts due to reinsurers................................... 677,606 1,810,696
Deferred revenues........................................... 190,231 201,389
Deferred income tax liability............................... 1,127,198 1,218,547
Other liabilities........................................... 9,205,872 9,943,970
------------ ------------
Total liabilities.................................. 245,781,031 246,883,214
------------ ------------
Series C Preferred Stock (Issued and outstanding 51,680).... 5,168,000 5,168,000
------------ ------------
Redemption accrual on Series C Preferred Stock.............. 800,238 683,214
------------ ------------
Series D Preferred Stock (Issued and outstanding 40,000
and 22,500, respectively)............................... 4,000,000 2,250,000
------------ ------------
Redemption accrual on Series D Preferred Stock.............. 62,500 --
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Series B Preferred Stock (Issued and outstanding 400)....... 4,000,000 4,000,000
Common stock (Authorized, 20,000,000 issued and outstanding
7,774,064 and 7,638,057, respectively).................... 77,741 76,381
Common stock warrants (Authorized, issued and outstanding
657,031 and 658,231, respectively)........................ -- --
Additional paid-in capital.................................. 16,727,176 16,410,412
Accumulated other comprehensive income...................... 65,238 857,872
Retained earnings......................................... 7,533,013 6,973,206
------------ ------------
Total stockholders' equity......................... 28,403,168 28,317,871
------------ ------------
Total liabilities, Series C Preferred Stock, Series
D Preferred Stock, Redemption accrual on Series C
and Series D Preferred Stock and stockholders'
equity........................................... $284,214,937 $283,302,299
============ ============
See notes to unaudited consolidated financial statements.
E-46
327
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
------------ ------------
REVENUES:
Gross premium and policyholder fees earned.................. $32,065,891 $31,405,191
Reinsurance premiums assumed................................ 249,718 203,508
Reinsurance premiums ceded.................................. (21,891,240) (21,124,418)
----------- -----------
Net premium and policyholder fees earned.................. 10,424,369 10,484,281
Net investment income....................................... 2,798,928 2,708,238
Net realized gains/(losses) on investments.................. 47,078 (26,563)
Fee income.................................................. 568,090 632,921
Amortization of deferred revenue............................ 11,158 15,839
----------- -----------
Total revenues.................................... 13,849,623 13,814,716
----------- -----------
BENEFITS, CLAIMS AND EXPENSES:
Increase in future policy benefits........................ 316,718 319,875
Claims and other benefits................................. 6,937,047 6,888,484
Interest credited to policyholders........................ 1,918,138 1,742,876
Increase in deferred acquisition costs.................... (856,245) (486,035)
Amortization of present value of future profits........... 43,600 56,709
Amortization of goodwill.................................. 38,503 38,503
Commissions............................................... 6,252,963 5,149,828
Commission and expense allowances on reinsurance ceded.... (7,413,729) (5,881,505)
Other operating costs and expenses........................ 5,545,565 5,211,567
----------- -----------
Total benefits, claims and other deductions....... 12,782,560 13,040,302
----------- -----------
Operating income before taxes............................... 1,067,063 774,414
Federal income tax expense.................................. 356,426 241,361
----------- -----------
Net income.................................................. 710,637 533,053
Redemption accrual on Series C and Series D Preferred
Stock..................................................... 179,524 108,356
----------- -----------
Net income applicable to common shareholders................ $ 531,113 $ 424,697
=========== ===========
Earnings per common share:
Basic.................................................. $ 0.07 $ 0.06
=========== ===========
Diluted................................................ $ 0.05 $ 0.04
=========== ===========
See notes to unaudited consolidated financial statements.
E-47
328
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
----------- -----------
Cash flows from operating activities:
Net income.................................................. $ 710,637 $ 533,053
Adjustments to reconcile net income to net cash used by
operating activities:
Deferred income taxes..................................... 356,428 241,361
Change in reserves for future policy benefits............. (647,071) 2,411,454
Change in policy and contract claims...................... 459,095 1,241,688
Change in deferred policy acquisition costs............... (856,245) (486,035)
Change in deferred revenue................................ (11,158) (15,839)
Amortization of present value of future profits........... 43,600 56,709
Amortization of goodwill.................................. 38,503 38,503
Change in policy loans.................................... (76,970) (120,987)
Change in accrued investment income....................... (168,572) (511,816)
Change in reinsurance balances............................ (4,305,924) (6,017,415)
Change in due and unpaid premium.......................... (198,345) (117,120)
Realized (gains)/losses on investments.................... (47,078) 26,563
Other, net................................................ (1,319,531) (756,014)
----------- -----------
Net cash used in operating activities....................... (6,022,631) (3,475,895)
----------- -----------
Cash flows from investing activities:
Proceeds from sale of fixed maturities available for
sale.................................................... 1,547,670 123,817
Proceeds from redemption of fixed maturities available for
sale.................................................... 3,180,477 3,385,994
Cost of fixed maturities purchased available for sale..... (9,218,217) (4,164,824)
Change in amounts held in trust by reinsurer.............. (282,773) (1,184,489)
Change in amounts held for reinsurer...................... -- --
Proceeds from sale of equity securities................... 205,800 192,260
Cost of equity securities purchased....................... (104,106) (180,638)
Change in other invested assets........................... 38,719 (327,236)
Sale of business, net of cash held........................ -- 1,457,733
----------- -----------
Net cash used in investing activities....................... (4,632,430) (697,383)
----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock................ 318,124 247,933
Net proceeds from issuance of Series D Preferred Stock.... 1,812,500 --
Increase in policyholder account balances................. 1,309,488 1,533,089
Change in reinsurance balances on policyholder account
balances................................................ (702,260) (588,429)
Increase in loan payable.................................. -- --
Principal payment on notes payable........................ (250,000) (175,000)
----------- -----------
Net cash provided by financing activities................... 2,487,852 1,017,593
----------- -----------
Net decrease in cash and cash equivalents................... (8,167,209) (3,155,685)
Cash and cash equivalents at beginning of period............ 17,092,938 25,014,019
Cash and cash equivalents at end of period.................. $ 8,925,729 $21,858,334
=========== ===========
Supplemental cash flow information:
Cash paid during the period for interest.................. $ 92,934 $ 87,358
=========== ===========
Cash paid during the period for income taxes.............. $ 25,000 $ --
=========== ===========
See notes to unaudited consolidated financial statements.
E-48
329
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements have been prepared on the basis of
generally accepted accounting principles and consolidate the accounts of
Universal American Financial Corp. ("Universal" or the "Parent Company") and its
subsidiaries (collectively the "Company"), American Progressive Life & Health
Insurance Company of New York ("American Progressive"), American Pioneer Life
Insurance Company ("American Pioneer"), American Exchange Life Insurance Company
("American Exchange"), WorldNet Services Corp. ("WorldNet") and Quincy Coverage
Corp. ("Quincy").
The interim financial information herein is unaudited, but in the opinion
of management, includes all adjustments (consisting of normal, recurring
adjustments) necessary to present fairly the financial position and results of
operations for such periods. The results of operations for the three months
ended March 31, 1999 are not necessarily indicative of the results to be
expected for the full year. The consolidated financial statements should be read
in conjunction with the Form 10-K for the year ended December 31, 1998. Certain
reclassifications have been made to prior year's financial statements to conform
with current period classifications.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which is required to be adopted
in years beginning after June 15, 1999. Because of the Company's minimal use of
derivatives, management does not anticipate that the adoption of the new
Statement will have a significant effect on earnings or the financial position
of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("Statement 131"), effective for years
beginning after December 15, 1997. Statement 131 requires that a public company
report financial and descriptive information about its reportable operating
segments pursuant to criteria that differ from previous accounting practice.
Operating segments, as defined, are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision-maker in deciding how to allocate resources and in
assessing performance and was implemented by the Company starting in the
December, 1998 financial statements. The financial information reported includes
segment profit and loss, certain revenue and expense items and segment assets
and reconciliations to corresponding amounts in the general purpose financial
statements. Statement 131 also requires information about revenues from products
or services, countries where the company has operations or assets, and major
customers. The adoption of Statement 131 does not affect results of operations
or financial position.
2. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, for the
three-month periods ended March 31, 1999 and 1998 are as follows:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
1999 1998
----------- ----------
Net income........................................ $ 710,637 $533,053
Unrealized gain/(loss) on securities.............. (792,634) 124,232
--------- --------
Comprehensive income/(loss)....................... $ (81,997) $657,285
========= ========
E-49
330
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PENDING TRANSACTIONS
Universal American Financial Corp. Share Purchase Agreement with Capital Z
Financial Services Fund II, L.P.
On December 31, 1998, the Company executed a Share Purchase Agreement ("UA
Purchase Agreement") with Capital Z Financial Services Fund II, L.P. ("Capital
Z"), whereby Capital Z has agreed to purchase up to 26,031,746 shares of
Universal common stock for a purchase price of up to $82.0 million (the "Capital
Z Transaction") subject to adjustment as outlined in the Purchase Agreement.
Pursuant to terms of the UA Purchase Agreement, the number of shares of
Universal common stock and the aggregate purchase price to be paid by Capital Z
will be reduced based upon the aggregate number of shares of Universal common
stock purchased by certain members of management and agents of the companies
being acquired pursuant to the Penn Union Purchase Agreement discussed below,
but in no event will it be less than 19,841,270 shares. Thus, as a result of the
closing of the transactions contemplated by the UA Purchase Agreement, Capital Z
will acquire a controlling interest in Universal. Specifically, if Capital Z
purchases the minimum number shares under the UA Purchase Agreement, it will
acquire 45.6% of the then outstanding shares of Universal common stock on a
fully diluted basis, and if Capital Z purchases the maximum number of shares, it
will acquire 59.8% of the then outstanding shares of Universal common stock on a
fully diluted basis.
The UA Purchase Agreement is subject to (i) regulatory approvals in the
states in which Universal's insurance subsidiaries are domiciled, (ii)
shareholder approval and (iii) the consummation of the Penn Union Transaction
(see below).
Penn Union Acquisition
On December 31, 1998, Universal entered into a purchase agreement (the
"Penn Union Purchase Agreement") with PennCorp Financial Group, Inc. ("PFG") and
certain subsidiaries of PFG, to acquire all of the outstanding shares of common
stock of certain direct and indirect subsidiaries of PFG, including the
insurance companies as follows (the "Penn Union Transaction"):
NAME OF INSURANCE COMPANY STATE OR PROVINCE OF DOMICILE
- ------------------------- -----------------------------
Pennsylvania Life Insurance Company Pennsylvania
Peninsular Life Insurance Company North Carolina
Union Bankers Insurance Company Texas
Constitution Life Insurance Company Texas
Marquette National Life Insurance Company Texas
Penncorp Life of Canada Ottawa
The Penn Union Purchase Agreement calls for a purchase price of $175
million with $136 million in cash and $39 million in seller financing. In
addition, the Company will incur approximately $12 million in transaction costs
associated with this transaction. The Company will finance the cash portion of
the acquisition with the $82 million of proceeds generated from the UA Purchase
Agreement discussed above and from the execution of a $80 million credit
facility that consists of a $70 million term loan and a $10 million revolving
loan facility.
The Penn Union Purchase Agreement is subject to approval by the insurance
regulators of the jurisdictions in which the acquired companies are domiciled.
Management expects this transaction to close in the second quarter of 1999,
although no assurances can be given that it will occur. Based on financial
information as of December 31, 1998, the assets and liabilities to be acquired
in
E-50
331
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
connection with the Penn Union Transaction are approximately $844 million and
$669 million, respectively.
4. FEDERAL INCOME TAXES
The Company files a consolidated return for Federal income tax purposes, in
which American Pioneer and American Exchange are not currently permitted to be
included. American Pioneer and American Exchange file a separate consolidated
Federal income tax return.
5. EARNINGS PER SHARE
Per share amounts for net income from operations are shown in the income
statement using (i) an earnings per common share basic calculation and (ii) an
earnings per common share-assuming dilution calculation. A reconciliation of the
numerators and the denominators of the basic and diluted earnings per share for
the three months ended March 31, 1999 and 1998 is as follows:
FOR THE THREE MONTHS ENDED MARCH 31, 1999
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Net income................................... $ 710,637
Less: Redemption accrual on Series C and
Series D Preferred Stock................... (179,524)
---------
Basic EPS
Net income applicable to common
shareholders............................... 531,113 7,706,061 $0.07
=====
Effect of Dilutive Securities
Series B Preferred Stock..................... 1,777,777
Series C Preferred Stock..................... 179,524 2,176,000
Series D Preferred Stock..................... 1,123,457
Non-registered warrants...................... 2,015,760
Registered warrants.......................... 657,031
Incentive stock options...................... 374,250
Director stock options....................... 23,000
Agents and others stock options.............. 72,785
Treasury stock purchased from proceeds of
Options and warrants....................... (1,071,636)
--------- ----------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions................... $ 710,637 14,854,485 $0.05
========= ========== =====
E-51
332
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOR THE THREE MONTHS ENDED MARCH 30, 1998
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Net income................................... $ 533,053
Less: Redemption accrual on Series C
Preferred Stock............................ (108,356)
---------
Basic EPS
Net income applicable to common
shareholders............................... 424,697 7,417,957 $0.06
=====
Effect of Dilutive Securities
Series B Preferred Stock................... 1,777,777
Series C Preferred Stock..................... 108,356 2,176,001
Non-registered warrants...................... 2,015,760
Registered warrants.......................... 668,481
Incentive stock options...................... 296,000
Director stock option........................ 16,000
Treasury stock purchased from proceeds of
options and warrants....................... (1,211,574)
--------- ----------
Diluted EPS
Net income applicable to common shareholders
plus assumed conversions................... $ 533,053 13,156,402 $0.04
========= ========== =====
6. INVESTMENTS
As of March 31, 1999 and December 31, 1998, 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.
MARCH 31, 1999
---------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
CLASSIFICATION COST GAINS LOSSES VALUE
- -------------- ------------ ---------- ----------- ------------
US Treasury securities and
obligations of US
government.................... $ 5,751,777 $ 133,051 $ (31,153) $ 5,853,675
Foreign government debt
securities.................... 399,863 8,077 -- 407,940
Corporate debt securities....... 67,066,345 969,352 (962,722) 67,072,975
Mortgage-backed securities...... 63,405,626 878,005 (840,326) 63,443,305
------------ ---------- ----------- ------------
$136,623,611 $1,988,485 $(1,834,201) $136,777,895
============ ========== =========== ============
US Treasury securities and
obligations of US
government.................... $ 6,444,302 $ 181,694 $ (28,440) $ 6,597,556
Corporate debt securities....... 63,502,687 1,680,539 (472,027) 64,711,199
Mortgage-backed securities...... 62,280,125 1,821,084 (612,330) 63,488,879
------------ ---------- ----------- ------------
$132,227,114 $3,683,317 $(1,112,797) $134,797,634
============ ========== =========== ============
E-52
333
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and fair value of fixed maturities at March 31, 1999 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
------------ ------------
Due in 1 year or less................................ $ 2,578,523 $ 2,598,941
Due after 1 year through 5 years..................... 27,970,700 28,304,024
Due after 5 years through 10 years................... 20,942,662 20,648,729
Due after 10 years................................... 19,319,234 19,329,105
Mortgage-backed securities........................... 65,812,492 65,897,096
$136,623,611 $136,777,895
============ ============
7. SERIES C PREFERRED STOCK
During 1997, the Company issued 51,680 shares (par value $100) of Series C
Preferred Stock for $5.2 million, of which $2.4 million was purchased by UAFC
L.P. ("AAM") an unaffiliated investment firm, $0.6 million by Chase Equity
Partners, L.P., $1.4 million by Richard A. Barasch (the Chairman and Chief
Executive Officer of the Company), members of his family, and members and
associates of the Company's management and $0.8 million by owners and employees
of Ameri-Life & Health Services, a general agency that sells the Company's
senior market products. This transaction received the approval of the Florida
Insurance Department.
Under the terms of the Series C Preferred Stock, the Company had the right
to require conversion of the Series C Preferred Stock into the Company's common
stock at a conversion price of $2.375 per common share if the average reported
bid price of its common stock for any 60 day period in which such bid prices are
reported exceeded $3.45 per common share. This condition was satisfied on March
5, 1999. On March 11, 1999 the Company gave notice of the conversion of the
Series C Preferred Stock, and all of the 51,680 outstanding shares of Series C
Preferred Stock were converted to 2,175,986 shares of common stock on April 1,
1999.
The Company, AAM, the holders of the Series C Preferred Stock, Barasch
Associates Limited Partnership ("BALP") and Richard A. Barasch entered into a
stockholders' agreement at the closing of the transaction which contained the
following conditions:
- The holders of the Series C Preferred Stock were given registration
rights and informational rights.
- The Series C Preferred Stockholders agreed to vote their shares for the
election of a person designated by AAM as the director elected by that
Series.
- BALP and Mr. Barasch granted the Series C holders a co-sale right should
they sell any shares of the Company's common stock held by them, except
to certain "permitted transferees".
This stockholders' agreement will be superceded by a new agreement upon the
closing of the Capital Z transaction. (See Note 3).
8. SERIES D PREFERRED STOCK
On December 31, 1998, the Company contracted to sell 40,000 shares (par
value $100) of Series D Preferred Stock to UAFC, L.P. for $4.0 million. The
Series D Preferred Stock was divided into two sub-series, Series D-1 and Series
D-2. The 22,500 Series D-1 Shares were issued on
E-53
334
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1998 and the 17,500 Series D-2 shares were issued on February 12,
1999. The Series D Preferred Stock has the same provisions as the Series C-1,
Preferred Stock, except (i) that the Series D has no voting rights except as
required by law, (ii) the conversion price on the Series D-1 was $2.70 rather
than $2.375 per share, (iii) the conversion price of the series D-2 was $2.70
or, if a "change of control" transaction, as defined, occurs in 1999, the
conversion price will be equal to the per share price at which common stock is
issued in the change of control transaction, and (iv) if the issuance of voting
shares to a Series D shareholder requires regulatory approval, the conversion
will be postponed until such approval is obtained or ceases to be required. The
pending Capital Z Transaction will be a "change of control" within the meaning
of the terms of the Series D Preferred Stock.
On March 11, 1999, the Company gave notice of conversion of the Series D-1
and D-2 Preferred Stock. Since the conversion of the Series D-1 and D-2
Preferred Stock held by UAFC, L.P. to common stock would result in its owning
more than 10% of the Company's voting stock, implementation of the conversion
would require that the New York Insurance Department either (i) approve of UAFC,
L.P. becoming a controlling shareholder of the Company or (ii) determine that
such conversion would not result in UAFC, L.P. becoming a controlling person of
Universal. The completion of the conversion of the Series D Preferred Stock was
therefore deferred until such conditions are satisfied or are no longer
applicable. If the pending Capital Z Transaction closes, no approval of the
conversion of the Series D Preferred Stock will be required, because the UAFC,
L.P. will, after conversion of the Series D Preferred Stock and the issuance of
stock to Capital Z as anticipated in the Capital Z Transaction, hold less than
10% of Universal's then outstanding stock. If the Capital Z Transaction does not
close, the Company anticipates that it will obtain the required approval of a
change of control or determination that no change of control is involved in the
conversion of the Series D Preferred Stock.
The shareholder agreement applicable to the Series C Preferred Stock also
applies to the Series D Preferred Stock.
9. STOCKHOLDER'S EQUITY
Preferred Stock
The Company has 2,000,000 authorized shares of preferred stock to be issued
in series with 92,080 shares issued and outstanding at March 31, 1999, of which
400 shares are Series B, 51,680 shares are Series C and 40,000 are Series D (see
Note 7 for a discussion of Series C Preferred Stock and Note 8 for a discussion
of Series D Preferred Stock).
Series B Preferred Stock
The Company has 400 shares of Series B Preferred Stock issued and
outstanding, with a par value of $10,000 per share, which are held by
Wand/Universal Investments L.P. I and II ("Wand"). The Series B Preferred Stock
is convertible into Common Stock at $2.25 per share (subject to adjustment) and
is entitled to dividends as if already converted, only when and if dividends are
declared on the Common Stock. The holders of the Series B Preferred Stock may
not require the Company to redeem it unless the Company engages in certain
defined transactions. The Company has the right to require a conversion if it
raises additional equity from the public on pricing terms that meet certain
criteria.
E-54
335
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Common Stock
The par value of common stock is $.01 per share with 20,000,000 shares
authorized for issuance. The shares issued and outstanding at March 31, 1999 and
December 31, 1998 were 7,774,064, and 7,638,057, respectively. During the three
months ended March 31, 1999, the Company issued 136,007 shares of its common
stock for $383,429.
Common Stock Warrants
The Company had 657,031 common stock warrants issued and outstanding at
March 31, 1999 and 658,231 issued and outstanding at December 1998, which are
registered under the Securities Exchange Act of 1934. At March 31, 1999 and
December 31, 1998, the Company had 2,015,760 warrants outstanding which are not
registered under the Securities Exchange Act of 1934. The warrants have no par
value, have an exercise price to purchase common stock on a one to one basis at
$1.00 and expire on December 31, 1999.
10. STATUTORY CAPITAL AND SURPLUS REQUIREMENTS AND DIVIDEND RESTRICTIONS
American Progressive, American Pioneer and American Exchange are required
to maintain minimum amounts of capital and surplus as determined by statutory
accounting. The minimum statutory capital and surplus requirements of American
Progressive, American Pioneer and American Exchange as of March 31, 1999 for the
maintenance of authority to do business were $2.5 million, $2.7 million and $0.8
million, respectively. However, in these states substantially more than such
minimum amounts are needed to meet statutory and administrative requirements of
adequate capital and surplus to support the current level of the insurance
subsidiaries' operations. At March 31, 1999 the adjusted statutory capital and
surplus, including asset valuation reserve, of American Progressive, American
Pioneer and American Exchange was $9.8 million, $12.4 million, and $3.5 million,
respectively.
11. BUSINESS SEGMENT INFORMATION
Universal has four business segments: Senior Market Accident & Health
Insurance, Other Accident & Health Insurance, Life Insurance, and Non-insurance
Businesses. The Senior Market Accident & Health segment offers Medicare
supplement, home health care, nursing home, and hospital indemnity products. The
Other Accident & Health Insurance segment offers mainly major medical insurance
and some products that are not currently material. Products offered by the Life
Insurance segment include annuities, universal life, and other traditional and
term life products. The Non-insurance Businesses segment consists mainly of the
Parent Company and WorldNet.
E-55
336
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial data by segment as of and for the three months ended March 31,
1999 and 1998 is as follows:
MARCH 31, 1999
-------------------------------------------------------------------------
SENIOR OTHER
ACCIDENT & ACCIDENT & LIFE NON-INSURANCE
HEALTH HEALTH INSURANCE BUSINESSES TOTAL
----------- ----------- -------------- ------------- ------------
Net premiums and
policyholder fees
earned............... $ 6,338,564 $ 2,394,771 $ 1,691,034 $ -- $ 10,424,369
Net investment income.. 257,748 188,613 2,323,986 28,581 2,798,928
Realized gains......... 4,336 3,172 39,089 481 47,078
Fee and other income... -- -- 11,158 568,090 579,248
----------- ----------- ------------ ----------- ------------
6,600,648 2,586,556 4,065,267 597,152 13,849,623
Policyholder
benefits............. 5,065,227 1,938,952 2,167,724 -- 9,171,903
Increase in deferred
acquisition costs.... (938,832) (22,142) 104,729 -- (856,245)
Commissions and general
expenses............. 2,093,137 661,975 1,459,447 252,343 4,466,902
----------- ----------- ------------ ----------- ------------
Total benefits,
claims and other
deductions...... 6,219,532 2,578,785 3,731,900 252,343 12,782,560
Operating income before
taxes................ $ 381,116 $ 7,771 $ 333,367 $ 344,809 $ 1,067,063
=========== =========== ============ =========== ============
ASSETS
Cash and investments... $14,425,089 $10,555,889 $130,063,877 $ 3,337,004 $158,381,859
Deferred policy
acquisition costs.... 8,153,725 1,067,244 17,147,496 -- 26,368,465
Accrued investment
income............... 341,385 249,815 3,078,090 37,855 3,707,145
Goodwill............... 3,709,519 606,562 -- -- 4,316,081
Present value of future
profits.............. 965,210 560,791 -- -- 1,526,001
Due and unpaid
premiums............. 354,376 141,443 228,435 -- 724,254
Reinsurance
recoverable.......... 37,117,483 9,725,164 34,708,873 -- 81,670,793
Other assets........... -- -- -- 7,639,612 7,639,612
----------- ----------- ------------ ----------- ------------
Total assets...... $65,066,787 $22,906,908 $185,226,771 $11,014,471 $284,214,937
=========== =========== ============ =========== ============
E-56
337
UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 1998
-------------------------------------------------------------------------
SENIOR OTHER
ACCIDENT & ACCIDENT & LIFE NON-INSURANCE
HEALTH HEALTH INSURANCE BUSINESSES TOTAL
----------- ----------- -------------- ------------- ------------
Net premiums and
policyholder fees
earned............... $ 5,750,573 $ 2,345,737 $ 2,387,971 $ -- $ 10,484,281
Net investment income.. 84,765 174,072 2,428,131 21,270 2,708,238
Realized gains......... (831) (1,707) (23,816) (209) (26,563)
Fee and other income... -- -- 15,839 632,921 648,760
----------- ----------- ------------ ----------- ------------
Total revenues.... 5,834,507 2,518,102 4,808,125 653,982 13,814,716
Policyholder
benefits............. 3,988,044 1,734,217 3,228,974 -- 8,951,235
Increase in deferred
acquisition costs.... (472,876) 7,022 (20,181) -- (486,035)
Commissions and general
expenses............. 2,024,960 770,132 1,346,616 433,394 4,575,102
----------- ----------- ------------ ----------- ------------
Total benefits,
claims and other
deductions...... 5,540,128 2,511,371 4,555,409 433,394 13,040,302
Operating income before
taxes................ $ 294,379 $ 6,731 $ 252,716 $ 220,588 $ 774,414
=========== =========== ============ =========== ============
ASSETS
Cash and investments... $ 5,042,770 $10,355,627 $144,450,626 $ 1,303,838 $161,152,862
Deferred policy
acquisition costs.... 5,008,311 569,207 15,468,110 -- 21,045,628
Accrued investment
income............... 121,109 248,708 3,469,233 30,390 3,869,440
Goodwill............... 3,842,434 627,660 -- -- 4,470,093
Present value of future
profits.............. 1,044,278 618,014 -- -- 1,662,292
Due and unpaid
premiums............. 312,638 120,246 232,507 -- 665,391
Reinsurance
recoverable.......... 34,350,729 7,399,843 44,996,656 -- 86,747,228
Other assets........... -- -- -- 6,694,583 6,694,583
----------- ----------- ------------ ----------- ------------
Total assets...... $49,722,269 $19,939,305 $208,617,132 $ 8,028,811 $286,307,517
=========== =========== ============ =========== ============
E-57
338
INDEPENDENT AUDITORS' REPORT
Board of Directors of PennCorp Financial Group, Inc.
We have audited the accompanying combined balance sheets of Certain
Insurance Operations of PennCorp Financial Group, Inc. as described in Note 1
(the "Acquired Companies") as of December 31, 1998 and 1997 and the related
combined statements of income, changes in business equity, comprehensive income,
and cash flows for each of the years in the three-year period ended December 31,
1998.
We conducted our audits in accordance with generally accepted audit
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of the Acquired
Companies as of December 31, 1998 and 1997 and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1998, in conformity with generally accepted accounting principles.
KPMG LLP
April 14, 1999, except as to Note 18 which is as of May 26, 1999
Raleigh, NC
E-58
339
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED BALANCE SHEETS
(IN THOUSANDS)
AS OF DECEMBER 31,
------------------------
1998 1997
---------- ----------
ASSETS
Investments:
Fixed maturity securities available for sale, at fair
value (amortized cost $538,743 in 1998 and $501,128 in
1997).................................................. $ 558,020 $ 521,844
Equity securities available for sale, at fair value (cost
$6,790 in 1998 and $7,423 in 1997)..................... 6,792 7,564
Mortgage loans on real estate............................. 1,640 7,335
Policy loans.............................................. 22,463 23,731
Short-term investments.................................... 87,633 48,366
Other investments -- affiliated........................... 5,906 43,232
Other investments -- unaffiliated......................... 3,910 7,858
---------- ----------
Total investments................................. 686,364 659,930
Cash........................................................ 19,914 14,819
Due from reinsurers......................................... 89,078 86,051
Due from affiliates......................................... 1,796 70,511
Accrued investment income................................... 8,920 8,797
Accounts and notes receivable, net of allowance of $3,684 in
1998 and $4,086 in 1997................................... 16,725 21,747
Present value of insurance in force......................... 88,233 106,864
Deferred policy acquisition costs........................... 115,130 173,214
Other assets................................................ 20,919 14,714
Costs in excess of net assets acquired...................... 96,947 109,535
---------- ----------
Total assets...................................... $1,144,026 $1,266,182
========== ==========
LIABILITIES
Policy liabilities and accruals............................. $ 635,302 $ 666,598
Income taxes, primarily deferred............................ 4,310 41,962
Capital lease obligation.................................... 2,484 3,109
Affiliated surplus note payable............................. 102,125 113,000
Deferred ceding allowance................................... 26,920 33,227
Accrued expenses and other liabilities...................... 36,004 22,446
---------- ----------
Total liabilities................................. 807,145 880,342
---------- ----------
Business equity................................... 336,881 385,840
---------- ----------
Total liabilities and business equity............. $1,144,026 $1,266,182
========== ==========
See accompanying notes to combined financial statements.
E-59
340
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF INCOME
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
Revenues:
Premiums.............................................. $195,988 $223,283 $293,509
Interest sensitive policy product charges............. 3,568 1,721 2,753
Net investment income................................. 47,938 47,405 48,113
Net gains (losses) from sale of investments........... 6,207 4,795 (616)
Other income.......................................... 11,408 17,550 9,252
-------- -------- --------
Total revenues................................ 265,109 294,754 353,011
-------- -------- --------
Benefits and expenses:
Policyholder benefits incurred........................ 126,316 147,055 175,173
Change in liability for future policy benefits
and other policy benefits.......................... 48,330 (2,604) (15,137)
Amortization of present value of insurance
in force and deferred policy acquisition costs..... 105,046 39,666 38,497
Amortization of costs in excess of new assets
acquired........................................... 5,547 5,594 5,613
Interest expense...................................... 11,100 13,711 12,213
Underwriting and other administrative expenses --
unaffiliated....................................... 54,921 39,793 58,564
Underwriting and other administrative expenses --
affiliated......................................... 22,964 33,155 36,048
-------- -------- --------
Total benefits and expenses................... 374,224 276,370 310,971
-------- -------- --------
Operating (loss) income before income taxes............. (109,115) 18,384 42,040
Income tax (benefit) expense............................ (35,257) 7,589 17,606
-------- -------- --------
Operating (loss) income................................. $(73,858) $ 10,795 $ 24,434
======== ======== ========
See accompanying notes to combined financial statements.
E-60
341
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CHANGES IN BUSINESS EQUITY
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
Balance at beginning of period.......................... $385,840 $364,179 $371,844
Net (loss) income....................................... (73,858) 10,795 24,434
Capital contributions received.......................... 1,000 2,474 1,227
Dividends received from operations not acquired......... 14,930 10,000 7,400
Dividends paid.......................................... -- -- (7,000)
Deemed capital contribution relating to post employment
benefits obligation forgiven by affiliates............ 3,272 -- --
Deemed capital contribution (dividend) in connection
with acquisitions and dispositions of:
Marketing One......................................... 10,270 -- (35)
PennCorp Occidental Corp.............................. -- -- 3,292
Southwestern Life..................................... -- -- (40,000)
Knightsbridge......................................... 4,748 -- --
Other................................................. 59 -- --
Deemed (dividend) capital contribution from reinsurance
transactions with affiliates.......................... (838) -- 2,465
Deemed capital contribution relating to acquisition of
Constitution, Union Bankers, and Marquette............ 830 -- --
Change in net unrealized foreign currency translation... (7,809) (5,641) 568
Change in net unrealized investment gains............... (1,563) 4,033 (16)
-------- -------- --------
Balance at end of period................................ $336,881 $385,840 $364,179
======== ======== ========
See accompanying notes to combined financial statements.
E-61
342
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
Net (loss) income.......................................... $(73,858) $10,795 $24,434
-------- ------- -------
Other comprehensive income:
Change in foreign currency translation adjustment, net of
taxes................................................. (7,809) (5,641) 568
Change in unrealized holding gains on securities
available for sale, net of taxes (benefits) of $841,
($2,171), and $8...................................... 564 9,030 32
Reclassification adjustments for gains included in net
income (loss)......................................... (2,127) (4,997) (48)
-------- ------- -------
Other comprehensive (loss) income.......................... (9,372) (1,608) 552
-------- ------- -------
Comprehensive (loss) income................................ $(83,230) $ 9,187 $24,986
======== ======= =======
See accompanying notes to combined financial statements.
E-62
343
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income......................................... $ (73,858) $ 10,795 $ 24,434
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Adjustments relating to universal life and investment
products:
Interest credited to account balances................ 4,442 2,280 4,121
Charges for mortality and administration............. (3,568) (2,612) (2,753)
Capitalization of deferred policy acquisition costs.... (41,173) (49,491) (45,350)
Amortization of intangibles, depreciation and
accretion, net....................................... 118,823 43,595 43,998
Change in due from reinsurers.......................... (3,027) 33,769 (117,089)
Changes in policy liabilities, accruals and other
policyholder funds................................... 42,163 (36,195) (25,511)
Reinsurance reserves (recaptured by) assumed from
affiliate............................................ (27,716) 67,368 --
Change in other assets................................. (5,251) 2,553 (3,668)
Change in accrued expenses and other liabilities....... 75,963 (61,614) 28,092
Change in notes and accounts receivable and accrued
investment income.................................... 4,899 (134) (2,748)
Change in taxes payable................................ 683 3,436 3,002
Change in deferred income taxes payable................ (30,680) 3,693 21,124
Net (gains) losses from sales of investments........... (6,207) (4,795) 616
Other, net............................................. 1,446 2,254 1,468
--------- --------- ---------
Net cash provided (used) by operating activities..... 56,939 14,902 (70,264)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of fixed maturities available for sale.............. 60,926 40,338 169,902
Maturities and other redemption of fixed maturities
available for sale..................................... 82,580 62,381 29,316
Sales of mortgages, real estate and other investments..... 13,220 568 117
Sales of equity securities................................ 280 20,436 8,972
Sales of subsidiary to affiliate.......................... 10,270 -- 3,292
Sale and maturities of obligations of affiliates.......... 30,662 -- 1,592
Partial liquidation of affiliated partnership interest.... 8,498 -- --
Principal collected on mortgage loans..................... 3,231 997 1,509
Change in short-term investments, net..................... (39,266) (4,046) (8,192)
Purchases of fixed maturities available for sale.......... (183,520) (132,955) (95,188)
Purchases of other investments............................ -- (3,859) (4,196)
Purchases of equity securities............................ -- (6,405) (8,209)
--------- --------- ---------
Net cash (used) provided by investing activities..... (13,119) (22,545) 98,915
--------- --------- ---------
See accompanying notes to combined financial statements.
E-63
344
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CASH FLOWS, CONTINUED
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Receipts from interest sensitive products credited to
policyholders' account balances........................ $ 9,113 $ 1,980 $ 2,157
Return of policyholders' account balances on interest
sensitive products..................................... (54,902) (5,477) (49,542)
Capital contributions received............................ 1,000 2,474 1,227
Principal paid on affiliated surplus notes................ (10,875) (6,000) (1,000)
Deemed capital contribution relating to past employment
benefits obligation forgiven by affiliates............. 3,272 -- --
Dividends paid............................................ -- -- (7,000)
Dividends received from operations not acquired........... 14,930 10,000 7,400
Payments on capital lease obligation...................... (425) (570) 3,409
Reductions in notes payable............................... -- -- --
Deemed (dividend) capital contribution from reinsurance
transactions with affiliates........................... (838) -- 2,465
-------- -------- --------
Net cash used by financing activities................ (38,725) 2,407 (40,884)
-------- -------- --------
Increase (decrease) in cash............................... 5,095 (5,236) (12,233)
Cash at beginning of year................................. 14,819 20,055 32,288
-------- -------- --------
Cash at end of year....................................... $ 19,914 $ 14,819 $ 20,055
======== ======== ========
SUPPLEMENTAL DISCLOSURES:
Income taxes paid (received).............................. $ (6,936) $ 1,980 $ (6,552)
Interest paid............................................. 7,276 13,510 12,428
NON-CASH FINANCING ACTIVITIES:
Deemed capital contribution relating to surplus
debentures............................................. $ -- $ -- $ 40,000
Deemed dividend in connection with acquisition of
Southwestern Life...................................... $ -- $ -- $(40,000)
Deemed capital contribution of Constitution, Union
Bankers, and Marquette................................. $ 830 $ -- $ --
See accompanying notes to combined financial statements.
E-64
345
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Pursuant to a Stock Purchase Agreement, Universal American Financial Corp.
("Universal") has committed to acquire from PennCorp Financial Group, Inc.
("PennCorp") all of the outstanding shares of certain insurance operations
including: Pennsylvania Life Insurance Company ("PLIC") including its wholly
owned subsidiaries, Peninsular Life Insurance Company ("Peninsular") and
Penncorp Life Insurance Company ("Penncorp Life"), Constitution Life Insurance
Company ("Constitution") including its wholly owned subsidiary, Union Bankers
Insurance Company ("Union Bankers"), Union Bankers' wholly owned subsidiary,
Marquette National Life Insurance Company ("Marquette"), and PennCorp Financial,
Inc. ("PCFI"). The acquired operations are collectively referred to as the
Acquired Companies.
The Acquired Companies operate under a single segment, the Career Sales
Division, to offer a broad range of accident and sickness, life and accumulation
insurance products to individuals through both a contractually exclusive sales
force and general agents.
The accompanying combined financial statements include the combined assets
and liabilities and the related combined operations of the Acquired Companies.
This presentation represents the group of related companies to be acquired by
Universal, and therefore excludes the assets, liabilities and business equity of
the subsidiaries of the Acquired Companies not being acquired. Accordingly, the
accompanying combined financial statements also exclude the results of
operations for those entities. The use of or source of funds resulting from
purchases and dispositions of subsidiaries not acquired have been reflected as
deemed dividends or deemed capital contributions to the extent they related to
the exchange of net tangible assets to subsidiaries of PennCorp. The financial
statements reflect all expenses incurred by the parent on behalf of the Acquired
Companies. It is management's belief that the methodology used to allocate the
parent expenses paid on behalf of the Acquired Companies reflects a reasonable
share of total expenses paid and represent what the shared expenses would have
been on a stand alone basis. All significant intercompany accounts and
transactions have been eliminated. The issuance of surplus debentures to other
PennCorp entities have been reflected as deemed capital contributions in these
financial statements. Repayments of principal and interest on these surplus
debentures are reflected as deemed dividends. These financial statements have
been presented at their historical costs, in accordance with generally accepted
accounting principles ("GAAP"). No adjustments have been made to reflect any
effects of the Universal purchase discussed above. Accordingly, these financial
statements are not necessarily indicative of the financial position or the
results of operations and cash flows of the Acquired Companies which would have
occurred or which will be obtained in the future, had the effects of the
proposed purchase been reflected. All dollar amounts presented hereafter are
presented in thousands, unless otherwise noted.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities as well
as revenues and expenses. Accounts that the Acquired Companies deem to be
acutely sensitive to changes in estimates include deferred policy acquisition
costs, policy liabilities and accruals, present value of insurance in force and
deferred taxes. In addition, the Acquired Companies must determine requirements
for disclosure of contingent assets and liabilities as of the date of the
financial statements based upon estimates. As additional information becomes
available, or actual amounts are determinable, the recorded estimates may be
revised and reflected in operating results. Although some variability is
inherent in these estimates,
E-65
346
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
management believes the amounts provided are adequate. In all instances, actual
results could differ from estimates.
In 1996, a valuation system conversion was implemented to take advantage of
improvements in computer valuation software. The conversion involved a number of
PennCorp's insurance subsidiaries, both acquired and not acquired. Such system
conversions are common in the insurance industry. Conversions frequently take
advantage of increased computer power and use additional detail (ie., more
refined grouping of policies by type of plan and age of policyholder) in the
calculation of the reserves. This typically results in some level of reserve
difference between the prior system and the new system. Many companies, when
doing a conversion, implicitly grade in to any differences between the old
valuation system and the new valuation system through the use of altered
assumptions in their new valuation systems. The Acquired Companies chose to make
the grading explicit for the purpose of better tracking of underlying results.
At the conversion date, the reserve levels determined utilizing the new
valuation system were lower than the reserve levels then carried. The factors
that caused reserve levels using the new system to be lower were primarily
related to the refined grouping of policies by type of plan and age of
policyholder. At that time, PennCorp developed a schedule to grade in the
differences from the original to the new valuation system. The scheduled grading
amortized the initial difference using a rate based on the expected life of the
insurance premium in force. Continued refinements, combined with the grading
described above, resulted in the original indicated difference being reduced to
zero by the end of 1998. The grading reflected in the Acquired Companies'
operating results had a positive impact on operating income before taxes, as
compared with results which would have been solely derived under the new
valuation system without such grading, of $0, $2,369 and $5,965 in 1998, 1997
and 1996, respectively. Further grading was not required due to the refinements
that were made as detailed analysis of reserves from the new system were
evaluated. The principal refinement based on the analysis of the results from
the new system was related to long term care policies. This refinement is fully
described in Note 6. The refinements that were offset against the indicated
redundancy were not reflected in the accompanying combined income statements.
Reported reserves were prepared separately for the Acquired Companies and
companies not acquired for the years ended December 31, 1998 and 1997. Prior to
1997, historical reserves for certain of the Acquired Companies were, in some
cases, determined on an inseparable basis with the entities that are not being
acquired. For purposes of these combined statements the reserves have been
segregated to the Acquired Companies by utilizing the converted valuation system
for each individual company's underlying policies in force for periods prior to
1997. For purposes of the segregation reserve assumptions used for those periods
prior to 1997 are consistent with those used at the time of the conversion and
for subsequent periods. If segregated using another method, the results for the
Acquired Companies may be different than the results as presented in the
accompanying combined financial statements.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Investments
Fixed maturity securities may be classified as available for sale, trading
or held for investment. This classification is generally determined at the date
of purchase. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", fixed maturity and equity securities classified as available for
sale are recorded at fair value, as they may be sold in response to changes in
interest rates, prepayment risk, liquidity needs, the need or desire to increase
income or capital or other economic factors.
E-66
347
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in unrealized gains and losses related to securities available for sale
are recorded as a component of business equity, net of applicable taxes and
amounts attributable to deferred policy acquisition costs and present value of
insurance in force related to universal life and investment-type products.
In accordance with SFAS No. 115, securities classified as trading
securities are reported at fair value with realized gains and losses and
unrealized gains and losses included in the determination of net income as a
component of other income. At December 31, 1996, the Acquired Companies'
investment portfolio included $1.150 classified as trading.
In accordance with SFAS No. 115, the Acquired Companies' fixed maturities
reported as held for investment were classified as held to maturity and
accordingly, were recorded at cost, adjusted for amortization of premium or
discount. As a result of PennCorp's decision to exit the private placement bond
sector, the Acquired Companies transferred all of their remaining assets in the
fixed maturities held for investment portfolio aggregating $5,500 to its fixed
maturities available for sale portfolio as of April 1, 1997. Pursuant to the
transfer the Acquired Companies marked all assets subject to the transfer to
fair value. At the date of the transfer, the fair value of these assets
approximated carrying value and resulted in no change in business equity.
Mortgage-backed securities are amortized using the interest method
including anticipated prepayments at the date of purchase. Significant changes
in estimated cash flows from original assumptions are reflected in the period of
such change. Mortgage loans on real estate are recorded at cost, adjusted for
the provision for loan losses, if necessary. Policy loans and short-term
investments are recorded at cost which approximates fair value. Short-term
investments include securities purchased with maturities generally less than
three months.
Other investments include real estate, collateral loans and limited
partnerships. Real estate, substantially all of which was acquired through
foreclosures, is recorded at the lower of fair value, less estimated costs to
sell, or cost. If the fair value of the foreclosed real estate less estimated
costs to sell is less than cost, a valuation allowance is provided for the
deficiency. Increases in the valuation allowance are charged to net income.
Collateral loans are carried at their aggregate unpaid principal balances, net
of a valuation allowance. Limited partnerships are carried on the equity method.
The Acquired Companies regularly evaluate the carrying value of their
investments based on current economic conditions, past credit loss experience
and other circumstances. A decline in net realizable value that is other than
temporary is recognized as a realized investment loss and a reduction in the
cost basis of the investment in the period when such determination is made. The
Acquired Companies discount expected cash flows in the computation of net
realizable value of its investments, other than certain mortgage-backed
securities. In those circumstances where the expected cash flows of residual
interest and interest-only mortgage-backed securities, discounted at a risk-free
rate of return, result in an amount less than the carrying value, a realized
loss is reflected in an amount sufficient to adjust the carrying value of a
given security to its fair value.
Realized investment gains and losses, determined on the basis of specific
identification, are included in the determination of net income.
(b) Insurance Revenue Recognition
Accident and health insurance premiums are recognized as revenue ratably
over the time period to which premiums relate. Revenues from traditional life
insurance policies represent premiums,
E-67
348
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
which are recognized as earned when due. Benefits and expenses are associated
with earned premiums so as to result in recognition of profits over the lives of
the policies. This association is accomplished by means of the provision for
liabilities for future policy benefits and the deferral and amortization of
policy acquisition costs.
Revenues for interest sensitive products such as universal life and annuity
contracts represent charges assessed against the policyholders' account balance
for the cost of insurance, surrenders and policy administration. Benefits
charged to expenses include benefit claims incurred during the period in excess
of policy account balances and interest credited to policy account balances.
(c) General Expenses
The combined financial statements presented include all costs of doing
business for the Acquired Companies. The investment function is performed at the
parent level and all cost associated with this function are reimbursed by the
Acquired Companies based on the level of invested assets under management at
each company. Underwriting, marketing, agent and client service and claims
adjudication costs are directly incurred and paid by the Acquired Companies. All
other costs incurred associated with the Acquired Companies are either directly
identifiable costs or allocable shared service costs. The directly identifiable
costs are distributed directly to the Acquired Companies. The allocable costs
are distributed to the Acquired Companies based on an activity based allocation,
primarily time studies. The results of this methodology are reviewed and the
time studies are updated on a quarterly basis. It is management's assertion that
the time study method used to allocate the allocable costs is a reasonable
methodology in allocating these costs, which is largely human resource or
employee related costs.
PLIC has an agreement with the affiliates of PennCorp with respect to the
reimbursement of certain direct and joint costs for services and materials paid
by PLIC on behalf of the Acquired Companies, in some cases and other affiliates.
Joint costs are allocated to the various affiliates primarily based on time
studies. These reimbursements are netted against the expenses paid.
(d) Policy Liabilities
Liabilities for future policy benefits for traditional life products have
been computed on the net level premium method, based on estimated future
investment yield, mortality, morbidity and lapses. The portion of the
traditional life reserves determined using methods other than the net level
premium method represents one-half of 1% of total liabilities. For accident and
health products, liabilities for future policy benefits are established equal to
the excess of the present value of future benefits to or on behalf of
policyholders over discounted net future premiums. Estimates used are based on
the Acquired Companies' experience adjusted to provide for possible adverse
deviation. These estimates are periodically reviewed and compared with actual
experience. Liabilities for future policy benefits for interest sensitive
products include the balance that accrues to the benefit of the policyholders
and amounts that have been assessed to compensate the life insurance
subsidiaries for services to be provided in the future.
Policy and contract claims represent estimates of reported claims and
claims incurred but not reported based on experience. For certain long-term
policies, the estimates are based on the Acquired Companies' experience applied
to industry tables.
E-68
349
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(e) Accounts and Notes Receivable
Accounts and notes receivable consist primarily of agents' balances and
premium receivable from agents and policyholders. Agents' balances are partially
secured by commissions due to agents in the future and premiums receivable are
secured by policy liabilities. An allowance for doubtful accounts is
established, based upon specific identification and general provisions, for
amounts which the Acquired Companies estimate will not ultimately be collected.
(f) Deferred Policy Acquisition Costs and Present Value of Insurance in Force
Estimated costs of acquiring new business which vary with, and are
primarily related to, the production of new business, have been deferred to the
extent that such costs are deemed recoverable from future revenues. Such
estimated costs include commissions and certain costs of policy issuance,
underwriting, and other costs directly associated with these functions to the
extent such costs are determined to vary with and are primarily related to the
production of new business. Costs deferred on accident and health and
traditional life policies are amortized, with interest, over the anticipated
premium-paying period of the related policies in proportion to the ratio of
annual premium revenue to expected total premium revenue to be received over the
life of the policies. Expected premium revenue is estimated by using the same
mortality, morbidity and lapsetions used in computing liabilities for future
policy benefits. For interest sensitive products and limited pay life products,
policy acquisition costs are amortized in relation to the emergence of
anticipated gross profits over the life of the policies.
The present value of insurance in force represents the anticipated gross
profits to be realized from future revenues on insurance in force at the date
such insurance was purchased, discounted to provide an appropriate rate of
return and amortized, with interest, based upon the policy liability or contract
rate, over the years that such profits are anticipated to be received in
proportion to the estimated gross profits. Accumulated amortization was $159,335
and $146,288 as of December 31, 1998 and 1997, respectively.
The Acquired Companies monitor deferred policy acquisition costs and
present value of insurance in force utilizing assumptions related to underlying
profitability. An impairment loss is recorded in the period in which the
carrying value exceeds the present value of these expected cash flows and is
included in the determination of net income. An impairment loss related to
deferred policy acquisition costs was recognized in 1998 (see Note 9).
(g) Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on a
straight-line basis primarily over 20 to 30 years. Accumulated amortization was
$37,878 and $31,697 as of December 31, 1998 and 1997, respectively.
(h) Intangible Assets
The Acquired Companies monitor the recoverability of the carrying value of
costs in excess of net assets acquired utilizing the methodology prescribed in
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Assets to
be Disposed of." This accounting standard modified the methodology companies
utilize to evaluate the carrying value of certain assets by requiring, among
other things, companies to evaluate assets at the lowest level at which cash
flows can be determined. The Acquired Companies also review long-lived and
intangible assets for impairment
E-69
350
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
whenever events or changes in circumstances indicate the carrying amounts of
these assets may not be recoverable. Recoverability of these assets is
determined by comparing the forecast undiscounted net cash flows of the
operation to which the assets relate, to the carrying amount, including
associated intangible assets, of such operation. If the operation is determined
to be unable to recover the carrying amount of its assets, intangible assets are
written down initially, followed by the other long-lived assets of the
operation, to fair value. Fair value is determined based upon discounted cash
flows or appraised values, depending on the nature of the associated assets.
In analyzing a likely fair value impairment, the Acquired Companies weigh
the implied fair values based upon the hierarchy established by SFAS No. 121. In
the event of an impairment loss, it would be recorded in the period in which the
carrying value exceeds the expected future gross cash flows and would be
included in the determination of net income.
(i) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, and operating losses and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which the temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
The Acquired Companies are parties to tax sharing agreements. Constitution
is the parent of the group that includes Union Bankers and Marquette as well as
Southwestern Life Insurance Company ("Southwestern Life"), an entity not
combined in the Acquired Companies. Pennsylvania Life and Peninsular and other
life insurance subsidiaries of PennCorp not included in the Acquired Companies
are included in a different consolidated return with Pacific Life & Accident
Insurance Company as the parent. Penncorp Life files a separate return in
Canada. PCFI is a member of a consolidated return separate from any life
insurance companies. Under each of the appropriate tax sharing agreements, each
company pays the tax parent of its federal consolidated return group an amount
equal to the tax due on a separate company basis. Losses and credits, if any,
are reimbursed when the company that generates the loss or credit uses the loss
or credit on its return calculated on a separate return basis.
(j) Foreign Currency Translation
The financial statement accounts of the Acquired Companies' Canadian
operations, which are denominated in Canadian dollars, are translated into U.S.
dollars as follows: (i) Canadian currency assets and liabilities are translated
at the rates of exchange as of the balance sheet dates and the related
unrealized translation adjustments are included as a component of business
equity, and (ii) revenues, expenses and cash flows, expressed in Canadian
dollars, are translated using a weighted average of exchange rates for each
period presented.
(k) Reinsurance
Financial reinsurance that does not transfer significant insurance risk is
accounted for as deposits and is reflected as a component of due from
reinsurers. The cost of reinsurance related to long-duration contracts is
accounted for over the life of the underlying reinsurance policies.
E-70
351
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Balances due to, or from, reinsurers have been reflected as assets and
liabilities rather than being netted against the related account balances.
Realized gains on retroactive reinsurance arrangements are deferred and
amortized into net income over the estimated duration of the reinsured business.
(l) Business Combinations
Business combinations accounted for as a purchase result in the allocation
of the purchase consideration to the fair values of the assets and liabilities
acquired establishing such fair values as the new accounting bases. Purchase
consideration in excess of the fair value of net assets acquired is allocated to
"costs in excess of net assets acquired." Should the fair value of the net
assets acquired exceed the purchase consideration, such excess is utilized to
reduce certain intangible assets, primarily "present value of insurance in
force." Allocation of purchase price is performed in the period in which the
purchase is consummated and may be preliminary. Adjustments resulting from the
completion of the purchase allocation process affect the value of the assets and
liabilities acquired.
(m) Business Equity
Pursuant to the consummation of the proposed Stock Purchase Agreement
mentioned above, the historical values for the equity accounts will be reset
based upon the terms of the agreement, as well as the establishment of the final
holding company structure. Accordingly, for the purposes of balance sheet
presentation, total equity is presented in a single line item, Business Equity.
The changes in the Business Equity account reflect only the historical changes
of the individual companies on a combined basis.
(n) New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 defines derivative instruments and provides comprehensive accounting and
reporting standards for the recognition and measurement of derivative and
hedging activities (including certain instruments embedded in other contracts).
It requires derivatives to be recorded in the balance sheet at fair value and
establishes criteria for hedges of changes in the fair value of assets,
liabilities or firm commitments, hedges of variable cash flows of forecasted
transactions, and hedges of foreign currency exposures of net investments in
foreign operations. Changes in the fair value of derivatives not meeting
specific hedge accounting criteria would be recognized in the Combined Statement
of Income. SFAS No. 133 is effective for all fiscal quarters of all years
beginning after June 15, 1999. The Acquired Companies are evaluating SFAS No.
133 and have not determined its effect on the combined financial statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." This SOP provides
guidance for determining whether cost of software developed or obtained for
internal use should be capitalized or expensed as incurred. In the past, the
Acquired Companies have expensed such costs as they were incurred. This SOP is
also effective for fiscal years beginning after December 15, 1998. The Acquired
Companies are currently evaluating the financial impact as well as the changes
to its related disclosures.
E-71
352
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
In December 1997, the AICPA issued SOP 97-3. SOP 97-3 provides: (1)
guidance for determining when an entity should recognize a liability for
guaranty-fund and other insurance-related assessments, (2) guidance on how to
measure the liability, (3) guidance on when an asset may be recognized for a
portion or all of the assessment liability or paid assessment that can be
recovered through premium tax offsets or policy surcharges, and (4) requirements
for disclosure of certain information. This SOP is effective for financial
statements for fiscal years beginning after December 15, 1998. Early adoption is
encouraged. Previously issued annual financial statements are not restated. The
Acquired Companies will report the effect of initially adopting this SOP in a
manner similar to the reporting of a cumulative effect of a change in accounting
principle. The Acquired Companies are currently evaluating the financial impact,
which is expected to be immaterial, as well as the changes to its related
disclosures.
(o) Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(3) ACQUISITIONS
Pursuant to a Stock Acquisition Agreement, effective December 14, 1995,
Constitution, and its affiliates, Union Bankers, Marquette and Southwestern Life
were acquired by SWF, a corporation organized by PennCorp and Knightsbridge
Capital Fund I, LP ("Knightsbridge"). Prior to December 14, 1995, Constitution,
Union Bankers and Marquette were wholly-owned subsidiaries of Southwestern Life,
whose ultimate parent was I.C.H. Corporation ("ICH"). Subsequently, on December
14, 1995, Constitution issued a surplus debenture in the amount of $80,000 to
its former immediate parent, in exchange for all of the outstanding common stock
of Union Bankers, including its wholly-owned subsidiary, Marquette. The fair
value of the net assets of Constitution, Union Bankers and Marquette amounted to
$25,967 resulting in $76,673 of costs in excess of net assets acquired which
will be amortized over 30 years. The acquisition was accounted for as a purchase
in accordance with generally accepted accounting principles and accordingly the
purchase price was allocated to the assets and liabilities acquired based on
estimates of their fair value as of the acquisition date, which became the new
cost basis.
On January 1, 1996, the common stock of Southwestern Life was contributed
to Constitution by SWF. Concurrently, Constitution issued to SWF a surplus
debenture in the amount of $40,000. The surplus debentures issued by
Constitution have been reflected as liabilities in these financial statements.
Interest incurred on these surplus debentures was $10,948, $13,510, and
$12,034 for the years ended December 31, 1998, 1997, and 1996, respectively.
Principal maturities were $10,875, $6,000 and $1,000 for the years ended
December 1998, 1997 and 1996, respectively.
On January 2, 1998, PennCorp consummated the acquisition from Knightsbridge
and Messrs. Fickes and Stone, of their respective holdings of common stock and
common stock warrants of SWF for an aggregate purchase price of $73,777 (not
including acquisition expenses). The fair value of the net assets acquired
amounted to $46,350 resulting in $28,257 of costs in excess of net assets
acquired which will be amortized over 30 years. This acquisition of the
remaining interest in SWF was accounted for as a step purchase. As a result,
approximately 22% of the assets and liabilities of the acquired entities,
including Union Bankers, were marked to the fair value at the date of
acquisition. The net effect of adjusting Union Bankers assets and liabilities to
fair value as of the acquisition date was an increase in the business equity of
Union Bankers of $830.
E-72
353
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The net assets of Southwestern Life are excluded from all periods as they are
not part of the companies being acquired. The pro forma combined total revenues,
income before taxes and net income of the Acquired Companies, as if this step
purchase occurred as of January 1, 1997, would not have been materially
different from the historical amounts reported.
On August 9, 1995, PLIC purchased an 87.3% interest in the common stock of
Marketing One for $9,603. In addition to the common stock, PLIC purchased a bond
from Marketing One in the amount of $4,500. In 1996, the bond matured with
accrued interest of $35. In lieu of repayment of the bond, PLIC was issued
additional shares, increasing its ownership to 90.8%. On January 1, 1998, PLIC
sold its interest in Marketing One to a related party for $121 of cash and
$10,149 of fixed maturities, which approximated its carrying values. The
proceeds from the sale of Marketing One have been reflected as a deemed capital
contribution.
In 1996, PennCorp Occidental Corp. was sold by Peninsular to a related
party for $3,292, which approximated its carrying value. The proceeds from the
sale of PennCorp Occidental Corp. have been reflected as a deemed capital
contribution.
Southwestern Life, Marketing One and PennCorp Occidental Corp. are not part
of the Acquired Companies, accordingly, the assets, liabilities, business equity
and results of operations of each of these companies are not included in these
combined financial statements.
(4) FOREIGN INFORMATION AND BUSINESS SEGMENT INFORMATION
The Acquired Companies operate under a single segment, the Career Sales
Division, and the only significant foreign operations are conducted in Canada.
The components of operations were as follows:
YEARS ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- --------
Total revenues:
U.S........................................ $ 211,141 $ 241,100 $300,626
Canada..................................... 53,968 53,654 52,385
---------- ---------- --------
$ 265,109 $ 294,754 $353,011
========== ========== ========
Operating (loss) income before income taxes:
U.S........................................ $ (98,172) $ 8,242 $ 25,963
Canada..................................... (10,943) 10,142 16,077
---------- ---------- --------
$ (109,115) $ 18,384 $ 42,040
========== ========== ========
AS OF DECEMBER 31,
------------------------
1998 1997
---------- ----------
Total assets:
U.S........................................ $ 967,938 $1,084,414
Canada..................................... 176,088 181,768
---------- ----------
$1,144,026 $1,266,182
========== ==========
E-73
354
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(5) INVESTMENTS
The Acquired Companies held no investments in a single entity, other than
obligations of the U.S. Government or agencies thereof, totaling in excess of
10% of total business equity as of December 31, 1998 or 1997.
The amortized cost and fair value of fixed maturities available for sale by
categories of securities are as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
December 31, 1998:
Mortgage-backed securities................. $190,543 $ 3,688 $ (456) $193,775
U.S. Treasury securities and obligations of
U.S. Government corporations and
agencies................................ 29,845 1,039 (23) 30,861
Debt securities issued by foreign
Governments............................. 47,086 7,032 (10) 54,108
Corporate debt securities.................. 271,269 8,938 (931) 279,276
-------- ------- ------- --------
Total fixed maturities available for
sale.................................... $538,743 $20,697 $(1,420) $558,020
======== ======= ======= ========
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
December 31, 1997:
Mortgage-backed securities................. $155,780 $ 6,055 $ (659) $161,176
U.S. Treasury securities and obligations of
U.S. Government corporations and
agencies................................ 29,277 719 (73) 29,923
Debt securities issued by foreign
Governments............................. 53,522 6,792 (8) 60,306
Corporate debt securities.................. 262,549 8,517 (627) 270,439
-------- ------- ------- --------
Total fixed maturities available for
sale.................................... $501,128 $22,083 $(1,367) $521,844
======== ======= ======= ========
The amortized cost and fair value of fixed maturities available for sale,
by contractual maturity, are shown below:
DECEMBER 31, 1998
---------------------
AMORTIZED FAIR
COST VALUE
--------- --------
Due in one year or less.............................. $ 22,101 $ 22,325
Due after one year Through five years................ 141,034 147,514
Due after five years Through ten years............... 137,063 144,151
Due after ten years.................................. 48,002 50,255
Mortgage backed Securities, principally Obligations
of U.S. Government agencies........................ 190,543 193,775
-------- --------
$538,743 $558,020
======== ========
E-74
355
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
Investments with a fair value of $19,994 and $19,509 were on deposit with
certain regulatory authorities as of December 31, 1998 and 1997, respectively.
Included in fixed maturities available for sale as of December 31, 1998 and
1997, are below investment-grade securities with amortized costs of $9,716 and
$19,227 respectively, and fair values of $9,645 and $19,918, respectively.
Included in fixed maturities available for sale as of December 31, 1998 and
1997, are unrated securities with an amortized cost and fair value of $5,750.
The Acquired Companies had non-income producing investments with an
amortized cost and fair value as follows:
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------- -------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- ------ --------- ------
Fixed maturities.......................... $ 315 $ 335 $ 315 $ 38
Equity securities......................... 33 17 33 10
Other investments......................... 1,900 1,900 1,900 1,900
------ ------ ------ ------
$2,248 $2,252 $2,248 $1,948
====== ====== ====== ======
At December 31, 1998, business equity included net unrealized appreciation
of equity securities of $2 consisting of gross unrealized gains of $118, less
unrealized losses of $116. At December 31, 1997 net unrealized appreciation of
equity securities of $141 consisted of gross unrealized gains of $234, less
unrealized losses of $93.
Following is an analysis of realized gains and (losses) from sale of
investments:
YEARS ENDED DECEMBER 31,
---------------------------
1998 1997 1996
------ ------ -------
Fixed maturities:
Gross gains......................................... $2,476 $ 450 $ 1,557
Gross losses........................................ (349) (476) (2,005)
Equity securities:
Gross gains......................................... -- 5,247 699
Gross losses........................................ -- (224) (203)
Other investments:
Gross gains......................................... 4,128 -- --
Gross losses........................................ (59) (200) --
Real estate........................................... 75 (2) (135)
Mortgage loans........................................ (64) -- (529)
------ ------ -------
$6,207 $4,795 $ (616)
====== ====== =======
E-75
356
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Following are changes in net unrealized appreciation (depreciation) on
investments and foreign currency translation:
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
Investments carried at fair value:
Fixed maturities.................................. $(1,439) $ 9,707 $(2,381)
Equity securities................................. (139) (3,027) 2,110
Other investments................................. (473) 16 460
------- ------- -------
(2,051) 6,696 189
Less effect on other balance sheet accounts:
Value of business acquired and deferred policy
acquisition costs.............................. (353) (492) (213)
Deferred income taxes............................. 841 (2,171) 8
Change in foreign currency translation............ (7,809) (5,641) 568
------- ------- -------
Change in unrealized investment gains and losses and
foreign currency translation...................... $(9,372) $(1,608) $ 552
======= ======= =======
Major categories of net investment income consist of the following:
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
Fixed maturities.................................... $37,729 $43,276 $40,015
Equity securities................................... 468 121 303
Mortgage loans...................................... 439 748 1,218
Policy loans........................................ 1,292 1,367 1,404
Short-term investments.............................. 3,095 2,379 2,803
Collateral loans.................................... 326 (220) 191
Real estate......................................... 54 66 68
Other investments................................... 5,622 1,185 3,454
------- ------- -------
Gross investment income........................... 49,025 48,922 49,456
Less: investment expenses......................... 1,087 1,517 1,343
------- ------- -------
Net investment income............................... $47,938 $47,405 $48,113
======= ======= =======
E-76
357
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1998 and 1997, the Acquired Companies held mortgage loans
involving both residential and commercial real estate with carrying values of
$1,640 and $7,335, respectively. The average outstanding loan balances were
approximately $86 and $198 at December 31, 1998 and 1997, respectively. At
December 31, 1998 and 1997 mortgage loan investments were concentrated in the
following states:
DECEMBER 31, 1998 DECEMBER 31, 1997
---------------------- ----------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
CARRYING CARRYING CARRYING CARRYING
VALUE TOTAL VALUE TOTAL
-------- ---------- -------- ----------
California............................... $ 759 46.3% $3,518 48.0%
Texas.................................... -- -- 2,400 32.7
Canada................................... 187 11.4 300 4.0
Florida.................................. 346 21.1 724 9.9
New Jersey............................... 203 12.4 219 3.0
All other................................ 145 8.8 174 2.4
------ ----- ------ -----
Balance, end of period................... $1,640 100.0% $7,335 100.0%
====== ===== ====== =====
Other investments -- affiliated includes the following investments:
AS OF DECEMBER 31,
-------------------
1998 1997
------- --------
American Amicable Holding Corporation promissory note... $ -- $30,662
KB Investment Fund I, L.P. -- SWF....................... -- 3,750
KB Investment Fund I, L.P. -- Acordia, Inc. ............ -- 3,228
SWF redeemable preferred stock.......................... 5,906 5,592
------ -------
Total assets....................................... $5,906 $43,232
====== =======
In September 1995, PLIC received the American Amicable Holding Corporation
promissory note as partial consideration for the common stock of Occidental Life
Insurance Company of North Carolina ("Occidental"), an affiliate. In February
1998, PLIC sold the note to affiliates Southwestern Life and Security Life and
Trust Insurance Company, at carrying value.
In March 1995, PLIC purchased an interest in Knightsbridge with an
underlying investment in SWF for $3,750 (see Note 13). In January 1998, PLIC
liquidated its limited partnership investment in Knightsbridge related to SWF as
part of the purchase of the remaining interest in SWF by PennCorp. PLIC realized
a gain on this transaction totaling $4,748. This realized gain was reflected as
a deemed capital contribution to PLIC.
In August 1997, PLIC purchased an interest in Knightsbridge with an
underlying investment in the preferred stock of Acordia, Inc. ("Acordia") for
$3,228. At the time of the transaction, Acordia was 28.6% owned by
Knightsbridge. In December 1998, PLIC sold its interest to an unrelated party
for $5,037 and recognized a realized gain of $1,809.
Investment income earned on the above assets totaled $782, $4,130, and
$2,267 for the years ended December 31, 1998, 1997 and 1996, respectively.
E-77
358
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(6) POLICY LIABILITIES AND ACCRUALS
Policy liabilities and accruals consist of reserves for fixed benefit, life
and accumulation products.
For interest sensitive life products and annuity products, the liability
for future policy benefits is equal to the accumulated fund value. Fund values
are equal to the premium received and interest credited to the fund value less
deductions for mortality costs and expense charges. Current interest rates
credited range from 4.0 to 6.5 percent. Mortality costs and expense charges are
established by the Acquired Companies based upon their experience and cost
structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is
based primarily upon Commissioners' Standard Ordinary Tables with interest rates
ranging from 2.5 to 6.0 percent. Fixed benefit products establish a liability
for future policy benefits equal to the excess of the present value of future
benefits to or on behalf of the policyholder over the future net premium
discounted at interest rates ranging primarily from 4.5 to 8.0 percent.
Traditional life products and fixed benefit products future policy benefits may
also be determined using the Acquired Companies experience as to mortality,
morbidity and lapses with a provision for adverse deviation. The Acquired
Companies may vary assumptions by year of policy issue.
Policy liabilities and accruals also include provisions for reported claims
in process of settlement, valued in accordance with the terms of the related
policies and contracts, as well as provisions for claims incurred and unreported
based on the Acquired Companies' prior experience.
In 1996, a valuation system conversion was implemented to take advantage of
improvements in computer valuation software. The conversion involved a number of
PennCorp's insurance subsidiaries, both acquired and not acquired. Such system
conversions are common in the insurance industry. Conversions frequently take
advantage of increased computer power and use additional detail (i.e., more
refined grouping of policies by type of plan and age of policyholder) in the
calculation of the reserves. This typically results in some level of reserve
difference between the prior system and the new system. Many companies, when
doing a conversion, implicitly grade in to any differences between the old
valuation system and the new valuation system through the use of altered
assumptions in their new valuation systems. The Acquired Companies chose to make
the grading explicit for the purpose of better tracking of underlying results.
At the conversion date, the reserve levels determined utilizing the new
valuation system were lower than the reserve levels then carried. The factors
that caused reserve levels using the new system to be lower were primarily
related to the refined grouping of policies by type of plan and age of
policyholder. At that time, PennCorp developed a schedule to grade in the
differences from the original to the new valuation system. The scheduled grading
amortized the initial difference using a rate based on the expected life of the
insurance premium in force. Continued refinements, combined with the grading
described above, resulted in the original indicated difference being reduced to
zero by the end of 1998. The grading reflected in the Acquired Companies'
operating results had a positive impact on operating income before taxes, as
compared with results which would have been solely derived under the new
valuation system without such grading, of $0, $2,369 and $5,965 in 1998, 1997
and 1996, respectively. Further grading was not required due to the refinements
that were made as detailed analysis of reserves from the new system were
evaluated. The principal refinement based on the analysis of the results from
the new system was related to long term care policies. This refinement is fully
described below. The refinements that were offset against the indicated
redundancy were not reflected in the accompanying combined income statements.
E-78
359
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
During 1998 the Acquired Companies refined their calculation for policy
benefit reserves for long term care products which resulted in an increase of
approximately $15,750. The Acquired Companies allocated $9,950 of previously
identified redundant reserve and additionally increased policy reserves by
$5,800. The increase in long term care benefit reserves specifically resulted
from the separation, for valuation purposes, of long term care and hospital
income plans to recognized that the long term care reserve factors, which
originally patterned those of hospital income policy factors, should be higher
at later durations than the hospital income factors produced. Additionally, it
was determined that an optional inflation rider to certain long-term care
policies required unique benefit factors. The additions to benefits from the
inflation coverage have a benefit pattern, in addition to that caused by aging
of the insured, which increases by policy duration.
While management believes the estimated amounts included in the financial
statements for policy liabilities and accruals are adequate, such estimates may
be more or less than the amounts ultimately paid when the claims are settled. In
addition, the Acquired Companies are involved in certain litigation regarding
policyholder benefits. The Acquired Companies intend to vigorously defend their
position relative to these claims; however, if unsuccessful, the level of
reserves currently provided could be adversely affected.
The following table presents information on changes in the liability for
policy and contract claims:
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
-------- --------- ---------
Policy and contract claims at beginning of
period...................................... $144,504 $ 148,931 $ 161,807
Less reinsurance recoverables................. (19,247) (18,452) (4,277)
-------- --------- ---------
Net balance at beginning of Period.......... 125,257 130,479 157,530
-------- --------- ---------
Add claims incurred, net of reinsurance
related to:
Current year................................ 92,891 107,662 143,311
Prior years................................. 30,037 (936) 1,341
-------- --------- ---------
122,928 106,726 144,652
-------- --------- ---------
Deduct claims paid, net of reinsurance related
to:
Current year................................ (44,742) (57,083) (91,382)
Prior years................................. (53,841) (54,865) (80,321)
-------- --------- ---------
(98,583) (111,948) (171,703)
-------- --------- ---------
Policy and contract claims, net of related
reinsurance recoverables at end of period... 149,602 125,257 130,479
Plus reinsurance recoverables................. 23,910 19,247 18,452
-------- --------- ---------
Policy and contract claims at end of Period... $173,512 $ 144,504 $ 148,931
======== ========= =========
The Acquired Companies have been closely monitoring the development of its
claim reserve experience. This historical method utilized primarily claims lag
factors in the establishment of the claim reserve. Based on recent results of
independent calculations of the claim lag factors, performed annually, this
methodology indicated a deterioration in the adequacy of claim reserves
associated with Pennsylvania Life's disability income products underwritten
prior to PFG's owner-
E-79
360
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
ship of Pennsylvania Life. The estimated amounts included in the financial
statements for policy liabilities are based upon management's best estimate in
each year for which the financial statements are presented. Disability claim
adequacy analysis included statutory claim information, independent third-party
review of claim lag factors and method and other claim tests. Previous results
indicated no reason to consider a new methodology as results appeared consistent
between periods and claim reserves appeared adequate. Once results of such
analysis began to vary outside an acceptable tolerance, the Acquired Companies
reviewed their methods to determine the reasons for the variances.
Pennsylvania Life sells disability income products in the low to moderate
income market. The lag factor method is one method which utilized Pennsylvania
Life's experience considering its products and market. The Acquired Companies
believe that available industry data for establishing claim reserves was not
appropriate for Pennsylvania Life's products and market. The utilization of a
case reserve method for Pennsylvania Life required experience, in addition to
that utilized by the lag factor method, to create case reserves based on
Pennsylvania Life's experience. This experience was not sufficient until
recently. With recent system upgrades, Pennsylvania Life was able to obtain
better benefit data distinguishing disability benefits from other benefits which
may be payable under the same policy form. With the systems upgrades and more
robust experience the company was able to consider a more refined claims
methodology such as seriatim case reserves. During 1998, Pennsylvania Life
implemented a method which substituted case reserves for most disability claims.
The new method utilizes more detailed information by policy and by line of
business resulting in a more refined estimate. As a result, the accident and
health claim reserve for Pennsylvania Life increased by $25,691 during 1998. The
effect of the change in methodology is inseparable from the effect of the change
in accounting estimate and is accordingly reflected in operations for the year
ended December 31, 1998.
(7) LONG-TERM DEBT AND LEASE OBLIGATIONS
The outstanding principal amounts of notes payable consist of the
following:
DECEMBER 31,
--------------------
1998 1997
-------- --------
Capitalized lease obligations, expiring 2002......... $ 2,484 3,109
Affiliated surplus note obligation, maturing
2002(1)............................................ 60,600 73,000
Affiliated surplus note obligation, maturing
2003(1)............................................ 37,900 40,000
-------- --------
$100,984 116,109
======== ========
- ---------------
(1) See note 3 -- Acquisitions.
Interest costs for the surplus notes were $10,948, $13,510 and $12,083 for
the years ended December 31, 1998, 1997 and 1996 respectively. The interest
rates on the surplus notes are variable based on the LIBOR Loan Rate plus two
and one half percent. At December 31, 1998, the effective rate for the surplus
notes was approximately 9.63 percent. The aggregate maturities of notes payable
during each of the five years after December 31, 1998 are as follows:
1999 -- $16,400; 2000 -- $17,400; 2001 -- $19,600; 2002 -- $24,000; and
2003 -- $21,000. Payments on the surplus notes are subject to regulatory
approval based on certain restrictions (see note 10).
E-80
361
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Interest costs for the capital lease obligations totaled $152, $201 and
$179 for years ended December 31, 1998, 1997, and 1996, respectively. The
interest rate on the capital lease obligations is fixed at 8.0 percent. The
aggregate commitments for these capital lease obligations for each of the five
years after December 31, 1998 are as follows: 1999 - $727; 2000 - $728;
2001 - $917; 2002 - $112; and 2003 - $0.
The Acquired Companies are also obligated under operating leases, primarily
for office space. Rent expense was $5,010, $7,097, and $5,977 for the years
ended December 31, 1998, 1997, and 1996, respectively.
Minimum operating lease commitments are:
1999........................................................ $1,276
2000........................................................ 1,039
2001........................................................ 656
2002........................................................ 311
2003 and thereafter......................................... 21
------
Total minimum payments required........................ $3,303
======
(8) INCOME TAXES
The total provisions for income tax (benefit) expense are as follows:
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
-------- ------ -------
Current -- U.S. .................................... $ (4,551) $1,838 $(5,837)
Current -- foreign.................................. 778 2,058 2,319
Deferred -- U.S. ................................... (29,134) 1,676 16,683
Deferred -- foreign................................. (2,350) 2,017 4,441
-------- ------ -------
Income tax (benefit) expense........................ $(35,257) $7,589 $17,606
======== ====== =======
Income taxes computed using the prevailing corporate tax rate of 35% are
reconciled to the Acquired Companies' actual income tax expense attributable to
income as follows:
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
-------- ------ -------
Tax expense computed at statutory rate.............. $(38,190) $6,435 $14,714
Amortization of costs in excess of net assets
acquired.......................................... 1,941 1,177 1,184
Change in deferred tax asset valuation allowance.... (4,468) (525) 1,052
Gain on sale of Knightsbridge....................... 2,337 -- --
Other............................................... 3,123 502 656
-------- ------ -------
Income tax (benefit) expense........................ $(35,257) $7,589 $17,606
======== ====== =======
E-81
362
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Temporary differences between the financial statement carrying amounts and
tax bases of assets and liabilities that give rise to the deferred tax assets
(liabilities) relate to the following:
DECEMBER 31,
-------------------
1998 1997
------- --------
Deferred tax assets:
Future policy benefits.................................... $66,318 $ 49,358
Invested assets, subject to capital gains treatment....... 2,135 8,542
Net operating loss........................................ -- 8,181
Capital loss carryforward................................. 899 --
Minimum tax credits....................................... 708 --
Foreign tax credits....................................... 7,933 20,783
Deferred ceding gain...................................... 10,193 11,629
------- --------
88,186 98,493
------- --------
Deferred tax liabilities:
Deferred policy acquisition costs......................... $18,962 $ 43,243
Present value of insurance in force....................... 31,642 37,004
Other assets and liabilities.............................. 29,865 37,147
Net unrealized gain....................................... 6,296 7,137
------- --------
86,765 124,531
------- --------
1,421 (26,038)
Valuation allowance......................................... (5,685) (16,560)
------- --------
Net deferred tax liability.................................. $(4,264) $(42,598)
======= ========
The valuation allowances at December 31, 1998 and 1997 are attributable to
deferred tax assets principally arising from differences in the book and tax
bases of invested assets subject to capital gains treatment that existed as of
the date of the acquisition of the insurance subsidiaries ("acquisition capital
gains"), foreign tax credits which could potentially expire prior to
utilization, and certain other deferred tax assets, the benefits of which the
Acquired Companies do not expect to realize. The net change in the total
valuation allowance for the year ended December 31, 1998 was a decrease of
$10,875 which relates primarily to the utilization of foreign tax credits and a
reduction in the bases of acquisition capital gains, offset by an increase
relating to certain tax assets, the benefit of which the Acquired Companies do
not expect to realize. Of this decrease, $6,407 relates to the bases of
acquisition capital gains that were allocated to reduce costs in excess of net
assets acquired as the benefit of those losses were realized in 1998. To the
extent that the remaining income tax benefits relative to the acquisition
capital gains are ultimately realized, the reduction in the related valuation
allowance of $2,135 at each period would be allocated to reduce costs in excess
of net assets acquired.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon those
considerations, management believes it is
E-82
363
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
more likely than not that the Acquired Companies will realize the benefits of
these deductible differences, net of the existing valuation allowance at
December 31, 1998.
The Acquired Companies' federal income tax returns are routinely examined
by the Internal Revenue Service ("IRS"). PLIC and Peninsular are included in the
consolidated tax return of Pacific Life and Accident Insurance Company ("PLAIC")
with other affiliates. Constitution, Union Bankers and Marquette are included in
the Constitution consolidated tax return along with Southwestern Life. The IRS
has examined the Constitution consolidated group's federal income tax returns
through December 14, 1995, and pursuant to a settlement agreement with the IRS,
all tax years through December 14, 1995, are closed. The examination of the
returns for the periods through December 31, 1996 has recently commenced. The
returns for the PLAIC consolidated group are not currently under examination.
The Acquired Companies are parties to tax sharing agreements. Constitution
is the parent of the group that includes Union Bankers and Marquette as well as
Southwestern Life, an entity not combined in the Acquired Companies.
Pennsylvania Life and Peninsular and other life insurance subsidiaries of
PennCorp not included in the Acquired Companies are included in a different
consolidated return with Pacific Life & Accident Insurance Company as the
parent. Penncorp Life files a separate return in Canada. PCFI is a member of a
consolidated return separate from any life insurance companies. Under each of
the appropriate agreements, each company pays the tax parent of its federal
consolidated return group an amount equal to the tax due on a separate company
basis. Losses and credits, if any, are reimbursed when the company that
generates the loss or credit uses the loss or credit on its return calculated on
a separate return basis.
Under federal income tax laws which existed prior to 1984, certain earnings
of life insurance companies were accumulated in a special tax memorandum account
designated as the "policyholders' surplus" account. This account, with a balance
of $8,400, was frozen as of December 31, 1983. Under certain conditions, the
amount accumulated in the "policyholders' surplus" account can become taxable.
In addition, on February 1, 1999, the Clinton Administration released its Fiscal
Year 2000 Budget which included a revenue raising provision that would require
life insurance companies to include the balance of these special deductions in
taxable income over a ten year period as of the beginning of the first taxable
year starting after the date of enactment. At this time, it is uncertain whether
this provision will be included in any legislation proposed by Congress, and if
included, whether such provision would be enacted into law. As it is not
currently considered likely that a tax would become due on any such balances, no
deferred income taxes have been provided. However, if such tax were to become
payable, it would amount to approximately $2,900.
The minimum Tax Credit carryforward of $708 can be carried forward
indefinitely under the current federal income tax law. The capital loss
carryforward of $2,569 expires in 2003.
E-83
364
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(9) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE
Deferred policy acquisition costs represent commissions and certain costs
of policy issuance and underwriting. Information relating to these costs is as
follows:
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
Balance at beginning of period..................... $173,214 $147,877 $118,588
Policy acquisition costs deferred:
Commissions...................................... 24,390 23,400 17,864
Underwriting and issue costs..................... 16,316 26,091 27,486
Released by coinsurance of Medicare business (see
Note 11)......................................... (730) -- (1,243)
Write-down of unrecoverable costs.................. (65,216) -- --
Policy acquisition costs amortized................. (28,520) (22,314) (14,530)
Change in unrealized investment (gain) loss
adjustment....................................... 3 (359) (211)
Change in foreign currency translation
adjustment....................................... (1,810) (1,481) (77)
Union Bankers step purchase accounting
adjustment....................................... (2,517) -- --
-------- -------- --------
Balance at end of period........................... $115,130 $173,214 $147,877
======== ======== ========
As a result of PennCorp's purchase of the remaining interest in SWF on
January 2, 1998, the assets and liabilities of the entities acquired were marked
to fair market value. (See Note 3 -- Acquisition). Union Bankers was the only
entity included in the Acquired Companies that had material adjustments related
to this purchase. The primary effect of these adjustments on Union Bankers was
the reduction, on a pro-rata basis, of both deferred policy acquisition costs
and the present value of insurance in force as a result of a lower fair value
for these assets than was then carries on the historical basis. The reductions
in the carrying value of the deferred policy acquisition costs and the present
value of insurance in force were substantially offset by a corresponding
reduction in the deferred ceding gain. (See Note 11 -- Reinsurance).
During 1998, the Acquired Companies' assumptions as to future morbidity
have increased primarily as a result of adverse trends identified by the
Acquired Companies with respect to disability income claim reserves (See Note
6). Additionally, effective in 1998, PLIC modified the commission structure and
related participation in agency profitability. The commission structure was
modified to provide a lower base commission structure for future business. In
conjunction with the lower base commission structure, agent bonuses can now be
paid for increased policy persistency and premium growth for new business,
without increasing compensation expense over the prior commission structure. As
a compromise for the lower base commissions, the Acquired Companies
participation in the agency profits with respect to existing business was
eliminated. The elimination of the profit participation in the existing business
reduced the margin for recoverability of the unamortized deferred policy
acquisition cost. Based on a recoverability analysis, comparing future
discounted cash flows from these blocks of business to unamortized deferred
policy acquisition costs, it was determined that the unamortized deferred policy
acquisition costs for these blocks of business were not fully recoverable from
future profits. This resulted in a charge to income and a reduction of
unamortized deferred policy acquisition costs of $65,216.
As part of purchase accounting for PennCorp's acquisitions of the Acquired
Companies, a present value of insurance in force asset was established which
represents the value of the right to
E-84
365
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
receive future cash flows from insurance contracts existing at the date of
acquisition. Such value is the actuarially determined present value of the
projected cash flows from the acquired policies, discounted to provide an
appropriate rate of return. The present value of insurance in force asset was
also tested for recoverability. Based on the tests performed, the present value
of insurance in force asset was recoverable.
The methods used by the Acquired Companies to value the health, life and
annuity products purchased are consistent with the valuation methods used most
commonly to value blocks of insurance business. It is also consistent with the
basic methodology generally used to value insurance assets. The method used by
the Acquired Companies includes identifying the future cash flows from the
acquired business, the risks inherent in realizing those cash flows, the rate of
return the Acquired Companies believe they must earn in order to accept the
risks inherent in realizing the cash flows, and determining the value of the
insurance asset by discounting the expected future cash flows by the discount
rate the Acquired Companies require.
The discount rate used to determine such values is the rate of return
required in order to invest in the business being acquired. In selecting the
rate of return, the Acquired Companies consider the magnitude of the risks
associated with actuarial factors described in the following paragraph, cost of
capital available to the Acquired Companies to fund the acquisition,
compatibility with other activities that may favorably affect future profits,
and the complexity of the acquired company. The discount rates used by the
Acquired Companies to determine the present value of business acquired at the
date of each acquisition ranged from 9.2% to 17.5%.
Expected future cash flows used in determining such values are based on
actuarial determinations of future premium collection, mortality, morbidity,
surrenders, operating expenses and yields on assets held to back policy
liabilities as well as other factors. Variances from original projections,
whether positive or negative, are included in income as they occur and will
affect the present value of insurance inforce amortization rates for insurance
products accounted for under SFAS No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments." To the extent that these variances
indicate that future cash flows will differ from those included in the original
scheduled amortization of the present value of the insurance in force, current
and future amortization may be adjusted. Recoverability of the present value of
insurance in force is evaluated annually and appropriate adjustments are then
determined and reflected to the financial statements for the applicable period.
E-85
366
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Information related to the present value of insurance in force is as
follows:
YEARS ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
-------- -------- --------
Balance at beginning of year.................... $106,864 $124,884 $171,818
Released by coinsurance of Medicare business
(see Note 11)................................. (2,828) -- (22,936)
Union Bankers step purchase accounting
adjustment.................................... (3,963) -- --
Net amortization................................ (10,842) (17,352) (23,967)
Change in unrealized investment (gain) loss
adjustment.................................... (356) (133) (2)
Change in foreign currency translation
adjustment.................................... (642) (535) (29)
-------- -------- --------
Balance at end of year..................... $ 88,233 $106,864 $124,884
======== ======== ========
Expected amortization of the present value of insurance in force, based
upon current assumptions and accretion of interest at a policy liability or
contract rate ranging from 5.5 to 9.2 percent for the next five years is as
follows:
BEGINNING GROSS ACCRETION NET
BALANCE AMORTIZATION OF INTEREST AMORTIZATION
--------- ------------ ----------- ------------
1999............................... $88,233 16,916 6,972 9,944
2000............................... 78,289 15,356 6,372 8,984
2001............................... 69,305 13,466 5,639 7,827
2002............................... 61,478 11,836 4,994 6,842
2003............................... 54,636 10,754 4,420 6,334
(10) STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
Cash generated by the insurance companies included in the Acquired
Companies is made available to PennCorp, the ultimate parent, principally
through periodic payments of principal and interest on surplus debentures,
funded primarily by dividends from the insurance companies included in or owned
by the Acquired Companies.
Dividend payments by insurance companies are limited by, or subject to the
approval of the insurance regulatory authority of each insurance company's state
of domicile. Such dividend requirements and approval processes vary
significantly from state to state. In 1998, the insurance companies included in
the Acquired Companies are not able to pay dividends without prior approval from
their respective insurance regulatory authorities.
The surplus debentures in the amount of $102,125 and $113,000, at December
31, 1998 and 1997, respectively, are included in net assets in the combined
statements (see Note 1 on the basis of presentation). Pursuant to the terms of
the surplus debenture issued by Constitution to the benefit of Southwestern Life
Companies, Inc. ("SLC"), Constitution may make principal and interest payments
to the extent that Constitution's statutory surplus, plus liabilities relating
to the surplus debentures, less the statutory carrying value of Southwestern
Life and Union Bankers, exceeds $1,200. Constitution's statutory surplus at
December 31, 1998 was $152,385 (unaudited), of which $143,914 (unaudited) was
attributable to its ownership of Southwestern Life and Union Bankers.
Liabilities relating to the surplus debentures at December 31, 1998 were $7,297,
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367
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
representing accrued principal and interest. At December 31, 1997,
Constitution's surplus was $174,715 of which $161,098 was attributable to its
ownership of Southwestern Life and Union Bankers.
The insurance subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by their respective
state insurance departments. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the National Association of Insurance Commissioners ("NAIC").
Permitted statutory accounting practices encompass all accounting practices that
are approved by insurance regulatory authorities; such practices differ from
state to state, and may differ from company to company within a state, and may
change in the future. Furthermore, the NAIC has a project to codify statutory
accounting practices, the result of which is expected to constitute the only
source of prescribed statutory accounting practices. Accordingly, that project
will likely change to some extent prescribed statutory accounting practices and
may result in changes to the accounting practices that insurance enterprises use
to prepare their statutory financial statements.
Statutory capital and surplus of the insurance companies as reported to
regulatory authorities December 31, 1998 and 1997 totaled $175,466 (unaudited)
and $226,312, respectively. Statutory net (loss) income of the insurance
companies as reported to regulatory authorities totaled $(29,626) (unaudited),
$9,469 and $21,473 for the years ended December 31, 1998, 1997 and 1996,
respectively.
For the year ended December 31, 1998, Pennsylvania Life requested and
received permission for the use of Pennsylvania Life's own termination rate
experience and other assumptions from the Pennsylvania Department of Insurance,
providing for a grade in period to full statutory tables, as required by the
Pennsylvania Department of Insurance, over a three year period. Use of the full
statutory tables would further increase the claim liabilities over the amounts
reported in the Annual Statement at December 31, 1998, by $16,200, and reduce
statutory surplus by the same amount.
During 1998, Constitution requested and received permission from the Texas
Department of Insurance to recognize the loss on the sale of its investment in
Fund America Investors in the amount of $6,900 through earnings rather than
defer the recognition through Interest Maintenance Reserve. This permitted
practice does not have an effect on Constitution's statutory surplus.
Beginning in 1993, the NAIC imposed regulatory risk-based capital ("RBC")
requirements on life insurance enterprises, including the insurance companies.
The RBC model serves as a benchmark for the regulation of life insurance
companies by state insurance regulators. RBC provides for targeted surplus
levels based on formulas which specify various weighting factors that are
applied to financial balances or various levels of activity based on the
perceived degree of risk, and are set forth in the RBC requirements. Such
formulas focus on four general types of risk: (a) the risk with respect to a
company's assets (asset or default risk); (b) the risk of adverse insurance
experience with respect to a company's liabilities and obligations (insurance or
underwriting risk); (c) the interest rate risk with respect to a company's
business (asset/liability matching); and, (d) all other business risk
(management, regulatory action, and contingencies). The amount determined under
such formulas is called the authorized control level RBC ("ACLC").
The RBC guidelines define specific capital levels based on a company's ACLC
that are determined by the ratio of a company's total adjusted capital ("TAC")
to its ACLC. TAC is equal to statutory capital, plus AVR and certain other
specified adjustments. The specified capital levels, in declining order, and
applicable ratios are generally as follows: "Company Action Level" where TAC
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368
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
is less than or equal to 2.0 times ACLC or the TAC is less than or equal to 2.5
times ACLC with a negative trend; "Regulatory Action Level" where TAC is less
than or equal to 1.5 times ACLC; "Authorized Control Level" where TAC is less
than or equal to 1.0 times ACLC; and "Mandatory Control Level" where TAC is less
than or equal to 0.7 times ACLC. Companies at the Company Action Level are
required to submit a comprehensive financial plan to the insurance commissioner
of the state of domicile. Companies at the Regulatory Action Level are subject
to mandatory examination or analysis by the commissioner and possible required
corrective actions. At the Authorized Control Level, companies are subject to,
among other things, the commissioner placing it under regulatory control. At the
Mandatory Control Level, the insurance commissioner is required to place a
company under regulatory control.
At December 31, 1998 PLIC's TAC was $27,735 (unaudited), or 1.73 times
ACLC, placing it within the Company Action Level.
On September 30, 1998, PLIC entered into a reinsurance agreement with an
unaffiliated reinsurer to coinsure certain inforce individual life and health
business written or acquired by PLIC prior to January 1, 1998. In addition, as
part of the stock purchase agreement, PennCorp is required to deliver each of
the Acquired Companies to Universal with a minimum target surplus. These target
surplus levels were designed to place PLIC's TAC at 3.00 times ACLC. For PLIC,
this target surplus had been set at $36,000. As a result, PLIC's TAC will be in
compliance with regulatory RBC requirements. To achieve this, several actions
are planned. These actions include the sale of Penncorp Life by PLIC to PennCorp
for fair value; the replacement, by PennCorp, of certain non-performing assets
held by the Acquired Companies with investment grade bonds assigned an NAIC
rating of 1 or 2; and the reallocation of capital.
Attaining and maintaining the required RBC levels depends on future events
and circumstances, the outcome of which cannot be assured and the ultimate
outcome cannot be presently determined. Accordingly, no adjustments that may
result from the ultimate resolution of this uncertainty have been made in the
accompanying financial statements. Management presently believes that it will
implement its plan and meet and maintain RBC requirements.
At December 31, 1998, Union Bankers, Constitution, Peninsular, and
Marquette's TAC is in compliance with regulatory RBC requirements.
PLIC's Canadian branch and Canadian subsidiary report to Canadian
regulatory authorities based upon Canadian statutory accounting principles that
vary in some respects from U.S. statutory accounting principles. Canadian net
assets based upon Canadian statutory accounting principles were $56,191 and
$51,428 as of December 31, 1998 and 1997, respectively.
There were no remittances to PLIC from the Canadian operations during 1998,
1997 or 1996.
(11) REINSURANCE
In the normal course of business, the Acquired Companies reinsure portions
of certain policies that they underwrites to limit disproportionate risks. The
Acquired Companies retain varying amounts of individual insurance up to a
maximum retention of $500 on any life. Amounts not retained are ceded to other
insurance enterprises or reinsurers on an automatic or facultative basis. The
Acquired Companies cede varying amounts of certain accident and sickness
policies up to a maximum cession of $800, as well as varying portions of certain
disability income products.
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
During 1998, PLIC entered into a financial reinsurance agreement with an
unaffiliated reinsurer to coinsure certain in force individual life and health
business written or acquired by PLIC prior to January 1, 1998. Such reinsurance
provided PLIC with approximately $20,000 of additional capital and surplus for
the year ended December 31, 1998.
Reinsurance contracts do not relieve the Acquired Companies from their
obligations to policyholders. Therefore, the Acquired Companies are contingently
liable for recoverable unpaid claims and policyholder liabilities ceded to
reinsurers in the unlikely event that assuming reinsurers are unable to meet
their obligations. The Acquired Companies evaluate the financial condition of
their reinsurers to minimize their exposure to significant losses from reinsurer
insolvencies.
The effect of reinsurance on policy revenues earned and the related
benefits incurred by such reinsurers is as follows:
YEARS ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
--------- --------- --------
Direct policy revenues and amounts assessed
against policyholders....................... $ 296,278 $ 324,375 $327,118
Reinsurance assumed........................... 2,495 5,029 22,514
Reinsurance ceded............................. (102,785) (106,121) (56,123)
--------- --------- --------
Net premiums and amounts earned............... $ 195,988 $ 223,283 $293,509
========= ========= ========
Effective July 1, 1996, Union Bankers entered into reinsurance agreements
with Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its
Medicare supplement business in force on July 1, 1996 and to coinsure 80% of its
Medicare policies issued on or after July 1, 1996. The Acquired Companies
recorded a deferred gain on the transaction of $53,893 as of July 1, 1996, which
is being amortized into income over the life of the business. As a result of the
step purchase accounting adjustments at January 2, 1998, the deferred gain was
reduced by $7,310. During 1997, the reinsurance agreements were amended to
include new Medicare business issued by Constitution. Effective July 1, 1998,
Union Bankers and Constitution amended these agreements with Cologne by
increasing the coinsurance percentage to 100% and modifying certain other terms.
The Acquired Companies recorded an additional deferred gain of $10,634 net of
offsets to reduce deferred policy acquisition costs and present value of
insurance in force relating to the Medicare supplement business of $730 and
$2,828, respectively. For the years ended December 31, 1998 and 1997 and the
period from July 1, 1996 to December 31, 1996, $9,631, $14,221 and $6,445,
respectively, of the deferred gain has been recognized and is included in other
income. The Acquired Companies are not subject to any negative experience
adjustments if the ceded business is unprofitable; however, the Acquired
Companies may participate in a portion of future earnings from the ceded
business after Cologne recovers its initial ceding commission plus interest at a
specified rate. The Acquired Companies retained administration for the ceded
block of business and are reimbursed by Cologne for administrative costs at the
rate of 8.5% of ceded renewal premiums and 11.5% of ceded first year premiums.
Peninsular has entered into three reinsurance agreements with an affiliate,
Occidental. The three agreements consist of a "Coinsurance of Individual and
Group Annuities" effective December 31, 1986, an "Indemnity Reinsurance"
effective July 1, 1991 and a "Coinsurance of Individual Universal Life
Insurance" effective October 1, 1992 whereby Peninsular is assuming the business
from Occidental.
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The effect of this reinsurance on revenues earned and the related benefits
incurred is as follows:
YEARS ENDED DECEMBER 31,
---------------------------
1998 1997 1996
------ ------ -------
Revenues assumed...................................... $3,845 $4,848 $20,788
Policy benefits and expenses assumed.................. $5,797 $6,403 $24,661
Pursuant to the terms of the agreements, assets with a market value equal
to the statutory liabilities ceded were transferred to Peninsular on the
effective dates of the respective treaties.
GAAP reserves for the business assumed from Occidental were $47,367 and
$51,197 as of December 31, 1998 and 1997, respectively.
Effective January 1, 1996, Union Bankers and Constitution ceded on a
coinsurance basis substantially all of their inforce annuity business to
Southwestern Life. Pursuant to the terms of the agreement, assets, with a market
value equal to the statutory reserves held by Union Bankers and Constitution
were transferred to Southwestern Life. Statutory and GAAP reserves at the date
of transfer were $34,827 and $37,291, respectively. This resulted in a deemed
capital contribution to Constitution of $2,465. These agreements were terminated
on September 30, 1998. Pursuant to the terms of the recapture provision, assets,
with a market value equal to the statutory reserves for the recaptured policies,
were transferred to Union Bankers and Constitution. Statutory and GAAP reserves
at the date of recapture were $27,337 and $28,414, respectively. This resulted
in a deemed dividend from Constitution of $1,077.
Effective December 31, 1997, Marquette assumed on a coinsurance basis a
specified block of flexible premium deferred annuity policies from Southwestern
Life. Marquette received assets equal to the statutory reserves with respect to
the assumed policies. At December 31, 1997, the statutory and GAAP reserves for
these policies were $67,630. This agreement was terminated on September 30,
1998. Assets with a market value equal to the statutory reserves on the
termination date were transferred back to Southwestern Life. Statutory and GAAP
reserves on the termination date were $27,716. The gain recognized on the assets
transferred of $239 was reported as a deemed capital contribution.
(12) RETIREMENT AND PROFIT SHARING PLAN
On October 1, 1990, PennCorp established the PennCorp Financial, Inc.
Retirement and Savings Plan, a defined contribution plan, for eligible
employees. This plan and the Marketing One Incorporated 401(k) Profit Sharing
Plan merged with the Southwestern Financial Services Corporation Savings
Investment Plan on January 1, 1998 and the name of the plan was changed to the
PennCorp Financial Group, Inc. Retirement and Savings Plan. Employees are
eligible to participate in the plan after six months of employment in which they
are credited with 500 hours of service. Participants may contribute from 1 to
15% of pre-tax compensation and/or from 1 to 10% of after tax compensation. Each
employer participating in the plan matches each payday, 50% of pretax
contributions up to 6% of compensation. If approved by the Board of Directors,
each employer may make a discretionary profit sharing contribution annually on
behalf of employees eligible to participate in the plan based on their
compensation for the prior plan year. Employee contributions are fully vested at
all times. The employer matching contributions made for employees who
participated in the PennCorp Plan prior to January 1, 1998 vest at the rate of
50% per calendar year of service. The employer matching contributions made for
all other participants and the
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
employer discretionary contribution vests at the rate of 20% per year of
service. All participants are fully vested at death, disability or attainment of
age 65. The assets of each account are invested at the direction of the
participant. Eleven funds with various investment objectives are available to
the participants. Distributions are normally made in a lump sum. Participants of
the PennCorp plan prior to January 1, 1998 may elect to receive an annuity in
various forms of payment. Expenses related to this plan are charged to each
subsidiary or affiliate for its allocable share of such contributions based on
the percentage of payroll. The expenses allocated to the Acquired Companies
relating to this plan were $635, $530, and $534 for 1998, 1997, and 1996
respectively.
In addition, PennCorp has an established bonus plan for insurance
subsidiary officers. The amount available to pay awards for any year is
determined by a committee of senior executives of PennCorp and is subject to
approval of the Board of Directors of PennCorp. Awards are based on the
performance of PennCorp and the performance of eligible participants. The
Acquired Companies incurred bonuses of $749, $2,957 and $1,360 for the years
ended 1998, 1997, and 1996, respectively.
PennCorp and SWF also provide certain health care and life insurance
benefits for retired employees. The plans provide certain health care and life
insurance benefits for retired employees. Employees meeting certain age and
length of service requirements become eligible for these benefits. The
obligation for the accrued postretirement health and welfare benefits is
unfunded. Following is an analysis of the accumulated benefit obligation and the
liability for accrued postretirement benefits, for the Acquired Companies for
the years ended December 31, 1998 and 1997:
1998 1997
------- -------
Benefit obligation at beginning of year..................... $ 7,977 $ 8,469
Service cost................................................ -- --
Interest cost............................................... 286 344
Plan participants' contributions............................ 73 44
Actuarial loss (gain)....................................... 576 (397)
Forgiveness of allocated portion of liability............... (3,668) --
Benefit paid................................................ (527) (483)
------- -------
Benefit obligation at end of year......................... $ 4,717 $ 7,977
======= =======
The liability for accrued benefit obligation for the Acquired Companies
includes the following at December 31, 1998 and 1997:
1998 1997
------- -------
Accumulated benefit obligation.............................. $ 4,717 $ 7,977
Unrecognized transition obligation.......................... (3,015) (3,204)
Unrecognized actuarial (gain) loss.......................... (769) (589)
------- -------
Benefit obligation at end of year......................... $ 933 $ 4,184
======= =======
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Components of net periodic benefit cost for the Acquired Companies include
the following for the year ended December 31, 1998 and 1997:
1998 1997
---- ----
Interest cost............................................... $286 $344
Amortization of transition obligation....................... 189 226
---- ----
Benefit obligation at end of year......................... $475 $570
==== ====
Prior to 1998, the liabilities for the accrued postretirement benefit
included both the individual company specific liability and an allocated portion
of the service companies' liability. During 1998, SWF assumed the allocated
portion of the service companies' liability, amounting to $3,272, which
represents $3,668 of the accumulated benefit obligation, back from the Acquired
Companies. This was reflected as a deemed capital contribution.
For measurement purposes, annual rate increased ranging from 5.5% to 7.0%
in the health care cost trend rate were assumed for 1998; the rates were assumed
to decrease gradually to 4.0% by the year 2015 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. Weighted average discount rates ranging from 6.5% to
7.5% were used in determining the accumulated postretirement benefit obligation.
To illustrate, increasing the assumed health care cost trend rates by one
percentage point in each year would increase the accumulated postretirement
health care benefit obligation as of December 31, 1998 by $172 and the aggregate
of the service and interest components of net periodic postretirement health
care benefit cost for 1998 by $10.
(13) RELATED PARTY TRANSACTIONS
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Combined Financial Statements.
During 1995, two of PennCorp's officers and directors, Messrs. Stone and
Fickes, formed a fund, Knightsbridge, for the purpose of making equity and
equity linked investments in companies engaged primarily in the life insurance
industry. Knightsbridge has received subscriptions for approximately $92,000 in
limited partnership interests, including a $15,000 subscription from PennCorp.
The general partner of Knightsbridge is Knightsbridge Capital L.L.C.
("Knightsbridge Capital"), the members of which are David J. Stone and Steven W.
Fickes. Allan D. Greenberg, a member of the Company's Board of Directors,
formerly owned a 5% interest in Knightsbridge Capital which was purchased by
Messrs. Stone and Fickes. The general partner of Knightsbridge cannot be removed
by the limited partners, unless a court has finally determined that the general
partner has committed a willful and material breach of the limited partnership
agreement.
The Acquired Companies have management and services agreements with
entities affiliated with Knightsbridge, a shareholder and a director of
PennCorp. In connection with an Advisory and Management Services Agreement with
Knightsbridge Management, L.L.C., the Acquired Companies incurred fees of
$2,127, $2,600 and $4,782 for the years ended December 31, 1998, 1997 and 1996,
respectively. Each insurance company has an Investment Management Agreement with
Knightsbridge Consultants, L.L.C. For the years ended December 31, 1998, 1997,
and 1996 fees incurred totaled $1,048, $614, and $703, respectively.
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373
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
PLIC has an agreement with its affiliates with respect to the reimbursement
of direct and joint costs for services or material paid on behalf of the
Acquired Companies, in some cases, and other affiliates. Pursuant to this
agreement, PLIC received $30,725, $30,522, and $32,093 for 1998, 1997, and 1996,
respectively.
Pursuant to a service agreement, PennCorp Financial Services, Inc.,
provides data processing services for the Acquired Companies. The Acquired
Companies incurred expenses of $7,793, $9,523, and $8,392 for 1998, 1997, and
1996, respectively.
A corporation whose principal owners are shareholders, directors or
officers of PennCorp, provides actuarial and tax advisory services to the
Acquired Companies. Advisory fees of $222 and $210 were incurred in 1997 and
1996, respectively. No advisory fees were incurred in 1998.
Constitution, Union Bankers, and Marquette were parties to a management and
services agreement with Southwestern Financial Services Corporation ("SFSC"), a
subsidiary of SWF. SFSC provided substantially all administrative, management,
investment, personnel, data processing, facilities and certain other services
for SWF, its subsidiaries and affiliates and certain other unrelated parties.
Under the management and services agreement with SFSC, those companies paid fees
for personnel, data processing, and other services equal to the cost of such
services to SFSC. The amount of fees incurred in accordance with the agreement
was $13,044, $20,810 and $22,664, for the years ended December 31, 1998, 1997,
and 1996, respectively.
(14) OTHER COMMITMENTS AND CONTINGENCIES
Certain lawsuits have been brought against the Acquired Companies in the
normal course of the insurance business involving the settlement of various
matters and seeking compensatory and in some cases punitive damages. Management
believes that the ultimate settlement of all such litigations will not have a
materially adverse effect on the Acquired Companies combined financial position
or results of operations.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered through a reduction in future premium taxes. The insurance
subsidiaries paid assessments of $481, $787, and $541 for the years ended
December 31, 1998, 1997 and 1996, respectively.
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(15) FINANCIAL INSTRUMENTS
The following is a summary of the carrying value and fair value of the
Acquired Companies' financial instruments as of December 31, 1998 and 1997:
DECEMBER 31,
--------------------------------------------
1998 1997
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
VALUES VALUE VALUE VALUE
-------- -------- -------- --------
ASSETS:
Cash and short-term investments..... $107,547 $107,547 $ 63,186 $ 63,186
Fixed maturities.................... 558,020 558,020 521,844 521,844
Equity securities................... 6,792 6,792 7,564 7,564
Mortgage loans...................... 1,640 1,640 7,335 7,335
Policy loans........................ 22,463 22,463 23,731 23,731
Other investments................... 3,910 3,662 14,836 14,582
Agent and premium receivables....... 16,725 16,725 21,747 21,747
LIABILITIES:
Capital lease obligations........... $ 2,484 $ 2,484 $ 3,109 $ 3,109
Affiliated surplus notes............ 102,125 102,125 113,000 113,000
Universal life and investment
contract liabilities.............. 97,541 97,541 104,753 104,753
The following methods and assumptions were used by the Acquired Companies
in estimating their fair value disclosures for financial instruments:
Cash and Short-term Investments, Agent and Premium Receivables: The
carrying value of short-term investments and amounts receivable approximate
their fair value due to the short-term maturity of these instruments.
Fixed Maturities and Equities Available for Sale: Fair values for
fixed maturities available for sale are based on quoted market prices,
where available. For fixed maturities not actively traded, fair values are
estimated using values obtained from independent pricing services or are
estimated based on expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments.
The fair values for equity securities are based on quoted market prices.
Mortgage and Collateral Loans: The fair value for mortgage and
collateral loans are estimated using discounted cash flow analyses, based
on interest rates currently being offered for similar loans to borrowers
with similar credit ratings. Loans with similar characteristics are
aggregated for purposes of the calculation.
Other Investments: Other investments consist primarily of limited
partnerships and joint ventures. The fair values are estimated to
approximate carrying values. These are evaluated periodically.
Policy Loans: Policy loans are an integral part of life insurance
policies which the insurance companies have in force and, in the Acquired
Companies' opinion, cannot be valued separately. These loans typically
carry an interest rate that is tied to the crediting rate applied to the
related policy and contract reserves.
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Capitalized Lease Obligations: Fair values of the Acquired Companies'
capitalized lease obligations approximate carrying values.
Affiliated Surplus Notes: The carrying value of the affiliated
surplus notes approximates its fair value due to the variable rates of
interest based on underlying market indices.
Universal Life and Investment Contract Liabilities: The carrying
value and fair values for the insurance companies' liabilities under
universal life and investment-type insurance contracts are the same as the
interest rates credited to these products are periodically adjusted by the
Acquired Companies to reflect market conditions. The fair values of
liabilities under all insurance contracts are taken into consideration in
the overall management of investment maturities with amounts due under
insurance contracts.
(16) RESTRUCTURING CHARGES
As a result of the Acquired Companies initiative to transfer administration
of its comprehensive and Medicare supplement blocks of business to third party
administrators, the Acquired Companies recorded a pre-tax restructuring charge
of $1,834 during the first quarter of 1998. The restructuring charge was
reported as underwriting and other administrative expenses on the combined
statements of income and recognized primarily severance and related benefits
incurred due to the elimination of approximately 145 positions. Total payments
made under the restructuring plan through December 31, 1998 amounted to $1,214.
As a result of the voluntary termination of certain employees prior to meeting
eligibility criteria, the restructure charge was reduced by $397. The
restructure plan was substantially completed as of December 31, 1998.
(17) YEAR 2000 COMPLIANCE
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g., "98" represents 1998). It is
highly likely that such systems will not be able to accurately process data
containing date information for the year 2000 and beyond. The year 2000 issue
has the potential to affect the Acquired Companies through the disruption of the
processing of business both internally and between the Acquired Companies and
other businesses with which it interacts.
Although the Acquired Companies believe that their operating divisions,
outside vendors and most critical business partners will be sufficiently
compliant that the year 2000 issue should not cause a material disruption in the
Acquired Companies' business, there can be no assurance that there will not be
material disruptions to the Acquired Companies' business or an increase in the
cost of doing business. Although the Acquired Companies believe that the year
2000 issues should not cause a material disruption in business, they are
currently evaluating various contingency plans associated with remediation tasks
which management believes are at a higher risk for failure.
(18) SUBSEQUENT EVENT -- PENDING SALE OF THE CAREER SALES DIVISION
On December 31, 1998, PennCorp, the ultimate parent of the Acquired
Companies and several of PennCorp's subsidiaries entered into an acquisition
agreement to sell the Acquired Companies to Universal, in conjunction with
Capital Z Financial Services Fund II, L.P.'s ("Capital Z"), simultaneous equity
investment in Universal. The purchase price was originally $175,000, consisting
of $136,000 of cash and $39,000 original principal amount of Subordinated Notes.
Subsequent to the execution of the acquisition agreement on December 31, 1998,
the parties agreed to amend the
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CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
acquisition agreement to reflect, among other things, the addition of American
Exchange Life Insurance Company, a subsidiary of Universal, as a purchaser of
some of the Acquired Companies and a reduction in the purchase price to
$137,000, consisting of $130,500 in cash. In addition, immediately prior to the
closing an affiliate of PennCorp that is not being purchased by Universal or
American Exchange Life Insurance Company will receive $6,500 in the form of a
cash dividend payable by Union Bankers. PFG's board of directors and a majority
of the banks comprising the participating institutions in PennCorp's amended
Bank Credit Facility have approved the amendments to the acquisition agreement.
To finance the transaction, Universal will issue approximately $91,000 of
new equity in the form of common stock to Capital Z and some agents and members
of management of the Acquired Companies at a price of $3.15 per share. In
addition, Universal will pay a portion of a transaction fee in its common stock
to an affiliate of Capital Z.
Universal also intends to fund the transaction by borrowing $70,000, which
has been committed by a syndicate of lenders arranged by Chase Securities, Inc.
("CSI"). The lenders will make an additional $10,000 available to Universal on a
revolving credit basis.
The closing of the acquisition and the Capital Z issuance is subject to
certain closing conditions, including receipt of all required regulatory
approvals and the completion of actuarial reviews of the statutory reserves of
PLIC. The Capital Z issuance and the increase in the authorized shares of
Universal, which are conditions to closing the acquisition, require the approval
of Universal's shareholders.
The acquisition agreement contains other pre-closing restructuring
provisions, including the termination of the current reinsurance agreements
between Peninsular and Occidental, an affiliate, relating to the assumption by
Peninsular of Occidental's reserves and the establishment of a new reinsurance
agreement, whereby Peninsular will cede 100% of its existing direct business to
Occidental. These transactions will be settled at amounts equal to the statutory
reserves at the date the new agreements become effective. At December 31, 1998,
Peninsular's net GAAP reserves, including the amounts assumed from Occidental,
were approximately $60,400 and the related statutory reserves were approximately
$68,000. Accordingly, it is anticipated that Peninsular will recognize a pre-tax
loss of approximately $7,600, as a result of the above transactions.
E-96
377
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors of PennCorp Financial Group, Inc.
We have reviewed the accompanying combined balance sheet of Certain
Insurance Operations of PennCorp Financial Group, Inc., as described in Note 1
(the "Acquired Companies") as of March 31, 1999, and the related combined
statements of operations and comprehensive income (loss) for the three month
periods ended March 31, 1999 and 1998, and combined statements of cash flows for
the three month periods ended March 31, 1999 and 1998. These combined financial
statements are the responsibility of the Acquired Companies' management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We previously audited, in accordance with generally accepted auditing
standards, the combined balance sheet of the Acquired Companies as of December
31, 1998, and the related combined statements of operations and comprehensive
income (loss), shareholders' equity, and cash flows for the year then ended (not
presented herein); and in our report dated March 19, 1999, we expressed an
unqualified opinion on those combined financial statements.
KPMG LLP
Raleigh, North Carolina
May 26, 1999
E-97
378
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED BALANCE SHEETS
(IN THOUSANDS)
AS OF AS OF
MARCH 31, DECEMBER 31,
1999 1998
----------- ------------
(UNAUDITED)
ASSETS
Investments:
Fixed maturity securities available for sale, at fair
value (amortized cost $563,940 as of March 31, 1999 and
$538,743 in 1998)...................................... $ 575,322 558,020
Equity securities available for sale, at fair value (cost
$5,489 as of March 31, 1999 and $6,790 in 1998)........ 5,505 6,792
Mortgage loans on real estate............................. 1,563 1,640
Policy loans.............................................. 22,260 22,463
Short-term investments.................................... 54,586 87,633
Other investments -- affiliated........................... 5,987 5,906
Other investments -- unaffiliated......................... 3,927 3,910
---------- ---------
Total investments................................. 669,150 686,364
Cash........................................................ 15,720 19,914
Due from reinsurers......................................... 89,270 89,078
Due from affiliates......................................... -- 1,796
Accrued investment income................................... 9,114 8,920
Accounts and notes receivable, net of allowance of $3,686 as
of March 31, 1999 and $3,684 in 1998...................... 16,029 16,725
Income taxes receivable..................................... 410 --
Present value of insurance in force......................... 85,823 88,233
Deferred policy acquisition costs........................... 117,105 115,130
Other assets................................................ 20,739 20,919
Costs in excess of net assets acquired...................... 95,697 96,947
---------- ---------
Total assets...................................... $1,119,057 1,144,026
========== =========
LIABILITIES
Policy liabilities and accruals............................. $ 631,485 635,302
Income taxes, primarily deferred............................ -- 4,310
Capital lease obligation.................................... 2,322 2,484
Affiliated surplus note payable............................. 98,500 102,125
Due to affiliates........................................... 1,792 --
Deferred ceding allowance................................... 24,497 26,920
Accrued expenses and other liabilities...................... 24,081 36,004
---------- ---------
Total liabilities................................. 782,677 807,145
---------- ---------
Business equity................................... 336,380 336,881
---------- ---------
Total liabilities and business equity............. $1,119,057 1,144,026
========== =========
See accompanying notes to unaudited combined financial statements.
E-98
379
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF INCOME
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 1998
-------- -------
(UNAUDITED)
Revenues:
Premiums.................................................. $45,116 55,555
Interest sensitive policy product charges................. 604 638
Net investment income..................................... 11,868 12,332
Net gains (losses) from sale of investments............... 92 (606)
Other income.............................................. 3,371 3,193
------- ------
Total revenues.................................... 61,051 71,112
------- ------
Benefits and expenses:
Policyholder benefits incurred............................ 27,211 35,737
Change in liability for future policy benefits and other
policy benefits........................................ 5,733 3,274
Amortization of present value of insurance in force and
deferred policy acquisition costs...................... 9,279 10,481
Amortization of costs in excess of net assets acquired.... 1,383 1,394
Interest expense.......................................... 2,556 3,470
Underwriting and other administrative expenses............ 15,196 18,961
------- ------
Total benefits and expenses....................... 61,358 73,317
------- ------
Operating loss before income taxes.......................... (307) (2,205)
Income tax (benefit) expense................................ 360 (299)
------- ------
Net loss.................................................... $ (667) (1,906)
======= ======
See accompanying notes to unaudited combined financial statements.
E-99
380
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CHANGES IN BUSINESS EQUITY
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 1998
-------- -------
(UNAUDITED)
Balance at beginning of period.............................. $336,881 385,840
Net loss.................................................... (667) (1,906)
Capital contributions received.............................. 3,303 1,000
Deemed capital contribution in connection with dispositions
of:
Marketing One............................................. -- 10,270
Knightsbridge............................................. -- 4,748
Other..................................................... -- 59
Deemed dividend from reinsurance transactions with
affiliates................................................ -- (161)
Deemed capital contribution relating to acquisition of
Constitution, Union Bankers, and Marquette................ -- 830
Other comprehensive income (loss):
Change in net unrealized foreign currency translation..... 1,668 1,869
Change in net unrealized investment gains (losses)........ (4,805) 1,396
-------- -------
Balance at end of period.................................... $336,380 403,945
======== =======
See accompanying notes to unaudited combined financial statements.
E-100
381
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 1998
-------- -------
(UNAUDITED)
Net loss.................................................... $ (667) (1,906)
------- ------
Other comprehensive income:
Change in foreign currency translation adjustment, net of
taxes.................................................. 1,668 1,869
Change in unrealized holding gains on securities available
for sale, net of tax (benefit) of $(2,587) and $752.... (4,713) 790
Reclassification adjustments for (gains) losses included
in net income (92) 606
------- ------
Other comprehensive (loss) income........................... (3,137) 3,265
------- ------
Comprehensive (loss) income................................. $(3,804) 1,359
======= ======
See accompanying notes to unaudited combined financial statements.
E-101
382
CERTAIN INSURANCE OPERATIONS OF PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 1998
-------- -------
(UNAUDITED)
Cash flows from operating activities:
Net loss.................................................. $ (667) (1,906)
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Adjustments relating to universal life and investment
products:
Interest credited to account balances................. 446 1,346
Charges for mortality and administration.............. (604) (398)
Capitalization of deferred policy acquisition costs..... (7,887) (11,755)
Amortization of intangibles, depreciation and accretion,
net.................................................... 10,518 18,102
Change in due from reinsurers........................... (192) 6,220
Change in policy liabilities, accruals and other
policyholder funds..................................... (4,590) (7,816)
Change in other assets.................................. 180 (7,760)
Change in accrued expenses, and other liabilities and
due from affiliates.................................... (10,756) 57,599
Change in notes and accounts receivable and accrued
investment income...................................... 502 (3,194)
Change in taxes payable................................. (4,014) 3,029
Change in deferred income taxes payable................. 1,986 2,232
Net (gains) losses from sales of investments............ (92) 606
Other, net.............................................. (715) (240)
-------- -------
Net cash provided (used) by operating activities... (15,885) 56,065
-------- -------
Cash flows from investing activities:
Sales of fixed maturities available for sale.............. 10,507 3,854
Maturities and other redemptions of fixed maturities
available for sale...................................... 875 14,125
Sales of other investments................................ -- 49,517
Principal collected on mortgage loans..................... 5 2,690
Change in short-term investments, net..................... 33,046 (16,075)
Purchases of fixed maturities available for sale.......... (33,408) (93,022)
-------- -------
Net cash (used) provided by investing activities... 11,025 (38,911)
-------- -------
Cash flows from financing activities:
Receipts from interest sensitive products credited to
policyholders'
account balances........................................ $ 1,516 233
Return of policyholders' account balances on interest
sensitive products...................................... (366) (12,552)
Capital contributions received............................ 3,303 1,000
Principal paid on affiliated surplus notes................ (3,625) (3,625)
Other..................................................... (162) --
-------- -------
Net cash used by financing activities.............. 666 (14,944)
-------- -------
Increase (decrease) in cash................................. (4,194) 2,210
Cash at beginning of period................................. 19,914 14,819
-------- -------
Cash at end of period....................................... $ 15,720 17,029
======== =======
Supplemental disclosures:
Income taxes paid (received).............................. $ 2,233 (2,317)
Interest paid............................................. 3,453 2,678
Non-cash financing activities:
Deemed capital contribution of Constitution, Union
Bankers, and Marquette.................................. $ -- 830
See accompanying notes to unaudited combined financial statements.
E-102
383
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
Pursuant to a Purchase Agreement, Universal American Financial Corp.
("Universal") has committed, subject to the amendment of certain terms discussed
in Note 6, to acquire from PennCorp Financial Group, Inc. ("PennCorp") all of
the outstanding shares of certain insurance operations including: Pennsylvania
Life Insurance Company ("PLIC") including its wholly-owned subsidiaries,
Peninsular Life Insurance Company ("Peninsular") and Penncorp Life Insurance
Company ("Penncorp Life"), Constitution Life Insurance Company ("Constitution")
including its wholly-owned subsidiary, Union Bankers Insurance Company ("Union
Bankers"), Union Bankers' wholly-owned subsidiary, Marquette National Life
Insurance Company ("Marquette"), and PennCorp Financial, Inc. ("PCFI"). The
acquired operations are collectively referred to as the Acquired Companies.
The Acquired Companies operate under a single segment, the Career Sales
Division, to offer a broad range of accident and sickness, life and accumulation
insurance products to individuals through both a contractually exclusive sales
force and general agents.
The accompanying combined financial statements include the combined assets
and liabilities and the related combined operations of the Acquired Companies.
This presentation represents the group of related companies to be acquired by
Universal, and therefore excludes the assets, liabilities and business equity of
the subsidiaries of the Acquired Companies not being acquired. Accordingly, the
accompanying combined financial statements also exclude the results of
operations for those entities. The use of or source of funds resulting from
purchases and dispositions of subsidiaries not acquired have been reflected as
deemed dividends or deemed capital contributions to the extent they related to
the exchange of net tangible assets to subsidiaries of PennCorp. The financial
statements reflect all expenses incurred by the parent on behalf of the Acquired
Companies. It is management's belief that the methodology used to allocate the
parent expenses paid on behalf of the Acquired Companies reflects a reasonable
share of total expenses paid and represent what the shared expenses would have
been on a stand alone basis. All significant intercompany accounts and
transactions have been eliminated. The issuance of surplus debentures to other
PennCorp entities have been reflected as liabilities in these financial
statements. These financial statements have been presented at their historical
costs, in accordance with generally accepted accounting principles ("GAAP"). No
adjustments have been made to reflect any effects of the Universal purchase
discussed above. Accordingly, these financial statements are not necessarily
indicative of the financial position or the results of operations and cash flows
of the Acquired Companies which would have occurred or which will be obtained in
the future, had the effects of the proposed purchase been reflected. All dollar
amounts presented hereafter are presented in thousands, unless otherwise noted.
The financial statements are prepared in accordance with GAAP. These
principles are established primarily by the Financial Accounting Standards Board
("FASB") and the American Institute of Certified Public Accountants ("AICPA").
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities as well as revenues and expenses. Accounts that the
Acquired Companies deem to be acutely sensitive to changes in estimates include
deferred policy acquisition costs, policy liabilities and accruals, present
value of insurance in force and deferred taxes. In addition, the Acquired
Companies must determine requirements for disclosure of contingent assets and
liabilities as of the date of the financial statements based upon estimates. As
additional information becomes available, or actual amounts are determinable,
the recorded
E-103
384
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
estimates may be revised and reflected in operating results. Although some
variability is inherent in these estimates, management believes the amounts
provided are adequate. In all instances, actual results could differ from
estimates.
The financial statements should be read in conjunction with the Acquired
Companies' audited financial statements for the year ended December 31, 1998,
which included in the accompanying Universal Proxy Statement pursuant to Section
14(A) of the Securities Exchange Act of 1934.
(2) NEW ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED
In June 1998, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 133 defines derivative instruments and provides
comprehensive accounting and reporting standards for the recognition and
measurement of derivative and hedging activities (including certain instruments
embedded in other contracts). It requires derivatives to be recorded in the
balance sheet at fair value and establishes criteria for hedges of changes in
the fair value of assets, liabilities or firm commitments, hedges of variable
cash flows of forecasted transactions, and hedges of foreign currency exposures
of net investments in foreign operations. Changes in the fair value of
derivatives not meeting specific hedge accounting criteria would be recognized
in the Combined Statement of Operations. SFAS 133 is effective for all fiscal
quarters of all years beginning after June 15, 1999. The Acquired Companies are
evaluating SFAS No. 133 and have not determined its effect on the combined
financial statements.
(3) SIGNIFICANT TRANSACTIONS
On January 2, 1998, PennCorp consummated the acquisition from Knightsbridge
and Messrs. Fickes and Stone, of their respective holdings of common stock and
common stock warrants of Southwestern Financial Corporation ("SWF") for an
aggregate purchase price of $73,777 (not including acquisition expenses). The
fair value of the net assets acquired amounted to $46,350 resulting in $28,257
of costs in excess of the assets acquired which will be amortized over 30 years.
This acquisition of the remaining interest in SWF was accounted for as a step
purchase. As a result, approximately 22% of the assets and liabilities of the
acquired entities, including Union Bankers, were marked to the fair value at the
date of acquisition. The net effect of adjusting Union Bankers assets and
liabilities to fair value as of the acquisition date was an increase in the
business equity of Union Bankers of $830. The net assets of Southwestern Life
are excluded from all periods as they are not part of the companies being
acquired.
On August 9, 1995, PLIC purchased an 87.3% interest in the common stock of
Marketing One for $9,603. In addition to the common stock, PLIC purchased a bond
from Marketing One in the amount of $4,500. In 1996, the bond matured with
accrued interest of $35. In lieu of repayment of the bond, PLIC was issued
additional shares, increasing its ownership to 90.8%. On January 1, 1998, PLIC
sold its interest in Marketing One to a related party for $121 of cash and
$10,149 of fixed maturities, which approximated its carrying values. The
proceeds from the sale of Marketing One have been reflected as a deemed capital
contribution.
In March 1995, PLIC purchased an interest in Knightsbridge with an
underlying investment in SWF for $3,750. In January 1998, PLIC liquidated its
limited partnership investment in Knightsbridge related to SWF as part of the
purchase of the remaining interest in SWF by PennCorp. PLIC realized a gain on
this transaction totaling $4,748. This realized gain was reflected as a deemed
capital contribution to PLIC.
E-104
385
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Southwestern Life and Marketing One are not a part of the Acquired
Companies, accordingly, the assets, liabilities, business equity and results of
operations of each of these companies are not included in these combined
financial statements.
(4) FOREIGN INFORMATION AND BUSINESS SEGMENT INFORMATION
THREE MONTH PERIODS ENDED
MARCH 31,
-------------------------
1999 1998
----------- ----------
Total revenues:
U.S.............................................. $ 47,473 57,327
Canada........................................... 13,578 13,785
---------- ---------
$ 61,051 71,112
========== =========
Operating loss before income taxes:
U.S.............................................. $ (1,298) (5,287)
Canada........................................... 991 3,082
---------- ---------
$ (307) (2,205)
========== =========
Total assets:
U.S.............................................. $ 935,822 1,069,688
Canada........................................... 183,235 187,622
---------- ---------
$1,119,057 1,257,310
========== =========
(5) RESTRUCTURING CHARGES
As a result of the Acquired Companies initiative to transfer administration
of its comprehensive and Medicare supplement blocks of business to third party
administrators, the Acquired Companies recorded a pre-tax restructuring charge
of $1,834 during the first quarter of 1998. The restructuring charge was
reported as underwriting and other administrative expenses on the combined
statements of income and recognized primarily severance and related benefits
incurred due to the elimination of approximately 145 positions. Total payments
made under the restructuring plan through March 31, 1999 amounted to $1,364. As
a result of the voluntary termination of certain employees prior to meeting
eligibility criteria, the restructure charge was reduced by $396 during 1998.
However, during 1999, the estimate of remaining costs was revised and the
liability was increased by $44. The restructure plan was substantially completed
as of March 31, 1999.
(6) OTHER COMMITMENTS AND CONTINGENCIES
Certain lawsuits have been brought against the Acquired Companies in the
normal course of the insurance business involving the settlement of various
matters and seeking compensatory and in some cases punitive damages. Management
believes that the ultimate settlement of all such litigations will not have a
materially adverse effect on the Acquired Companies combined financial position
or results of operations.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that
E-105
386
CERTAIN INSURANCE OPERATIONS OF
PENNCORP FINANCIAL GROUP, INC.
TO BE ACQUIRED BY UNIVERSAL AMERICAN FINANCIAL CORP.
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
state is unable to meet its policyholder obligations. Assessments from guaranty
associations, which have not been material, are recorded in accordance with
Statement of Position 97-3 issued by the AICPA, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments."
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g. "98" represents 1998). It is highly
likely that such systems will not be able to accurately process data containing
date information for the year 2000 and beyond. The year 2000 issue has the
potential to affect the Acquired Companies through the disruption of the
processing of business both internally and between the Acquired Companies and
other businesses with which it interacts.
Although the Acquired Companies believe that their operating divisions,
outside vendors and most critical business partners will be sufficiently
compliant that the year 2000 issue should not cause a material disruption in the
Acquired Companies' business, there can be no assurance that there will not be
material disruptions to the Acquired Companies' business or an increase in the
cost of doing business. Although the Acquired Companies believe that the Year
2000 issues should not cause a material disruption in business, they are
currently evaluating various contingency plans associated with remediation tasks
which management believes are at a higher risk for failure.
PennCorp has recently held a series of discussions with representatives of
Universal regarding certain closing conditions outlined in the purchase and sale
agreement, specifically, the actuarial report regarding the adequacy of the
level of statutory reserves on PLIC. Universal has indicated that such findings
are not acceptable under the current contractual arrangements. PennCorp and
Universal are working towards an amendment to the existing purchase and sale
agreement which would require approval by both parties and a majority of the
banks comprising the participating institutions in PennCorp's amended Bank
Credit Facility.
E-106
387
UNIVERSAL AMERICAN FINANCIAL CORP.
PROXY
THIS PROXY IS SOLICITED BY
THE BOARD OF DIRECTORS OF UNIVERSAL AMERICAN FINANCIAL CORP.
FOR THE SPECIAL MEETING OF SHAREHOLDERS TO BE HELD ON , 1999
The undersigned hereby (i) acknowledge(s) receipt of the notice of special
meeting of shareholders and the proxy statement dated , 1999, relating
to the special meeting of shareholders of UNIVERSAL AMERICAN FINANCIAL CORP. to
be held , 1999 and (ii) appoints , as proxies, with full
power of substitution, and authorizes them, or either of them, to vote all
shares of capital stock of Universal American entitled to vote standing in the
name of the undersigned at said meeting or any adjournment or postponement
thereof upon the matters specified on the reverse side of this card and upon
such other matters as may be properly brought before the meeting, conferring
discretionary authority upon such proxies as to such other matters. THIS PROXY,
WHEN PROPERLY EXECUTED, WILL BE VOTED AS DIRECTED BY THE SHAREHOLDER. IF NO
DIRECTION IS MADE, A PROPERLY EXECUTED PROXY WILL BE TREATED AS A VOTE IN FAVOR
OF ALL OF THE PROPOSALS.
The proxies are authorized to vote upon such other business as may properly come
before the meeting as recommended by the board of directors.
SHAREHOLDERS WHO ATTEND THE MEETING MAY VOTE IN PERSON EVEN THOUGH THEY HAVE
PREVIOUSLY MAILED THIS PROXY CARD.
[X] PLEASE MARK YOUR VOTES AS IN THIS EXAMPLE.
PROPOSAL NO. 1 -- CAPITAL Z ISSUANCE
Approval of the issuance and sale to Capital Z Financial
Services Fund II, L.P. and, some agents and members of
management of the Penn Union Companies and some holders of
preemptive rights of up to 28,888,888 shares of common stock
of Universal American and the payment of a part of a
transaction fee to an affiliate of Capital Z in Universal
American common stock, which will result in a change of
control of Universal American. The number of shares issued
and purchased and the price paid for the shares may be AGAINST [ ABSTAIN [
adjusted under the share purchase agreement. FOR [ ] ] ]
(CONTINUED ON REVERSE SIDE)
388
PROPOSAL NO. 2 -- AMENDMENTS TO CERTIFICATE OF INCORPORATION
Approval to amend Universal American's certificate of incorporation to:
(a) Increase the number of authorized shares of common stock
from 20 million shares to 80 million shares. FOR [ ] AGAINST [ ] ABSTAIN [ ]
(b) Provide for shareholder action by written consent
instead of a meeting of shareholders. Written consent
would only need to be executed by shareholders holding
the number of shares required to approve the action
taken by written consent. FOR [ ] AGAINST [ ] ABSTAIN [ ]
(c) Eliminate the requirement that holders of 66 2/3% of the
Universal American's outstanding voting capital stock
approve amendments to certain provisions of the
certificate of incorporation, which means only majority
approval will be necessary for those amendments. FOR [ ] AGAINST [ ] ABSTAIN [ ]
(d) Remove the provision which requires the vote of holders
of 66 2/3% of the outstanding voting capital stock to
call a special meeting of the shareholders. The board
will amend the by-laws to allow special meetings of the
shareholders to be called at the request of 50% of the
outstanding voting capital stock. FOR [ ] AGAINST [ ] ABSTAIN [ ]
(e) Replace the present method of electing directors and the
length of the term each director serves with a system in
which all directors are elected at one time each for a
term expiring at the next annual meeting. Directors are
currently elected to three-year staggered terms. FOR [ ] AGAINST [ ] ABSTAIN [ ]
(f) Require 66 2/3% of Universal American's board of
directors approve certain important corporate actions. FOR [ ] AGAINST [ ] ABSTAIN [ ]
PROPOSAL NO. 3 -- AMENDMENTS TO THE 1998 INCENTIVE COMPENSATION PLAN
To amend Universal American's 1998 Incentive Compensation Plan to allow a
limited number of agents and members of management of the Penn Union Companies
and Universal American to be granted options to purchase shares of Universal
American common stock at the per share purchase price to be paid by Capital Z.
The per share purchase price may be below the fair market value of the common
stock at the time the options are granted.
Please check this box if you plan to attend the meeting. [ ]
Please mark, date, sign and mail this proxy card in the envelope provided. No
postage is required for domestic mailing.
Signature(s) Date
Note: Please sign exactly as name appears hereon. When shares are held by joint
tenants, both should sign. When signing as executor, administrator,
trustee or guardian, please give full title as such. If a corporation,
please sign in full corporate name by President or other authorized
officer. If a partnership, please sign in partnership name by authorized
person.